Morpho Midnight: The Future of Fixed-Rate Lending | Paul Frambot

TRANSCRIPT
David:
[0:02] Bankless Nation, we got Paul from Morpho back on the podcast talking about a

David:
[0:07] new thing out of the world of Morpho called Morpho Midnight. We're going to talk about it and everything else that's going on in the world of Morpho and Vaults broadly. Paul, welcome back onto the show.

Paul:
[0:14] Hey, thanks for having me again.

David:
[0:16] Paul, what is Morpho Midnight?

Paul:
[0:18] Yeah, Morpho Midnight is basically the next version of Morpho after Morpho Blue. So Morpho, we're infrastructure that allow people to earn interest on one end and get some financing on the other end. So we give you a stack that allows you to create some lending markets, right? In Morpho Blue, you could select one collateral, a loan asset, an oracle, and you had this like variable rate open term lending experience that was like pretty convenient and pretty passive to get into. And we've done this for the last two years, but what we realized as we were talking to more and more institutions is that one thing was lacking. It was control over the interest rate, Whether you're a consumer, you know, a retail user of a large app like, you know, Robinhood or Coinbase, you want predictability on your rate, like you want, you know, you want to know how much you're going to pay. But most importantly, if you're a large institution, you want control on the rate because you want to price the risk accurately, right?

Paul:
[1:20] It's actually not a thing in traditional finance to have your interest rates rely on like arbitrary formulas or arbitrary governance like it is the case in DeFi. And so basically the combination of those two feedbacks made it obvious that the future of DeFi financing had to move away from the so-called interest rate model that we have today that basically dictates what the rate is going to be, to a much more, you know, traditional way, which are zero coupon obligation. So long way of saying more for midnight is like a fixed rate, fixed term, lending and borrowing infrastructure that allows you to build lending and borrowing markets that have a term and has a fixed rate.

David:
[1:57] And to me, this seems like Morpho is building... Financial infrastructure that is very ubiquitous in TradFi. And in Morpho and also DeFi broadly, we kind of built the things that made sense for us to build in the first place, like Aave, Morpho, Morpho Blue, things that don't really mesh well with TradFi, but do mesh well for retail participants. The AMM, for example, is just a retail friendly phenomenon. And Morpho Blue is like the same thing. It's just like, oh, like retail actually doesn't really care about stable interest rates. They just, you know, they're okay to be exposed to the market of whatever the market wants to pay them in that moment. And it can flex up, it can flex down. And that's just like not true for institutions. And so based off of your customer feedback from talking to institutions, I'm like, I'm sure they were like, we are looking for the form factor that we are familiar with, please build it. And that's what Morpho Blue is.

Paul:
[3:00] Yes, I think pretty much. I like the way you explain that is in the early days of DeFi, basically you had multiple constraints. Gas was high. And also the set of users that was interacting with the chains was basically users with their Metamask wallet that had a little bit of money. And they were in no way financial experts, right? So basically the protocols initially had to internalize a lot of the complexity in order to provide a passive experience to users and they could not rely on any other intermediaries to do that.

Paul:
[3:32] So this is why the early versions of Uniswap, for example, is passive both on the LP side and on the trader side, right? You can do passive LPs on Uniswap B2 and passive trading. This is why compounds or Aave manage the risk for you. They manage the rate for you. They manage everything for you, right? But as the ecosystem grows and like the complexity of the players, you know, they're more and more complex and understand they want more control, right? And so as a DeFi protocol, you have an interest in modularizing some parts of your code and of the responsibilities that you have and leave it to the market because the market will price it better and it will scale much more because it'll be able to discover much more use cases. So what does that mean in practice? In the case of Uniswap, they turn Uniswap V2 into Uniswap V3 that externalize the LP, like some of the LP management a little bit more.

Paul:
[4:26] And so it's not easy to passively LP on Uniswap V3. It's still easy to take. But in Uniswap before, it's actually hard to take and it's actually hard to LP directly at the smart contract level. Because like DeFi is like in layers now. You have a wide set of, you know, you have those MEV bots or like market makers that are going to run the different auctions in Uniswap X, whatever. That basically overall provides the market efficiency that is closer to a TradFi infrastructure. And lending followed the same thing, which is it started with the very passive thing that manage both the risk and the rate for you. And then Morpho Blue, we came in, like Morpho Blue is harder to use than it is to use Aave, right? Because you have to choose beyond like this, like, you know, 2000 markets, 1000 volts, like, you know, It's hard. And so you rely on those curators to basically simplify the experience. So you have one extra layer. And Midnight goes one step further in that direction and says, hey, you know what? The protocol should not manage the risk, but it should also not manage the rate. And the ecosystem participants should do it. Anyway, long way of saying that DeFi is layering, and that's a good thing, in my opinion, is just going to provide us much more flexibility and much more market efficiency. And it will give the serious institution the control de mort.

David:
[5:40] The thing that I want to know is that when... When we discovered crypto or discovered DeFi, there are some DeFi primitives that just felt really elegant because it gave some numbers and some parameters and it gave it up to the market, right? And so we learned that EtherDelta, the first order book exchange on Ethereum, is like not the way that we're going to build that. And what came after EtherDelta? Uniswap. And Uniswap created X times Y equals K.

David:
[6:10] And it worked well with blockchains. It resonated with the construction of blockchains. And the inputs and the outputs were all determined by the market. And it felt very elegant and it felt very DeFi native. It was intuitive to financial first timers like myself who learned finance through crypto. And it all worked. And that was like the early era of 2021 DeFi and beyond.

David:
[6:34] And now we have things like Morpho Midnight coming online. And what are the four ingredients of a Morpho Midnight loan? You have the loan token, the collateral asset, a maturity date, and then permissions for any sort of permissioning system that a vault manager would want to create. And this is all, it doesn't feel DeFi resonant. It feels very much like TradFi asking for product features and then Morpho Midnight building them. But that's my bias as an individual DeFi on-chain enthusiast. And I want to know, the question I have is like, is fixed term, fixed rate lending, borrowing and lending, is that also a logical conclusion for finance? Or is that just kind of how finance, we built finance top down? Do you get what I'm saying?

