A big thanks to Samneet Chepal and @wvaeu for creating this transcript! If you haven’t listened to the episode yet, you can find it here.
Hasu 0:00
So welcome back to Episode Two, the second half of our top 20 on the biggest DeFi projects. I’m here once again with Su and Arthur and if you haven’t listened to the first part where we introduce Arthur and talk about all projects, DEX categories and spot lending, and synthetics lending, and go back and listen to that first. Otherwise, welcome back. Today, we will cover kind of, like, ah, we call them token bridges. So basically bridging kind of assets between different blockchains or between bank accounts and options, basically tokenizing stuff. And then we have a category that’s sort of money games, which we get to, and then basically the three things, three, projects in the top 20 that didn’t really fit into any category of their own. So we have Yearn, Nexus Mutual, and Libra. So welcome back you two and let’s start with the bridges.
Arthur 1:10
So the first bridge, I think that we’re going to talk about is Ren, or their flagship asset is Ren BTC. So Ren BTC was actually initially launched as an ICO in early 2018 as Republic Protocol. Initially it wanted to do like a dark pool for decentralized trading. But I think after a while, they pivoted to, like, instead of doing like, like a trustless asset bridge for other assets, like starting for Bitcoin and also like they have other assets or hiding their Bitcoin, the Ren BTC is the most successful one right now. And I think that the approach taken by them is, is very, it is a very useful and pragmatic approach, because I think that there’s a huge demand to use Bitcoin in the DeFi ecosystem, or just in Ethereum ecosystem in general. And the other solution, when they were launching is rapid, easy, which is like a centralized solution, which I didn’t talk about in the previous podcast. And so Ren BTC is supposed to be the more decentralized version of Bitcoin on Ethereum blockchain, and is done using like, what they call a cryptographic method called secure multi party computation SMPC to solve this to make it trust, so you can verify that there is a real Bitcoin backing this Ren BTC or using the cryptographic method. So I think this has been fairly successful since the launch, the Ren BTC is probably like the second highest synthetic BTC on the Ethereum blockchain. The first one is Wrapped BTC and its getting into the Curve pool and got a decent amount of liquidity and it’s kind of interesting that how Wrapped BTC seems like the favorite coin for the a lot of the DeFi hackers to get away with they usually convert their gains to Ethereum then do Wrapped BTC and then convert from Ren BTC to the real Bitcoin. And I’m not sure what happened to the to the afterwards but seems like quite a number of the hacker exploits on DeFi have used that route to get their money out from the system. Yeah, and beyond that, I think that the value capture is okay, I think that is decent. But I think that the number seems like it’s… because they take a certain percentage of fee for every conversion that if you can’t wrap your Bitcoin into Ren BTC you pay like one basis point, and vice versa when you unwrap. So the key challenge is what will happen to the fee if a lot of the Ren BTC is just not going to go through back and forth. I mean, once they enter the Ethereum ecosystem, they’re just going to stay there and not going to be converted out anymore so that the fee value capture on this part will be a little bit vague in that sense. And there was also some controversy about the current state of decentralization on trustlessness. I mean, I’m not the expert in this, but there are some who say that, that currently they are not really using the real SMPC – it’s like probably not a peer review or open source. I’m not expert on this, but I heard something about this. But yeah, but so far, it’s just been doing pretty well. Among all the cross chain of bridge projects I think it’s definitely doing is probably the most successful so far if you count Wrapped BTC out.
Hasu 4:53
Yeah, I agree with the characterization as a WBTC competitor. Also because they sort of disagree with the characterization of it being trustless. So, I’m also not an expert on this. But I think that the right way to think about multi party computation is basically just an implementation of multi signature. Right. So it’s sort of like a consortium where you have different machines in the Ren office or wherever they store, controlling or holding all the extra BTC in custody, and then issuing Ren BTC, against that on Ethereum. But yeah, I mean, they could kind of change this at any time. I think they have full control over it. So I don’t actually see this as trustless. I see it right now is fully custodial, which might be totally fine. Tether is fully custodial, right? But it’s its value proposition – it’s regulatory arbitrage. And that’s kind of the bracket where I put Ren BTC into right now. And it’s kind of proven by the hackers using it to cash out their BTC. And so far, the Ren team has never stopped any of those withdrawals, although they could, and that alone shows that it’s custodial. They do want to go I think in the future into a direction that’s a bit more like TBTC. So you have kind of fidelity bonds for the different notes that custody the key shots of those Bitcoins. So you would then have a protocol that watches the behavior of the custodians. And they have to put up a bond. And when they misbehave, for example, they deny withdrawal, or they withdraw coins that don’t have authorization, then that bond would be confiscated. So that’s I think, a possible direction for Ren to go, but it has this trade off, right? If you want your custodians to put up additional bonds, then the system will become more expensive to you. So I actually think it’s necessary for them to start with this custodial way. Because if the system was expensive to use read from the start, then I think it would be way harder to build the necessary network effect and liquidity for this token, so that users might eventually be willing to pay like this kind of upcharge for additional security. Any of you know much more Terra?
