DeFi 借贷的下一场战役：你的金库里装了什么 | DeFi Frontier

Yeah, I would say Aave compresses risk, Morpho isolates it, and Lotus clears it. We are not afraid of bad debt. That is one of the biggest limiting dogmas in on-chain credit today: “Oh my God, what if we have bad debt?” And so, you have all these management layers and governance layers that go around, and they’re not solely focused—but a huge focus is—“How do we not get bad debt on the platform?”

Because it’s kind of become this KPI for all on-chain lending. Frankly, I think it’s stupid. It doesn’t make sense in any other financial system. Bad debt is just something that gets commoditized, and there are all kinds of ways that you deal with that. But really, that is the credit risk that you should be expressing.

It’s not something where we should have this paternal layer that comes in and says, “Oh, we have to set these incredibly conservative governance parameters.” In Lotus, that is what you are generating higher yield on as a lender. And that all gets reflected in the interest rates at whatever level you’re lending at, or whatever level you’re borrowing at.

Today’s show features the founder of Lotus, David Reising. David, thanks for joining us. How are you doing?

I’m doing great. Super good to be here with you guys.

David, we were speaking offline about what you’ve been building with Lotus. You’ve been building it for almost a year, and I feel like there have been a lot of stresses in the lending market recently that make what you’re building, and when you’re shipping it, a really opportune time.

Today, we’re going to talk through a lot of the novel concepts behind Lotus. We’re going to talk about what you think is broken in DeFi lending today and how Lotus is rethinking lending. We’ll get into the weeds a bit on some topics you’ve been writing a lot about in your blogs. One of them is the missing middle, this idea of connected liquidity and productive debt, and just how you’re thinking about positioning yourself in a competitive market landscape that’s already really established.

1. The team behind Lotus

So, maybe we’ll just start with a little bit about your background. What were you doing previously in DeFi, and who’s the team behind Lotus in general?

Yeah, you bet. We actually came up against a problem at Index Coop. I was the head of product at Index Coop, building mostly structured products and leverage tokens. So, I know DeFi Dad knows about the leverage suite over at Index. We thought that was the strongest product that they had. There were a lot of thematic indexes and different types of automated products, and they just didn’t see the market fit that the leverage tokens did, or different kinds of automated leveraged carry loops, that kind of thing.

What we ran into was that we couldn’t build the products that we wanted to build. We can get into that a little bit more and unpack that. Before Index Coop, I was the head of product at Exodus Wallet for a few years. Prior to that, I was working on their exchange and money movement products, staking, and different asset integrations.

2. The problem with shared pool design like Aave

Before that, I was doing some aviation stuff, which has surprisingly been one of the more translatable skill sets I’ve had: statistical work with aviation and systems design.

It’s funny because we’ve been wanting to host a conversation with you about Lotus for a while. I think one of the challenges was, if we were going to host a conversation, how do you get people to be open-minded enough to want to learn about another lending and borrowing protocol, given the dominance of Aave and the emergence of Morpho?

We’re recording this just a few weeks after the rsETH incident took place on Aave. I feel like the timing couldn’t be any better. So, why don’t we talk a little bit about your thoughts on what’s broken, or where there’s room for improvement, in terms of DeFi lending and borrowing today?

Yeah, sure. That situation’s wild, and I’ve got a bunch of different feelings on it. I’m definitely glad that the users who have been impacted look like they’re on their way to getting taken care of and unsticking the markets and everything.

I think it’s also really important that, even though I disagree with the way that some of these systems are designed today, this was still some nation-state attack, and that was the ultimate party that was in the wrong on this. That being said, it creates sort of a bittersweet moment for us because it’s challenging for the whole sector. But it does highlight some of the issues that we’ve been talking about as we’ve been building Lotus over the last 8 months.

3. The “missing middle” in DeFi lending

David, something else I want to touch on is that, within the Crypto Twitter sphere, there’s been a lot of discussion about what the price of risk is even worth and what yield people should be getting. You’ve been writing these blog pieces, and one of them touched on this idea of the missing middle. It looks like that’s a core tenet of how Lotus is being designed.

Why don’t you flesh that out for us? Explain what this missing middle actually means in Lotus.

Yeah, thanks. When we look at the current lending landscape, the opportunities to generate yield out there today through these credit markets, there are 2 dominant trades that we see.

One is having very safe, as close to pristine collateral as you can have on-chain: Bitcoin, ETH, and a couple of versions of that that we tend to trust, like cbBTC and wrapped staked ETH. You can get pretty de minimis yields there. You can get a little bit because you have the staking rate on wrapped staked ETH. There’s very, very, very precious little opportunity to earn any kind of meaningful safe yield on Bitcoin.

