This episode unpacks the evolving landscape of DeFi risk curation, revealing how specialized entities are reshaping lending markets and creating new investment paradigms, particularly with the advent of fixed-rate protocols.
The Genesis and Role of Risk Curators
- Michael, the host, introduces the topic by referencing a previous discussion on Morpho V2 and the desire to delve deeper into risk curation with leading market players: Tarun of Gauntlet and Adrian of Steakhouse, alongside co-host Monae of BA Lab.
- Adrian from Steakhouse defines the basic role of a risk curator, emphasizing Morpho's pivotal role in establishing this concept.
- He highlights two key aspects: modularization, where protocols like Morpho aim for the smallest financial primitive, allowing complexity to be built by stacking these primitives, and outsourcing risk, siloing risk decisions to allow for faster scaling.
- Adrian notes, “this new cohort of Boralin protocols is probably making the bet that you can scale much faster under this curator model than by running a sort of monolithic approach.”
- This model allows users to select vaults matching their risk appetite, a contrast to monolithic protocols where users accept wholesale risk.
- Strategic Implication: The rise of risk curators signals a shift towards more specialized and potentially scalable DeFi lending. Investors should monitor how this modularity impacts protocol resilience and user choice.
Gauntlet's Journey into Risk Curation
- Tarun from Gauntlet explains their evolution from optimizing Proof-of-Stake (POS) protocols (systems where network consensus is achieved by users staking their own crypto assets) in 2018 to DeFi risk management.
- Initially, Gauntlet focused on issuance strategies for POS networks to maximize throughput without centralizing validator sets.
- The emergence of active community participation in DeFi (Decentralized Finance)—a system of financial applications built on blockchain technology—drew Gauntlet towards this space.
- Tarun points out the challenges with DAO (Decentralized Autonomous Organization) governance, where short-term token price impacts often outweighed long-term system safety. He states, “the DAO model has this very weird incentive where any kind of action you have to vote on that maybe has a short-term negative price impact but in the long term makes the system safer was like very hard to convince this group of people of.”
- This led Gauntlet to explore models with a fifth agent—the curator—to coordinate liquidity providers, borrowers, arbitrageurs, and oracle providers more efficiently, aiming for improved capital efficiency, similar to how Uniswap V3 improved capital efficiency by splitting liquidity providers into active and passive.
- Speaker Analysis: Tarun's perspective is rooted in extensive experience with early DeFi and POS protocol design, giving him a deep understanding of incentive misalignments and the potential for new models like curation.
- Actionable Insight: Investors should scrutinize the governance models of protocols and the incentive structures for curators, as these can significantly impact risk parameters and long-term viability.
Incentive Structures and Challenges for Risk Providers
- Monae raises the point about potential conflicts in curator incentives, such as taking on more risk for higher-yielding vaults to capture more fees.
- Adrian acknowledges the “adverse selection issue” and draws parallels to MakerDAO's older core unit model, where difficulty in making changes inadvertently led to a safer system.
- He contrasts this with Morpho's fragmented curator ecosystem, where users can define their risk appetite.
- Steakhouse designs its Morpho vaults with an Aragon DAO construct, making LPs a “mini DAO” to align incentives and make vaults harder to change, reflecting a philosophy of immutability.
- Adrian observes, “in crypto there's an element of risk premium that consistently gets underpriced.”
- Tarun agrees that specialization will come from how risk is tranched, which can be difficult in traditional DAO models where some members might benefit from higher-risk assets.
- He argues that curator competition should lead to better outcomes, citing Morpho's generally higher utilization rates compared to pooled protocols.
- Strategic Implication: The design of curator incentives is crucial. Researchers should analyze how different models (e.g., fee structures, LP governance) affect risk-taking behavior and market stability.
Curator Models: Pooled vs. Isolated and RFQ Dynamics
- Tarun discusses the Morpho model where suppliers (managed by curators) are segmented from a pooled set of borrowers, creating a one-to-many matching problem that can be efficient.
- He notes that historically, successful DeFi protocols have featured passive liquidity provision, as pure RFQ (Request for Quote) systems—where users request quotes from market makers—can suffer from liveness issues during market shocks.
- Tarun argues, “pure RFQ intent type of things that require lots of interactions just don't generally work on chain.”
- He likens curator competition to an auction mechanism for each transaction, which is absent in original DeFi protocols.
- In lending, the adverse selection for curators is less severe than for AMM LPs because the loss in a liquidation is of a fixed size and duration, unlike the continuous, unpredictable trades in an AMM (Automated Market Maker)—a type of decentralized exchange protocol that relies on mathematical formulas to price assets.
- Actionable Insight: Investors should consider the trade-offs between RFQ-based efficiency and the reliability of passive liquidity pools, especially during volatile market conditions. The curator's role in mitigating these risks is key.
Curators as On-Chain Market Makers and Auction Dynamics
- Michael draws a comparison between AMM liquidity provision and the role of curators on Morpho, suggesting a form of on-chain market making.
- Adrian agrees there are similarities but notes curators have more dimensions to optimize across than AMM LPs, including managing utilization rates to avoid liquidity traps.