Arthur 7:25
Yes. So yeah, I’ll talk about Terra, actually, I have a pretty decent understanding of it. Terra was an ICO launched in 2018 and they raised a fair amount of money. And I think one of the reasons is because the co-founder, one of them is a very successful entrepreneur in the Korean e-commerce market. He launched one of the biggest e-commerce startups in Korea called TMON, Ticket Monster. And so that give him a lot of credentials to launch this and the launch of a decentralized stablecoin protocol built on a Cosmos SDK. So you can think of them as part of the Cosmos ecosystem. And the concept is pretty similar to the first initial design of Havven (HAV) actually, the precursor to Synthetix. Basically what happened is like the user of the stablecoin will pay a fee to the Terra token holder for providing this stability service. I think that the concept as a whole is very sound but on the detail in it, like in the details for example, how do you maintain the price stability and a peg? We won’t go too deep into this but there are some small challenges to it. But basically, I think that the general concept is sound, that you’re paying Terra, the Luna token holder, for providing some backstop to the stablecoin but also providing the stability to that. In a way you can think of it in a real world circumstance on a payment or when you’re using Visa and MasterCard for payment that the merchant pays 2% to Visa and MasterCard for having them to process this transaction. So the logic I think on that level is very sound.
Hasu 9:13
I mean, in a blockchain I guess, I get why you can’t do it kind of in a regulated environment, with Visa and MasterCard, but in a blockchain environment can’t you just wrap the the payment token and then transact with that so the underlying kind of Terra coin or whatever it’s called, doesn’t move?
Arthur 9:30
Yeah, I think that is definitely a way to get around it. But again, I think that the crux is like the network effect of the original stable coin so strong that the wrapped version will not be able to overcome it. So there’s definitely a lot of effort that will need to go to build the network effect and the distribution channel for that original version of the Terra stable coin so that even if a person wrapped it you will not get accepted anywhere. And the main use case of Terra stable coin has always been in the Korea commerce scene, I think mainly in e-commerce. If you measure it by some metric, they have the largest amount of fee paid to use a protocol because they have a Chai app that in Korea, you can download the app and use it to pay for a lot of e-commerce services. I mean, they have some way to get around it so that the user actually not using the stablecoin, but in a way that they are using the stablecoin. I’m not sure the exact details, I don’t really use it. But that actually leads to some new fee generation for the Terra validator as the staker. So they generated a fair amount of fee and the daily user is pretty impressive. I think that they have more than one and a half million of total registered user and daily users, I think 15,000-ish, I can’t recall the exact number. But it’s probably the most successful if you measure it by real world adoption in terms of payments. So the current user through the Chai app, are using a Terra protocol for the payment services and the stablecoin in some indirect method. And they are trying to get into the DeFi right now. I think that what they realized that this spent a lot of effort to build the e-commerce adoption in Korea, and actually they want to expand to Southeast Asia but it’s the real world move way slower than the crypto world. So I think that they are recognizing that right now, and they’re actually trying to move into the DeFi space. I think the launch of new thing called the Mirror Protocol. I think they partnered with some of the other Cosmos ecosystem projects. And I think that with the launch of the Cosmos IBC, they might be able to interoperate with each other. So I think this is doing fairly well. It’s just that their approach is not so crypto native, compared to most if not all of the other DeFi protocols we are about right now. So yeah, I think that it has a good amount of success in the mainstream space.
Hasu 11:56
Something I didn’t understand yet. So the Terra stablecoin, is it backed by dollars in a bank? Or is what is it backed by?
Arthur 12:04
It’s actually backed by the Luna token so it’s a little bit like Synthetix. Again, I’m not expert but I think that’s how it works and the fee that goes to the Luna token is what makes the Luna token valuable.
Hasu 12:18
I see. Okay, gotcha. Anything on Terra, Su?
Su 12:22
Yeah, I don’t really consider it DeFi per se. I mean, it’s definitely like crypto and then finance but not sure if it’s full DeFi just because it’s not really interoperable with anything that’s currently in DeFi. I mean the way that the original token sale for Terra was done I think it makes it quite a different project. I mean, it’s kind of got this interesting thing, right, where it’s a Korean project, but then has this like, very long list of investors that are like standard crypto funds. I never quite understood that. But I think maybe that’s a product of the time that it was conceived in. But with that said, yeah, it’s impressive the adoption that they have. I’m not sure the business model for the idea of the coin, is that proven? But we’ll have to see.
Hasu 13:26
THORChain, I think it’s a bridge like Ren BTC, but also has some elements of an exchange like Uniswap – it both tokenizes different coins. And I don’t really know how it works. And then you can trade these coins on sort of an off-chain exchange, or is it not actually off-chain? Because they do have their own blockchain? Right?
Arthur 13:46
Yeah. So again, okay, I’m not an expert at this, I try my best to explain how it works. I think that how was this like, I think from a user perspective, you have a key role of a validator that they actually putting on more Rune,the native token of THORChain, as the collateral to backstop the interoperability of it, so that you can actually go from the native token to the native token directly without using the wrapped version. So let’s say you want to change from Bitcoin to Litecoin you can actually use THORCHain to do so. It’s a bit like a Shape Shift, a decentralized version of Shape Shift launched by Eric Voorhees (OG Bitcoiner). And I think how they achieve this is using an economic guarantee like there’s always more Rune backing to the collateral being like it because they’re using an AMM as well but they have their own version of a CLP model of AMM that are providing liquidity for this but there was always more Rune backing the AMM asset so that you are not that worried that you will be like corrupted or what might be attacked because they have more to lose if something happened. But yeah, you can change from like a Bitcoin to Litecoin or to like Bitcoin Cash directly using THORChain. I think that is the vision that it saves all the wrapping hassle and the value capture is seen to be very strong like the order fee will go to the Rune token staker and validator. Yeah, I think that that’s my understanding of it. And I think that it has a very strong community as well, quite similar to Synthetix in a way that propels it to very monstrous gains this year. Although it is still in the testnet but it has been fairly successful if you measure it by price action and the performance of the token so far.
Su 15:31
Yeah, I think Rune’s an interesting project definitely seemed a bit hype-centric when it first came out. But I think that the bridging liquidity design that they have is definitely unique. And they have a first mover advantage there as well. It just remains to be seen what it will actually look like in mainnet. So I think it’s hard to really speculate about it as a project until actually, you can actually play with it and it works.