Then you have this other side, which is mostly correlated loop trades, which I’m sure you guys know all about, too. But why isn’t there anything in between that?

If we look at the way that the market today is generating yield on these incumbent lending protocols, most of the yield is coming from different levels of risk in the collateral that’s being lent against. What I mean by that is, when you look at Aave, you have 1 risk level and 1 rate level per market.

4. The problem with isolated markets like Morpho

You have heterogeneous borrowing demand from all kinds of different borrowers, with different reasons why they’re borrowing and different levels that would be more appropriate for one versus the other, but they’re all fit into this 1 rate, 1 risk level.

The other approach is isolated markets, which certainly, in our rsETH situation, would have absolutely held up better. You would have seen much less impact to people who had no direct exposure to that collateral set. But with that, you still have a tendency for all of the risk and the rate to herd to 1 market that’s been set up.

If it’s a BTC-USDC market, you may have a couple of different risk levels. By risk level, I’m actually talking about the liquidation threshold in a particular market. But because all those markets are disconnected from each other, they’re disconnected on liquidity and disconnected on rate information, you basically just end up with 1 static market where there’s any meaningful liquidity.

And so because of that, you don't have an opportunity to price risk on a spectrum. What Lotus does is imagine our credit markets as an actual curve. Think of a yield curve for Treasuries. It takes that same kind of shape.

What we're doing is creating opportunities for lenders to earn additional yield by lending to higher-risk borrowers on a market-risk axis instead of a tail-risk axis. This is the really important piece. You have the real credit risk, which is basically your risk in the event of a liquidation if you're a lender. Is there going to be enough liquidity? Are the liquidations going to proceed before I get to a point where I have any bad debt?

What we see in the other markets, regardless of whether it's a single-pool model or isolated, is that you're going out on a collateral-quality frontier.

5. What does Lotus aim to solve in DeFi lending?

One of the frustrations lately, coming off of the Resolv exploit and now this rsETH exploit or LayerZero exploit, however you want to describe that, is that so many of us thought that certain platforms, Aave being one of them, were more like a risk-free rate—that they were safer platforms to use. But we are continually reminded that so much of DeFi is interconnected, and contagion tends to play out when one major primitive or one major asset goes down. No matter how safe you thought you were, you feel the pain in some way, or you're at least in a panic.

How do you begin to address that? I guess this is part of what you guys are building at Lotus, right? Maybe just talk to us more about the problem at hand that we're facing.

Yeah, that's a great question. If you look at the last few big issues on lending protocols—rsETH, USR, and before that, last year, we had xUSD, which was a little bit different—two of those were from some kind of key exploit. Then we had one where there was an insolvency issue with xUSD.

The thing that I'm seeing is, if I want to deposit into a vault—let's say it's a curated vault and there are 20 different collaterals in that vault—as a risk manager, how am I supposed to audit all 20 of those collaterals to a sufficient degree to really understand what the risk of one of those things going to zero is? I'm a risk manager, and I've got an analyst and some people who are operating this. How am I actually going to do that?

For me, I came down to: I can't. I can't actually put that on Lotus, on our platform, with a degree of confidence that we're not going to have some tail-risk event.

Because we can create similar yields, or even higher yields, against high-quality collateral, I think this is the real advantage for us. We don't have to worry. We can make that part of our brand for a while. We're not opposed to other new forms of collateral, but it gives us an opportunity to have really, really high-quality collateral that we feel really, really good about on our platform.

6. The elevator pitch for Lotus

David, if I were to ask you, “What is the 20- to 30-second condensed version of what Lotus is?” What would you say? How do you break this idea down versus what's already out there, like Aave and Morpho?

Aave compresses risk, Morpho isolates it, and Lotus clears it. At any level of risk, it doesn't get expressed.

We're not afraid of bad debt. That is one of the biggest limiting dogmas in on-chain credit today: “Oh my God, what if we have bad debt?” You have all these management layers and governance layers around it. They're not solely focused on this, but a huge focus is, “How do we not get bad debt on the platform?” It has become this KPI for all on-chain lending.

We think that's frankly stupid. It doesn't make sense in any other financial system. Bad debt is just something that gets commoditized, and there are all kinds of ways that you deal with it. That is the credit risk that you should be expressing. It's not something where we should have this paternal layer that comes in and says, “Oh, we have to set these incredibly conservative governance parameters, or we need to do this and that and the other thing.”

