How DeFi lending actually works (with Paul Frambot, cofounder and CEO of Morpho Labs)

I think one thing that might hold people back from participating in DeFi is this idea that there is risk involved. The community has been tricked into thinking that we should build a trustless system to be able to do underclatularized loans and credits, which is obviously wrong. The mechanism that we're building is completely cryptoagnostic. It does not have to work with cryptocurrencies. It could work with any form of tokenized assets in general. Project for me five to ten years out. What does the shape of finance look like? One single database for the entire world. Paul, thanks for being here. You're building out Morpho. Tell us what is Morpho. What are you doing? Morpho is a non-chain lending and borrowing infrastructure. So we allow people on one end to earn yield and on the other end people take loans. And that's done on chain in an open way. For somebody who maybe is not into crypto, how would you describe what you're doing? Crypto is about exchanging money with out banks. Morpho is about lending and borrowing without banks. There's no intermediary and effectively you can lend and borrow much more open without intermediaries. Okay, so disintermediated banking? Yes, disintermediated access to loan, like open access to capital in general, to like if someone has an ambition and wants to do something and they can prove that they're trustworthy, then they can get it loan without having to rely on like a specific entity. What misconception do people have about what you're trying to solve? The biggest misconception about DeFi lending is that the protocols that operate the lending and borrowing engine are in charge of issuing the loans. And that in the blockchain world, in the trustless world, the lending opportunities should be trustless and should be risk-free. And for approximately seven, eight years, we've been building lending and borrowing protocols that were understood as this like fully autonomous engine where the thing was trustless and nothing that could happen. Whereas in reality, what we realize building lending and borrowing protocols is that we should have trustless execution of the loans, but the loans themselves are obviously risky and that you could take losses from them. As a result, I think the industry have had a very hard time framing how undoclaturalized loan could ever exist because you don't have legal recourse. People could simply run away with the money. The community has been tricked into thinking that we should build a trustless system to be able to do undoclaturalized loans and credits, which is obviously wrong. Like, it's not going to be the case. I think moving away from this to a model where the only thing that's trustless is connecting people and executing the loan logic in itself, but more lending the market effectively prised the risk as opposed to getting the protocol to issue the loan, you get the market to issue the loan. So I think that was like a key realization for us as we were building more for. And I think still today is not well understood in the crypto-native Twitter in general. Yeah. I mean, I think one thing that might hold people back from participating in DeFi is this idea that there is risk involved, risk maybe that they don't want to take on. What would you say to people who have that hang up? The Morphan code is very, very close to the code that you have in the traditional finance system. I think there is this misconception like association with crypto and crypto volatility and prices where people get to lose a lot of money by just investing and losing money due to the volatility. Whereas the mechanism that we're building is completely crypto agnostic. Like, it does not have to work with cryptocurrencies. It could work with any form of tokenized assets in general, whether there are stocks, whether there are the safest investment products in the world such as Trisgeris, civil coins, etc. etc. And I think the way one should reason about risk when they get into those products is effectively yes, you have mostly two things. You have the operational risk, literally like the code is it safe. And you have the market risk. Like, when I'm the product I'm investing in it, is the person that is borrowing the phone going to repay. And those are effectively theoretically can be much better on chain. Because on the operational risk, you don't have counter parties. It's like executed purely into code. And there is an argument to be made that open source code goes like safer over time because of how many reviews it gets. And on the market side of things is really not much that is different from a traditional loan that you get. Except that again, this time the loan is underwritten in the open, which means that you have maybe much fairer competition to assess the price of the risk you're taking. Meaning that when some some borrow gets underwritten in the blockchain, you have a lot of lenders competing to give you the best and fairer price. So you're going to take risk and you're going to be compensated fairly for the risk you're taking whereas in the traditional financial world maybe you're taking a bigger risk but with the financial rewards that's going to be to a lesser extent. So anyway, so I guess the way one should think about the risk in crypto lending versus in trade by lending is like through the similar like risk analysis, but with blockchain technology having the potential to lower those risks in general. You're having lots of conversations with tradfi institutions. How much education do they require about defying about what you're building? A lot frankly, but also the good news and surprisingly good news, at least it was a surprise to me, they learned very fast. Approximately two years ago, like a year ago, we were like spending with those institutions who were mostly like the research labs, like they were like trying to do a state of the market or like just to inform their leaders to make sure they're not losing anything very important. But there was no actually like business drive, right? But as soon as they started to sense business drive and this business right meant like literally like distribution, like distribution is coming on chain. And chain, there's a lot of money on chain that's underserved in terms of yield, in terms of financial