Hasu 15:58
Okay, so moving on to the final asset which is Reserve.
Arthur 16:03
I think one thing the most impressive thing about it is actually they spent a lot effort at an earlier stage of their protocol to analyze all the different pros and cons of the different stable coin models and in the end, they figured out that all of them have some key issues so that they came up with their own model. They adopted a gradual decentralized Seigniorage model where initially, I think stablecoin RSV is actually backed by actual dollars in cash, but they tend to gradually decentralize it to make it backed by the Reserve Right token itself. And I think one thing that sets themselves apart from other stablecoins or bridge protocols is they actually want to push for the adoption in the developing country first. And I think they spent a lot of effort in Venezuela to get the users to adopt stablecoin with a pretty normal mission, obviously, because we all know the situation Venezuela is in right now and they do need a stable currency. And I think they’ve been spending quite a fair amount of effort to penetrate Venezuela. Yeah, in terms of getting the stablecoin to become like a de facto currency instead of their own Venezuelan Bolivia. I’m not sure how successful it has been, but they definitely have a very impressive list of backers earlier on, yeah that’s all I know.
Hasu 17:23
Just going through the documentation right now on the screen. It says that the protocol is supposed to have three phases. So first, the centralized phase, where every token is backed by a small number of collateral tokens, each of which is tokenized US dollar, and then a decentralized phase where reserve is backed by changing basket of assets in a decentralized way. But it’s like, it’s more than 100% backed in every phase. Then the independent phase where they want to launch their own unit of account. So it’s no longer pegged to the dollar. Okay, so that’s a pretty ambitious goal to build the network effect for that.
Arthur 18:05
Yeah. And their backers are like probably the top investor list in crypto – if you look at the investor list — they have Peter Theil, Sam Altman, and other top Silicon Valley investors in that list.
Hasu 18:22
I guess that they changed their goals. So the architecture changed pretty radically because what I just read is nothing like what I first read about them in like 2018, when I looked into them, so it’s interesting to see them still stick around here.
Arthur 18:38
Yeah, but I think that they are probably also one of the few DeFi protocols that don’t really consider themselves DeFi. I mean, I have never seen them trying to interoperate with other DeFi protocols, or like trying to work together with any of the DeFi protocols that we have mentioned so far.
Hasu 18:57
So now next is a category that has a bunch of different things. So let’s, hop I guess into Yearn. Yearn is sort of a grassroots ecosystem with the main goal to allow users to deposit coins and then invest those coins in a way that the user can just set and forget. I’d be curious to hear what you think about them.
Arthur 19:19
I think Yearn is among all the different DeFi protocols that emerged this summer, you can say that it captured the most amount of attention and also had the most meteoric price action on a way up and also when it comes down – it’s pretty volatile. And I think the key is just that when you put it in a DeFi perspective it’s a little bit like a, I am saying this not to like offend the Bitcoiners, but I do think it’s similar to the Genesis with like how Bitcoin was being born in a fair launch. I mean, yes, Andre Cronje is he’s not anon, but the whole fair launch factor has captured a lot of people’s imagination on how a DeFi protocol can launch without VC involvement and it can be a pretty grassroots and community oriented protocol and still be fairly successful. And I think that if we’re just focusing on this aspect, and they’ve been fairly successful, in that end. I think the coin distribution right now is also fairly distributed. We actually know a few big YFI farmers that farmed more than 1000 YFI, and they actually sold most of it before it hit $10,000. So the distribution is actually, I think, quite distributed right now. And I think half of the supply is actually in centralized exchanges right now. So I think a lot of people have actually sold and bought it on and off again. So in that sense, you can say its a little bit like the Bitcoin of DeFi. It’s not money. The founder says it’s a worthless governance token, but everyone knows that it’s not really worthless because the people are willing to pay $22,000 for one YFI. So I think that is interesting. The first version of the project is really to be a yield aggregator because there’s so many new yield projects coming out like Aave, Compound, and Curve. So like for average users it’s very daunting to interact with all of them alone. So that you use Yearn you can just solve all of your issues because it just helps you aggregate and find the best yield for you and the founder built this to use it himself. And obviously he doesn’t want to govern the project, he launched a token to decentralize the governance process. And I think that that product has been quite successful for the first one to two months. And after that, I think there’s a new other day… they don’t move fast enough to catch up with the new yield farms. So I think that I need a new stuff – other new yield farming vehicles actually took some of the TVL away. And I think that even right now, I think that they are still trying to figure out a scalable way to run this yield aggregation strategy, because when the yield is lower than a certain level, people are just not going to do it anymore because the issue is you need to pay a performance fee and management fee for using the Yearn. And I think that right now the key challenge is that if you’re talking about this yield aggregation strategy alone, the key question to ask is, is it even possible to get a market neutral strategy that is also scalable at the same time, but yet achieve, a probably take a double digit APR consistently, I think this is actually quite challenging and difficult. And I think that version of the product is doing okay – it has like 400 million of TVL. But it has not really been growing for some period of time. But they are trying to go for like a more ecosystem play method – they are collaborating a lot the other DeFi protocols that for some one of them we’ve mentioned in a previous podcast, which is to Sushi Swap, and also a lot of smaller ones like Pickle and others as well, I can’t really recall the names. And I think it’s shaping up a bit like a kingmaker of DeFi in a sense for especially for the more fair launch, a grassroots community driven coin. When you collaborate with coin I think they can bring a lot of value to the table on how they’re going to run the DAO and the whole protocol and some synergy they can explore. I think that kind of becomes like a not so pure play anymore. They’re actually there’s more to Yearn right now. They can become whatever the community they want to become in a way. So it is a pretty special protocol. But it’s also quite hard to value right now. Even among the DeFi coins it’s among the more volatile one. And is this kind of like a trader’s favorite because it’s fairly liquid and it also moves. And I think that’s the state of Yearn, It’s definitely one of the top DeFi protocols but I think that it’s quite hard to define what it is right now.
