Hi everyone, welcome to Unchained, your no hype resource for all things crypto. I'm your host, Laura Shin. Thanks for joining this live stream. Before we get started, a quick reminder, nothing you hear on Unchained as investment advice. This show is for informational and entertainment purposes only, and my guests and I may hold assets discussed in the show. For more disclosures, visit unchainedcrypto.com. Bitcoin changed how money works. Citraya changes how Bitcoin scales. With a trust-minimized BTC and a native stablecoin, CTUSD, Citreya enables Bitcoin capital markets with lending, privacy, Bitcoin yield, and more. Get started at citreya.xyz slash unchained. EtherFi is giving unchained listeners 15% cash back on food and ride apps. And that's on top of the 3% you get on everything else. Your bank is charging you to use your own money. I switched. Go to ether.fi slash unchained to claim your discount. Today's guest is Paul Frambeau, co-founder and CEO at Morpho. Welcome, Paul. Hey, thanks for having me. We've had quite a series of dramatic events over the last week and a half in DeFi since North Korea's Lazarus Group drained almost $300 million worth of RSE from KelpDAO's Layer Zero Bridge. It then used that RSE as collateral in Aave, leaving almost $200 million in bad debt. Meanwhile, Morpho had only about $1 million worth of ETH borrowed against the RSETH in two isolated markets. How did Morpho manage to fare nearly unscathed? Yeah, I guess, you know, the first thing to understand with Morpho and the main difference with other lending protocols out there, like Aave, is that Morpho does not manage assets or does not choose which collateral assets are being underwritten. Morpho provides a modular stack of isolated lending markets that anyone can deploy and build their own lending products in the form of vaults for people to earn yield on. So what that means is that in Morpho, you can have the safest as well as the riskiest products. But they are isolated to the extent that the vault curator is configuring them to be like that. So I'll give you an example, like the Coinbase USDC LAND product, which is powered by a Morpho vault, is actually only allocating into isolated markets that are extremely safe. And then the opposite, you have vaults on Morpho right now. We have more than 1,000 vaults that have a much higher yield but are underwriting much riskier assets. And we don't pretend to be a single pool of liquidity that is like only up technology. we provide a stack for people to build their own products to deposit USDC and earn from. And in that case, it turns out that some curators had underwritten kelp in vaults that were meant to be more riskier. And in total, I think the ETH exposure is like a million dollar, as you pointed out. But I think it's important to understand it's not comparable to the exposure of Aave because we're not a staff manager. One should think of the Aave DAO as like a vault curator. It's like also some people like compare Morpho and Aave and try to put one against the other. But the reality is that we're not really competing with Aave. We're just infrastructure for asset managers like Aave, but also others. So our builders are the ones competing with Aave in some way. So yeah, that's like the first explanation. The second explanation is actually Morpho is a stack that is heavily focused towards real-world loans. So 90% of our volume is stablecoins in terms of active loans, right? And like to give you a rough order of magnitude in DeFi lending, 50% is roughly like 50-60% of active loans are in stablecoins. A lot of it, of the rest is like East Free staking loops and East Staking loops and others. We don't get to focus too much on that. We think stablecoin loans is what truly is going to be the true scalable market. if we truly want to unlock like real world lending and everything. And so this is the only place where we spend our time and energy as a team. So I know that this question may not apply to how Morpho is set up, because as you mentioned, it's really the curators who are setting the parameters on, you know, each of, you know, on what they're managing. But you might have heard that there was a report published on Dirt Roads by Luca Prosperi, which kind of used some different frameworks to kind of analyze how much DeFi lenders should be compensated for the risk that they take on when they lend on DeFi. And according to at least one of those analyses, it found that they are grossly undercompensated. And in that model, they said that that's because what they're doing is essentially similar to a put option. However, you know, there's been some disagreements. Stakehouse Financial also kind of had their own analogy for what's happening in on-chain lending, and they compared that to actually repo agreements. And so they didn't feel that DeFi lenders were being undercompensated for the risk. But I'm sure you see there's a lot of Twitter, you know, conversation about this as well. So I was wondering what your opinion is generally on, how to properly compensate DeFi lenders or even how to sort of calculate what risk they are taking on? Yeah, it's a great question. And I think, you know, obviously the answer heavily depends on what, you know, are the underlying strategy of the vault or of the lending protocol. But I say the following is that the risk range can vary a lot depending on the type of assets that you underwrite. We