Euler V2 (EUL): A comprehensive overview of a modular lending ecosystem

What is Euler V2?

The limits of V1

Launched in 2021, Euler V1 was a decentralized lending platform that already stood out from the players of its time through a permissionless vision in creating new credit markets for assets.

Although this model was unprecedented, it suffered from some limitations: the market parameters were controlled by Euler and organized around a three-tier risk management system: isolation, cross, and collateral tiers. By default, a newly listed asset on the protocol was in "isolation" mode and could only be used as collateral under certain conditions.

This system, although more flexible than Aave or Compound, was still limited in its ability to accommodate markets with different logics. Furthermore, the monolithic architecture of the liquidity reserve shared among all assets amplified the impact of the 2023 hack.

In this context, Euler V2 was born from a dual realization: the limits of a monolithic approach, and the need for a more resilient, flexible, and adaptable infrastructure. Thus, Euler Labs decided to pause V1 to work on an entirely new version of the protocol.

Euler V2: a modular lending model

The general idea behind Euler V2 is to build a modular lending ecosystem. To achieve this, the protocol relies on an architecture centered around three core pillars: Vaults, the Euler Vault Kit (EVK), and the Ethereum Vault Connector (EVC).

• The Vault is an ERC-4626 smart contract functioning as an isolated structure and designed to hold a single ERC-20 token. This allows liquidity for each asset to be segregated, making the protocol resistant to systemic risks.
• The Euler Vault Kit is the tool that allows anyone to deploy a Vault (and thus a lending and borrowing market) for an asset, and to apply various customizable parameters (accepted collateral, interest rates, deposit limits, etc.).
• The Ethereum Vault Connector is the tool used to manage relationships between different Vaults, notably enabling the use of an asset from one Vault as collateral to borrow an asset from another Vault.

This new model allows for the permissionless creation of lending and borrowing markets and offers greater flexibility, with the possibility to customize features according to use cases, and enhanced security through risk isolation by separating liquidity for each asset.

Comparison V1 and V2

Euler V2 does not represent a mere update but a complete paradigm shift compared to the previous version. Here are the main differences between the two architectures:

• Architecture: V1 relied on a monolithic structure with a single liquidity pool shared among all assets. V2 adopts a modular architecture where each asset is isolated in a dedicated ERC-4626 Vault.
• Risk: The systemic risk of a single liquidity pool is replaced by a compartmentalized risk for each market.
• Market creation: V1 allowed for permissionless token listings, but parameters were predefined by the DAO (notably through a tiered risk system). V2 enables fully permissionless market creation, with complete customization of parameters at deployment.
• Risk management: V1 used a rigid three-tier system (Isolation / Cross / Collateral), with uniform rules. V2 delegates this management to “risk curators” or automates it for unmanaged markets, allowing a flexible and market-specific approach.
• Customizable parameters: V1 centralized the definition of oracles, interest rates, and liquidation thresholds. V2 gives each market creator the freedom to choose their own oracles, rate curves, hooks, and operational limits.

→ Check out our analysis on Euler’s history and the secret of its rebirth:

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The architecture of Euler V2

Euler Vault Kit (EVK)

The Euler Vault Kit (EVK) is the core of Euler V2’s permissionless infrastructure. It is a deployment framework designed to allow any user or protocol to create a Vault — and therefore a new credit market — completely autonomously.

The Vault is the fundamental building block of Euler V2, as it stores both the collateral assets deposited by borrowers and the funds deposited by lenders.

Concretely, a Vault is an ERC-4626 compliant smart contract, dedicated to a single ERC-20 token. Each Vault operates as an isolated structure, with all of its operating rules defined by the creator using the EVK.

These configuration parameters are numerous:

• The tokens accepted as collateral in the Vault.
• The interest rate curve, which can be chosen from several integrated models (linear, exponential, stepped) or fully customized via a hook.
• Deposit and risk exposure limits: maximum TVL, borrowing limits, Loan-to-Value (LTV), liquidation threshold, etc.
• Price oracles, with the possibility to use Chainlink feeds, Uniswap TWAPs, Pyth, or any other validated system.
• Custom hooks, which allow extending the Vault’s features (see dedicated section).
• The type of governance applied to the Vault: Trustless (non-managed, with fixed parameters) or Managed (administered by a curator who can dynamically adjust parameters and manage risk)

Thus, Vaults can be designed for a wide variety of use cases, ranging from ultra-conservative stablecoin markets to exotic, highly volatile, or experimental markets. This flexibility is at the heart of Euler V2’s thesis: to create an infrastructure capable of supporting the full diversity of decentralized finance needs without imposing a one-size-fits-all model.

