Structured Vaults
Introduction
The main problem with making lending markets for RWAs is the lack of secondary market liquidity. This prevents looping and, worst of all in the case of RWAs, prevents liquidations.
To solve for this, Mystic has come up with a novel lending primitive: structured vaults. These vaults, built atop of Morpho's infrastructure, essentially mimic a real-life credit product by creating safety vaults tied to each Morpho vault to act as first-loss capital, thus enabling RWA liquidations.
What Are Structured Vaults
At their most granular, they are Morpho vaults. However, something has been added to them: each vault is tied to one or multiple vaults called Safety Vaults. Built on the ERC-4626 standard, these accept only one token each and act as first-loss capital for the vault: in case of liquidation/bad debt, safety vaults take the loss first to protect the (Morpho) vault. The set of Safety Vaults protecting a single Morpho Vault comprises that vault's Safety Module.
How it Works
Curators tie a number of safety vaults at their discretion to each of their Morpho vaults, creating effectively a composable Safety Module for each of their curated vaults. Since each safety vault can protect more than one Morpho vault, this enables an interesting dynamic - shared safety. Curators can now protect each other's vaults or multiple of their own vaults with the same safety vault. Let's look at an example:
In this example, very similar to the above, there are two Morpho vaults, each with their own Safety Module. However, the USDC Safety Vault protects both the Eth Vault and the USDC Vault, effectively bringing shared safety to the markets.
From a more operational perspective, lenders can supply WETH to the Morpho vault (Senior position) and then stake their receipt token in the Safety Module to protect the respective Morpho vault (Junior position). They can also stake directly in the Safety Module to have a direct Junior position.
An important note to make is regarding stakers in the USDC Safety Vault - they get cumulative yield for both Morpho vaults that the vault secures, as in case of liquidation, both get to tap into the vault for first-loss capital. The order in which they may do so is defined below in realization mechanisms.
Vault Compensation
Curators can choose to incentivize the safety vaults with rewards or assign a percentage of the Morpho vault's yield that goes only to safety vault participants.
Liquidity Extension
In the event that a safety vault has the same asset as the borrow asset of a Morpho vault it is covering, the vault manager can call for a liquidity extension - moving funds from the safety vault to the Morpho vault, so they may be borrowed. This enables the safety vault to effectively act as a Junior Tranche, as its participants may also become lenders. Liquidity extensions need to be enabled per safety vault.
Liquidations in Structured Vaults
In case of defaults, first liquidation bots active on each market will participate to liquidate the debt. Only in case they do not participate or the asset is illiquid will the Mystic liquidation process trigger. In this case, two things happen sequentially:
First, Mystic Dutch auctions the collateral with whitelisted parties up to the asset's liquidation threshold. If all the debt is solved this way, the liquidation is thereby settled. If not, liquidation then falls to the respective safety vaults.
If bad debt reaches a safety module, debt is then realized according to each safety vault's realization mechanism. Upon realization, the respective receipt tokens are burned / withdrawn for their respective assets to cover the necessary debt.
Dutch Auction
When there is a liquidation, and assuming there is insufficient DEX liquidity to cover it , it is then up to the auction process to solve it.
Here, multiple parties act as solvers and compete for the liquidation by participating in a dutch auction, placing bids on Mystic's bidding system as the price descends until it hits the LLTV price. Ultimately, the best bid will take the liquidation. The winning solver then fronts the liquidity necessary to settle the market and wins the corresponding collateral plus a liquidation premium as a reward.
This innovative model brings a cushion that enables RWAs to be woven into DeFi effectively for the first time, by predictably bridging their offchain-onchain redemption times and making them significantly more liquid and DeFi-ready.
Realization Mechanisms
If only one safety vault is associated with a single Morpho vault, then it is immediate that it takes any loss that happens. However, it may happen that one safety vault is covering multiple Morpho Vaults or that one Morpho vault is being covered by multiple safety vaults. In these scenarios, two realization formats are possible:
Automatic realization: all safety vaults equally share the loss.
Tiered realization: vaults cover a percentage of the debt proportional to the yield they receive per Morpho vault, meaning highest-paid vaults get liquidated first. Let's look at two examples:
Let's say a single Morpho vault is covered by two safety vaults, one of $5M earning 10% APY and one of $10M earning 15% APY (because the vault manager incentivized them differently). In this case, the vault earning 15% gets liquidated first in proportion to its yield difference. The $5M vault is still responsible to cover the debt, only a smaller percentage of it.
Let's say a single safety vault is covering two Morpho vaults, and both get liquidated simultaneously. In this case, the market paying more to the vault gets prioritized and is covered first. If both vaults pay the same, then the vault equally covers both.
Vault managers decide which realization mechanism they want to apply to their safety modules. Do note, safety vaults can have Senior-Junior relationships between them, which enables curators to effectively build a sequence of vaults protecting a Morpho vault and decide the order in which they are liquidated.
Benefits
Lenders unlock additional utility on their receipt tokens while maintaining total transparency and control.
RWA liquidations are now possible, and with them, the introduction of RWAs in DeFi.
Morpho vaults unlock new customizable security systems that combine different assets.
Curators earn by taking a performance fee on yield generated by their curated vaults.
This whole architecture was built to be extremely flexible and scalable - new vaults can be added permissionlessly according to curator need. In addition, the whole system is extremely capital-efficient and modular, as the same asset can protect more than one vault at the same time and risks can be closely managed according to curator preferences.
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