found that over the last few exploits that has been in DeFi, it's actually mostly related to OPSEC, which is maybe not something that is as well underwritten and priced by the markets as it should be. And so our position is more of that we should provide a market infrastructure for lenders and bars to price trust. And what I mean by this is that bars should expose why they should be trusted, like the collateral they have or the identity they have or whatever. And then the lenders is an open marketplace. The rate should be determined by them. And in this capacity, we don't have an opinion on what should be the risk rate or the different risk premiums. premiums, but we feel like it's for the market to discover that, basically, within the permissionless MorphoStack. Now, specifically, I haven't read the study of Luca, neither the answer from Stakers Financial. The production framing is very weird to me. I think it's much closer to, like, I don't see how that would be close to a potential, especially as we move towards more and more under collateralized loans in the Morpho stack. To me, the analogy and how we explain this to traditional finance, etc., is that it's much closer to a repo agreement. And this is the lens through which they understand and think themselves about pricing. And when you think about the risk of such a repo structure, you have obviously the market structure, which is the Morpho protocol contract, where you have a risk of smart contracts. which I like to believe has a very, very low premium, then you have the risk of the collateral, the pricing of that collateral, and the liquidation loan to value. And all this together is actually very few trust assumption. And if you take high quality collateral like treasury bonds or Bitcoin and reliable price sources, I think there are fair arguments to make that the price of trusting those loans or the risk of those loans can actually be very close to the one in Tratify and does not require crazy premiums. I've seen some tweets going for pretty crazy numbers. I won't comment on that, but I think it's pretty far away from the reality. And I'm sorry, but does that then also compensate for just the risk of sort of those OPSEC reasons that you discussed? Because as we know, a lot of these hacks are not even of the protocol. It's like literally just around key management and stuff like that. Yeah, no, I think it's just depending on what asset we're talking about. If we're talking, you know, WETH as collateral on the Morpho markets priced by an Oracle like Chainlink. Honestly, I don't think there is such like risk because there is no like such thing as a multi-stick behind the scenes anywhere in the process. However, if we're talking this new wrapped RWA that is done by a startup that does not even have basic OPSEC procedures, then yes, that should absolutely be priced in. The reality though it very hard to properly underwrite those assets Now we seen all the fintechs we been working with are much more careful about this now obviously And so they require curators to like provide proper due diligence on every single of those assets including assessment of the OPSEC best practices which is not something they would expect maybe a year ago And so that has been interesting to see as well. Okay. So, yeah, one other kind of, you know, aspect of this that I wanted to explore in terms of risk was just you saw that after it was revealed that, you know, the Layer Zero bridge had sort of, you know, out of the box, had a one-of-one setup for the DVN. Then there was some finger pointing going back and forth between Kiltdown, Layer Zero over who was really responsible. But I was curious, how do you think about that? And how do you think users who want to engage in either DeFi lending or borrowing, how should they judge whether or not something is safe for them to engage with? Right. I think it really comes down to how much assets your lending protocol is underwriting and how. When you have a pool model or a hub model that is underwriting 50 different assets, even though the caps are small. We're talking like in the case of Aave, it used to be a very big $30 billion protocol. And the cap for kelp was like, I don't know, but maybe $200 million top of mind. So one looking at this would be, oh, actually, that sounds like a very minimal exposure compared to the size of Aave. But the reality is that even the small exposure, a relative exposure can trigger panic, which turns into a very big relative exposure, as we've seen. I think this is really fundamentally like duplicating the number of assets underwriting into a single pool model that aggregates the liquidity for everybody. like you multiply the black swan risk by, you know, even though at the high level, those assets individually look safe, then you have to imagine that each of those assets rely on 10 different providers that rely on 10 different providers that relies on RPCs that can be hacked by North Korea, right? And if you are a lending pool like Aave of 40 billion, technically you should have continuous monitoring of those 40 different assets, the 10 providers of each of those 40 different assets, et cetera, et cetera, which is absolutely unrealistic, especially if you ask token holders to do it, which is basically like the process of a monolithic lending pool today. It's like token holders have to approve those bulk parameters, those risk