Under the Hood: Unpacking Our Morpho Vault Curation Methodology

Since mid-March, we’ve launched a dozen Gauntlet-curated Morpho vaults across Morpho’s Ethereum and Base deployments. Each vault offers suppliers exposure to lending markets with varying risk profiles. Ensuring these vaults meet our robust risk guidelines, are attractive to the DeFi community, and remain resilient enough to handle inherent crypto market volatility is central to our approach to curation.

Our vaults are categorized into two distinct risk levels: Prime and Core. Our Prime vaults primarily allocate liquidity to blue-chip markets and maximize risk-adjusted yield while targeting a minimal risk of insolvent debt. Our other Core vaults offer exposure to markets with higher yields that may come with incrementally more risk. 

Today, we explore our Morpho vault curation methodology and how we approach essential levers, including collateral assets, reallocations, risk-based constraints, and more. We’ll cover:

1. Morpho Vault Structure
2. Market Allocation Strategy
3. Strategic Adjustments

Morpho Vault Structure

Morpho vaults have three main pillars: a supply asset, a vault APY, and allocated markets.

Supply Asset: The supply asset is the foundation for a vault. For example — WETH is the supply asset for Gauntlet WETH Prime, and USDC is the supply asset for Gauntlet USDC Core. To access Gauntlet-curated vaults, a supplier must add some amount of supply to the vault.

Vault APY: Annual percentage yield, APY, is the main economic draw of MetraMorpho vaults. It represents the annualized return suppliers receive as a percentage of the assets supplied to a vault. APY is determined by the markets to which a specific vault allocates its supply, as well as any incentives in those markets. APYs change dynamically based on several parameters, including market utilization and supply allocation. 

Allocated Markets: As just mentioned, a vault’s supplier APY results from the underlying lending markets to which it allocates. Each market has four components: collateral asset, loan asset, liquidation loan-to-value (LLTV), and a net borrow APY. As in any lending market, borrowers must provide collateral assets to receive loan assets. The LLTV indicates the level at which a borrower’s position becomes eligible to be liquidated to prevent insolvent debt. And, the borrow APY reflects the interest a borrower must pay on a loan. 

Market allocation is a crucial lever that allows us to optimize vaults for risk-adjusted yield. Next, we dig into how we achieve this. 

Market Allocation Strategy

Market allocation is the most impactful action influencing vault composition, with a central role in defining a vault’s risk profile and overall APY.

To inform our allocation strategy, we use fine-tuned Agent-Based Simulations (ABS) that model market scenarios and user interactions within DeFi protocols. Our methodology incorporates detailed models for liquidity, price trajectories, and network congestion based on sophisticated agent models and simulations that interact with smart contracts. 

When allocating to a market, there are three main actions we can take that impact a vault’s risk profile and APY:

1. Adding a new market: When a new market is added and supply is allocated, the vault APY will change based on the allocation percentage and the supply APY rate outlined above. 
2. Adjusting market allocations: To ensure Gauntlet-curated vaults remain risk- and yield-optimized, our models constantly review market allocations and make necessary adjustments.
3. Adjusting market caps: The caps we set serve to limit vault exposure to any one market. A cap represents the total amount of supply that can be allocated to a particular market.

Depending on a vault’s risk profile, we make allocation decisions based on the factors outlined below. 

Our models incorporate data based on these risk factors and allow us to project the impact of market adjustments on APY. This increases the confidence in our allocation adjustments and ensures we can react promptly to changing market conditions. 

Strategic Adjustments

We continuously assess adjustments and reallocations once a market is allocated to a vault. This is necessary, as risk factors in allowlisted markets can rapidly shift with market conditions and utilization changes (e.g., borrowers enter or leave the market, or more supply is allocated). 

We group strategy adjustments into two categories:

Risk off: This involves continuous data checks to ensure enough liquidity in decentralized exchanges (DEXs) to support potential liquidations without causing significant market disruptions. This process is crucial for maintaining the vault's stability and security.

Yield Optimization: We aim to maximize risk-adjusted yield by analyzing and reallocating assets among different markets. This strategy ensures we take advantage of opportunities while maintaining a balanced risk profile.

• Yield Analysis: We assess the yield in different markets, considering the current yield rates and the shape of the yield curve. This modeling allows us to predict potential changes and opportunities.
• Utilization Management: We monitor utilization rates to avoid over-leverage and ensure optimal risk-adjusted yield.
• Adaptive Strategy: Yield follows time and utilization patterns. By understanding these dynamics, we can make informed decisions to reallocate assets to markets and optimally manage vault APY.

Gauntlet’s risk-first approach

Our Morpho vault strategy is defined by a commitment to understanding and managing risks associated with vault compositions. Effective risk management is essential to maintaining our vaults' stability, security, and attractiveness.

That strategy is built on a multifaceted approach that includes frequent data checks and advanced simulations to anticipate and mitigate potential risks. We stay ahead by closely monitoring key factors such as DEX liquidity, volatility, slippage, and utilization management. 

This process allows us to implement daily yield optimization strategies and maintain real-time monitoring, ensuring we seize opportunities while keeping risk management and safety at the forefront. In doing so, we are positioned to navigate the complexities of the market confidently, balancing the pursuit of yield with a commitment to vault integrity.

As new opportunities appear across our industry, we are driven to continue collaborating closely with the Morpho team and other partners as they expand and enhance their composable and permissionless lending platform at the vanguard of DeFi. 

Gauntlet Team