Morpho Labs Co-Founder Slams Illiquidity FUD: Vaults Remain Robust Post-Stream Finance Collapse

Morpho Labs' leadership fires back at critics questioning vault liquidity—calling the concerns "baseless" after Stream Finance's meltdown.

The DeFi space watches closely as Morpho reassures users their funds are safe, liquid, and fully operational despite sector-wide contagion fears.

"Our vaults have weathered worse," quips the co-founder, dropping subtle shade on competitors' risk management. Classic DeFi drama—where the real yield is in the Twitter threads.

Merlin Egalite on what he thinks about “illiquidity” in vaults 

According to Egalite, any illiquidity is isolated and contained to the given markets with an imbalance, which is why he boasted that during the market stress, only 3–4 out of 320 vaults on the Morpho App experienced temporary illiquidity while the rest operated normally. 

“Claims of protocol-wide illiquidity are mispresented,” he stated. “In the end, illiquidity doesn’t mean losses or bad debt. It means a short-term imbalance where most funds are borrowed, while the market responds in real time, repricing risk and finding its equilibrium.”

Paul Frambot, Morpho’s CEO and co-founder, echoed the sentiment in a separate tweet, pointing out the risky nature of DeFi. 

“A vault is comparable to an onchain fund, and just like traditional funds, some will perform well and others won’t, but this is what we must accept and mitigate if we want to build a truly open and decentralized system,” he wrote before claiming that the fact that “only 1 out of ~320 vaults on the Morpho App had limited exposure to xUSD is evidence that the model works.” 

“Morpho’s isolated market + vault model meant all 319+ other vaults and their depositors, each with different risk profiles, had zero exposure,” Frambot continued. “Many assume losses equal system failure. However, in open financial systems, losses are a natural consequence of risk-taking, even when systems operate exactly as designed.”

Frambot urged the industry to focus on better surfacing and educating about risks because for DeFi to become the backend of finance and scale to trillions in lending volume, “lending infrastructure must remain separate from risk management.”

The Stream Finance situation remains unsolved

As of the time of this writing, the Stream Finance debacle remains unresolved, with ongoing investigations and frozen operations that have resulted in the protocol suspending all deposits and withdrawals while retrieving remaining liquid assets. Meanwhile, the outfit’s stablecoin, Stream USD (xUSD), continues to trade depegged at around $0.165, down dramatically from its $1 target.

DeFi research group Yields and More has since identified nearly $285 million in direct debt exposure across multiple lending protocols, an exposure that affects the likes of Euler, Silo, Morpho, and Gearbox, with curators TelosC, Elixir, MEV Capital, and Varlamore among the most exposed creditors.

It remains unclear how settlements will occur between xUSD, xBTC, and xETH holders and lenders against these tokens. xBTC and xETH are Stream’s yield-bearing wrapped versions of Bitcoin and ethereum and were used as collateral across DeFi lending markets.

A CoinMarketCap report claims an anonymous on-chain trader, Cbb0fe, had cried wolf days earlier, warning that Stream’s on-chain data reportedly showed xUSD’s supporting assets at only approximately $170 million, even though borrowing had reached $530 million, an imbalance that created a leverage ratio exceeding 4x through the protocol’s recursive looping strategy.

There has been backlash since users discovered Stream had allegedly been accumulating an undisclosed insurance fund from profits, with pseudonymous user chud.eth going as far as accusing the team of allegedly retaining a 60% undisclosed fee.

In response, Stream claimed that those funds were to be used always as an insurance fund, citing internal communications and investor updates. The protocol has since acknowledged that they have not been very transparent about how the insurance fund works, but no recoveries have been reported yet, and liquidity for xUSD remains NEAR zero.

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