parameter changes, which to me is not really a good expectation from token holders. Even a centralized risk provider is too complex, especially if the risk provider can leave at any point in time, as we've seen. And so that treats, in my opinion, too much risk. Okay. And as you mentioned before, when people are engaging in Morpho, they should sort of analyze each vol and look at the curator. So how do you assess whether a curator is kind of doing their due diligence versus one that maybe is less trustworthy? Yeah, so it's a great question. One should think of Morpho's position as Etherscan almost, or Ethereum, or credit. So if you go to our interface, you're going to have this terrible UX, I've got to be honest, where you're going to have hundreds and hundreds and hundreds of vaults. And for each of them, we're going to give you a ton of details about what is the risk, what they do, what is their track record, et cetera. We're not providing a consumer easy to use UX. If you are a simple user that does not want to think about those things, you should go to one of the 200-ish partners that are integrating more for that are providing those experience. We integrate with every single exchange, whether that is like Binance, KX, Gemini, Kraken, Coinbase, obviously, and others. They get to the work of picking a curator and making sure that those vaults have the proper risk configurations for their users, the proper risk isolation. And this is how users that don't want to choose, they use those interfaces. Users that are more experts and want to understand and go deep, the same way you would go deep on Etherscan if you know perfectly Ethereum and what you would do, or through your terminal directly, then you go to the Morpho platform or to the Morpho API or to the Morpho contract directly. That's really how we think about it. And by the way, I think this is the only way to scale DeFi lending, right? I want 7 billion people on earth to benefit from on-chain loans, right? And an open credit network. I'm not going to underwrite, or Morpho is not going to underwrite 7 billion people. We're going to need thousands and thousands of curators, banks, asset managers, whatever you want, to go after each bar in the world and give them a price for a loan, right? And we won't do all of this. We just provide a connecting layer for everybody and a stack for everybody to do this underwriting and access global and competitive liquidity. And to me, this is what DeFi is about. DeFi is not about decentralized underwriting or decentralized brokerage. DeFi is about providing an open marketplace for the financial activities that you have in Tratify. Except now, because it's open, you have better price discovery, which means deeper liquidity and better prices for end users and better discoverability of the different products. So in practice, it comes down to it's going to be cheaper and you're going to have more types of products, it's going to be the exact same products that you would have before, maybe slightly different, but the pricing is going to be so much more efficient because you connect globally to everybody. And one other question I want to ask, you know, I know that with all of this contagion that happened in DeFi, that you had a lot of conversations with institutions and Morpho itself is known for being part of one of the, it's actually probably the best known sort of DeFi mullet set up in all of crypto, you know, with the Morpho protocol powering crypto loans on Coinbase. What effect are you seeing that the Kelp Dow attack and the ensuing DeFi contagion is having on institutional appetite for these types of arrangements? Right. Well, you know, when the Kelp situation happened, the first thing I thought, and like, you know, when Aave went illiquid and had $12 billion blocked. I felt good about Morpho because of how Morpho operates and its position. But I was worried about the institutions reacting to this. Because in traditional finance, if you freeze more than $10 billion for a week, this is a very serious issue. And so I picked the phone and I started to call them. And I was like, hey, explaining what's going on and making sure they understand. what is happening. And I think, you know, I was actually... There's a positive thing and a negative thing, right? The positive thing, two positive things, is they understand that this technology is the future regardless of what's happening on chain. They understand that having an open global financial system is a promise that is way too big to fail, right? They are all convinced that this is what we're marching towards as a technology. What they're not convinced by is the current way we're doing underwriting. And basically their reaction is like, oh yeah, DeFi, you guys are jokers. The way you underwrite is not serious at all. And to some extent, it's hard to prove them wrong. Currently with the track record that we have over the last few months with so many hacks happening, etc. So I think the question is like, how do we empower them with technology that they can trust, that they can control? And what I mean by control is that they can use and configure without having to rely on trusted intermediaries in order to operate the financial services that they operate in TradFi with the same skill and trustworthiness that they would in the off-chain world. And so TLDR is that they are convinced by the technology. A second big