What you need to know 🐳

Aave and Morpho, two giants of decentralised lending, are often pitted against each other by their respective communities, but their aims and designs are quite distinct.

While Aave establishes itself as a turnkey solution for managing loans, akin to a decentralised bank, Morpho is positioned more as a flexible infrastructure designed to develop customised lending markets.

In this new season, we'll explore the differences, strengths and limitations of these two projects in depth.

Introduction

Aave has established itself as the leading decentralised lending protocol with more than $22 billion in deposits, five times more than the second-largest protocol in the sector, JustLend.

Aave was originally inspired by the Compound model: a lending and borrowing system built around a single pool that aggregates all user transactions. This model was subsequently adopted by almost all lending protocols. The huge liquidity that Aave has attracted has made it more attractive and driven a wedge between it and its competitors.

Morpho, launched in January 2024, is building an infrastructure on which to develop a free lending and borrowing marketplace on which other protocols or companies can coordinate, with the aim of offering greater flexibility and customisation.

While Aave and Morpho are often contrasted, it is important to bear in mind that they do not have the same objective. Aave is a turnkey solution that integrates its entire value chain, from infrastructure to application and risk management. Morpho, on the other hand, is primarily an infrastructure decoupled from risk management.

The two solutions have their respective strengths and weaknesses, which we propose to compare where possible.

Aave

Aave is a vast pool of liquidity that connects lenders and borrowers via its application. This pool encompasses a variety of assets, each with its own parameters, including:

• Deposit and borrowing limits
• The "loan-to-value" ratio (or Loan To Value), which determines the maximum amount that can be borrowed in relation to the value of the collateral deposited by the user
• The liquidation threshold, which defines the point at which a position can be liquidated - anyone can then liquidate this position and obtain a premium
• The interest rate model, which adjusts dynamically according to the use of each asset: the more liquidity is borrowed, the higher the interest rates

These parameters are designed to protect the capital of the protocol and its users, the major risk being the accumulation of bad debt.

Bad debt occurs when a borrower cannot repay their loan and the lender cannot recover the full amount owed, even after seizing the collateral.

This can occur when a borrowing position is not liquidated in time and the value of the collateral becomes less than the value of the loan. This can be the result of a lack of liquidity, high volatility or late price updates. Curve founder Michael Egorov, for example, has caused bad debt within several lending protocols because of his huge CRV collateralised loans.

Thus, an asset is considered safer if it benefits from high liquidity and low volatility. Aave must therefore be vigilant about the assets it supports and the management of their parameters to avoid systemic risks.

Aave's modular evolution

Aave has gradually evolved its modus operandi to accommodate the addition of new assets with various risk profiles and correlation levels.

Isolation mode allows new assets to be listed as isolated assets (for borrowing or use as collateral). There are many restrictions placed on users of this mode, including their borrowing capacity and the types of assets they can borrow.

This system allows Aave's governance to list riskier assets while protecting the protocol from systemic risk.

There is also E-mode (efficiency mode), which optimises capital efficiency by increasing borrowing capacity when assets borrowed and used as collateral have correlated prices, as is the case with stablecoins.

The creation of new, fully independent markets appears to be Aave's new expansion strategy. Each new market represents a pool isolated from the others, with different risk factors, optimised for specific use cases.

So, in July 2024, Aave launched a market built around wstETH, the liquid staking token issued by Lido. Then, in September 2024, another market was created around weETH, the liquid restaking token issued by Etherfi.

World Liberty Financial, the crypto project for which Donald Trump is ambassador, has also issued a proposal to launch its own market on Aave. This project would offer the Aave DAO 20% of the profits generated on this product and 7% of the total quantity of WLFI tokens.

Aave governance

The Aave DAO uses service providers specialising in risk analysis, such as ChaosLabs and Llamarisk. These entities can adjust certain limited parameters without necessarily waiting for a vote by the DAO.

However, any significant changes must be approved by a vote of the DAO, following a well-established verification process.

Despite its proven track record in risk management over the past four years, Aave's decentralised operation is causing friction. The gmBTC listing proposal is one example, where some users deplore the slowness of the process.

Also, Aave's governance is heavily influenced by Aave Chan Initiative (ACI), a delegation structure. In recent votes, its weight has been close to 40% - a proportion that may seem excessive. Nevertheless, AAVE token holders remain free to delegate their rights to the entity of their choice, especially as ACI only represents around 2.3% of AAVE tokens in circulation.

Aave's business model

Aave generates most of its revenue by collecting a small portion of the fees paid by borrowers of the protocol.

Aave also launched its own stablecoin in mid-2023: the GHO. The aim being to increase the protocol's revenue through borrowing fees and extend its influence in the DeFi.

Aave is thus acting with an ecosystem logic: Avara, formerly Aave Companies, is also responsible for developing the decentralised social network Lens and the wallet Family.

This ecosystem and diversification strategy is echoed by most of the DeFi giants (read our feature on the strategies of the DeFi GMs).