Paul:
[7:25] Oh yeah, it's a great question. I love that question because I have a strong perspective on this. So first I would... So the answer is, I think, yes. I think fixed rate, fixed term is the right primitive for financing.

David:
[7:38] It is a true primitive.

Paul:
[7:40] It is the true and it's the only true primitive. And it's a deep, deep conviction that I have. Because if you have variable rate, what does it vary on? What is the function? And the function, the answer to that is that it's arbitrary. You rely on something to say what is the rate, which makes it not a primitive. A primitive does not rely on anything for its existence, right? Whereas a fixed rate, fixed rate market, the primitive is a zero coupon obligation, which is an extremely simple construct, much simpler than the mess that a lending pool is because a lending pool is a mess, right? It's a very simple construct, which you could describe in even simpler parameters than, XY equal K. It's basically the idea that you have this object that you can trade that at the maturity will be valued at one and the interest rate is determined by the discount that you have compared to one. And so this object is extremely simple. And I think, you know, I like to believe this is the right primitive because it does not depend on anything. And the reason we could not get there in the first place is that we needed to manage the rate, for people, which once you have this layer of curators that are able to handle the complexity on behalf of simpler users, then it does not make sense anymore to internalize this by the protocol.

David:
[9:01] Maybe if I'm hearing your answer correctly, you know, aside from all the other reasons why it failed, one reason why EtherDelta failed was because there just weren't enough people trading on it. It was dogshit UX in addition to that. And maybe the best thing, the best mechanism in that moment of time was actually Uniswap, X times Y equals K, because that matched the amount of participants that we had on chain in that moment.

David:
[9:26] And there was a, Dharma was a startup that I remember back in 2017, and it was actually doing Morpho Midnight. It was doing fixed term, fixed rate loans, peer-to-peer style loans, no central contract, unlike Aave, unlike Morpho.

Paul:
[9:43] Yeah, and even Aave had Eastland before, which looked like Dharma to some extent.

David:
[9:47] And so we've actually tried this before, but it never worked back then. And I think your answer is, well, we had not nearly enough market participants in the level of sophistication and liquidity in order to bootstrap that whole thing.

Paul:
[9:59] I think that's mostly right. I think there's a few reasons, three reasons. I think the design, so, okay, first thing is like gas. At the time would not allow you to, you know, do crazy stuff, right? The second is the most important, which is the liquidity. And by liquidity, I mean the collection of participants that all together make markets active and easy to enter and leave without moving the price too much. You did not have that at all back then, right? And so, of course, like a product like Compound, when it came out that, you know, provides you that simple user experience was a much broader product market fit because the market at the time was like basically us with our Metamask wallet, right? And we knew nothing about it. Now, our users, like, you know, Apollo is like the largest private credit fund in the world. They're, you know, investing in Morpho. Those guys are the most complex portfolio manager in the entire world. Like, they don't need someone to tell them, hey, my, you know, DAO is going to set the rate for you. They hate that, right? And, you know, I've pitched to like all the largest traditional financial institutions in the world. And like, pretty much half of them are like, Like this interest rate model thing is the most stupid thing we've ever seen. Which, why?

David:
[11:12] Why do they think it's stupid?

Paul:
[11:14] Because they don't, like, from their perspective as portfolio managers, they want to control their, like for a given risk, they want to be able to control their rate and their terms. And the DeFi construct does not let you, does not make you owner of your terms. You basically, the terms that you have are dictated either by a formula in the case of Morpho Blue or a governance in the case of Aave. And basically to their eyes, it's a retail product. It's basically like Aave is the asset manager and you deposit money into it and they choose the risk profile for you, right? And so basically they don't, and from their perspective, they're the good asset managers. They don't want to rely on anybody doing that for them, right? Which by the way, is different than trading. I think DeFi trading and DeFi lending has a very different trajectory. And I think Unisop has been able to get to much cleaner primitive sooner because it's lower dimension. Like lending involves risk and risk is multidimensional, which, you know, requires some management and everything if you want to handle it properly.

Paul:
[12:17] But yeah, and I think the third reason is that, frankly, when you look at Eastland and Dharma, it's like the designs have a lot of problems, right? In general, you know, you mentioned the UX of East Delta and everything. It's just like there's a lot of thought that goes into midnight that, for example, you know, you don't have liquidity fragmentation in midnight. Like you can like post one liquidity across 10,000 markets that are isolated and your liquidity will be available to borrow in all of those markets at the same time. Those are like key features that are truly zero to once in terms of like liquidity,

Paul:
[12:54] et cetera, that, you know, yeah, basically would make that work.

David:
[12:58] Can we go through the actual just construction of a Morpho midnight market? You talked about it a little bit and I kind of gave the four ingredients, but I want to hear it from you. Maybe you can explain from bottom up, like the building blocks that go into a Morpho Midnight market. And then once we have that market and we have many markets, how do those kind of compose together too? But let's start from the bottom and we can go higher.

Paul:
[13:18] Sure. Let's construct the whole thing. So the cooperative is actually not so different from Morpho Blue. You have collateral assets, you have a loan asset, you have an oracle to price those collaterals and those loan assets. And instead of having an interest rate model, instead you have a term.

David:
[13:37] And an interest rate model is the utilization curve, right? That's the same thing, right? And that's the thing that the institutions are like, I don't want somebody else to tell me what that curve is. I want to set that for myself.

Paul:
[13:48] Yes, exactly. Exactly. It's basically in Morpho Blue, the market had a formula that dictates the race based on the amount of liquidity, like supply and demand that was in the market. In the case of Morpho Midnight, we externalize that and we say, hey, you know what? The market is going to price the interest rate. The market is going to set what it is. And that's true in our perspective. That's true technology. We as Morpho are computer scientists. We're not finance people. We want every financial component to be removed from the infrastructure. And that's what Midnight truly achieved in a way that we will never be able to do it. So anyway, basically, a Morpho Midnight market should think of as a zero coupon bond that can be traded in order or like a zero coupon like obligations. It's not exactly a bond, but an obligation that can be traded. And the price of that obligation until the term dictates the amount of interest rate that you will have.

