What is a lending protocol: Aave, Compound, Morpho, and the three-party model

A lending protocol is a set of smart contracts that let one person lend crypto and another borrow it, without a bank, broker, or loan officer standing in between. Depositors supply assets and earn interest. Borrowers post collateral and draw a loan against it. The contract, not an institution, enforces the terms.

How it works

Every major lending protocol runs the same three-party model. Suppliers deposit an asset (say, USDC) into a shared pool and receive a yield-bearing claim on it. Borrowers deposit a different asset as collateral (say, ETH) and draw a loan in the supplied asset, typically at less than the collateral's value; that gap is the overcollateralization cushion. The protocol itself sets the terms algorithmically: interest rates float with utilization (how much of the pooled supply is currently borrowed), and if a borrower's collateral value falls too close to their loan value, anyone can trigger a liquidation and repay part of the loan in exchange for a discounted slice of the collateral.

Aave and Compound pioneered the pooled model: all suppliers of an asset share one pool, all borrowers against a given collateral type draw from that same pool, and risk parameters are set by protocol governance for the whole system at once. Morpho Blue took a different design path: each market is a single, isolated pairing of one collateral asset, one loan asset, one oracle, and one liquidation threshold, deployed permissionlessly and immutable once created. Isolating markets this way means a failure or a bad parameter in one market can't spread risk into another, which matters more as the assets get less liquid or more customized.

Why it matters

Lending protocols replace the credit function a bank normally performs, taking deposits, assessing collateral, setting rates, managing default, with code that runs the same way for every user, all the time, and can be audited by anyone. That transparency is the trade a bank can't offer: the rules, the collateral, and the liquidation logic are visible on-chain before you ever supply a dollar.

The tradeoff is that the collateral requirement is rigid. Because there's no credit officer to assess character or income, a lending protocol can only lend against collateral it can seize and sell instantly. That's fine for liquid crypto assets. It's the reason bringing real-world credit on-chain needs additional infrastructure the base protocol doesn't provide: a way to price, monitor, and enforce claims against assets a smart contract can't liquidate in a DEX trade.

Where this shows up in Rekord

Rekord builds on Morpho Blue specifically because isolated markets let real-world credit and crypto-collateral positions sit in separate, independently risk-parametrized markets rather than one shared pool. For the reasoning, see Why Rekord built on Morpho Blue instead of forking a monolithic lending protocol.