Introduction​

Vesu is the latest innovation in DeFi’s lending sector, enabling fully permissionless, over-collateralized lending markets that combine the strengths of both pooled and isolated liquidity systems. It integrates Aave-inspired lending pools to enhance efficiency, alongside the provision for permissionless pool creation, thereby removing the governance overhead found in existing lending markets and maximizing decentralization. At its core, Vesu delivers an experience reminiscent of Aave, offering users access to aggregated liquidity in lending markets. This framework facilitates the lending and borrowing of designated assets under specific conditions. However, Vesu diverges from Aave in its unwavering commitment to unpermissioned, truly neutral protocols. By adopting this stance, Vesu allows the “free markets” to coordinate around capital allocation instead of a central governance unit.

But beyond the “free markets” approach, Vesu also offers numerous technical advantages to provide users with the best user experience and rates. Let’s take a look at a few of these features.

Lending Pool Design​

Much like market leader Aave, Vesu is designed to support maximal liquidity pooling and capital efficiency. However, other than Aave, Vesu is a modular protocol and supports permissionless pool creation. While all liquidity is managed in a monolith, risk is isolated between pools. To better understand the benefits of such a design, let’s first back up and understand the different, specific elements that come together to form a lending protocol, such as a position, a lending pair, and a lending pool.

The deposits and debts of the Vesu protocol are tracked by “positions”. A single position keeps track of the collateral assets supplied and debt assets borrowed by the position owner in a specific lending pair. Unlike platforms like Aave, which utilize a global account model to track interactions within a pool, Vesu allows users to maintain distinct positions for each lending pair, facilitating precise oversight of individual pairs. This design enables the enforcement of pair-specific loan-to-value (LTV) ratios, directly addressing the unique risk profiles associated with each lending pair. Opting for simplicity, Vesu's approach further reduces implementation complexity and increases security.

A lending pair constitutes a one-way lending agreement, enabling participants to deposit a designated collateral asset (e.g., WETH) in exchange for borrowing a specific debt asset (e.g., USDC). In Vesu, this process is governed by a predetermined loan-to-value (LTV) ratio, underpinned by liquidation protocols to enforce compliance. Due to the permissionless nature of Vesu’s pools, lending pairs are configurable during the creation of a new lending pool.

Expanding from the foundation laid by lending pairs, lending pools facilitate more elaborate lending configurations through the amalgamation of multiple lending pairs. This arrangement allows for the pooling of assets, thus serving as collective liquidity for all constituent lending pairs within a pool. This design principle not only enhances capital efficiency but also maintains liquidity isolation across different lending pools, effectively segmenting risk (more on this later).

Illustrating the versatility of lending pools:

• Pool A exemplifies the simplest form of a lending pool configuration, comprising a single lending pair. This arrangement allows for the borrowing of USDC against WETH collateral, adhering to a maximum loan-to-value ratio of 80%.
• Pool B introduces a bi-directional configuration, where collateral assets are interchangeable with debt assets. This mirrors the traditional financial practice of rehypothecation, wherein collateral assets are reused to augment capital efficiency. However, this practice inherently introduces additional risks through the creation of collateral chains. While Vesu lending pools do not inherently offer borrowers the option to opt out of their collateral being rehypothecated, the utilization of uni-directional lending pairs provides a nuanced level of control over the activation of collateral rehypothecation at the pool level.
• Pool C unveils a configuration that accommodates the borrowing of USDC with various collateral assets. Each lending pair within this pool prescribes a specific, collateral-dependent maximum loan-to-value ratio crucial for balancing capital efficiency against the safety nets provided by liquidation protocols.

Risk Isolation​

Isolated pools represent discrete lending environments that cater to a specific assortment of assets. This approach is notably different from a unified cross-collateral pool where any asset might be borrowed against another. While isolated pools do not eliminate risk, they do confine it to the individual pool instead of the protocol's entire total value locked (TVL). In this design, each pool has its own liquidity and risks, separate and apart from the other pools in the Vesu ecosystem. This mechanism acts as a form of risk containment for assets deemed as higher risk. Moreover, the advent of isolated pools allows for the introduction of a broader range of assets and the adoption of more daring operational parameters.

“Bad debt” occurs within a lending pool when the liquidation process fails to cover the total outstanding debt when selling the collateral tied to a position. This scenario is akin to traditional bank runs, where even the mere anticipation of bad debt, irrespective of its actual presence, can trigger a rush to withdraw the remaining liquidity from a pool. A proven strategy to counteract the risk of such liquidity crises involves the communal absorption of any developing shortfall among the liquidity providers of the pool. Vesu takes a similar approach. Consequently, any emerging shortfall is apportioned among the liquidity providers according to their share of the liquidity pool and executed within the same transaction that sees the shortfall arise. This method of immediate “bad debt” absorption stops a potential “bank run” scenario.