The EVK also includes all the functions needed for the operational management of a Vault: minting of deposit shares (sTokens), minting of debt shares (dTokens), interest processing, liquidation management, etc.

Finally, it is important to note that the kit is modular and extensible: new modules can be developed and integrated at any time, allowing the Euler ecosystem to evolve without requiring updates to the main protocol.

Ethereum Vault Connector (EVC)

The Ethereum Vault Connector (EVC) is the component that interconnects multiple Vaults to create functional credit markets. This role is crucial, as it enables users to deposit an asset as collateral in Vault A and borrow a different asset from Vault B.

From a technical standpoint, the EVC acts as both a state manager and an intermediary between the vaults and all other parts of Euler. Here are some examples:

• The EVC is responsible for updating user account states. This account contains details on collateral positions, open debts, and associated vaults. With each user action, the EVC updates the account.
• When a user wants to open a new position in a Euler market, the EVC communicates with the controller, a core function of each vault. It then determines whether the action is authorized based on its impact on the user’s solvency.
• The EVC also manages operations affecting multiple vaults simultaneously, using a batching mechanism that improves user experience and reduces gas costs.
• When a user's position health becomes critical, the EVC enforces each Vault's rules and triggers liquidations.

The EVC is designed as a modular registry. New Vaults can be connected at any time, provided they respect the protocol’s standard interfaces. It also enables integrations with external layers, notably other DeFi protocols.

In summary, the Ethereum Vault Connector is the component that allows the modular architecture to be fully utilized, ensuring consistent management of user positions across multiple markets while allowing each Vault complete control over its internal rules.

Markets in Euler V2

In Euler V2, a market is a structure where borrowers can obtain loans and lenders can deposit their assets to earn interest. Concretely, a market connects several vaults to form a coherent lending and borrowing environment.

Market creators are curators whose role is to deploy vaults on Euler via the Euler Vault Kit (EVK) and then connect them through the Ethereum Vault Connector (EVC).

For example, Usual Money is the curator of a market called “Usual Stability Loan” connecting two vaults on USD0 and USD0++. Thus, users can deposit USD0 to borrow USD0++. Note that this market represents $688 million in TVL, or just under a third of Euler's total TVL.

When creating a market, curators determine several parameters and rules that will govern user interactions. These include risk assessment methods, oracles, interest rate curves, hooks, governance types, and more.

It is important to note that market deployment is permissionless and that the same vault can potentially be integrated into several markets, as long as its parameters are compatible. This modularity enables greater composability and can potentially accelerate liquidity and growth for new markets.

Since markets are fully configurable, there are several major categories on Euler V2:

• Simple collateral-debt pairs: Vault A → Vault B. This is the most basic market, where Vault A can be used to borrow from Vault B, like in the Usual Stability Loan example above.
• Collateral-debt pairs with rehypothecation: Vault A ←→ Vault B. In this market type, assets from Vault A can be used as collateral to borrow from Vault B and vice versa.
• Multiple collateral: Vaults A, B, C → Vault D. Here, assets from Vaults A, B, and C can be used as collateral to borrow the asset from Vault D.
• Cross-collateralized: Vault A ←→ Vault B ←→ Vault C ←→ Vault A. In this case, assets from Vault A can be used as collateral to borrow from Vaults B and C; assets from Vault B can be used to borrow from Vaults A and C; and assets from Vault C can be used to borrow from Vaults A and B.
• Fully customizable: This category encompasses all possible combinations of the previous types. For example, Vault A in a "simple collateral-debt pair" market can be connected to a "multiple collateral" market, one of whose vaults is connected to a "cross-collateralized" market.