In Lotus, that's what you're generating higher yield on as a lender. You're saying, “Hey, if I'm going to go out and lend to somebody at a 92% liquidation threshold, I'm going to have an increased probability of significant loss, basically, as a lender.” You're asking, “Over the course of a year, what's the percentage chance I'm going to lose more than 1% on my position?”

That all gets reflected in the interest rates at whatever level you're lending or whatever level you're borrowing at. But what that enables is this vastly superior all-in financing package.

It's not just a rate, right? If you think about it, as a borrower, the rate that you're comfortable with isn't just the rate. It's not just the rate that's being quoted to you today. A rate—and this is why we don't see credit going through aggregators, solvers, and routers in the same way that we've seen every other liquidity primitive move in the same direction—has a lot more going on with a loan, basically.

It changes shape over time. The rate changes, and the liquidity depth changes for a borrower or a lender. There's just a lot going on there that needs to be accounted for.

Yeah, so just to reiterate, I think of Aave as a platform where, if I'm lending ETH on Aave mainnet—Ethereum mainnet—I'm basically lending against all the different collaterals on that platform, which is a lot. There are a lot of assets listed there, and this is what's led to this panic, this freezing of contracts, and basically all this shared risk on Aave.

Morpho sought to isolate all those different markets. Now, I think the downside to Morpho—and I don't think they shy away from this—is that because there are so many different lenders and borrowers interacting across the different markets, some of them, you can say they're isolated, but they're not, because you're lending in one market and they're deploying that to another market.

It's a valid, differentiated approach. We love Morpho. We love what Aave has accomplished. Am I characterizing all of that, though? Because again, this leads into what you guys are building. To be honest, if listeners are wondering, I think Nomadic and I are still struggling to fully understand this. We're doing this interview because we desperately want to understand the design behind this.

Yeah, I think that's a fair characterization. Again, Aave compresses, or pools, that risk, and in exchange you get this incredibly deep pool of USDC, particularly, that you can borrow against.

I think there do need to be those big pools of capital that you can borrow against predictably. I think it's going to look more like repo-style markets on-chain. That's kind of what we're building. It's not exactly like repo, but that's really the long-term vision.

We see ourselves as this place where, because we can clear risk at any level, you end up with this very deep, connected pool of liquidity. But it's isolated in terms of losses: they're going to flow to where those loans were originated and to the lenders who provided the capital.

So David, thankfully, I can sort of visualize some of this already, too, because you did give me some early access to the beta version of the Lotus app, which is beautiful, by the way. Something really cool is that you can essentially pay for a higher LLTV. If you want an extremely high LLTV, you can pay for that by having a higher borrowing cost, and you can actually see the curve start to materialize when you start punching numbers into this.

Say you have 1 Bitcoin and want to borrow $20,000. The curve is pretty flat, and everything's priced similarly because there's not a lot of risk there. But if you punch in $50,000 that you want to borrow, all of a sudden you see the curve emerge, and you can borrow up to 95% LLTV for around 11%. I just pulled it up right now, and then you can still borrow at 80% LLTV at around 4.997%. There's a middle ground in there, too.

7. How tranching plays a role in Lotus

You get a lot of agency as a borrower for what you want to do, what kind of risk you want to pay for, essentially. There's also this idea that I was reading about: there are junior and senior tranches built into this.

Can you explain that a little more for me? And maybe remind people what junior and senior tranches are, although if you've been following DeFi, it's hard not to be hit over the head with that a lot lately.

Yeah, that's a really great question on the tranching. Let me just touch on that really quick. We have a piece on this on X as well, but what we built is architecturally more similar to Uniswap V3 than to any kind of tranching design.

Now, it's not going to look just like V3. I don't want to give that impression, but it's sort of this range-bound liquidity, right? With tranching, we're seeing a number of different interesting protocols trying different things here.

Royco, Strata—there are a few of them. What they’re doing is much closer to the tranching that we would think of in a classical sense, with a true junior-senior profile. What that means is, if you’re junior capital in a two-tranche structure, you’re basically the first-loss capital. You’re going to get wiped out before the senior pool takes on losses.

That’s what we’re saying. With Lotus, it’s not that simple a structure, but we use some of the same nomenclature to make it a little easier for people to understand, because it is a new form factor. I’ll walk through the key pieces of what makes one of our markets tick.

Let’s use a BTC/USDC market as an example, just like you saw when you were in our testnet, which was awesome. Imagine that market up to, say, 80% liquidation loan-to-value. The risk is basically exactly the same for a lender, and that’s because there’s so much distance between where your liquidation threshold is and the point where that loan would become undercollateralized. It just doesn’t really change that much.