Paul:
[14:46] Just like a traditional zero coupon obligation, basically. So that's the core privilege. Now, in order to access those obligations, it's a bit like Morpho Blue. Morpho Blue, you have thousands of markets. Morpho Midnight, you have thousands of obligations. So you probably want to make sure like to route through all those like different markets, you probably want to use a vault, right? And this vault is basically going to be in charge of allocating across the different markets that it's interested in. When you're a vault and you deposit into Morpho Blue, you just have to select the risk, right? Like the risk parameters. But you don't really choose the rate at which you invest, right? Whereas in Midnight, you can say, hey, here's the risk I'm willing to take. Like I'm willing to lend to a Bitcoin-backed loan market. And this time you can say, hey, I'm willing to lend at like 5% and not below 5%, right? And not only you can do that, but you can also manage the liquidity. So you can manage the rate, but also the liquidity. And you can say, hey, you know what? Happy, I don't care if I have my money right now. I can lock it for six months, in which case I can achieve higher capital utilization. Or you want to say, hey, I really want a lot of liquidity, in which case you can also do that. So to the eyes of the user, the vault looks like Morphu Blue Vault.

Paul:
[16:09] But behind the scenes, the curator, when you use Morpho Bidnight behind the scenes, they're going to basically buy those obligations. And you should think of the vault as like aggregating those different obligations.

David:
[16:20] Right. Aggregating the different obligations, but still below the hood are the two market participants that are new. So this is a new behavior from both the borrower and the lender because the borrower is borrowing for a fixed term. The lender is lending for a fixed term. And so that part of the whole supply chain needs to get bootstrapped by the whole midnight product arm, right?

Paul:
[16:43] Yes. It has to be bootstrapped by the Midnight product arm, but from a user perspective, you probably still want to be passive, like the users in the Coinbase app and the Robinhood app, they still want to be passive to some extent. So this is why votes are still important, and they will basically roll the different obligations on your behalf, et cetera. And it's actually part of the bootstrapping.

David:
[17:05] So it's like we have like Dex aggregators, and this is a little bit like Morpho, Midnight, like I don't know what you call these things that the individual market for a Morpho Midnight market.

Paul:
[17:15] Oh obligations?

David:
[17:16] Obligations. These are aggregated and so like if I'm a if I'm a depositor looking for yield and I want like you know I just want to get utilization on my USDC then Morpho Blue will allocate across Morpho Midnight according to like my intent if you will.

Paul:
[17:31] Yes. I think that's right but as a user of the vault you would never see any of that like you know the trader is going to But it gets.

David:
[17:38] That's helping you bootstrap liquidity on the midnight side because like there is USDC

Paul:
[17:42] Or whatever.

David:
[17:43] Available to immediately come and fill in

Paul:
[17:45] Borrowing requests. Yes, exactly. And this is the sort of like, you know, part of the strategy, a strategy of the launch, of midnight is that midnight has billions of dollars already accessible if we turn on the switch of like vaults being able to allocate. It's a parameter in the code of MorphoVaults is that we can basically say now all the MorphoVaults that have all those billions of dollars of liquidity they can allocate into midnight. We are conscious this is, you know, a big decision. Like there's a lot of liquidity involved. So we really want to take our time. We want the launch of Morpho Midnight to be as slow as possible. We want ecosystem participants, market makers, lenders, bars to get familiars with the code integrate into their API. We want to take our time. DeFi has been rough, like for the last, you know, six months. And then once we show confident about the state of the markets, you know, we can vote for basically the vaults to allocate into midnight.

Paul:
[18:42] And that will bring like, you know, nine figure scale, 10 figure scale pretty easily.

David:
[18:47] I suppose building the mechanism, the primitive of a fixed rate, fixed term loans, that's one thing. And it's nice to have that on chain as a feature. But the uniquely DeFi thing is the fact that there's also Morpho Blue right next door that you're able to flip the switch. And then these things, you know, one plus one equals three. And there's some synergies here. I guess that part is uniquely enabled by DeFi.

Paul:
[19:13] Definitely. I think there's a million things that are uniquely enabled by DeFi. I think the first thing is, you know, I like to sum up all the advantage of crypto by one word, which is openness. Because the system, the infrastructure is open, basically have two concrete benefits. The first one is you have better pricing because of very open and fierce competition, right? When you think about it, like.

Paul:
[19:39] When Coinbase users are coming to Morpho and Chain to borrow, they have tens of thousands of lenders that are competing to give their users the best rate possible. And because the infra is open, it's like completely global, right? And so as a result, the DeFi borrow product of Coinbase delivers much better rates than what you would get if you were to use a centralized desk for the same financing opportunity. And that's like the key killer use case is that the spread between the lending rate and the borrowing rate is going to be crushed in a crypto environment because everything is so open. So that's the first benefit of openness. And the second benefit is obviously accessibility. Like the code is open source. Everything is readable. So it's much easier to integrate. Like we integrate in pretty much every single fintech in this world, right? And it's like the same pieces of code that are being reused times and times over again. So it's like the compounding effects of open source, of open infrastructure are extremely strong. They're extremely hard to activate. You know, as we know, this industry is like, there's like a lot of inertia to activate. But I can tell you, like, as we think about adoption and liquidity and the torque

Paul:
[20:45] effects, it's just this thing is incredibly snowballing.

David:
[20:48] Let's talk about the secondary market activity that happens after a midnight, sorry, what did you call it again?

Paul:
[20:54] The obligation, we can say market.

David:
[20:56] Obligation, market. Yeah, the obligation. but I want to know like why you call it the obligation because you're talking about when a midnight morpho midnight market is created we've created an obligation and that's a token right and that's a zero coupon bond equivalent

Paul:
[21:10] Yeah exactly so it's a zero coupon obligation that basically you should think of like uh, an object that that is traded and so the market trades the object which is the obligation that's like terminology but whatever.