Price Oracle​

The assessment of a position's solvency is crucial for the stability and trustworthiness of lending protocols. This assessment hinges on whether the value of the collateral within a position is adequate to cover its debt should the borrower default. Traditionally, this solvency check is conducted using external data feeds known as oracles, which supply real-time price data. Recognized for their efficiency, oracles are central to most lending protocol designs. However, alternative methodologies exist that utilize internal mechanisms for price discovery. Within this framework, Vesu positions itself by outsourcing the oracle functionality to the extensions (more on that below) associated with each lending pool. This delegation of oracle price feeds to the extension allows pool designs to continuously innovate on the oracle solution.

Lending Hooks​

The introduction of "lending hooks" by Vesu represents a significant stride toward flexibility and innovation. Lending hooks operate much in the same way than Uniswap v4 hooks with triggers after certain actions. These hooks are essentially separate programs that are invoked at various stages of user interaction with the lending protocol. Specifically, Vesu offers the following lending hooks:

• price
• rate_accumulator
• before_modify_position
• after_modify_position
• before_liquidate_position
• after_liquidate_position

These hooks serve as entry points for user-defined custom logic and functionalities, ranging from oracle price feeds to interest rate calculations, position modifications and liquidations. The flexibility offered by these hooks allows developers to tailor lending pool behaviors to specific needs or market conditions, thereby enhancing the protocol's utility and appeal.

Flash Loans​

One of DeFi’s most innovative “unlocks” that separate it from TradFi has been the creation and evolution of flash loans. Flash loans, by design, are unsecured loans that must be repaid within the same transaction or the transaction is reverted. Vesu's particular integration of flash loans into its protocol allows flash loan users to access its protocol-wide liquidity rather than being confined to the liquidity available within individual pools. This access to global liquidity enables a plethora of advanced financial strategies, such as more efficient liquidations and sophisticated position rebalancing, that is not possible on other lending protocols. Another unique aspect of flash loans on Vesu is that users can utilize them without facing any fees. This fee-less approach underpins Vesu’s commitment to fostering an open and inclusive financial ecosystem.

Conclusion​

Vesu aims to set a new standard in the DeFi lending space by offering a unique amalgamation of pooled and isolated liquidity systems to create a modular, efficient, and fully decentralized lending protocol. Drawing inspiration from the current market leaders, Vesu enhances user experiences by facilitating access to aggregated liquidity and permitting permissionless pool creation. Its modular pool design and the incorporation of strict risk isolation coupled with Uniswap v4-style hooks offer a flexible and secure environment for users to freely create and experience a new wave of lending markets. By championing the principles of permissionless innovation and free-market capital allocation, Vesu not only addresses existing challenges within DeFi lending but also paves the way for a more inclusive, secure, and user-centric future in decentralized finance.

DeFi’s Beginnings and Constant Evolution​

In the ever-evolving landscape of DeFi, the paradigms of traditional financial services continue to be fundamentally challenged and redefined. Arguably, DeFi’s biggest and earliest widespread breakthroughs were the decentralized exchange (DEX) and on-chain borrowing and lending platforms. The evolution of the DeFi lending space has been marked by significant milestones, beginning with the launch of ETHLend in 2017. ETHLend introduced a peer-to-peer lending model on the blockchain, eliminating intermediaries and using ether as collateral, making lending more accessible and efficient.

Aave and Compound expanded on ETHLend's foundation, introducing liquidity pools and features like over-collateralization and flash loans, which revolutionized DeFi lending by offering more efficiency and composability. The pooled liquidity model further simplified the lending and borrowing process, ensuring security and ease of access for users. Compound is also known for its governance model which was one of the first to emphasize a decentralized decision-making process, as well as bringing the idea of “yield farming” mainstream.

The DeFi lending space continued to evolve with the introduction of adaptive interest rate models, oracle-less designs, and permissionless pool creation. The latter has been pushed by platforms like Morpho and represents the latest advancement in DeFi lending. It allows for the creation of new lending pools by anyone without a central governance unit deciding on supported assets and other risk parameters.

Lending protocols have become essential to any DeFi ecosystem and have continually rolled out efficiency advancements over the years. In today’s protocols, features like pooled liquidity, flash loans, and risk-mitigation techniques are commonplace. On the other hand, one can see two distinct design approaches with respect to how risk parameters are managed.