products and they see this as a business opportunity. And as soon as they realized that, they started pouring in like a lot more resources and they started learning much faster than what they used to do in the past. And so the bad news is we do have to educate pretty much like Old World Street, right? At the same time, the good news is that they learned super fast, right? Hopefully they don't learn too fast, right? Because we want to preserve an edge for some time and grow alongside them. That's I'd say the big like surprising like take away of last six months. Who's been most surprising in terms of their ability to get up to speed so quickly and conversely, who are you embarrassed about? I think the way I think about like the adoption like curves like wallets, exchanges, Fintech, NeoBanks, SM manager banks. Those are like the order by which this sort of like disruption order. So like what it's like the fastest to integrate decentralized finance. And then you have the exchanges and you see like the common basis of the world that start moving on chain and they start like removing their servers to like move on chain. And then you have Fintechs that are like, oh, like you know all this like crypto technology could effectively make me my financial services much better. And so they're following the move that Coinbase is doing. And the new banks are kind of like in the middle slower than Fintechs, but they're still quite tech native companies to the move fast. Which leaves us with the two tri-try-try pillars, which are like the SM managers and the banks. I'm impressed by SM managers. I'm embarrassed by banks in general. There are exceptions in both cases, right? But SM managers have definitely been like the fastest to execute. You're working with Apollo. Yeah, the Apollo's of the world. Like Apollo has been particularly impressive by how fast they've been moving. But you know other SM managers have been great as well. Like you know like the fidelity team that the BlackRock team obviously and and the venture of others. But I will say Apollo has been specifically like very, very impressive. And from there you have the banks, right? And the banks, they have to obey to a much like you know more important set of regulation, at least for this specific type of activities, which really prevents them from like moving as fast. And they're still in the paradigm where when you get to talk to them, they take a lot of you. But they don't give back as much, right? It's not entirely true for all the banks, right? We have some some exist, surprising, but it's in Europe and France, we have like the largest like banking adoption, where like they're launching stablecoins and they're launching their morph of volts. And we have, for example, the Sockgen in France announced that they're moving progressively their loan books on on morphal, which I was not hoping to get like a year ago, right? And it's been very impressive and it's getting a ton of attention. Because they like you, your French, so you want to say it off? Yeah, I'm sure like the the France, you know, vibe helps. Like, you know like our offices are not so far away, like they come to our office, we go to their office like every now and then. So that surely helps. Proximity helps. Also, we'll say that Sockgen is probably by far the most like forward-thinking bank on crypto in the world. They were like issuing on-chain loans like three years ago. They have their own stablecoins. And in general, like European banking is waking up, especially as they don't see any Euro-Stablecoin like really taking off. And you know, some could already go circle is doing a good job with your C, which is true, but it's nowhere close to the state of adoption that USDC has. No. There's a massive gap and opportunity to take like, you know, the crown of the Euro-Stablecoin, especially if you're European native. Like it's very hard for a circle as a US-based company to like claim that that crown, even though I think they're doing a good job. 99% of stablecoins are denominated in USD. Do you think there is an opportunity for a Eurocoin? Can it exist and compete in that environment? There are a lot of people that get paid in euros, right? And so that reason alone should make it a big enough opportunity for settling and paying and storing value in Euro. I'm interested in a Euro stablecoin that yields, right? Like I get paid in euros. And right now, it's widely underserved. Indeed, I, hopefully, it was more for widely adopted Euro stablecoin, which more has been a big thing. And maybe also those Euro stablecoins, frankly, I see free paths for them. Like either they come from a big fintech or a big slash exchange, a big bank, or they come from a circle. I think it's going to be one of the free. Not sure what the central bank is up to these days with the Euro-subaclone as well. They had plans. They changed the lot. OK, so project for me five to 10 years out. What does the landscape look like? I didn't have a financial background. I had a computer science background when I started in DeFi. So what I learned about finance over the last four years of talking to all the largest financial institutions of the well, all the payment companies, et cetera. And as I was building from scratch and first principle, I had zero bias about how to build a financial service myself. We build this out of pure intuition of what a financial service should be. This experience essentially taught me one thing about finance. That finance is essentially 50,000 different banks and credit unions that all have segregated infrastructure, like literally servers and databases that are segregated. And they don't trust each other very well. They don't connect very well with one another. And effectively, the entire inefficiency of the financial system comes from the fact that you have 50,000 databases that are asynchronously updating each other that don't trust each other and requires an enormous amount of middlemen that effectively update the values and the entries from one place to the other. And you pay 25 different intermediaries in order to connect one database to the other. You don't even know what database exists. So you need a payment network to connect the different banks and you have to make the information, secure, et cetera. And when you look at this, you're like, wow, that's a huge mess. And then