David:
[21:24] Right and so like the idea like maybe correct me if i get these details wrong but the idea is that if you are offering five percent yearly on a one year alone then this obligation is issued and it's worth 95 cents exactly but then it will it will settle, it will resolve in one year at $1 and then this thing can be traded between market participants on elsewhere or elsewhere from Morpho and it can be traded and that kind of creates a market, a marketplace. How do you see that side of the market? And to be clear,

Paul:
[21:57] The market happens on Morpho so you can't like, I mean you could trade it elsewhere if you wanted to but there's really no reason to because all the liquidity will be aggregated at the Morpho market level.

David:
[22:08] So you set that on Morpho. How will that market emerge? Will that be like an order book?

Paul:
[22:13] Yes, it is like an order book. It is like an order book. It is like an order book where basically, you know, curators can come in and make offers. So in Morpho Midnight, you can make, make bar offers, take bar offers, make land offers, and take land offers. You have really four types of orders. So as a land maker, you can offer your liquidity to bars at a given rate. And so when it gets taken by a bar, you basically are, entering the loan, and now the two participants can decide to exit if they want to, in which case they can take existing offers or they can make offers themselves to exit, right? But it's important that the primary and the secondary markets are in the same construct, right? Like the protocol makes almost no difference between the two, which means that, you know, if for example, you are, there is like this end of year maturity that is happening, that you're in, well, maybe, you know, if you want to live one month before the end of the year, maybe you'll be able to match with someone that is here just because they wanted a one month maturity loan, right? And those are like the same markets, basically.

David:
[23:27] And so the reason why I have some sort of like retail oriented aversion to fixed rate, fixed term marketplaces is because an individual like contract or agreement or like market obligation is not the market. And the reason why I call things like Uniswap's X times Y equals K or Aave's model is because there it is the market. It's just like aggregated a bunch of people. And so like when two parties come together and they agree on fixed rate, fixed term loans. I'm like, well, that's so top down. How do you know that's even what the market going rate is? But I think what happens here is that when a ton of these things are created, then in aggregate, the market emerges because there's so many individual building blocks producing it.

Paul:
[24:16] No, I actually think you have both of those effects in Midnight. So if I'm reading your question correctly, for a given obligation, you can have, It's an end-to-end relationship, just like on Unisop or on Aave. It's not like an OTC. You could do an OTC transaction if you wanted to through the midnet construct. But if you take the BTC, USDC market at the end of the year, it functions exactly the same as a Morpho Blue pool or an Aave pool, etc. It's like the given obligations are fungible the same way your A tokens are fungible, right? So it is a market for a given obligation. Now, on top of that, because you have so many obligations, you also have transversal network effects thanks to like multi-market offers, callbacks. We can talk about this. But yeah, does that make sense?

David:
[25:06] Yeah, I think so. The thing that I'm interested to see emerge is... Some sort of like interest rate curve on assets. Now, I think like the dominant asset inside of Morpho Midnight is going to be stable coins in dollars just because that's just the world that we live in. But there's going to be interest rates emerging on like non-crypto asset or non-stable coins like ETH and Bitcoin. And so maybe you can talk about that. You're smiling and you're nodding your head somewhat enthusiastically. So maybe talk about like how interest rates or like bond markets emerge for like things like Bitcoin and ETH.

Paul:
[25:42] Yeah, you know, the reason I'm laughing is because we released Midnight. And then literally 10 hours later, you had already like five or six threads on like the rate curve, even though, you know, the protocol was just launching, there was like 100K of liquidity or something. And people were already drawing the rate curves.

David:
[26:01] Doing TA on the rate curve.

Paul:
[26:03] And I was like, guys, it's still a very small market. Like, you know, anyone could manipulate that. But still, I think it's good, right? And I think it's true that you're going to have brand new data points that, you know, frankly, you don't have in DeFi or even in finance, you know, for some of this. Like as we tokenize assets, et cetera. So I'm very excited about this. I will say it's more like, I don't think it has so much business value for Morpho in the short term. So it's like, I need to like, it's a bit like a nerd, like interest for me. But yeah, I think, I think as the market participants get more complex, we will offer price discovery on a lot of different assets and their native interest rate, what I'm, most excited about is actually not the price discovery of the rate of the given stable coin, but more of the underlying trust assumption. What do I mean by this? Is that when you come to Morphe as a borrower, to borrow something, you have to prove yourself, right, to get the financing. So usually you come with a big stash of Bitcoin or a big stash of collateral. But Midnight lets you extend this to more than that if you want to. So there's a module in the protocol that lets you express why you should be trusted. So that could be collateral, but that could also be your identity or that could be your, you know, receivables, whatever. And then the curators will be able to see this and then price it.

Paul:
[27:25] And that equals to an article I wrote like a year ago approximately that's called The Price of Trust, which, you know, obviously I wrote in the context of Midnight. And basically, this is what I'm excited about is like more for Midnight as a machine to price trust assumptions and why you should be trustworthy or credit worthy in general. And anyway.

David:
[27:44] So as a borrower, I could I could give extra reasons as to why I am trustworthy. And some can be very like hard coded on chain crypto native like collateral. But it could also just be like, I have this business and we make this much money. And here are the documents to prove that. But it's up to you to believe that or not.

Paul:
[28:08] Exactly. Exactly. And this is the exciting part. You don't even need collateral at all. Like you could, I could come to the midnight market right now and say, Hey, you know, I'm Paul. I'm like the CEO of this thing. And I sign it, you know, I prove it in some capacity with a proving mechanism that has some trust factor. I'm requesting a hundred K. I'm sure people will lend to me. Right. They probably lend at a terrible rate, but then price it.

David:
[28:33] You'll have to, how, who would determine the rate? You would say like, Hey, lend me a hundred thousand.