But then there’s the point that you experienced as well, where you need to draw on greater financing power, essentially. You go further out on our curve, and by doing so, you’re taking a loan in one of the more junior parts of our market. You can imagine maybe 8 or 9 different levels in a market, each with its own tranche. They’re going to have their own actual risk profile and risk rating at the tranche level.

What makes it all work together is, let’s say DeFi Dad over here has a million dollars that he’s ready to put to work. He has a high risk tolerance and a long time horizon because he’s a true believer, so he’s willing to accept the risk of bad debt. He will get some bad debt as a lender at effectively 20x leverage, because that’s what we’re saying.

Now, somebody who wants to borrow up to 20x in an on-chain spot credit market can borrow from DeFi Dad. The problem for him is that he may have a million dollars out there, and let’s say it’s earning 22%. He’s done the math, the Sharpe ratio looks beautiful, and it’s a good position for him.

Because it’s at 20x leverage, maybe we go through a period with slightly lower utilization, and now only $500,000 of that is being borrowed. He’s getting 11% on all of his capital, and that’s not a great deal for that risk level. So we make a key assumption, and what it leads to is called cascading liquidity.

8. Demo of Lotus and BTC market curve explained

Basically, if he’s not fully utilized at that 95% tranche, the other $500,000 is going to flow down to the next most junior tranche and meet borrowing demand either locally or from any of the other levels on our curve where borrowing demand has been unmet. In a way, it starts to shape an order book across the curve, and that sounds—

David, I’m definitely more of a visual learner. Would you mind screen-sharing a bit and showing us what the app looks like? Maybe talk through the example you were just giving.

I’d be happy to. Let’s take a look at what you’d be looking at if you were a borrower. Come into Credit. Let’s say we want to do this BTC/USDC market.

All right, now I’m coming in and saying, “Where do I want to be in this market? What does the market look like?” This is the rate curve. You can see where it’s flat up to a certain point, which is what Nomadic was experiencing. Then, as your risk increases and your market risk increases out here, you see a linear rise in the rate.

That’s the borrow rate, and the suppliers are also compensated more. Over here, you can see how supply is being cascaded, as I mentioned, in these darker green bar charts. The lighter supply represents how much supply has been made locally here, and how much was actually supplied to this 92% tranche, where you also have almost the same amount of capital cascaded from these more junior supply areas.

Quick question, David. On the rate curve that you were showing, are we looking at a market where we’re lending cbBTC? Am I understanding that correctly?

Yeah, that’s right: cbBTC.

That’s your collateral, right? Cool. And are people borrowing a stablecoin against this?

Yeah, it would be USDC. LotusUSD plays an important part in this—it’s our productive debt. That’s the internal debt asset in our markets, and it makes sure that any lender is always going to earn at least a tokenized money-market rate.

But yes, if you’re a borrower, you’re going to experience this as having cbBTC collateral and receiving USDC as a result of your borrowing.

As a borrower, am I borrowing at a higher rate as my LTV goes up? Is that a good way to simplify this? Or is the lender earning a higher rate for lending to borrowers who have a less healthy-looking loan at a higher LTV?

That’s pretty close. The distinction is that it’s not based on loan-to-value, but rather liquidation loan-to-value. What we’re really saying is, if I’m a lender, what is my actual risk level here?

If I get locked in, I’m locking in my capital and making it available to anybody who could come in and borrow all of that capital. That’s the actual risk. It’s kind of like, “What’s my maximum risk that I’m taking here as a lender with this capital?” Versus maybe Nomadic only wants to borrow a little bit because he’s going to put a down payment on a new boat or something. Who knows what he’s got going on?

That’s the distinction. There is certainly more temporal risk with a higher LTV against the same LLTV, but what we’re really saying is how much borrowing power you’re paying to get access to.

9. Credora credit ratings and what value they add to Lotus

Can you flip to that other screen where you put in your one Bitcoin and let’s see what it looks like to borrow against it? For folks listening, David has input that he’s going to supply 0.25 cbBTC and then borrow $12,000 USDC. It looks like we’re now looking at risk levels. Are we selecting the rate at which we’re going to borrow?

That’s exactly right. This is based on the health factor for these different loans. We may find a better way to present this—we’re getting feedback on the testnet about that—but essentially, this is showing that if you want to have a lower liquidation price as a borrower, you’d rather be liquidated at, say, $50,500 instead of almost $55,000 or $60,000, you’re going to pay a higher interest rate.

That gives you a larger margin of safety as a borrower before your liquidation point. That’s one use case. The other use case for getting a higher LLTV is that you’re running some kind of trade, taking on leverage, and so on.