→ For further details, see our overview of all Euler V2 products:

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Risk Management

Euler V2 relies on a completely reimagined risk management system consistent with its new modular architecture. Unlike V1, which imposed a rigid logic (Isolation, Cross, Collateral tiers), V2 delegates this management at the vault level, with a dual approach: hard-coded risk parameters for trustless markets and “Risk Curators” responsible for dynamic evaluation of managed markets.

Types of Vaults: trustless vs managed

In Euler V2, each Vault is based on a fundamental governance choice that determines its risk management strategy: trustless or managed. This choice defines the market's flexibility level, the type of users targeted, and above all, the system's ability to adapt to changing market conditions.

• Trustless Vaults:

Trustless vaults are completely autonomous: their parameters are set once at deployment and then frozen over time. No actor, not even Euler Labs, can modify them. This includes accepted collateral, Loan-to-Value (LTV), liquidation thresholds, interest rate curves, and oracles.

This approach guarantees maximum predictability for users: the operating framework is transparent, deterministic, and immune to human or political decisions. This makes them particularly suitable for stable assets, conservative markets, or experimental use cases that want to avoid any form of intervention.

However, this total absence of governance comes with a structural risk: the inability to adapt parameters to changing market conditions. In the event of volatility in an asset, oracle failure, or sudden collateral depreciation, the Vault remains passive.

Thus, users must manage their exposure themselves, assuming full responsibility for their positions. Using this type of Vault is akin to adopting a fully autonomous approach to risk management and requires constant vigilance.

• Managed Vaults:

Conversely, managed vaults are administered by a Risk Curator, an actor responsible for active market supervision. This curator can adjust certain vault parameters in real time (within the framework’s authorized limits) to ensure its security and profitability.

They can react to changes in asset volatility, deactivate risky collateral, readjust LTV based on conditions, or update oracles as needed.

This approach is more flexible and allows for dynamic risk management, comparable to that performed by a risk manager in traditional finance. It thus targets more complex, volatile, or innovative markets where human oversight is preferable to a rigid framework.

The role of Risk Curators

Risk Curators are the designated actors responsible for supervising one or more managed vaults. Their mission is to ensure the security, profitability, and proper configuration of the markets they oversee.

As explained above, this role is similar to that of a traditional risk manager in finance, requiring rigor, transparency, and accountability to users. Curators can be professional entities (protocols, funds, DAOs) whose legitimacy is based on their technical expertise and reputation.

Euler does not impose a single governance model for these curators but provides mechanisms for community monitoring. In the future, it is possible that Euler governance (via the EUL token) could influence the assignment or revocation of these critical roles.

→ See our interview with Michael Bentley and our Analyst Notes, featuring the best moments explained and analyzed:

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The liquidation mechanism

General functioning

The liquidation system of Euler V2 is designed to adapt to the diversity of markets while ensuring maximum protection for lenders. Unlike traditional models where liquidation mechanisms are standardized and inflexible, Euler offers a fully customizable framework, integrated directly into each vault.

As in any lending protocol, a position becomes eligible for liquidation when it exceeds a certain safety ratio defined by the Loan-to-Value (LTV) or liquidation threshold. In Euler V2, these parameters are specific to each vault and can be adjusted based on the type of asset, its volatility, liquidity, and the market's risk tolerance.

When a position is liquidated, Euler follows a model similar to Aave or Compound, where the liquidator repays part of the at-risk account’s debt and receives a portion of the collateral at a discount, known as the liquidation incentive.

However, Euler completely redefines this logic at the vault level since each vault defines its own liquidation conditions, including:

• Customizable incentives: The discount rate given to the liquidator is configurable.
• Alternative liquidation modes: Hooks can introduce reverse auctions, DAO backstops, or other innovative closing forms.
• Contextual rules: Liquidations can be activated only under certain market conditions or limited to certain liquidator profiles (whitelists).

Risk management

One of the fundamental contributions of the vault system is that each liquidation process is completely isolated. It can only affect the specific market in question and has no impact on other vaults in the ecosystem. This property limits the contagion effects observed in monolithic protocols (as seen during the Euler V1 hack) and makes the protocol more resilient to extreme events.

Thus, in the event of instability in a specific market (collapse of a stablecoin, oracle manipulation, sudden collateral depreciation, etc.), the rest of the Euler ecosystem remains fully operational.