According to Token Terminal, Aave has generated a total of $58 million in revenue over the past 12 months.

The graph below reveals the cumulative revenue collected by Aave from which token issuance is subtracted. We can therefore see that the protocol is profitable and manages to generate profits without necessarily relying on liquidity mining.

Morpho

At the heart of Morpho is a simple, unchanging infrastructure that allows anyone to create their own custom loan market. Morpho provides the primitives needed to build lending and borrowing markets, without exercising control over the management of their risks.

This approach allows isolated loan markets to be created by specifying only the essential elements:

• a collateral asset
• a loan asset
• a liquidation ratio
• an interest rate model
• an oracle

The advantage of being able to create any isolated market without prior authorisation is that it offers great flexibility and accelerates innovation.

For example, it becomes possible to integrate assets deemed too risky for a global market such as Aave. Morpho thus makes it possible to use more exotic collateral or to create optimised markets for certain correlated assets.

The innovation also extends to oracles, as it is possible to use any oracle to create a market. Redstone and UMA, for example, have teamed up to enable Oracle Extractable Value (OEV) to be recovered during liquidations on certain Morpho markets.

Aave, meanwhile, relies solely on Chainlink and has refused to integrate UMA on its protocol. This conservative approach is understandable and necessary, given that Aave's structure makes it harder for it to take risks.

👉 Read our analysis of how oracles compare and work

Most users will not interact directly with these markets. That's why there is an opportunity to create a risk management layer on top of this immutable layer. Morpho has created its own with "Morpho Vaults".

Other players will be able to create their own overlays by adding, for example, regulatory specifics such as KYC.

Morpho Vaults

Morpho Vaults simplify the lender experience. Each vault accepts a specific asset, which is then lent on one or more Morpho markets. It is a tool that automates risk management and optimises returns for users.

Management of the operation of a Vault is divided between several groups:

1. The owner of the vault holds all the powers and can choose whether or not to integrate the following groups within his vault.
2. The curator selects the Morpho markets to which the vault can lend its assets and defines the allocation limits. These are generally entities with expertise in risk management, such as Gauntlet or Steakhouse Financial.
3. The allocator(s) dynamically adjusts the vault's allocation within the limits set by the curator. Their objective is to optimise returns according to the activity of the various markets.
4. The guardian has the power to revoke any changes to the Vault pending initiated by the other groups. Most often, the custodian is a DAO made up of the vault's depositors, allowing them to protect their interests.

Other protocols can also create these Morpho vaults. Decentralised stablecoin issuers, in particular, have an interest in this: they can access new distribution channels and benefit from the liquidity aggregation offered by Morpho. For example, Sky uses a Morpho vault as part of its integration with Ethena's USDe (more details here).

Morpho governance

Morpho governance is designed to be minimal, with most of the protocol's functionality immutable. Risk management is thus entirely entrusted to the entities managing the vaults, with a balance of power established between risk managers and liquidity holders.

The Morpho DAO can nevertheless add new liquidation ratio and interest rate curve options, which can then be used within the Morpho markets. It can also activate a levy on fees paid by borrowers for a given market, ranging from 0% to 25%. Currently, the DAO does not levy any fees, as its strategy is focused on maximising adoption of the protocol.

Morpho's objective is therefore to minimise its users' dependence on its DAO, as the DAO has only limited influence on the protocol.

Business model

As an almost immutable infrastructure, Morpho has little or no cost to keep running. However, Morpho's DAO does not currently generate any revenue, as the fee switch has not yet been activated.

The groups that create and manage the vaults are remunerated directly by taking a portion of the interest paid by borrowers.

In time, it is conceivable that companies will develop products similar to Aave, but based on the Morpho infrastructure. This is the path that Gauntlet, a former Aave provider, seems to be taking.

The Big Whale's opinion 🐳

One of the questions raised by this comparison is the importance that users place on DAOs and governance in general. DAOs often struggle to demonstrate active participation and real expertise in their protocol and sector. A DAO needs to prove its ability to add real value as a trusted intermediary.

Aave operates as a decentralised business: the DAO pays service providers to assist it, votes regularly on decisions and risk management, and should soon be redistributing part of its profits to its token holders.

Aave has built a brand image that inspires confidence in a large proportion of current DeFi users. This explains some of the conservative choices made by Aave, which, being responsible for all the risks of the protocol, must absolutely avoid any incident that could tarnish its reputation.

Aave has already succeeded in establishing itself and finding a market that allows it to generate profits. The DAO is looking to increase its revenues by opening up to new markets through the development of its ecosystem, particularly with its GHO stablecoin.

Aave's interface is currently more intuitive for the average user than Morpho's, where they have to choose a reliable curator to manage their risk.

Morpho is pursuing different objectives: its main goal is to become a credibly neutral lending infrastructure, on which corporates and DAOs can coordinate and collaborate to develop their own products with a user experience tailored to their respective users.

Morpho still needs to attract enough liquidity to achieve critical mass and convince the biggest financial players to build on its infrastructure rather than try to recreate it themselves.

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