you have Ethereum on the other hand, which is one single database for the entire world, like one single computer for the entire world. Or you don't get to have this mess of updating the different entries and having different trust levels and all this complex web of intermediaries. And so I can't help thinking of painting a much cleaner picture of finance where first we're all operating in the same computer. So there is no need for the middleman to update, couldn't quote, the end-updated databases and communications. So that's the first thing. The second thing is that the system is open, meaning that the competition is operating in a truly genuinely fair fashion, which means that for the first time ever, you're going to have the value that has been concentrated in those inefficiencies that's going to be pushed to the hedges of the network. Like the consumer is going to benefit immensely because whatever financial product that they use to have in a closed fashion is going to be super powered by the open blockchain. The reason being that when the system is open, you get to beg much more liquidity and aggregate much more intents from the entire world. So we were thinking about loans. But when you're going to ask for a mortgage, instead of going to a specific bank, you're going to come to the open blockchain and it's going to say, hey, here's why I should be trusted. And then you're going to have the entire world quote you on your interest rate and say, hey, we'll give you 3%, and maybe GP-Morgan is going to say 2.8. And maybe a random student in Argentina is going to have his own quantum model and is going to write you. And it's going to be this massively competitive open network where anyone gets to participate and anyone gets appreciated by their own fair value and their fair credit worthiness. And so fundamentally, I don't think we're going to have no you crazy financial pruners, like the financial pruners are going to roughly be the same. You're going to have options. You're going to have obligations and you're going to have trading. The main difference is that because of how open the system is is going to be widely more efficient. So the prices, the take rates are going to go down widely. So that's one. The second is the integrability being so easy, it will be much easier to get access to financial products in general just because technologically, it's super easy to integrate into a single database, as opposed to integrate with 50,000. And both in terms of moving from zero access to an access to financial services, but also in terms of having a much deeper and broader access to diversified financial pruners and also much more personalized. So really frankly, efficiency and much lower take rates, much broader access to a much wider set of financial services that are much more personalized are the key main differences when you run finance on chain. It's a compelling vision for the future. Yeah. Lightening round. All right, worst piece of advice you've received as a founder. Join an incubator? Yes. Or wait, like, I got some investors telling me, like, hey, you should finish school before starting more for like before talking to us. Obviously that wasn't you guys. Probably I would be very surprised. You didn't even ask if I was a student. You just invested. You didn't know I was a student, by the way, I never told you, but-- Not into the credential as a worker. What book would you recommend people read? Read right? Oh, no. Fantastic. I would read the sample. It's awesome. Like, I-- I-- Kristix in the book. Yeah, I can. Fantastic. It truly is. It truly is a very good book. And I-- That's the only way to write it. I really mean it. Like, we were liking one like, once a good book where you get like some like true like crypto wisdom. And like, we're in web through wisdom, like not just like the crypto trading aspect, like really the computer science aspect. And like, what effectively this more like industry brings to the world? Biggest productivity hack. The thing about productivism, like, is the sum of tiny things that you optimize here and there. I think for me, like, one of the latest things I learned is like this Slack feature where you can do like the catch-up messages. I don't know if you see that. So the available on the phone, unfortunately. But for whatever reason, you catch up so much faster with this like feature, which I find insane. And you sort of like swipe left or right, like mark on your head, mark red. But here's a good one. Like, when I work from one place to another, I turn on like, charge a bit of voice. And I ask it like a bunch of questions of things I don't understand, right? So typically I'm in a track fight call. Like, with an SM manager, they-- for a bunch of terms, I don't understand. And I pretend I do. And I'm like, yeah, and I just write them on my to-do list. And then from my to-do list, like, when I work from some place to another, I talk to a chat GPT. And I ask it like, hey, can you explain to me about this term or about this thing? And then you go very deep when you walk. And that's like a very nice way of making works productive when you go from one place to another. That's amazing. That's like the, the clueless premise of cheating on everything. Yeah. The AI company. Final question. Smallest hill you'll die on. Yeah, probably something wrong because everything the French culture-- Which aspect of the French culture? Food probably. Butter croissants, some other types. Yeah, exactly. Yeah. I think Butter croissants is a perfect example. In New York, I paid like $8 my Banscher Cora, which to me is insane. Like, it was not even close to be as good as like, a random French bakery. So, see, I think that would be like a good one. And in France, it's like $1. I recently learned that the shape of a croissant dictates the ingredients that were in there. There's like actually a French law where straight croissants are made of butter and curved ones can be made with other oils. Exactly. This is actually a very important distinction. I don't know if they follow it in America, but-- No, it's very important if you don't have transparency in the bakery and you end up buying like industrial croissants. You need transparency spoken like a true defy advocate. Yeah. Yeah. Croissants transparency. Yes. All right. Thank you so much, Paul. Thank you. [MUSIC PLAYING]