Paul:
[28:39] Whoever is willing to take the risk. And here's the key thing. When you externalize risk and you externalize rate from, obviously like, you know, we've been, you know, you know this better than I do. Like it's been like six years since we talk about like under collateralized loans. And we've always been asking, how is my DeFi protocol going to underwrite under collateralized loans? Like the answer is it does not. Like a piece of code is not here to give credit to people. Like credit is complex. However, maybe the largest private credit funds in the world know how to underwrite those things, right? And they'll give it a price, right? And so the key things, the key elements that you need to have in place in order to unlock the next pockets of loans and under collateralized credit, et cetera, is actually like externalizing the rate and externalizing the risk such that the market can price any type of risk. And maybe what you prove about yourself is like a little bit like, you know, fancy or not that trustworthy, but then the market will price it and say, oh, actually your statement like about your company, I don't believe that. I don't think that's a good document. Right. So they'll press, but maybe it is. Right. And so they'll give you a rate according to that.

David:
[29:43] Right. Because like somebody come in, could come in and say, hey, we represent the. We are Apple. Here are our S1s. And then it could be fraud.

David:
[29:54] Of course. And it's not for Morpho Midnight to ascertain whether that's fraud or not. But all of that information is made on-chain? It's just like public attestations?

Paul:
[30:03] So this is a module. And by the way, I should say we're not focusing on that for now. We're focusing on something that's possible in the protocol. But for now, we're starting with the very borrowing. I mean, not borrowing, but like over-collateralized crypto loans, etc. But that's something...

David:
[30:16] The basics.

Paul:
[30:16] We'll be able to share more in time about is the protocol lets you express on-chain trust signals about yourself, right? Whatever that means. It could be an oracle. Like, we don't say how... It's a very general module. It's basically...

David:
[30:30] Yeah, it's just like a memo field. Is it just... Yeah, exactly.

Paul:
[30:33] Is it just a memo field? It's like an empty module. And you can basically say, hey, here is my whatever, ZK proof of whatever, like, you know, and that the curators will assess this and will price it, right? And I think, by the way, I think this is the answer to under-collateral zones. I think this.

David:
[30:48] Will construct- I see how that would work.

Paul:
[30:51] It is, right? That's exciting, right? Yeah, absolutely.

David:
[30:54] Yeah, because it's like, what you're also doing is like, if somebody like Apple, the company Apple, for example, wanted to get a line of credit, it's on them to provide enough material to create trust in the market. And so they need to get their lawyers to sign off on something. Like they need to make a public statement about this. yes, this is actually us. This is actually what we're committing to. And then the people probably supplying money to that market are like, well, if Apple doesn't follow through on that, I'm going to sue them. Because I'm going to take them to a court. But that's, again, outside of anything on-chain.

Paul:
[31:32] Exactly. The value of on-chain is the matching. It's the open matching with end lenders, with end borrowers, which achieves better price discovery and better efficiency, which lowers the cost of capital for an Apple or for whoever, frankly, right? It's not restricted to Apple. Like if you want to have a home mortgage, you could, you basically, Morpho lets you run global auctions on every single lender in when you get your home mortgage. Like you're going to, instead of doing like a, just going to your bank and obey to whatever interest rate they give you, you're going to run an auction on 10,000 different banks, right? Now in practice, we are going to help facilitate this. Like obviously we're not responsible for the enforcement of any of that, But we can come up with a language for people to express why they are trustworthy. And if we, you know, a good language, good abstraction will allow for good capital formation and facilitate. So that's our role, right, in all of this. I think overall, this is the solution to like extending beyond the set of overclass horizons that we have. Took us a lot of time to realize, I'm not going to lie, but I think this is really the key of this.

David:
[32:40] The other thing that is exciting about that is that if that works, that starts to get identity to emerge on chain because you're going to want addresses and their credit history and who they are and their like history of repayment. And all of a sudden, like identity emerges out of that.

Paul:
[32:56] 100%. I think Morpho Midnight is going to be the first PMF of the identity layer. The identity layer had a PMF problem because there was no business case. But now the business case is going to be very clear is that your cost of capital is going to be a few bips lower if you provide that identity primitive.

Paul:
[33:13] Hence, there's like a clear value that you can achieve by having your identity on chain.

David:
[33:17] What assets do you expect to do well in Morpho Midnight? Obviously, like stablecoins are just so prolific and I would expect stablecoin yield and stablecoin borrowing with basic collateral like Bitcoin and Ether, which is the status quo, to also continue. But will there be new types of assets that will hit resonance with Morpho Midnight?

Paul:
[33:35] Yes. And I think first I should mention, as you said, that stablecoins is the major focus for us, like in general. One interesting statistic is that 92% of Morpho is loans are stablecoins, whereas the average for lending protocols is like around 50% or 60%. So there's still a lot of like ETH leverage, lending, et cetera, et cetera. We're actually the largest USDC like DeFi protocol on EVM by quite far now. And because we focus so much on just like, because we think stablecoin markets are the one that will eventually grow the most. That being said, There's a lot of value. It's a smaller market, but there's a lot of value for allowing people to lend assets and to short assets, whether that is ETH, Bitcoin, tokenized stocks at some points, like SEC lending, for example, securities lending in general is a big, big use case in Trotify. And so eventually Morpho Midnight should allow for this with the right compliance guidelines. And so I'd say I am excited because I think it's going to be a huge use case eventually if you look at try to find numbers.

Paul:
[34:41] But I'm even more excited about stablecoin lending in general.

David:
[34:45] What new entities do you think will be able to come on-chain because of Morpho Midnight? Either any sort of partners that you have lined up to actually make markets happen on Morpho Midnight or just like, what's the next most proximate Wall Street institution who's like, oh, finally they figured the crypto bros and figured out fixed term, fixed rate interest. Now I can go play on-chain. Like, who do you think that is?