reason is that they're convinced by the business aspect of things, which is they see all the fintechs coming on chain, every single fintech coming on chain. And they're like, hey, all this AUM that I have from the fintechs today, I'm going to lose it to Morph of Vault. So guess what? I need to come on chain and manage my own Morph of Vault and become an asset manager on chain because otherwise I'm going to lose flow coming from all the fintechs. So they get this, right? But now, and they even see this as an opportunity. They're like, hey, the current asset managers that are decentralized, like, oh, they are not doing a good job. It's an opportunity for me to come over and take this market powered by the work of technology, if you will. And so that's the upside. The flip side is obviously the most conservative institutions. They like a huge setback for them in terms of like you know how they can trust how they can effectively go to their leadership and push the pitch of like hey we going to move on and deposit funds. It just makes the pitch much harder internally. If the organization is not already convinced by the technology and there is no top-down direction that the on-chain is the future. If you're not in one of those organizations, then it's going to be much harder now to sell the on-chain vision. And if you were to kind of put a number on it, would you imagine that this sort of delayed some of those decisions by like three months or six months or maybe not, but I'm just curious? It's a great question. It definitely would be some delay, even not just from the chat by institutional player, but from the fintech adoption side of things. And rightfully so, right? Like you want to take a step back and understand what happened. You maybe want to change yield provider and loan provider as well. And then reflect, right? And also think, you know, about the question that we just discussed, which is the risk premiums. Like, is it worth it, right? To move on chain. And it's our job to prove that it will be worth it, that you'll get better price discovery. They should get access to opportunities that are much harder to get otherwise. And this is where we need to do work, right? Is like, keep like, you know, the security aspect of it's flawless, but at the same time, make it convincing enough from a financial product perspective. So I think we can fairly say that we've lost three to six months of institutional adoption for, I'd say, an average. Some people I've seen are not slowing down at all. They get the difference between like a morphine and an ave, for example. And they understand that things can be isolated and et cetera. But for the most conservative ones, it's probably delaying them even in years. Oh, wow. It's a bit scary when you say this, but, you know, and I'm only thinking like specific to having two persons I talk to and they're like, wow, actually, that, you know, that was a big, big thing. Wow. Okay. I mean, honestly, it makes sense with the way like AI, I think, is affecting, you know, the ability for hackers to do these exploits. All right. So in a moment, we're going to talk about some of the sort of rescue operations that happened that were a little controversial. But first, we're going to take a quick word from the sponsors who make this show possible. Bitcoin changed how money works. Citraea changes how Bitcoin scales. Citraea uses Bitcoin as both the settlement and data availability layer. As Bitcoin's application layer, Citraea enables the first trust-minimized BTC on a fully programmable platform and a native stablecoin for Bitcoin, CTUSD. Citraea offers Bitcoin capital markets with lending, privacy, payments. Bitcoin yield, trading, and predictions. Citraya expands Bitcoin's utility without sacrificing its security. Citraya mainnet is live. Get started at citraya.xyz slash unchained. Etherfy is giving unchained listeners 15% cash back on rideshares, groceries, and restaurants right now. Which honestly is kind of wild for a card like this. 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Well, after the big hack and the contagion, the Arbitrum Security Council had this moment in time where they saw the stolen funds sitting there for a period, and they used that time to freeze about $71 million worth of the stolen funds. This was a pretty controversial move, at least in parts of Twitter. I think other parts was a lot controversial. But I'm curious, what was your opinion on it? Did you think that was the right thing to do or the wrong thing? It's a great question. To be frank, I feel hard to answer. It's such a tough decision. So I know the Arbitrum team has put the thoughts into it before taking it. And I don't have the full context myself, so it's hard to judge if it's a good or one. But I trust the Arbitrum team seriousness and thoughtfulness to effectively have taken the right decision. Now, generally, about censorship, resistance, and ability to freeze funds on behalf of users, etc. I think it comes down to... Personally, it comes down to if you can do it, then not doing it feels a little bit immoral. Again, every situation has all its context, right? And it's interesting because as soon as you can't do it anymore, it's not immoral at all because you just can't do it. It's a little bit like the decentralized internet versus controlled internet, right? Like, you don't expect, you know, there's no one owning HTTP. So you