DeFi Lending Market’s Two Primary Designs​

Despite the multitude of parameters that can be tweaked in constructing different on-chain lending protocol designs, one element that cleanly segregates the market into two distinct camps is how the protocol ultimately handles risk management. The two competing approaches can be described as:

• Central governance: risk management is controlled by a central governance unit, generally a DAO, where parameters often are voted on, rolled out, and managed in a top-down manner (ex: Aave, Compound)
• Free markets (ungoverned): Protocols that actively repel and eschew central governance due to the attack vectors they enable and instead simply rely on smart contracts to adjust risk parameters and the free market (the users) to handle their own risk management (ex: Morpho Blue)

Central Governance Model​

The DAO-driven model relies on smart contracts for custody and general market mechanisms, yet also reintroduces central intermediaries to manage risk parameters. This hybrid model has allowed early lending platforms to create a moat of liquidity and users, yet it is also prone to shortcomings highlighting the challenge of scaling in a semi-decentralized context.

The arguments for a centrally governed model are that it enables the DAO to elect specialists to monitor on-chain activities and risk parameters that normal community members either will not or are incapable of doing. Protocols that have adopted this model typically defer to the specialist to adjust their risk parameters, ex: Loan-to-Value (LTV) ratios, as the market dictates. This approach not only aids in maintaining a unified liquidity pool but also ensures a “hands-off” experience for users who entrust the specialist with risk management on their deposits. In scenarios where the market environment deteriorates, it falls upon the specialist and the DAO to modify the protocol's parameters to better align with the changing conditions.

Despite its advantages, the central governance model of risk management is not without its shortcomings. DAOs, while pioneering in the DeFi space, are not immune to the operational, cyber and human risks that plague traditional organizations. Additionally, smart contract powered governance systems are vulnerable to the same design and technical flaws as the lending protocol itself as witnessed by past exploits resulting in losses of hundreds of millions USD. Furthermore, the politics within DAOs often mirror those of traditional entities, challenging the notion of neutrality and creating barriers to entry for newcomers. This political dynamic, coupled with governance bottlenecks, can significantly hinder the DAO's ability to make efficient capital allocation decisions, thereby limiting market scalability.

Free Markets Model​

The current alternative to the central governance model can be described as a hands-off, free-market approach to handling risk. The exploration of free market principles within the lending protocol landscape introduces a dynamic where lenders are empowered to navigate their own risk/reward pathways, essentially allowing market forces to dictate the equilibrium of risk parameters. This model hinges on the belief that free markets are better at allocating capital than any form of central governance and that only neutral, aka un-governed, technology empowers truly free markets.

Lenders and borrowers, under this regime, are granted the autonomy to select their liquidity pools based on personal risk tolerance or create new pools if the existing ones are not compliant with their tolerance. As one would expect, this creates a diverse array of lending and borrowing scenarios, catering to the varied needs of users.

At the protocol level, the absence of overarching governance simplifies the foundational codebase, making it more robust and secure. This design philosophy aims to streamline the core functions of the protocol, relegating complexity to use case specific peripheral modules.

However, the free market approach is not without its challenges. One significant issue is the fragmentation of liquidity, which can undermine capital efficiency. Isolated pools, while offering tailored risk/reward profiles, may struggle to achieve the same level of market penetration as their monolithic counterparts, primarily due to the need for continuous rebalancing across pools in order to optimize both borrowing cost and income from supplying assets. The requirement for borrowers to provide non-yielding collateral in many isolated markets exacerbates this issue, contrasting with monolithic models where assets can serve dual purposes—acting as collateral while still earning yield. The limitation on capital efficiency from the user perspective cannot be overstated, as users are more likely to make their decisions based on easy-to-comprehend KPIs rather than the nuanced trade-offs involving pooled vs. isolated liquidity.

Introducing Vesu​

Vesu, DeFi’s latest progression in the on-chain lending space, is a pioneering platform designed to facilitate fully permissionless, over-collateralized lending agreements. With its ambitious design, Vesu looks to combine the best aspects of both worlds: a liquidity monolith with permissionless, multi-asset lending compartments aka lending pools. Risk is isolated across lending pools and governance delegated to these pools individually. Vesu thus implements the free markets approach in that no central governance exists and lending pools can be created permissionlessly. Through its modular lending pool design, Vesu allows for a large degree of flexibility in terms of expressing different lending arrangements including a strict two asset design and more capital efficient multi-asset pools as known e.g. from Aave.

Moreover, one of Vesu’s biggest differentiators is the concept of extensions akin to Uniswap v4 hooks, empowering developers to create entirely new lending experiences. This flexibility positions Vesu not only as a lending protocol but also as a foundational platform for the development of new lending protocols. Additionally, because it is permissionless and there is no central governance adding friction and politics, Vesu offers a truly neutral technology for “free market competition” amongst lending markets.

At its core, Vesu addresses the limitations of existing protocols while introducing innovative features that cater to the needs of a broad spectrum of users. Its modular, permissionless, and scalable architecture, coupled with a focus on simplicity and security, positions Vesu as a cornerstone of the next generation of DeFi lending platforms.