Paul:
[35:08] All the large ones that have a crypto arm, if they haven't touched Midnight already, they will in the next 24 months. And I'm not saying this just like, you know, like, we literally talked to all of them. We actually built POCs with a bunch of them and some of them, they're not at POC stage anymore. They're actually like launching entire businesses. So, which by the way, is like a true interesting moment for the institutional adoption of crypto is like moving out of POCs. But yeah, I think, you know, the order of things has always been like wallets first, then exchanges, then fintechs, then neobanks, then asset managers, and then the actual banks is the order of the adoption. And then for each of those buckets, you look at the most aggressive players, and they will move in first. And then they will force the bigger players that are usually the most conservative in the category to lean in eventually. And yeah.

David:
[36:03] How does this fit into the whole neobank, neobrokerage revolution that we're kind of watching on Ethereum? So like last year about this time, there was this whole movement and like attention on neobanks. Like, oh, with stable coins, with such a proliferate growth of stable coins and easy to build wallets these days, it's easy to make a neobank. And like EtherFi kind of led that. Now we're getting into like neo brokerages well now there's tokenized stocks on chain and now with tokenized stocks it's easy to make a neo brokerage, a brokerage without actually being a broker dealer. I kind of see Morpho Midnight and Morpho Blue generally saying like well don't you want margin? And if you have all of these assets on chain like can't Morpho the platform create margin accounts for all of these things?

Paul:
[36:45] Yeah 100% like you know Morpho is infrastructure for all those like players to connect to global networks to offer good Yelp products or other products. So it's like an absolutely essential piece. Like if you want to offer some form of financial app, you have loans, you have yield. Otherwise you're just not a good financial app, right? It's going to be hard to defend without that. And I will say though, I think it's an interesting revolution. I will say anybody that has distribution now will think about financializing their user base. I don't even know if financializing is a word, but basically I think, yeah, I'm French. Sometimes I use words I'm like not 100% sure, but I think anybody that has a surface of interaction with a large set of users, will end up with user accounts that are powered by self-custodial wallets like a dynamic a turnkey or a preview and.

Paul:
[37:44] From there they will be able to access global networks on chain which will allow like a Twitter or like you know frankly whatever app that has distribution to or let the users earn interest on their balances. Or like now you have Uber that has, you know, Uber Cash and they will let you earn interest through chains like on this or Airbnb or like whatever. So I think it's, you could see it both ways. It's like, oh, it's going to be great for neobanks, but also everybody's going to become a neobank, including those that are not professional neobanks and that have the edge of having distribution from their other adjacent activity, basically.

David:
[38:19] Yeah, you definitely saw that, this pattern that you're talking about kind of emerging like a decade ago with McDonald's and Starbucks, where like Starbucks, you were like, you can deposit. They had something like hundreds of millions of outstanding obligations to their own customers who had loaded up their like Starbucks wallet with like $50 and then Starbucks was like collecting all the yield on that. And so like we saw early tremors of that. I remember talking about that a lot in 2021. And now what you're saying is like, well, if anyone has any sort of distribution, you can turn it, you can turn your app into a Venmo with yield so easily.

Paul:
[38:53] Yes, I think that's right. I think that's incredibly easy now. And that also comes down to the point I was making about openness and accessibility. Is like literally ChatGPT can build a new bank like very easily thanks to basically like you know like DeFi where you can just like issue embed like a self custodial wallet, it's like so easy and I think we reached this inflection point not so long ago by the way I think it's like a three month thing where it became the easiest way to build like a financial app is on crypto rails like there's no it's easiest it's easier, I don't think we have the quality of the financial products yet except in some

Paul:
[39:31] areas like payments or or yield sometimes but but eventually we just get better and better.

David:
[39:37] Talk about capital efficiency because institutions are going to come on chain they're going to put their money on chain if and only if it is more capitally efficient for them to do so and that's kind of always been the long promise of crypto just your capital goes further in crypto how does morpho midnight fit into this equation

Paul:
[39:54] Yes. Capital efficiency ultimately is going to be everything. I think the cost of capital for loans being better on chain is going to be the largest, the biggest gravity pull for the next wave of adoption. And again, I'm super biased because I'm building a protocol, but I really think it is. I really think financing is the cornerstone of finance. And as the name hints at. And I really think, financing is also some of the markets today in Tratify that isn't uncompetitive, and that gives a huge net interest margin to the financial system, which we should account for like 200, 300 bips on the entire economy. And because on on-chain rails, everything is open, if you have an infrastructure that lets you set the price, then you have open competition. And if you have open competition, you compress the net interest margin, which is both the reason we're going to be hated and loved because that's going to create an immense amount of disruption. And by the way.

David:
[41:00] We've threatened a bunch of business models, but then we also save other people a bunch of money.

Paul:
[41:05] Exactly. And, you know, it's like the story of tech is like disrupting industries. Took us a lot of time to disrupt finance because it's like, it's a much slower industry for regulations reasons, for, so trust reasons, et cetera. But we're there now, and I can tell you those, Like those banks and asset managers, they take this problem seriously. Like they really understand that the way they were making money is going to disappear because of the openness of the chain. And basically you can take two postures, either you prevent this from happening or you fully lean in. And because if you're first, then you have the opportunity to disrupt yourself and disrupt others before they do. And as a reality of the game theory is that you should fully lean in because some others are already started to fully lean in. And, and, and yeah, you don't have the choice. And I think actually DeFi has much more leverage on TradFi now than people might think. It's like, this is not a choice thing for them. Like they have to, because some of their competitors are already leaning in.

David:
[42:03] Say someone took some schraddenfreude in watching banks get unbundled. I would expect that this would be a very big moment along that journey. Because like something that you said is like collapsing the net interest margin. Well, you're just talking about collapsing how banks make money. And putting it back at the margins. And so there's been a bunch of things that we've invented in crypto that have created this whole bankless movement, technologically speaking. One, bankless money, Bitcoin and ETH, stable coins, the money of actual real banks. And then this is just also just taking kind of the back end of banks and allowing it to get expressed on chain. And so in 2026, we finally have fixed rate fixed term loans that is kind of where banks get a lot of their yield and supply a lot of um i just need to make a lot of their a lot of their money and so i so would suppose if somebody had a podcast called bankless they would be thrilled about this

Paul:
[43:03] I did i actually did not make the connection.