can't prevent them from operating a specific website, which one could think as a good thing. But if someone were to own HTTP in some capacity and there was like a specific website that was doing ARM very clearly to humanity overall, then it's hard to justify not shutting it down. Right. So it's very interesting tension where like between control and the morality question that is behind the action that are being taken. So anyway, it's kind of like a non-answer, but I have very high trust and respect for the Arbitrum team in general. And I trust that they did not take the decision lightly, for sure. And I also trust that we don't have all the contacts, right? So maybe that are the reasons we don't know about. Yeah, and just to make clear, it was the Arbitrum Security Council, which is like outside people. So yeah, it wasn't actually like off-chain labs or anything like that. But yeah, I do believe there was a lot of discussion around that. And for people who are interested to learn a little bit more about how it went down behind the scenes, Griff Green came on the show on Friday and talked about, you know, from his perspective as a Security Council member, you know, how he felt it came about. And he also described technically how it worked, which was also actually really interesting. So after that rescue, we then saw this DeFi United effort that began picking up steam earlier today on Monday. It finally hit its goal or really exceeded it, frankly. So the amount pledged by the likes of so so the people who pushed over the edge were Joe Lupin and consensus. they pledged you know ether to to help make people whole lido kelp down obviously etherfy i think the solana foundation pitched in um there were a number of entities you know that that wanted to help cover this bad debt in ave from from the attack i wondered what you thought of that as a way to address what happened yeah it's a great question and i gotta be honest i don't fully know what is defi united you know i saw the announcement on twitter but i also heard like it's a donation and then i heard it's like a loan that is under collateralized and you know so i i'm not exactly sure what happens with the funds and so i don't know if i can i can provide a good perspective on this yeah i saw somebody tweet it a mix but i myself yeah don have all the details but i saw it was a mix Right And then you know every time like we get proposals on this it was like a different terms for the loans etc So I'm not entirely sure. It's hard to give a perspective on this. It's also hard to know what are the incentives of people. Like, yeah, for sure. If you have like a 200 million bet that, oh, you're going to donate for yourself. So of course you're going to contribute. What's in it for the other people to contribute in there? And just not having this full transparency for me is a bit weird if it goes public and anyone can deposit into it. It actually was one of the conversations I had with some institutions is like having the same concerns as I have, it's like not truly understanding what's happening, which is by the way, very different from a recovery process that you would have in traditional financial world. and again like it doesn't mean because Stratfizer it's another way that we can't innovate and do new things I just yeah I'm just not sure what it does exactly to be completely honest yeah I mean I agree like it's not ideal like it would have been better to just you know have prevented the hack obviously but on another show that we have Dex in the City some of the lawyers were saying that if the industry doesn't kind of like self-regulate, then the regulators are going to come in. So in that regard, like maybe it's good that there is some industry effort to kind of, you know, remedy what happened. But, you know, let's just now zoom out a little bit because obviously this has been a really rough month for DeFi. There was the Resolve hack, there was Drift, now it's Keltow, which had this sort of massive contagion effect. So, you know, now with all of that going on, Like, are you just having thoughts as a DeFi founder about, you know, what the industry needs to do, you know, how this sector can kind of stabilize and how, you know, what sort of steps need to be implemented to grow into mainstream adoption? Well, for what I suppose, from our selfish perspective, we had the best months in terms of enterprise adoption of Morpho, right? We're at all-time high in terms of every enterprise integration that we have that is directly plugging into the protocol, which is the thing I care the most about, is how can we take DeFi to the masses, etc. And this is working and working well. If you take the Coinbase isolated lending markets, we reached a new all-time high yesterday, despite the price being super down in general. So to me, it's not just that DeFi is at risk. I think DeFi 1.0, like the old era, like kind of maybe, but I think, you know, it's just metamorphosing without playing words. Like before what it was supposed to be and now what it is, is like, you know, financial infrastructure for fintechs, for a traditional financial institution. That is live and growing and has immense potential, immense potential. We're talking like the credit market is $200 trillion, right? And we're just with crypto backlands, we're just $50 billion. It's tiny and there's so much room to grow in that direction. Yes, the very