Before we stop screen-sharing, I see a bunch of ratings. I’m seeing A-, A, and B. Maybe explain what these are and what they contribute to the protocol.

We’re really excited about these. When we were maybe a third of the way into building Lotus, we realized, “This is pretty different from what’s out there today. How do we provide all of this expressivity and these different levels, but present it in a way that people can actually use and understand?”

We started partnering with Credora prior to its acquisition by RedStone. They were a big part of helping us think through a lot of the design of the protocol. What we have now is dynamic risk ratings at a tranche level within each market. Every level has a rating.

If you go to the safest place in the market, that’s getting an A- credit rating, or risk rating, rather. With that, you basically have a 12-basis-point probability of taking a significant loss on an annualized basis at that level.

If you go further out here to 95%, which is what we were talking about earlier, you have a 2% chance that you’re going to get hit with more than a 1% loss on any loans that you make. This gives you a way to quantify the risk.

Market risk is much easier to statistically or probabilistically model than tail risk, because tail risk, by definition, is the thing you didn’t see coming. It’s hard to model. When we combine this with really high-quality collateral and give lenders and borrowers a spectrum to operate on, we think it creates a lot of great new tools. The people and the robots are all going to have access to this, and I think they’re going to love it.

10. How tranche-level risk ratings figure into Lotus Vaults

One last area where this manifests is in our vault ratings.

So, we only have 3 vaults because we only need 3 vaults. We’re not focused on just massive collateral expansion to drive growth of Lotus. But because we have these tranche-level risk ratings, we’re able to create pretty cleanly separated vaults by their risk mandate.

With this balanced vault, Block Analytica is risk-managing it for us. We really like them for the conservative side because they do a lot with Spark, and they’re the huge risk manager in that system. When you open one of these vaults, it inherits all of the ratings of the tranches that it’s allocating sleeves to.

In our conservative vault on Lotus, you can see that it’s going out to some of the safer zones in our markets. Then it inherits a portfolio credit rating. We’re pretty excited about that. We think it makes the vaults much easier to understand from a risk perspective, but it also gives people the tools they need down at the market level.

We did a podcast not too long ago with Credora. We’ve been seeing these different primitives all coming together, and we were just talking today about how there have been setbacks in this bear market, but we’re starting to notice some really big ideas being built. It’s a great feeling to realize there’s a great intent to build valuable products for DeFi, and you guys are within that pool.

We’re just really excited for these products to go more mainstream once they’re fully live and folks are on board.

11. Earning more consistent yield with Lotus productive debt

100%, man. It’s the bad times that everybody always talks about, right? But that’s when you start seeing interesting things getting built again. When you take the easy money down a little bit in the space, it leads to sharper ideas. It’s just harder to get lower-quality ideas financed, basically.

David, one other thing I want to get into—you mentioned this during that screen share—was the idea of productive debt. I think you brought this up in conjunction with LotusUSD. I saw a tweet recently that you’ve integrated WisdomTree Prime’s tokenized money market fund right into the core reserve framework of LotusUSD.

You’re calling this productive debt. It feels like a big unlock for lending. Maybe explain to us the idea behind this, how it works, and how it makes the whole process better.

The way that we came across this is, we were thinking, “How the hell do we get these markets stood up as a new credit market when you’ve got a couple of pretty entrenched, bigger players out there that are starting to form these—”

Liquidity moats.

We realized that if we don’t have some kind of rate to reference, you’re going to start these markets out at 0%. That in and of itself isn’t a huge problem to solve, but it is a factor in getting markets stood up and getting them stable enough that people can start using them and growing them.

Our solution was, if we have some kind of productive debt—some kind of yield-bearing asset that helps serve as a buttress for rates in the market—not only is that a great outcome for lenders, because it gives you something where you don’t have to worry about slipping below the risk-free rate, but it’s also really important to getting our market started.

That’s how we got into it. I was very surprised, actually, at the benefits productive debt has when combined with cascading liquidity. Because lender capital is always earning at least the current money market rate, which is around 3.5%, it leads to really tight spreads throughout the market.

There’s not a lot of fat left where most of these linear kink-type models are concerned. You’re looking at 90% as the point where those markets are going to try to hold you. That leaves structurally 10% of your capital that isn’t really working for you as a lender.

That’s one benefit in and of itself. Productive debt would have that benefit. But when you combine it with cascading liquidity, as you move more senior on our curves, it starts to create incredibly deep liquidity—deep liquidity pools.