Su 24:03
Yeah. Definitely YFI I think more so than any other coin of the DeFi summer, definitely a kind of a zero to one moment really where I kind of heard a funny phrase today, which was that this coin is so fair that I had to ape in as early as possible. Which is kind of ironic to me. And the idea that, you know, it’s like you know, because it’s so fair, it’s such a good buy at an early stage. And, and I think that like YFI really created this fair launch meme. The idea that you can have a DeFi protocol, which 100% of the coins are going to the users via some pre-defined metric and then see what happens and I think there’s a cardinality effect that is achieved by being the first to do that properly. Which is that like Arthur said, it’s like the Bitcoin on DeFi. It’s like you have the 30k cap, which I’m glad they did, because that was contested for a while, but it gave it a very commodity-like trading style, where you know that there was never any emissions. So in theory, if all the holders now, just believe it’s worth a million dollars, it’s going to go to a million dollars, right. That’ll just happen mathematically. But in practice, a lot of them will sell as it goes up. So it has that commodity fixed supply, thing that makes it very good to trade. And it has the kind of mythical Genesis story, which gives it an allure that is harder to replicate, even if you have a project that does the same thing. But kind of is launched after YFI. So I think it’s got that but like others said, you know, yield aggregation is a tough game in the longer term, because you don’t really know what fees will be paid, and how those will be received. And also, like longer term, if you don’t have inflation, then it will become harder to incentivize people to join the network. Because they would have to buy coins to then have a governance vote, as opposed to earn them. So you could have some issues with ossification from that.
Hasu 26:38
I guess you could use your cash flows, that it has a lot of cash flows, right, you could use those to buy up supply from the market.
Su 26:46
Yeah, you could, you could do that, you could do that there’s a number of ways you can do it. I mean, I think YFI holds a central role in DeFi. So people use it as a DeFi ETF as well. So that’s why you see the trading volumes are enormous on Binance and Coinbase. And, but it’s also very much a bet on Andre as well. Because Andre being the sort of volatile mythical figure that he is, kind of is the embodiment of YFI himself. So it’s definitely a bet on him and continued innovation and composability. So I think, you know, when people first analyzed YFI, they looked at it from the pure yield aggregation play perspective, and they didn’t really understand why it had any value, because you could just do the same thing. And they kind of didn’t understand the cultural context of that project as it was launching. So I think that prestige is actually very Bitcoin-like in the DeFi ecosystem and I think it will likely retain some of that prestige value over time – it’s just a matter of what innovations will they bring to also give cash flow values to the users and to the holders.
Hasu 28:06
I’ve been going through different stages with Yearn in terms of like, liking or not liking it. I liked it a lot in the very beginning, because same as Compound, it brought a lot of new innovation to the DeFi space, it’s one of those projects, if you tell people from outside of DeFi about it, and that’s kind of what makes it click for them. The things that you can do, right, this whole kind of superfluid collateral thesis, where we touched on this in the last podcast as well, but Yearn consisted of so many layers of basically tokenized balances that you could earn yields in several different protocols at the same time, all in a kind of set and forget nature. So it’s really highly capital efficient. And at the same time, it’s completely trustless and auditable. And I think that really highlights the power of the things that you can do in DeFi and with composability. But then, after kind of this, like first magic kind of wore off, then I saw that the people working on Yearn didn’t actually care about the user, it felt like they cared more about tinkering, like different stuff, constantly rewriting how the project worked. And that’s when you saw that like, you kind of notice there were like huge yield farming opportunities in DeFi and they just didn’t offer them for the users even though the market demand was there. And it was huge and projects like Harvest went over like a billion dollars of deposits when Yearn was at 200 even though Yearn had the capability to do this in a trustless way. And Harvest was actually for, like almost until the end was completely custodial. It was controlled by a single admin key, like a billion dollars, right? And there was this fun exchange between, I think you, Su and the founder of Harvest, what stealing a billion dollars and they said, who needs a billion dollars as the reason why they would have no incentive to steal it. But yeah, that was actually where I got really mad at them, and actually sold my coins. When they just refused to adopt new vaults and new strategies. I think they’re now at a point where they have started to add new strategies and kind of move a bit faster. But yeah, that’s kind of the downside of this super fair launch approach where you just have no people really incentivize to work on it, and, and the governance sort of so decentralized, that it becomes really hard to innovate.
Arthur 31:06
I need to add one thing, though, I think that the core group contributed in this form about Yearn and they’re actually getting paid for working on Yearn as well right now. But I think that even for a decentralized, fair launch protocol, you still need a person to act as a leader, I’m not sure who is the leader tight now, it’s probably Banteg and not sure if it’s Andre. I think without a leader figure if we come to some difference in opinion are you going to go voting every time? I think it’s not the best way of resolving some key issues, especially if only the insider know it better than anyone else. So I think that’s also probably one of the challenges of a decentralized community run protocol.
