Liquidity Curation

Liquidity Curation is the art and science of curating a vault's capital to optimize yield while adhering to a specific risk strategy. It is a dynamic process performed by the vault's Curator and Allocator, who work together to define risk parameters and deploy assets effectively.

The methodology for curation differs significantly between Morpho's vault versions:

• Vaults V2 use a powerful, protocol-agnostic framework based on Adapters and a granular ID & Cap System.
• Vaults V1 use a more direct model focused on allocating to Morpho Market V1 instances via Supply and Withdraw Queues.

Curation in Morpho Vaults V2

Curation in Vaults V2 is a two-tiered process that separates high-level strategy from tactical execution. The Curator sets the rules of the game, and the Allocator plays within them.

The Core Components of V2 Curation

A V2 Curator has three primary tools to build the vault's risk framework:

1. Adapters: The Gateway to Protocols

An Adapter is a smart contract that allows the vault to interact with an external protocol. The Curator's first job is to decide which protocols the vault can trust by enabling their respective adapters. This makes the vault a universal gateway, capable of allocating to:

• Morpho Market V1 (via MorphoMarketV1Adapter)
• Morpho Vault V1 (via MorphoVaultV1Adapter)
• Future Morpho versions and any other yield-bearing protocol with an adapter.

2. The ID & Cap System: Granular Risk Control

This is the heart of V2 risk curation. Instead of setting a simple cap on a single market, the Curator can manage exposure across abstract risk factors, each identified by a unique id.

An id can represent anything an adapter can define, such as:

• A specific collateral asset (e.g., stETH)
• A specific oracle (e.g., Chainlink)
• An entire protocol (e.g., all of Morpho Market V1)
• A highly specific market configuration

The Curator can apply two types of caps to any id:

• Absolute Cap: A fixed maximum amount of assets (e.g., "no more than 20M USDC allocated to markets with wBTC as collateral").
• Relative Cap: A maximum percentage of the vault's total assets (e.g., "no more than 30% of the vault may be exposed to Protocol X").

This system allows for sophisticated, multi-dimensional risk policies that were impossible in V1.

3. The Liquidity Adapter: Managing Active Liquidity

The Allocator can designate one enabled adapter as the vault's liquidityAdapter. This adapter serves two critical functions:

1. Receiving Deposits: All new user deposits are automatically routed to this adapter, ensuring capital is immediately put to work.
2. Fulfilling Withdrawals: If the vault's idle assets are insufficient to cover a user's withdrawal, funds are automatically pulled from this adapter.

It is typically set to a highly liquid and safe yield source to ensure smooth vault operations.

The Curation Workflow in Practice

1. Strategic Curation (The Curator):

   • Enables Adapters: Decides which protocols are in-scope for the vault's strategy.
   • Defines the Risk Framework: Sets absolute and relative caps on various ids to control exposure.
   • Appoints Allocators: Delegates the active portfolio management to trusted entities or smart contracts. (All these actions are timelocked for security).

2. Tactical Allocation (The Allocator):

   • Operates Within Boundaries: The Allocator uses allocate and deallocate to move funds between the vault's idle pool and the various enabled adapters.
   • Optimizes Yield: They can shift capital to adapters offering the best risk-adjusted returns, as long as no caps are breached.
   • Manages Liquidity: They set the liquidityAdapter to ensure there are sufficient funds for user deposits and withdrawals.

Curation in Morpho Vaults V1

Curation in Vaults V1 is focused exclusively on allocating capital across Morpho Market V1 instances. The system is more direct, relying on queues and per-market caps.

Strategic Market Curation

The Curator's primary role is to select a basket of Morpho Market V1 instances that align with the vault's strategy and set a hard supply cap on each one. This provides a simple but effective way to limit exposure to any single market.

The Queue System: How Capital Moves

The Allocator is responsible for managing two critical queues that dictate how capital flows in and out of the vault:

Supply Queue

The supply queue determines the order in which markets receive new deposits. When a user deposits assets, the vault attempts to supply liquidity to each market in sequence until the deposit is fully allocated or all market caps are reached.

• Yield Optimization: Interest-generating markets are typically placed first to maximize returns on fresh capital.
• Fallback Allocation: An "idle" market (a market with 0% LLTV where funds cannot be borrowed) is often placed last with a large cap to ensure no deposit fails.

Withdraw Queue

The withdraw queue determines the order in which markets are tapped to fulfill user withdrawals. This queue contains all markets where the vault has a non-zero supply or a non-zero cap.

• Liquidity First: Idle markets are positioned first to provide instant liquidity without impacting borrowing rates on active markets.
• Stability Preservation: Markets with high utilization are placed later in the queue to avoid causing large interest rate spikes that could drive

Practical Implementation

The market management system requires continuous monitoring and adjustment:

• Data-Driven Decisions: Base cap adjustments and queue positioning on utilization metrics, yield comparisons, and risk assessments
• Capital Flow Analysis: Monitor deposit and withdrawal patterns to optimize queue configurations
• Risk Mitigation: Implement gradual transitions to prevent rate spikes that could drive borrowers to competitors
• Stress Testing: Regularly simulate extreme market conditions to ensure queue systems remain robust