12. How productive debt dampens rate volatility

Probably the most interesting thing with productive debt is that we’ve seen this call for fixed-rate credit as the path to getting on-chain lending growing. This is what’s keeping real borrowers from coming on-chain: rate volatility is just too much. They can’t model it, and so you can’t really run trades.

To a large extent, that’s been true, because there’s a lot of rate volatility that we’ve seen—not even just because of big events, like we have an obvious one now. But we feel differently.

With productive debt, imagine you’re a borrower and your rate is 4.5% somewhere fairly senior in our curve. Well, 3.5% of that 4.5% is a very slow-moving money market rate. The other 1% of your rate is what’s actually moving around based on utilization within our markets, at a tranche level and then at a full-market level.

That means only a little bit of that interest rate is doing this, and most of it is just a brick. It’s moving as fast as the Federal Reserve—whatever Powell or whatever his name is doing now. That leads to a massive dampening of rate volatility.

Immediately, that makes it a much better financing package if you were to do variable-rate borrowing. But it also creates the foundational layer that we feel is necessary for our approach to fixed rates. You need to go down and grab that capital from a repo-style market, and then you can offer that fixed rate. It has to come from a place of stability and a lot of liquidity, though.

It’s a really interesting concept, and I think we’ve seen some similar ideas—not saying they’re the same—with Fluid’s Smart Debt. We just spoke to Alchemix and Scoopy about V3, and they’re doing some similar things on the collateral side.

13. Will productive debt become table stakes in DeFi?

I’m wondering if you think this idea of productive debt will start to become table stakes in DeFi in some way. I’m also wondering what the issuers are going to be thinking, because I think it can start with them.

You’ve got Circle out there. They’re not really doing much of this yield pass-through, from what I understand. They’re just clipping all that T-bill rate for themselves. But then you’ve got aggressive competition coming from the likes of Agora and PayPal, where they’re using the yield they’re clipping to win distribution. They’re trying to pass that yield through to people like yourselves, potentially. You guys are using WisdomTree in this instance, but what do you think is going to happen with this landscape?

Do you think this becomes more of a table stake in DeFi?

That’s a really interesting question. I’m not sure I have the clearest line of sight on whether that becomes table stakes or not. I think there are a few things.

14. Security: Audits, SEAL certification, and lessons from rsETH exploit

One is rate policy. If we get rate policy that’s a lot more dovish over the next 6 months and that base rate starts to come down, we may find that this can also have a reflexive outcome with our markets, where risk assets go up in those environments. Utilization should go up as well.

It may not be seen right now. Right now, it’s, “Oh my God, this could just be a product by itself, and it would do fine.”

And we've had people, or businesses, that would like to integrate it for that reason. For right now, we feel like it's table stakes. I'd like to think that 5 to 10 years from now, we have the on-chain vehicles and assets to be able to make this work fully on-chain. But we feel really good about where we're at now.

15. How Lotus differs in how it handles bad debt

It's WisdomTree with WTGXX, and it's also Coinbase Institutional for their USDC yield. I'd like to get another one in there eventually, but we're looking for the best, highest-quality options that we can get. It also helps with liquidity and redemptions. They all have different 24/7 facilities, so it gives us access to a few of those to make sure that there's liquidity available even over weekends and that kind of thing.

David, something you said earlier that stuck with me was about not shying away from bad debt. So let's talk about what happens if Lotus were to incur some bad debt, or how the protocol is designed to handle a situation where a borrower isn't paying back their loan. Talk to us about what's different there, because you're thinking ahead about this. This is clearly inexcusable when it comes to the likes of a shared-pool design with Aave.

It's something that's not preferred by lenders in Morpho; it's something they're looking to isolate and avoid. What's the difference in approach here, and what happens?

We want to give people access to 20x leverage and let lenders access the yields that generates. To be able to do that, and to be able to price and clear that risk across one of our market curves, the bad debt is going to go exactly where it deserves to go, which is to the higher-risk lenders that facilitated those borrowing positions.

For us, it's so clear that doing anything other than that is fundamentally incorrect. If you try to prevent bad debt or tame it, you take away this huge range of available borrowing power. It makes these markets much less capital-efficient.

You're looking at, “What's my all-in rate?” That's a way that you can cross-compare against these different markets. You're just not getting it there. There's no path to get past 7x leverage, and that's on Morpho directional leverage. Aave is around 4.3x.

That's not to say our problem is that there's not enough leverage happening. It's indicative of structures that, if they don't allow that to be priced, have made a choice to avoid something else. In that case, it's bad debt. So it's very limiting on borrower and lender expressivity—actually being able to precisely price risk in these markets.