Hasu 31:51
Yeah, exactly, exactly. So that’s kind of the managerial role that was kind of missing from Yearn. Because I carried kind of my, what I thought was constructive criticism to the team. And the answer that you got was if you want it, then write it yourself. That’s what we tell everyone. And I mean, that’s not really how you run a business. Right. So they didn’t really care what the user wanted. They had their own idea of what was interesting and fun to work on. And that’s what they did. So, but I think they are really turning it around right now. So like the criticism that I brought forward, I don’t think it’s really valid anymore, just giving my perspective on what really soured this protocol for me for a couple of months. So, moving on, to Nexus Mutual, it’s one of two, or maybe one of three big insurance protocols, the other two being Cover and then there’s one Asian one that I don’t know all that much about. So let’s talk about how Nexus Mutual works and what it does.
Arthur 33:01
Sure, so I think Nexus Mutual is fairly straightforward. It’s a mutual, which means that it’s a member-based pool and being an insurance pool, every member contributes capital, and has a claim on the capital pool, but also providing coverage for people who want to insure against them and in exchange, they share the premium proportionally to how much capital pool they contribute. So it’s a fairly ancient concept and just applying it to DeFi. And I think it works, in a sense that if you want to purchase any insurance, for the DeFi protocol, or the smart contract insurance that Nexus Mutual is insuring, yeah you can go and do it, and it works. So I think in that sense, you can say it pioneered the approach of private insurance for smart contracts, which is definitely a big issue in DeFi and in Ethereum, as well. And I think it has been quite successful in getting that objective achieved, which is to provide insurance coverage for users who want to interact with different smart contracts. I think that you can definitely say it is very successful. And the founder, the team, also is fairly legit and have a very credible profile. They work as actuaries and were in the insurance space before. Yeah, it’s a very solid insurance protocol. But I do think that recently it’s losing – probably not the right way to describe it. But I think that the way that the whole pricing model is designed as a bonding curve, essentially, there’s a lot of second order effects on the price and on the people who contribute the capital to become a Nexus Mutual member, because at 100% MCR (minimum capital ratio) you can’t redeem your NXM token for the capital, which is ETH, anymore, so you have your capital stuff, and the only way you can sell it is you wrap it into a wrapped Nexus Mutual and sell it on a exchange. And that is actually…. a lot of people don’t think it would happen. But it did happen and it’s still there and currently it’s still 100%, which means that you can’t redeem your NXM through the bonding curve. And as a result, wrapped Nexus Mutual trades at a substantial discount to the actual NXM, I think about 30% or more right now, which, which can affect the confidence of some of the members because in a way they didn’t realize that they can get trapped inside of capital pool, or they need to sell it at a 30% to 40% discount on the open market. And I think that actually this issue is not an issue if you’re coming in from a user perspective of using the protocol, because, yes, you still get your insurance coverage, and you still get a payout if your claim is the right claim. But from a member perspective, I think that kind of made a lot of people think twice before providing the capital in the future, especially for bigger holders, because it’s actually quite illiquid and it doesn’t give them the flexibility to enter and exit, not even in a short time, but even over a more reasonable timeframe.
Hasu 36:19
Could you describe for someone who may be interested in getting insurance on some DeFi protocol that they are using? How does the claims process work? Who decides if you’re getting paid out or not?
Arthur 36:32
I think right now, I think for Nexus Mutual is a, it’s a bit of a debate. And a little bit of a, I don’t think there’s a formal on-chain way, I think, okay, again, I’m not 100% sure – probably there’s some voting. But this is pretty arbitrary. I think there’s no former kind of methodology. But it’s a bit more of voting by the member and also combined with some expert opinion from the team as well, because they all have insurance backgrounds and stuff. So it’s not a guaranteed payout, but so far, they have paid off some claims successfully before.
Hasu 37:06
Do you think there’s a way to do this in a completely trustless way? So I mean, we are operating with smart contracts after all right? So isn’t there some condition that you can define that is, like definitely a hack and then people can 100% rely on that the insurance will pay out?
Arthur 37:25
I think that, yes, it can be fairly trustless. But you will not be like 100% trustless, because you need to rely on an Oracle and in this situation the Oracle is even harder to define because how are we going to define an Oracle for a hack, right? Because it has to go through a human to decide, oh, we think that this is a hack, so that we agree to pay other teams. So in the definition alone, you can debate on this for a fair amount of time on that. So I think that you can go fairly trustless but you will not be fully trustless purely run by code kind of way.
Hasu 37:57
Yeah, that makes sense.
Arthur 38:04
So Loopring is a first DEX in Ethereum to adopt zkRollup and you can say it is quite a big success in that sense that they are the first to adopt a zkRollup layer two solution. And when they do the process of starting the zkRollup I think that was a good call as there was a lot of buy in from a lot of people in the community. And because it’s the first practical implementation, and it works right now because you can use the zkRollup of Loopring for both the DEX trading and also for transfer. I think the transfer part is not really the major/initial objective it’s just because it’s so cheap to transfer on L2, so I guess they advertised this benefit as well, because you can transfer from two different account in a zkRollup with very, very low cost, and very quick as well. So I think that’s kind of the expansion of the scope. And I think they were order-book based model, because if you’re using zkRollup it’s quite cheap, the gas cost and the performance were good. So you don’t really need to use an AMM but I think the challenge is an order-book model is not that good for bootstrapping liquidity for DEXs. I think right now they’re actually going to offer an AMM DEX for Loopring as well, instead of a pure order-book model. So I think in that sense, the zkRollup technical implementation is definitely very successful but in terms of running a DEX their volume is not really in the top 10 right now. And even the user-base I think is okay but I wouldn’t say you could call it very successful. I think but one thing unique about Loopring is that it is one of the very few teams where the team is actually based in Asia and a big part of the team, the engineering team. It shows that there are some DeFi teams in Asia as well. So yeah, technically they are pretty solid, but they’re just pretty under the radar and pretty low profile in a sense.