- Tarun reinforces his auction analogy, citing auction theory: “how many bidders do you need for an auction to be mostly competitive... it's like the number you get for a lot of cases is like under six.”
- He suggests that even a small number of competing curators can significantly improve efficiency over static pooled models.
- This contrasts with AMMs, where more bidders don't always lead to much better prices for users relative to LP losses.
- Technical Term: Liquidity Trap in this context refers to a situation where a lending pool is fully utilized, preventing lenders from withdrawing their funds.
- Strategic Implication: The competitive landscape among curators is a critical factor. A small number of sophisticated curators can drive efficiency, but researchers should monitor for signs of collusion or insufficient competition that could undermine these benefits.
Morpho V2: Fixed-Rate Lending and Its Implications
- The discussion shifts to Morpho V2, which introduces fixed-rate lending, a significant departure.
- Adrian views Morpho V2 through a “TradFi lens,” comparing it to on-the-run (newly issued and highly liquid) and off-the-run (older, less liquid) treasuries.
- He anticipates blue-chip assets will quickly establish a cadence, while longer-tail assets might see more chaotic markets.
- A key feature is the ability for lenders to switch between fixed-rate V2 vaults and variable-rate V1 vaults. Adrian states, “there's a very clean transition from the lender perspective... defaulting down to a more continuous rolling model for the V1 markets which will hopefully provide a better lender experience.”
- Tarun provides historical context on failed fixed-rate protocols, which often struggled due to inefficient AMM-style pools for trading variable to fixed rates.
- He explains LVR (Loss Versus Rebalancing): an arbitrage loss incurred by LPs when arbitrageurs trade against the pool, profiting from price discrepancies with more liquid external markets. LPs end up holding more of the less valuable asset.
- LVR was particularly high in early fixed-rate AMMs because interest rate markets are spiky, leading to large, sudden losses for LPs holding duration risk.
- Pendle is highlighted as a success story from that era, by focusing on splitting yield-bearing assets into principal and yield components rather than direct variable-to-fixed swaps.
- Actionable Insight: Morpho V2's fixed-rate model, by allowing curators to manage the allocation between fixed and variable rates, could overcome past failures. Investors should watch how liquidity develops and how curators manage duration risk.
The Role of Curators in Fixed-Rate Markets
- Michael questions who captures the margin if active management by curators replaces inefficient AMMs in fixed-rate lending.
- Adrian likens the curator's role to that of a primary dealer in treasury auctions, providing liquidity and managing demand shocks. He notes, “leaning on the curator to essentially make that market a bit more liquid is a valuable service.”
- The effective duration in DeFi has often been very short (e.g., one block length), making arbitrary duration fixed-rate products illiquid without active market making.
- Tarun adds that curators in this model take on real duration risk, compensated by fees realized over the loan's term, unlike DEX market makers whose risk is shorter-term.
- Strategic Implication: Curators in fixed-rate markets take on more complex risks, including duration and interest rate risk. Their ability to price and manage these risks will be critical for the success of these new products.
Market Structure of Risk Curators: Competition and Concentration
- Michael asks why the risk curator market has remained relatively small despite the potential, and how fixed-rate lending might change this.
- Adrian notes that while the Morpho V1 space has many curators (20-30), fee compression and the need for technical expertise might lead to concentration around the top players.
- He doesn't expect interoperability between different protocols' fixed-rate offerings soon, potentially creating opportunities for specialized curators in different ecosystems.
- Tarun suggests that many markets naturally have a few large participants and a long tail.
- He mentions a paper he wrote on congestion costs in DEX RFQ systems: too many bidders sourcing inventory simultaneously can worsen prices. This is less clear in lending.
- For fixed-rate lending, the ability to generate differentiated borrower demand will be crucial. He observes, “in general if you look at lending businesses in traditional finance versus trading businesses trading concentrates more than lending.”
- Monae, putting on his “curator hat,” suggests that in Morpho V1, curators often need to consolidate around similar parameters for liquidity, making differentiation harder. V2 and other verticals might allow more product-based competition.
- Actionable Insight: The curator market might see both concentration in established areas (like blue-chip V1 vaults) and new specialization in emerging niches (like fixed-rate or specific asset classes). Researchers should track curator numbers, fee structures, and AUM concentration.
The Institutional Side of Curation
- Monae pivots to the institutional demand for fixed rates and the evolving BD/sales role of curators.
- Tarun believes the BD effort is currently shared between core protocols and curators.
- He contrasts lending with perpetuals markets, where vault creators are more hands-off, and the high yield attracts many long-tail curators.
- He revises his earlier statement, suggesting Morpho was the “first successful curation protocol,” citing earlier, less successful attempts like Maple V1 which suffered from adverse selection.
- The sales cycle (demand-side vs. supply-side focus) will depend on whether V2 generates more borrow demand than V1 can supply liquidity for.
- Adrian, from Steakhouse's “balance sheet tinted glasses” perspective, emphasizes that “all balance sheets start with the liabilities with the users.”