And it's not the boogeyman. That's the other thing. Your risk of a significant loss at that 1% was somewhere around 1.8% or 2% at a 20x leverage level. We feel that, especially when vault managers are the primary allocators and lenders in these markets, if we're able to cleanly segment the vault risks and make it really transparent what somebody is getting into with one of those profiles, that's totally appropriate. That's the nature of the vaults that are allocating in those markets.

16. Vault managers, curators, neobanks, and who else will use Lotus

David, let's talk a little bit more about these vault managers. I think you mentioned earlier that Block Analitica is running one of these vaults. I'm curious who this is all for. What type of customer do you see using Lotus?

We're seeing familiar building blocks that we're getting used to now with vault managers and curators in the Morpho style, but there are a lot of different moving parts going on under the hood with Lotus. Who is the user that you're targeting? It also looks very institutional, with all these Credora credit ratings and whatnot.

It is. It's really designed to be useful for institutions, particularly on the borrowing side. We'll certainly have bigger suppliers come in on the institutional side as well. But really, we're unlocking what you could think of as an on-chain prime brokerage in a lot of ways. That's what we're enabling for more of these institutions as they come on-chain.

Then you have this other question: Who's supplying the capital for the long run, too? Not just the capital that we negotiate to make sure we're liquid enough when we first get launched, but long-term. We've actually signed several deals—or the deals will be signed when we're live, right?—but we have the papers and everything with some neobank partners.

There's just a great hunger for yield. Right now, there just aren't as many ways to create that yield in a way that's really scalable and safe, or at least where the risk levels are understood. Some of these neobanks, particularly, and a lot of the other product builders that we're working with—Superform, XYZ, and YO—are all very interested in being able to take advantage of this new spectrum of opportunities.

If we boiled it down to those 3 vault profiles, the neobanks are very interested in the really stable vaults, very close to Lotus SD in terms of seniority. There's a lot of interest in that in LatAm through some of the more LatAm-focused neobanks. For the Asian market, it's definitely the high yield. Asia loves its higher-yielding stuff. We love them for that.

I'm actually the most excited about the balanced one over time, because I think that gives you a little bit of both. I think it should be set up to be a very safe vault profile for the most part, with pretty limited risk, but it goes just far enough out on that risk curve where you get a meaningful additional return.

17. What use cases could Lotus unlock?

Can we talk more about what this unlocks if you're successful in growing the platform and the protocol works as designed? Talk to us about more of the use cases or some of the products that become available. What can users look forward to having available to them?

Let's talk about some degenerate stuff that we can do with it.

Some of it isn't very degenerate, frankly, but it's a very cool new opportunity set. The first thing that I think you guys will like is the intra-market carry trade. We're really excited about this one because, specifically with Bitcoin, it's really hard to find Bitcoin yield that's even close to compensating you for going into some kind of wrapper or whatever. It's also hard to understand where that yield comes from. We don't know what's actually making it.

With the intra-market carry, you can get 2.5% by basically borrowing from a senior zone of a market. You take that USDC and resupply it a few clicks further out on the risk curve. What you've got is basically a neutral trade where you're capturing that delta. It's a very easy-to-understand trade to make, and it's just a borrow once, resupply once, and a great opportunity to earn some yield.

The same thing is available on wrapped staked ETH. I think we were looking at 6% as the yield. This was 3 weeks ago, so that could be up or down a little bit, but we think that'll be really attractive at launch.

Then I think there are so many opportunities as you get beyond where that 7.1x max leverage is today. Imagine what exists between 7x leverage and 20x leverage for on-chain credit markets. There's a whole host of opportunities with being the financing layer for the basis trade with perps. That's a huge area of opportunity.

Prediction markets are another one that we're looking at and talking to some potential partners about, including their market makers. How do we become the financing layer for where all this business is happening? There are different risk levels with all these things, and if you can't price that risk and keep it connected on a curve like we're doing, we think it's going to be really hard for anybody to offer that.

That's what we're trying to do: become, over time, this incredibly deep market that other credit markets and other products can go down to and reference.

David, we should probably touch on where you are with launching this. I don't want to gloss over the security angle here. This is net-new code, and it looks like everything has been made from the ground up. How do you get people comfortable depositing into something new like this? What are you doing on the audit and security side?

Yep, and great question. You have to be able to answer that question in this environment, right? So, just a little bit on our backgrounds again.

The combined team has managed $15 billion of AUM at different times, and maybe $100 billion of volume. We haven’t had any exploits across the team through Exodus, Index Coop, and so on. We’d like to think we’re veterans in that sense. We have an idea of the things to look out for, and we’re really focused on security.