Hasu 40:08
What do you see as the challenge for basically those launching a new layer two solution like, like Loopring? I mean, if I look at this, I’m asking myself, so what is actually the incentive to deposit any tokens there? So don’t you have a chicken egg problem?
Arthur 40:24
Yeah, exactly. I think this is a big issue right now. And it will get worse next year, if a lot of the layer two launch and we don’t really get a consensus of which one we are going to use. I think this is gonna be a pretty chaotic situation. I think that from what we learned in the DeFi summer, incentives work. I think some of the layer two solutions actually experienced the usage mining in a way that you give people some incentive to try it out to use the layer two solution, and also to incentivize the other protocol to build on top of you as well, so you get the network effect, and I think it becomes a bit like game theory. Which one are you going to adopt, like, right now – basically the middle and smaller DeFi protocols are all waiting for the bigger protocol to make a first move before they need to move. Because if they move, and the bigger one moves to another one, it’s quite pointless because you lose all the composability. So it’s, it’s a bit like a chicken game right now. And I think that layer two team can probably do something to nudge them. Again, I think that’s just my idea. And it’s definitely not an easy problem to solve but I do believe that incentive goes a pretty long way to help to tackle this issue.
Hasu 41:36
Yeah, right. Usage mining sounds like a very viable solution to this problem, right. Given that Loopring already has a token and I assume it earns some kind of fee?
Arthur 41:48
Oh, yes. One thing about Loopring is the users do get some fee from the trading volume. I think that’s if you become a Loopring staker you get a pretty substantial percentage of the fee, that goes through the Loopring exchange. But it’s just because the Loopring exchange doesn’t do that much volume so there’s not much fee to be distributed right now.
Hasu 42:13
So then we move on to our final category. We were kind of debating before this podcast that should this even be included, is DeFi coins. But CoinGecko includes it. So we will talk about it. And it’s very popular right now. So it’s the kind of Ponzi game/money games, Empty Set Dollar ESD and Ampleforth. So Arhur, could you describe how those work and why they are so popular right now?
Arthur 42:48
Yeah, I again, I’m probably not the best person to explain this. So but I’ll try my best. So Empty Set Dollar is an algorithmic stablecoin, that uses a novel economic incentive to incentivize the price to be stable. Right now the target is to be stable around $1, over a medium to long term. And they bake in a lot of economic incentives to bootstrap the initial network effect so that people are gonna participate in bootstrapping the network at the beginning. So the incentive of being early is extremely high if the ESD market cap did end up expanding, which it did, so I think when it gets that he obviously started from zero. And right now it’s at around 500 million market cap and when you think about it is actually quite insane, because that’s actually the Maker market cap as well. Okay, it’s getting close. It’s 430 right now, but it was like 500, yesterday. So it went from zero to 500 million, I think in two months. And by expanding the supply of the ESD, to the users who participated in economic incentive game, which is when the ESD trades below $1 there is an incentive to burn the ESD. So you acquire something called a coupon and what you can do with the coupons is if ESD trades above $1 in the future, you can use it to redeem it for more ESD. So let’s say you burn one ESD, you can claim that one and a half or 1.3 ESD in the future if ESD trades above par again when it goes below par. So there’s an incentive for the ESD participant to burn their ESD when you’re below par to a certain extent, so that they can get more ESD when it goes above par. There is an expiry date to the coupon so that if it doesn’t go above $1 within a certain time period, I think for ESD is around one week, and then coupons expire worthless. So there is a lot of game theory into ESD on how do they stabilize the price and bootstrap the initial value and the network effect of it. But another way to describe is also highly speculative and it’s a bit of a game theory game in a way that you have to know what other people are going to do so you can front-run them a little bit to do something before they’re gonna do it. And you also want to be the first one to exit when it trades substantially above $1 so that you can sell before it trades below $1 again, so there’s a big speculative element to it. I know a lot of people who are very interested in it right now, even people who I don’t expect to be participating in this type of game. I know some professional traders, and professional market makers in a professional trading firm and they are also doing it in their personal account, which is to my surprise. I think Su may have more to add on this as well.
Su 45:56
Yeah, I think, you know, the, the idea of an algorithmic stable coin is not bad, right? Because all money is kind of a money game, where it’s a shared belief. And we’re definitely in the very early stages of figuring out which ones may or may not work. I think Ampleforth was an early project, I think, mid 2019, it launched, it had some backers. So there’s an investor allocation, and then I think it did an IEO on Bitfinex – I think it was started at like 150 market cap and then went up slightly, and then went down a ton all the way down to like 10, or 15 mil, and then this year, with the with the usage of the Uniswap geyser, where people supply Ample and wrapped ETH into into a pool that kind of stabilized the price and allowed it to start going through a expansion cycle and that kind of did a 50x I think from the bottom in market cap. So obviously, it captured everyone’s imagination, because people… before this, kind of assumed that this kind of algorithmic stablecoin wouldn’t really work in practice. And I think that Ampleforth was interesting, because it gave people some ideas of what works and what might not work, I think YAM, I kind of consider the same in the same vein, where they like the ideas of the rebase. But ironically, now I think they’re actually considering taking out the rebase. So I think rebases expansion contraction, it’s ultimately a double sided sword. If you think you can create the mechanisms that incentivize people to kind of do the actions that would risk capital that ultimately brings stability to the stablecoin, then, then it’s good. And if they can’t, then you’re probably not happy with the contraction cycles. So I think ESD and DST, should kind of be seen in that light, where they’re trying to solve some of those problems that they foresaw and kind of saw bear out in the Ample case. But again, like even at the $500M market-cap it remains to be seen exactly how, how it will play out with a DAO in terms of coupons, right, in terms of how, how the game theory works, where does it make sense to just buy the coin itself or does it make sense to play the coupon game where you’re betting that it’ll stay above the TWAP will stay above dollar. These are all things that are so new that no one really knows how it’ll accrue. But I think the fundamental idea of an algorithmic stable coin is not a bad one. The key is to get a reasonable distribution of token holders that are not just trying to make a quick buck, but are trying to build something longer term that could be a decentralized money basically.