For example, a vault creator can choose to create a market where liquidations are carried out exclusively in USDC, regardless of the borrowed asset. This guarantees greater predictability for liquidators and helps maintain market liquidity even during periods of stress.

This level of granularity in configuration opens the door to unprecedented scenarios: partially insured markets, "grace period" liquidation mechanisms, hybrid modes between automated market makers and lending, and so on.

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The rewards mechanism

General functioning

Euler V2 introduces a much more sophisticated economic architecture than V1, designed to better align the interests of users, market developers, risk managers, and the DAO. One of the major innovations lies in the explicit separation between fees generated by vaults and rewards distributed through independent incentive mechanisms.

Unlike other protocols where collected fees directly fund distributed rewards, Euler V2 completely decouples these two elements. Fees are defined and collected at each vault level: interest paid by borrowers, liquidation commissions, or revenue generated from custom hooks.

Their allocation is also configurable: they can be directed to the Euler DAO, to the vault creator, or to a risk curator when a vault is managed. By default, the user receives 90% of the interest generated, while the remainder is split equally between the vault curator and the DAO.

Rewards, on the other hand, follow an entirely independent circuit. They are managed through a system of reward streams and reward programs, allowing any actor to fund and structure an incentive policy for protocol users.

Reward streams

The system relies on two components: Reward Streams, which define the allocation of a given token over a specified period, and Reward Programs, which specify the distribution rules.

This mechanism allows any protocol or third-party DAO to create an additional rewards stream (in points, tokens, etc.) on any market. The goal is often to attract liquidity to a specific vault, incentivize borrowing, reward risk management actions, and so on.

For example, a Reward Program might distribute 70% of the tokens from a stream to lenders of a Vault and 30% to borrowers, with dynamic weighting based on engagement duration or activity volume. The system is fully permissionless and programmable, while remaining compatible with front-end interfaces through the “Rewards Manager” governance module.

Fee Flow

The Fee Flow of Euler V2 is an open-source module designed to optimize the management of fees collected by the protocol. It is based on an auction mechanism aimed at converting the wide variety of assets collected through fees into a single asset: EUL.

In concrete terms, the fees generated by the vaults (for example in eUSDC, eDAI, or eWETH) are first accumulated in each vault. Then, they are sent to a contract called FeeFlowController to enter the Fee Flow auction circuit.

At each epoch, auctions are launched on the fee packages generated by the vaults. Their price is set according to a specific rule and then follows a linear decay curve until reaching zero. The auction closes when a buyer decides to pay the current price to obtain all the tokens accumulated in the contract.

Once the auction is completed, the tokens are transferred to the buyer (eUSDC, eDAI, eWETH, etc.), and the amount paid (in EUL) is redirected to Euler DAO’s treasury. The DAO can then decide to burn these tokens, redistribute them, or fund growth initiatives.

This mechanism presents several advantages:

• It allows the conversion of a wide variety of assets (including those without reliable oracles or with low liquidity) without relying on classic on-chain swaps.
• It significantly reduces exposure to MEV attacks, since the conversion is done via a transparent and predictable auction process.
• Even small amounts of fees can be integrated into a future auction flow if immediate transfer isn’t economically viable (for example, if gas fees are too high).

Take an example: if the protocol collects $10,000 in eUSDC, these fees will be bought by bidders, who monitor their value off-chain and wait for the price to drop to an attractive level. When a bidder wins the auction, they pay in EUL, receive the $10,000 in eUSDC, and the EUL collected is sent to the DAO.

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Conclusion and outlook

Euler V2 marks an important turning point in the evolution of the protocol, with a modular architecture that stands out for its flexibility and permissionless approach. By allowing each market to define its own parameters and by isolating risks through the Vaults, Euler addresses diverse needs while limiting the propagation of potential failures.

In the long term, this modularity paves the way for innovations that are still largely unexplored in DeFi: the integration of real-world assets (RWAs), uncollateralized loans, spot derivatives products, or even P2P lending without oracles.

Moreover, the concept of vault combinations, made possible by the EVC, could enable the creation of new yield loops and advanced strategies. This is notably one of the ambitions of the upcoming “Earn” product, which aims to make Euler a central platform for building complex financial products.

This content is part of an OAK Research initiative: a protocol-focused week. You can find all our other analyses on Euler on our platform.