David:
[43:06] About what i was doing

Paul:
[43:08] About like the the the sort of like what we're saying in and in the name of the podcast i think i think i think that's right i think, It's not just because fixed rate, fixed term is a big part of the banking industry that it's interesting. It's also because now it's market defined interest rate. This is more than being fixed rate, fixed term is because now it's a marketplace. This is how, this is the purest expression of we're going to have competitive cost of capital. This is it. We have an open market for trust. And by the way.

Paul:
[43:42] This is why I do Morpho in general is one way to think about this net interest margin is, so I like to think of borrowers as people that have ambitions to realize something in the world and they need capital to achieve it, right? And they need the lenders, which are the people, the believers, that the people that trust them to achieve stuff, right? And I think of this as a very noble activity. Finance does not look always the most noble activity. It looks like the only industry that moves value around without like creating value and yet takes a cut, right? It sounds very extractive, but when you paint the picture of like, okay, people have ambitions, they want to realize them, people believe in them, and so they transmit capital, it seems like a very important thing to do. Yet, the cost that is bared at the infrastructure level that connects the two layers is very high. And it's like the 300 bips that we've been talking about on the entire economy. I think of Morpho's mission is basically collapsing the cost of trust. Like, collapsing the cost at which humans have to believe in one another and trusting one another. And you achieve this by providing open rails in which people can compete to offer the best possible terms to their counterparts. And frankly, this is why I work in crypto and what I get excited about all of

Paul:
[45:01] those things is that the promise is, like, absolutely exhilarating in my perspective.

David:
[45:05] How much TVL do you think Morpho Midnight will have by the end of 2027?

Paul:
[45:10] Oh, by the end of 2027?

David:
[45:11] One and a half years.

Paul:
[45:12] So, okay.

Paul:
[45:14] I think everything is highly dependent on when we unlock the business cases for TratFi. Because, you know, if you look at the time today, like crypto back loans is like, what, a $60 billion market? It's great. I think Midnight is going to eventually eat a lot of that and will be the largely dominant player over, like, you know, anybody else, including Morpho Blue. But that's still in the order of magnitude of tens of billions, right? And that's probably going to take a few years to get there anyway. What I'm excited about is what are the new addressable markets that are going to be unlocked by midnight? What are those like? Because the order of magnitude can very quickly change, if you onboard new types of asset curators or asset managers in the network that basically handle trillions of dollars, right? So I'm not saying, obviously, midnight will be trillions of dollars by 2027. Those are timelines I don't fully control myself. But I think I think, I think, I hope it will be more than $10 billion that would be like, I hope it would have outgrown Morpho Blue. If that's not the case, I would be very disappointed, to be frank. And I would not be surprised if we've crossed like the $100 billion mark then. Because it, you know, frankly, like took two years to Morpho Blue to reach like $10 billion.

Paul:
[46:39] So I think that's not unreasonable to think in those orders of magnitude.

David:
[46:44] Yeah. Yeah, I did a podcast with the blockchain capital guys, and they said $2 trillion is like conservative by 2030.

Paul:
[46:54] For what? For what?

David:
[46:55] Excuse me, for stablecoins. For stablecoins. $2 trillion of stablecoins on chain by 2030. And I think that implies some sort of explosion in credit markets, credit borrowing and lending markets as well, because it's so fundamental and foundational to finance at large.

Paul:
[47:11] Yeah, I agree with that. And to be fair, I'm very bad at quantifying predictions. I've turned out to be pretty good in DeFi at defining like directions and, you know, at the high level. But quantifying how much and when is like, you know, depends a lot on, you know, maybe clarity not passing or clarity passing. It will influence a

Paul:
[47:28] lot or like things that are not in my control.

David:
[47:30] I want to get your take on Hester Persis' statements recently. She released some statements last week. I'd summarize them as like respectful to the sector, the vault sector, because it's grown pretty large while highlighting some key concerns that she has about the sector growing any larger. More specifically, she said that vaults may be investment companies or investment contracts. And she also said that lending strategies may create notes that are securities. What was your reaction when you read Hester Peirce's statements?

Paul:
[47:59] Yeah, so first I wasn't surprised. I actually, last week I spent the entire week in Washington meeting multiple times with the SEC, with the CFTC, with the different senators and staffers, et cetera. So we're in close contact with all of those regulators. I think generally... I'm thankful of the thoughtfulness that goes into, I don't know if you've read the full post, but it seems very reasonable to me. Like when you read it, you're like, hey, some of those vaults may be investment companies, right? And there's a bunch of vaults stack out there. There's a bunch of different types of vaults. And some of them are fully non-custodial, like fully immutable, where you can't change the risk parameters within the bounds of a time block. And some others are frankly just Fireblocks wallets, right? You just deposit into the Fireblocks wallet and then this Fireblock Wallet gets to manage everything. And there's a whole spectrum. And yes, I'm ready to believe that some of it is like investment companies, right? And some of it may not be, right? And so I think it's a very thoughtful statement to make. To her point, if it looks like something, then it probably is that something. And, you know, I encourage curators and, you know, just generally space actors to engage with the SEC. I think they've been very open, in my opinion, over the last, you know, months, as we know.

Paul:
[49:22] So, yeah. I think them acknowledging the spectrum of vaults was like the most important piece for me is that they truly understand that there is like a whole like spectrum of like non-custodiality control agency that a curator would have on the vault. And same for letting protocols. Like a lending protocol can have a lot of agency on how the risk parameters are set or no agency, like it's the case for Morpho.