- Steakhouse's thesis is to build for institutional use from the start, focusing on conservative, immutable vault designs.
- He highlights a key DeFi advantage: “the guarantee of enforceability and rule selection up front.” Immutability and lack of governance in Morpho's market parameters are seen as embedded supervision, attractive to institutions.
- Strategic Implication: As DeFi matures, institutional adoption will likely favor protocols and curators that offer transparency, robust risk management, and immutable or clearly defined governance.
Future of Curation: Specialized Lenders and New Frontiers
- Michael speculates on a future with highly specialized curators, perhaps even FinTechs or social platforms leveraging unique datasets (e.g., TikTok lending to creators).
- Adrian sees this as “last-mile underwriting.” He believes specialized entities might become curators or raise capital from wholesale lenders (other curators) on-chain. “I see it more likely of a system where it coexists rather than one that's strictly competitive.”
- Monae points out a challenge: Morpho V2's fixed-rate loans are still funded by demand deposits (variable-rate liabilities), which could be problematic for riskier, longer-duration assets if defaults occur, leading to bank runs.
- Tarun agrees, comparing such lending to private credit funds with gated redemptions.
- He sees Morpho as an opinionated syndication protocol. For new asset types like creator loans, challenges include syndication models, oracle solutions (potentially using ZKTLS (Zero-Knowledge Transport Layer Security)—a technology allowing verification of web data without revealing the data itself), and managing heterogeneous depositor risk profiles.
- Actionable Insight: The expansion of DeFi into new asset classes (like RWA or specialized credit) will require innovative curation models, robust oracle infrastructure, and potentially new funding structures beyond simple demand deposits.
Asset-Liability Management and the Path to Institutionalization
- Adrian discusses the liquidity trap in V1 borrow markets (100% utilization preventing withdrawals) as analogous to gated redemptions.
- He suggests that by analyzing user behavior and effective deposit duration, vaults can manage asset-liability mismatches, similar to how stablecoins operate. “Understanding the asset liability management and looking at things more like a stable coin is kind of the model that we're going to be taking.”
- The ideal end state involves on-chain origination and settlement, e.g., SMEs receiving stablecoin financing and using it for working capital.
- Michael brings up the business model of subsidizing products with financing divisions (e.g., car dealerships).
- Strategic Implication: Sophisticated asset-liability management will be a key differentiator for curators, especially as they deal with less liquid assets or fixed-duration loans funded by variable-rate deposits.
Value Accrual: Commoditization vs. Brand in Curation
- Michael asks if risk curation is a commoditized part of the stack and where value accrues.
- Monae believes curators are currently not monetizing heavily, focusing on acquiring deposits and building brand, as “whoever can get closest to the user and own like some sort of user relationship... that's sort of like where the intangible value of this curation business sits.”
- Adrian agrees the user relationship is key but believes differentiation will always be possible, similar to how multiple banks coexist. Interoperability challenges between protocols' fixed-rate offerings will also create secondary market needs and arbitrage opportunities.
- Tarun views curators more like multi-strategy hedge funds than banks, focusing on aggregate portfolio Sharpe ratio and efficient capital allocation.
- He states, “lending curation is the bedrock of everything else.” A curator's structural advantage often comes from their cost of capital and financing access.
- He sees the aggregation effect of curation as crucial, similar to wholesalers in marketplaces.
- Actionable Insight: While core risk parameter setting might face commoditization, brand, user relationships, specialized origination, and sophisticated portfolio management can be significant value drivers for curators.
Final Wrap-up with Michael and Monae
- Monae reiterates his view that the actual “curation” part (identifying strategies) is not highly defensible due to on-chain transparency allowing for trend-following and fee undercutting.
- However, brand (like Gauntlet or Steakhouse) and BD/distribution are significant moats. Users often trust the curator brand more than the underlying protocol for risk management.
- Michael and Monae discuss the potential for curators to cross-sell products across different DeFi opportunities (e.g., Morpho vaults and restaking products).
- Regarding BD, Monae notes that protocols like Morpho initially help open doors for curators but aim to remain neutral. Over time, BD will likely become more curator-driven due to direct economic incentives.
- They discuss examples of protocols/on-chain companies (like Spark, Moonwell, Seamless, Compound) running strategies on Morpho, sometimes with curators like BA Labs or Gauntlet as risk partners. These entities can leverage token incentives or unique low-cost funding sources (like Spark's access to DAI).
- Monae highlights the challenge and opportunity of Morpho V2 for curators: it requires a more active view on markets, duration management, and rate expectations, resembling bond dealing with PvP dynamics. “It's going to be a whole new ball game.”
- Strategic Implication: The evolution towards V2 and more complex products will demand greater sophistication from curators, potentially leading to a “flight to quality” where well-branded, highly capable curators capture more market share.
Conclusion
The DeFi risk curator role is rapidly evolving from simple parameter setting to sophisticated, multi-faceted asset management, especially with fixed-rate products. Investors and researchers must track how curators manage new complexities, build brand, and navigate the increasingly competitive landscape to identify sustainable value.