crypto native leverage loop is in a tougher spot. I agree, but it's also not where we spend too much time, nor what we get excited about. And so as a result, as the DeFi founder, to answer your question, I'm just worried about the perception. That's the only thing. The fundamentals are here. I'm very, very convinced about DeFi upgrading the financial system for everybody. It's just how long it's going to take to get there. And will the short-term events of DeFi 1.0 going to impact the perception that will prevent DeFi 2.0 to thrive? And this is what I try to mitigate as much as possible. And so you talked a little bit about how institutions are sort of like changing their approach or changing at least their thinking around this area. But what are you seeing in terms of like user behavior change? Great question. So, I mean, very clearly, it's like, hey, if you're like, you know, and have many conversations like this last week is like, basically, people only want to exposure to Bitcoin yield, like the two USDC yield that is just powered by Bitcoin. So when you talk to fintech, some of them are like, hey, well, you know what? Actually, we're going to change our strategy. It's going to be a single, not even multiple isolated morpho markets, a single morpho market, which is Bitcoin as collateral, because we know this is like a good risk reward tradeoff. And so the short term implications for us is that they're going to be much more careful about growth and just risk taking in general and rightfully so, right, in general. So isolating as much as possible their risk, understanding their risk for so much more. Like we've seen them hire a lot and upgrade a lot their, you know, their competency level on those matters as well. To the point where I feel like now they have, you know, sometimes much higher crypto native talent density than the crypto native projects themselves. And so I'm not even sure if this question applies. So tell me if it doesn't. But as we mentioned with AI and even the quantum threat, which I know is further out, but still, like there's just clearly more, you know, attack vectors that are being found. Also, as we're seeing the human aspect of all this is being exploited with social engineering being a major avenue for DPRK. So I was wondering, like, you know, how is Morpho adapting in this sort of new era? And I'm sure there's probably some aspect that you may not want to reveal, but I'm just curious, how are you thinking about how to make sure everything stays secure and your users stay safe? It's a great question. I think, you know, one of the biggest depends of the traditional, like, you know, financial system is the lack of transparency, right? From a cybersecurity perspective, there's nothing you can see. So it's much harder to attack. And in DeFi, everything is open. So if you start having very powerful tools, DeFi is kind of like an obvious target. It's like open. You can audit everything. You can send your best LLM and spend $2 million of compute on finding bugs everywhere. And that is very interesting because the force is shifting way too much into the hands of the attacker versus the developers on the other end. I think on the flip side, we have one tool that I think is extremely powerful to reestablish balance between the two. which is formal verification. AI can break a lot of things, but it still, until today, can't break math. And so if you build a protocol like we did, which is extremely simple, with specifications that are formally verified, but it doesn't matter if you're METOS v5 or if you're a junior security researcher, you won't break this bank because it's math. Right. And what's interesting about this AI era for Morpho is that we've already thought of our models and our code as deployed forever. And it's extremely different when you put them from the developer's perspective, immutable protocols from the upgradable protocol. We had both before Morpho and the old era of Morpho was upgradable. And we thought about it very differently because if you're immutable, you're going to be here forever. If there is just a small chance that you'll be hacked, while if you integrate this risk over an infinite period of time, you'll be hacked eventually. So you have to change your thinking and say, hey, it's like a zero risk model. It has to be flawless, right? To the eyes of any researcher in the future, including AI mythos like V.10. And so we feel good about the on-chain side of things, regardless of the power of the AI gods that we're going to submit. What I'm worried about generally for DeFi is also is like all the off-chain stack of things, right? And this is where we've been spending a lot of time internally upgrading all of this. In Morpho, you don't need to rely on the off-chain stack of Morpho to do stuff. But the reality is like we have a frontend. So if you go to Morpho.org, it's actually a phishing scam. We've seen so many DNS attacks of like other players. So we need to double down and be very careful about this. But that's like the $12 billion that are on Morpho that are on the smart contract, not our front end, obviously. So we feel good about that. All right. Well, Paul, this has been such a pleasure talking with you and learning more about other ways that borrowing and lending occurs in DeFi and also the institutional reaction to all of this. Thank you so much for coming on Unchained. Thank you. Thank you.