Hasu 49:21
Yeah, I guess I mean, where I kind of disagree is the characterization of it being a stablecoin at all, and I think that’s the misleading part. That’s maybe the easiest to talk about. So if you look at Bitcoin, in Bitcoin, you always have the same number of coins in your wallet unless you spend them. But the price of these coins fluctuates in the open market, and Ampleforth flips that around, where the price of your coins is always $1 but the amount of coins in your wallet constantly fluctuates. So that’s kind of what the rebasing mechanism does, right and I feel it’s very hard to argue that this makes your balance more stable. The balance fluctuates just as much based on market demand as it does with the coin like Bitcoin. So I don’t think it’s a scam or anything, it’s just a scam if you sell it as a stablecoin, because people want to own a stable coin, they want the number of the coins multiplied with the value of those coins to be stable. They want neither one of them to be stable, the other not right. You can think of both Ampleforth and ESD as like a base layer money, like Bitcoin. But where I kind of disagree is the way that it’s being sold as a stablecoin. So talking about Ampleforth, but that ESD not everyone’s balances change all the time. So they go a step further, they kind of keep the balances of those who don’t want to participate in kind of the economic game stable, they can just keep their coins on their account or in the DAO and then they kind of incentivize some people to reduce their balance by burning their coins, in exchange for more coins in the future. And, yeah, I mean, ultimately, if you want to argue that ultimately, these coins can have both a stable balance and a stable amount, then I think that’s just not going to work without some kind of backing. I think that’s the real problem, like not really, can you make money trading this? Or can they go to like a billion dollars in market cap, and then maybe collapse and have a new cycle and so on, I think those things are all possible. But what I don’t see is that you will eventually convince someone to hold this as an extra stable coin when there are other alternatives like USDC, Tether, DAI sUSD and so on.
Arthur 51:43
I have something to add, you know I used to be fairly skeptical of the algorithmic stablecoin model, because I just think that, in practice, that’s unlikely to work. Because the problem is when the price is below the peg, even if you believe it will go back to the $1 peg it can go way below the peg before you start going there. I mean, you can use some economic incentives to incentivize them, but who is gonna step in? I mean, nobody wants to step in earlier. I mean, everyone wants to be the last person to support the price, and then I buy the bottom I don’t want to buy when it’s gonna drop 20%. That’s always a question for the algos stablecoin stabilization method because you can’t redeem it at par. But I think one thing changed my view on business like I’ve been reading Sapiens – I know it’s a very popular book and I’ve been pretty late to this book. But basically it says that, you know, a lot of things it’s homosapien imagination and I do believe that for money there is some aspect to it and I do think that some people might claim it but I think a lot of the ESD community do recognize that it’s not going to be stable right now. But what they want to achieve is to use the speculative component of ESD to bootstrap the initial network effect to a certain level where it can be more stable – they don’t think it will be stable right now. They think that it’ll be stable when we hit, like $5 or $10 billion market cap or even higher. I’m not sure what’s the target right now. But I think that there’s some possibility that it will happen but I don’t think it is a very high possibility event. And I also think that one key issue with algo stablecoins is it might not be there when you need it the most because let’s say, what happened on March 13 this year, when the crypto market dropped like 50 to 70% in a day. I think in that moment, if the algo stablecoins can’t stand the test of being stable in that kind of event, I think the confidence will be destroyed in one single moment because it is not there to be stable when you need them the most.
Su 53:57
I kind of think that the the in the entire question of is it really a stable coin is almost irrelevant. Because I think like everyone involved knows that it’s a game of betting on. Is this game fun enough that the whole world will play it? Right? It’s like, you know, you know, laugh in the world laughs with you, right, but cry and you cry alone. So right now, they’re trying to get more people to laugh with them. And I think they do recognize that if they can get more and more people on board that the game is easier. If the game is easily understood then they can expand that way and you know if people own a small percentage of their portfolio in it, like I was kind of drawn to the original Ampleforth idea which is that this is a commodity money, which is very deep, you know, arguably less correlated with other crypto assets. Right? Because if like the whole market nukes 80% then probably Ampleforth is also gonna nuke also but you know in normal markets, it generally exhibits lower correlation. You know, it might be like 1.05 and then it might not rebalance or maybe like 0.88. And so, but the initial problem they had was like liquidity. And then later on, they solve that with the geyser.
So I think algo stablecoins, probably are in the first chapter. I think they’re the biggest issue I have with them is just Gini coefficients. I think reality is that there’s still not that many people involved in some of these and I think the Gini coefficients are not great. So that kind of makes it like not a distributed enough game. But I think if you can properly distribute the game, and you can then create the right, crypto-economic incentives like you kind of need that mix of brain power and distribution, which is tough, right? Because I think, you know, ESD they probably have the brain power, I don’t know if you can achieve the distribution and have those waves of coin distribution and profit taking, get it out, because the way that the DAO locks everyone in right, like kind of, it’s kind of like a cartel, basically, like you kind of need no defectors. And so like, but then that makes it almost like irrelevant what the market cap is – like the market, you can call it 20 billion but if everyone’s locked in the DAO then no one can, you know, it’s only 1% of the people can ever crystallize that value. So, it’s like the market cap is almost like marketing to get you to come in before it’s even higher. And kind of like a kind of say like all DeFi games can be reduced to FOMO3D, right, where you know, that it’s being programmed to go higher each period and so you’re kind of having to decide, either you don’t play at all, or you play as early as possible. So I think, no one’s really misled that it’s actually a stablecoin because if you thought it was a stablecoin, you wouldn’t buy it anyway because you’re trying to 5x your money, right? You buy this stuff, and then you play with it. And I think it’s like, it’s more Bitcoin, like, in that sense, where you’re trying to make a bet that this is something that other people will like, as a game, it’ll eventually because it’s so fun, it’ll become a money. And then because of that, it’ll have better liquidity and then probably be less volatile. But it’ll always be like a commodity, like money, basically.