We’ve gone through a series of really good private audits and remediated those. Right now, we’re scheduling our tier-one public audit. That’s the next big step for building confidence among allocators. A lot of our bigger institutional partners need that to give the final thumbs-up on moving significant capital through.

Another piece of that is what I mentioned with the collateral. As a new venue, it’s really important for us to focus on what we do really well and bring a ton of benefits to Bitcoin and ETH credit. We think we still have so many opportunities in those two biggest markets that we just don’t need to worry about the collateral game right now.

That helps a little bit. We just need to worry about being really, really good at our own platform security and our own code security. Another thing we’ll be doing is going through the SOC 2 certification framework. We think that’s a great checklist to make sure we have all of the little operational-security and administrative details covered, because that’s where people are getting hammered right now: key management, transitive dependencies from other packages they’ve had to run, and so on.

We’re going to be really clean on the things we can control and try to minimize the things we can’t control.

David, anything about the Aave-related exploit incident? I guess ultimately, the exploit happened through LayerZero’s infrastructure and affected Kelp, which plays a big role in that. There’s also Aave’s role, and I don’t think I’m mischaracterizing this: they greenlit collateral that ultimately allowed for the borrowing of all that debt.

I do believe some sort of circuit breaker would have been a smart design, looking back at it. This is something I believe Fluid employs, but Spark might also have a circuit breaker in case there’s too large of a borrow. I know Ethena came out after all of this took place and mentioned that they’ve always had a limit of, I think, $10 million in terms of bridging sUSDe or USDe. They talked about the fact that it’s a bottleneck and a bit of a pain for users who have that kind of liquidity, but they’ve had it in place because of incidents like this that they’ve worried about.

Taking all of that into account, what specifically have you taken away from this and either implemented or planned to implement into Lotus to prevent any future exploit?

We’re certainly looking into it. I have to admit, the circuit-breaker concept wasn’t on my radar among the top 50 things I needed to be thinking about until 2 weeks ago. But these are the opportunities where you have to look under every nook and cranny. You just can’t miss. These guys are too smart and have too many resources. I don’t know if all the exploits are from the same group, but they’re just too smart. You can’t mess up. The threshold is too high.

One of the things we’re looking at is going through all of our timelock policies, along with doing everything in that SOC 2 framework. It makes you think about all these things, and it makes you think about choices where you might like the product to be a little more adaptive or connected to other venues or other kinds of contracts.

There were a few decisions we made last week as a team. We said, “No, we’re just going to close the hatch here. We’re going to put a boulder in front of this potential hole or potential attack surface because the upside of what we could do with that surface right now isn’t high enough to justify the risk.”

To Morpho’s credit, we’re also using their V2 vault standard. Those guys are great when it comes to their approach to distribution. I think they’re some of the best thinkers out there in that area. We also think they’re great with their vaults, and we didn’t think we were going to be better experts on vaults than they were. So we adapted that, and it has been audited and is already out there.

We’ll just need to audit our adapter contract and make sure it’s really good for the vaults. The rest of it becomes our core protocol. We’ve made some decisions there as well, such as keeping the core protocol as slim as possible. Then you have modules and adapters around that, which can also help contain the severity of some of these events if you set them up the right way.

18. Closing + Lotus launch in summer 2026

We’re very excited for Lotus to fully go live and become available to anyone. As of this recording, you’re in a beta stage where users need to request access. Be sure to follow Lotus on Twitter for updates. Hopefully, this podcast serves as a great way to get fully caught up on the design behind the protocol.

David, thank you so much for joining us. I think this is a great place for us to start wrapping up. I want to remind our listeners that they can learn more about Lotus at lotuslabs.net. They should follow LotusFi_ on Twitter and follow David at David A. Reising—just his first and last name, with his middle initial. We’ll put that in the show notes so you can easily find it.

David, again, thank you for your time. Congratulations on coming up with what I think is a truly new innovation. Last bear market, we learned about Ether.fi and Ethena, and we did a podcast with Fluid. Those are just a few protocols that are top of mind and are household names now in DeFi.

We’re still relatively new to Lotus, but from what we understand, it feels like what you’re building could become another major platform in DeFi if it can attract liquidity and scale the way you’re hoping to scale it. I’m really optimistic that this is going to be another big platform in DeFi. Fingers crossed. I want to give you the final word before we go.

We’re excited about it. We’re ready to go. We’re looking at a launch in June, so we’ll keep our fingers crossed for that, too. But we have to make sure we get all our security work in order. It’s been fantastic chatting with you and being able to share a little more about Lotus.