David:
[49:45] Yeah, Shumishi said this line about vaults. This description is purposefully broad and generic. As with many new developments in crypto, this term does not have a specific widely understood definition. And only someone who's been paying attention to crypto for like five plus years would be able to like have that realization that sometimes we come up with words and the word itself is just like over purposefully broad and generic. For example the word token itself like some tokens are literally securities and others are just like a receipt token a utility yeah it just doesn't actually explain anything

Paul:
[50:18] Go for it sorry I was just gonna say frankly that's you know when I came up with the word curator yeah, I, that was also on purpose, right? I had no idea what this role was going to be about, right? Like, and is that, you know, closer to an asset manager? Well, not really, because it's non-custodial and they can't really manage assets. But at the same time, there are some parts of the activity that resembles that, but like, is that, you know, necessarily managerial activities, et cetera. And so I think, you know, the safe bet is like, it's a new thing, so you create a new word. And then eventually, you know, as we discuss with regulators and figure out, like, we draw the line on what should be, an investment contract in that case or not regulated under the SEC, then you can, maybe do a second iteration on the vocabulary you use in order to have maybe an extra objective, like a network token or a securities token in order to clarify verbiage.

David:
[51:11] Did you listen to my interview with Andrew Hong? I did not. A long ago? So you know Andrew and his company,

Paul:
[51:18] Heard? No, I'm not familiar.

David:
[51:22] He does AI-enabled inspect source of vaults. And so this vault deposits into that vault, which deposits into these vaults. And so he has a startup that shows you a sort of topology of all the intertwining permutations. The frankly scary level of intertwining-ness in a lot of the vaults. And so him and I were talking about just the vault industry and we were talking about the risks of said vaults. And we came down to the end of the podcast. And this was after he's like scaring me with all the different, you know, combinations of different vaults out there. And just like, if you think you are innocently supplying your USEC to get 6% in this vault, but then it explodes into 17 more vaults.

David:
[52:08] And like the problem statement that we kind of came up with is like no one in the vault space is taking a liability because Morpho doesn't want liability because you guys just want to be a neutral tech platform. And the curators don't want liability because no one wants liability. But like the conclusion that we came down to is like somebody in the vault vertical needs to take the liability and become registered and compliant with the three-letter agencies, four-letter agencies, so that they can, you know, I don't know what the correct term is. Maybe Heser had it in her paper, just like investment manager or whatever. But somebody needs to take on a regulated duty so that this thing can be a little bit more compliant and the risk is managed, but then these people are taking more upside, so this whole thing can grow 100 times bigger. That was kind of like my takeaway.

Paul:
[53:01] I think that's an interesting thought. I think there are basically three different actors. You have the distributor, the curator, and the infrastructure, right? And the vault infrastructure and the market infrastructure, as you separate those. You know, as Morpho, I think, we think of our responsibility as like, we want to provide code that is, you know, safe and, you know, audited and et cetera. And also we want to provide a controlled environment for the curator. Like for example, a Morpho Vault can't deposit into other vaults. A Morpho Vault can only deposit into Morpho markets And it guarantees the user and the responsibility that we have is that guarantees the user that Vault Curator can only add Morpho markets within the period of a time lock. And during that time lock, it's important to understand that users can withdraw. Whether the stable coins, if the vault is liquid, or the position in kind. No Morpho Vault Curator that has the correct parameters can.

Paul:
[54:01] Can steal your money without you having the right to withdraw, right? It's important to understand because like if I, you know, I give you an extreme example of like tomorrow, North Korea, like hacks a Morpho that has the proper configs like in place, where basically you're going to have a few days to exit the vault, right? Until the time lock goes down. And that's non-custodiality, right? So that's a guarantee and a responsibility that Morpho has as a technology platform, as the, yeah. Then you have the curator and you have the distributor. The distributor surely has a responsibility because they choose everything and they're only going to offer one option for the user and so they need to disclose as much as possible.

Paul:
[54:44] The risk to the user and I'm no one to say if they should take legal responsibility or not, etc. And then for the curator, I think similar except it highly depends on the vault stack. If you have full discretion on where the asset goes, then it's hard to think that if you're in control, then you're not liable, right? Like it's, at least in my perspective, right? But I think, you know, I take all of this with a grain of salt because there's a lot of nuances in every Vault stack, in every configuration, et cetera, that I'm not always aware of. That's at least my basic, like, mental model.

David:
[55:21] I think I'm aligned with that. I'm trying to get down to the bottom of this. And so I'm doing this episode with you about midnight, but then also I'm doing an episode with the upshift and the beta people and also with the Stakewise people because I want to kind of answer the question, who should have more legal liability in this vertical? Not that I think having legal liability is noble, although sometimes it is appropriate, but also that's how this thing gets bigger and safer at scale. And so like who should have reliability and how that looks? I'm sure, I mean, I'm sure Hester is on the case here. She is. Maybe I should just wait for her. But the curator feels the closest to having the most, because they're the ones like deciding how much risk and what that risk is. And they also need to have more upside too. They need to have a little bit more skin in the game. And so I want that to be a more loaded, encumbered job that has more upside. That's kind of like my first intuition, but I'm sure that there's plenty of cases where that doesn't quite make sense either.

Paul:
[56:19] Yeah, I think that's probably my intuition as well with the caveat that it's highly dependent on Vault product and the Vault infrastructure itself. Because you could imagine Vault infrastructure that are so non-custodial where like the reliance on the curator is purely operational and not managerial, and some other vaults where you expect them to manage. And if this is the expectation from the user, then maybe it should be, right, that way. So I think it's all about the implicit contract that you have with the end user and how their money is going to be protected and how much do they expect reliance on you to protect your money. I think it plays an important role here.

David:
[56:59] Cool. Paul, I'm excited to see Morpho Midnight grow. I'm sure you are very happy to get it out the door. Yes, I am. And then that one day will come where you flip on the switch and Morpho Blue and Morpho Midnight will be intertwined. And that will also be exciting. But for now, we will watch Morpho Midnight grow a little bit more organically. And we're excited to get more institutions on chain thanks to this primitive. So thanks for coming on the show and telling me about it.

Paul:
[57:23] Thanks, David.

David:
[57:24] Bangalistation, you guys know the deal. Crypto is risky, but not risky enough. You can lose what you put in, but the institutions are here. And so we're going even more westward. It's not for everyone, but we are glad you're with us on the bankless journey. Thanks a lot.