Hasu 58:04
Yeah, I think that’s, I think that’s spot on. I think it’s, it’s exactly right to think of it as a commodity like money, same as Ampleforth that has different properties from Bitcoin. I think where you’re also right, I mean, creating all the money games in DeFi to be something like FOMO3D, right. I think some of many of the projects that we talked about, like are not games, right? They are actually, yeah, products are like legit protocols where like, people interact with each other in a sustainable way. And the more they interact with each other, the stronger they get but here these are games that have mechanisms that make the system inherently unstable. And that’s kind of the whole point of it, right? That you have these these waves of, basically FOMO people depositing, and you have these extreme incentives not to withdraw your coins, that’s kind of the whole point and ESD it actually it started with I think a one epoch which was eight hours for the unbonding period for the coins in the DAO and then they raised it to 15 periods, so five days. And I think that just shows that they like they were never interested in like making it more stable because if you if you wanted actually to stabilize to get the coin back to $1, then the method you would use would be to bring more supply to the market, right? Actually, the positive rebase people in the DAO get more supply and then those people can go to Uniswap and sell the supply and that’s what pushes the price back down to $1. But the way they are taking it, it’s actually the exact opposite direction, right? They make it even harder to cash out to actually liquidate any coin. So you have this wave for like everyone’s balances grow inside the DAO but when they actually want to withdraw then the price collapses to like 30/40 cents and the question is always, well were those kind of expansion periods make up for the drop? Or would there be a time where it doesn’t recover? And that you’re exactly right that this depends entirely on basically how, how much fun the game is to play and if it can constantly find new money and new market participants to come in. So yeah, I guess those really don’t have much to do with DeFi in the sense that those are the protocols. They do compose with other DeFi protocols I guess to small boats or something like ESD and Ample – I think they both use the Uniswap V2 TWAP as their oracle so that’s cool. I think it’s good that we talked about it, because the hype for these things is really large right now. Yeah but I wouldn’t really count them toward DeFi.
Arthur 1:01:03
Yeah, I sort of agree in a sense you can say it’s DeFi but there’s a lot more of a speculative component into it right now than being used as a product, and goods and services. as
Hasu 1:01:24
So wrapping this up, so we covered all the categories. I’d like to spend a few minutes… where do you see DeFi going in 2021? We kind of covered like the categories that are like very obvious, kind of first, satisfying the whole, like speculative demand of the market, you have bridges that the tokens to DeFi that exists outside of it, then you have kind of the DEXs, where you can trade them and you have the lending protocols where you can lend them out, get some yield on them, others can borrow them. And then you have kind of the synthetics where you also can deposit or use your tokens as collateral and then create like tokenized debt against it. So what is next thing?
Arthur 1:02:14
I think early in 2021 more use cases for DeFi will be unlocked in DeFi, I think we’re only scratching the surface right now. We have a built a base level primitive like lending and borrowing, spot DEXs, some asset management protocols but there are still a lot of other financial use cases with lots of room to grow, proven it’s potential, especially with insurance. So I think right now, only Nexus Mutual can claim to provide successful insurance. I think that there will be more insurance protocols to emerge in 2021. And also derivatives, I think that a lot of derivative trading use cases is hampered due to the performance issue of Ethereum blockchain and I think there’s, on my count, there’s at least eight derivative trading protocols that are launching soon or already launched as well. So I expect this competition to really heat up this year. And with the combined the launch of the layer two solutions hopefully this will also unlock some other use case like some micro payments or even under-collateralized borrowing. I think this is something that comes to the holy grail of finance that a lot of people hope DeFi will achieve. Although it still remains to be seen how it could be done. I think, there are at least two or three protocols are trying to tackle this issue and they are going to launch in this year as well. I think we’re just gonna see it continue to grow barring any regulatory actions and it’s also potential that we see some established FinTech application tap into some of the product offerings of DeFi offered to the users, you can call the CDeFi, but probably bridging this to the mainstream audience as well through their FinTech offering. I think that is also likely to happen.
Su 1:04:13
I’m excited to see DeFi derivatives really take off this year. I think there’s a lot of pent up demand to use these a lot of pent up use cases. I think, if you think about existing DeFi with borrowing, lending and kind of being able to draw against an asset, you can kind of generalize that to being long that asset as perp or as a future. So I think that being able to do so and then get really get the liquidation cost down very low, almost as low as possible. You then allow people to use it properly. So I would like to see transaction costs go as low as possible. I would like to see these kind of usability metrics do really well next year because I think that then the then the canvas for DeFi goes a lot bigger. So I think whether it’s AMM or more central limit approach, I think once you have that and it’s composable you can, for instance, you can package a stablecoin that is like the coin plus it’s short perp. You can have an options protocol which liquidates into a perp or an aggregation of perps. There’s all these things you can do. But step one is to just get the market actually liquid and get the market actually going. So, fun to see.
