Ribbonfarm ( Feed )
Tuesday, 06 October 2020
MJD 59,128
Covid is the first global downgrade in the average human quality of life since World War 2. Some of the individual downgrades are adaptive for climate change as well, and will likely get locked in for a longer term. Lowered global human mobility at all scales, from local driving to international flyi
Covid is the first global downgrade in the average human quality of life since World War 2. Some of the individual downgrades are adaptive for climate change as well, and will likely get locked in for a longer term. Lowered global human mobility at all scales, from local driving to international flying, feels like the […]
Nic Carter ( Feed )
Monday, 05 October 2020
Public blockchain fee cyclicality and negative feedback loops

Invented in 1788 by James Watt, the centrifugal governor is a small, clever device that made steam engines viable in an industrial context. Effectively it takes rotational input from a steam engine and applies it to weighted balls. As they spin, the centrifugal force pushes them upwards, moving a

Invented in 1788 by James Watt, the centrifugal governor is a small, clever device that made steam engines viable in an industrial context. Effectively it takes rotational input from a steam engine and applies it to weighted balls. As they spin, the centrifugal force pushes them upwards, moving a lever connected to a valve. As they spin faster, the valve closes. In this manner the governor takes input from a steam engine and mechanically regulates the flow of steam and hence the speed of the engine.

This innovation made steam engines suitable for industrial processes which required stability and predictable speeds, like mechanical looms. The key idea is that as the system gains in energy, a negative feedback loop develops which caps its growth. For steam engines, this is part of their design and is a very good thing. As we will see, a similar phenomenon exists in public blockchains — with more mixed results.

The Curious Case of the Cyclical Fees

As the dust cleared on the mania of 2017, I noticed that Bitcoin fees and transaction count appeared to be following a repeating pattern. Blocks would fill up, fees would spike, transactions would start to drop, and then blocks would start to fill up again. By my count, this cycle repeated itself six times in 2017.

♦Chart available at Coin Metrics

Note that I’ve smoothed both average fees and transaction count on a 7 day moving average. People recall Bitcoin’s late-2017 “fee crisis” as a single event but in fact there were at least four periods of fees rising dramatically, and six if you count smaller peaks. It’s just that most people count fees in dollar terms, rather than native unit terms, so they only really noticed the final prolonged fee spike when the USD value of Bitcoin was spiking too.

On average, fees would peak about two weeks after transactions did. The entire cycle took two months to complete, although it accelerated throughout the year. As blocks became progressively fuller, a marginal new burst of transactions pushed fees into intolerable ranges for transactors. Of course, fees are just the symptom. The underlying constraint is block space.

You can visualize the hard stop develop by examining the relationship between block fullness and average fees.

Using this approach you can see that as blocks filled up and stayed full, fees crept upwards. As fees reached a peak, users chose to transact less and blocks emptied out, giving rise to the ragged patterns in block size. But as fees came down, blockspace looked more attractive to users and they flocked back to the protocol, causing blocks to fill up again. In the final grand fee spike around January 2018, blocks stayed full to the brim for months and fees reached eye-watering levels, in both BTC and USD terms.

Keep in mind that SegWit was officially activated on July 23, 2017. Since it represented an effective blocksize increase (allowing blocks to carry up to the equivalent of 4MB of data), you can see blocks burst through the 1MB limit in the latter half of the year. However because SegWit was not fully embraced by transactors right away, average block size grew only slowly.

Here’s a diagram of the process. I call it an oscillation, because it causes both fees and the utilization of blockchain resources to oscillate, like a sine wave. But you could also describe it as a negative feedback loop, as fees inhibit transactions when they hit certain thresholds.

This was little more than a curiosity. I pointed it out at the time, but the cycle didn’t really matter altogether too much — you couldn’t bet on where you thought transaction count would be in a week after all. The lesson I took from this was straightforward: at a certain point, users grow frustrated with fees and deprioritize on-chain transactions, especially if the fees are large relative to their transaction size. SegWit helped a fair amount, as did the institution of batching. Seen in a certain way, fees are self-correcting as they encourage large consumers of blockspace to be more parsimonious with their consumption of chain resources. But all this did was reinforce my idea that scaling Bitcoin will require a number of deferred transaction systems that settle to BTC under an array of trust models. The other takeaway for me was that users evidenced a clear transactional lifecycle, and after a period of acute fee pressure, required several weeks to return to their prior level of consumption.

Ethereum’s 2020 ‘Fee Crisis’

This year, when Ethereum fees started to creep up and then exceed those on Bitcoin, I wondered to myself whether Ethereum would see a reprise of Bitcoin’s fee-tx count dynamics. I puzzled over whether it would have the same effect, or be more disruptive to Ethereum, since so much liquidity is “on-chain” (as opposed to primarily off chain at exchanges). I figured we’d see the same thing, with a less dramatic oscillation, since the supply of Ethereum blockspace is somewhat dynamic and can increase in response to surging usage. As it turned out, fees would end up being more disruptive than I had expected.

♦Chart available at Coin Metrics

Like Bitcoin in 2017, Ethereum this year saw a utilization spike as transactions grew, which gradually drove up fees. Compound’s public token launch in mid June intensified the blockchain utilization and hence fee pressure, and a host of other launches saw fees reach a crescendo starting in mid August. Several notable launches, namely the dual launches of SushiSwap and Uniswap’s token, spiked fees to eye-watering levels. On Sep. 2, the average Ethereum transaction cost over $14. All told, $16.7m was paid in ETH fees that day, well surpassing miner revenue from new issuance which totaled $5.98m. And as those fees rose, some users chose to defer transactions, and transaction count started to drop. As we entered a new high-fee epoch in mid-August, Ethereum transactions per day started to steadily drop. Fees peaked much later on Sep. 2, but have also begun to come down over the last month.

Just two days later, on September 4, I predicted on the On The Brink podcast that Ethereum’s high fees would not only affect chain utilization, but also liquidity on decentralized exchanges. I’ll post a brief transcript below (the relevant part begins at 36:30):

Nic: We saw this fee-tx count oscillation happen in Bitcoin in 2017; I would predict that we would see the same thing with Ethereum. So effectively, fees rise as blockspace utilization rises, and at a certain critical threshold, users kind of get fed up and they stop transacting for a while — its not economical for them to transact — and so, transaction count and fees drop, and then, fees get cheaper so people start transacting again, and the cycle repeats.
And I think, if you look at the selloff, it’s probably partially due to that, because some of these more retail investors that were using these on-chain exchanges, they’re getting priced out of those trades. And if there’s no retail investors, that’s a lot of the uninformed flow that the smart traders trade against. And so I think there’s a hit to liquidity generally when that happens […]
Matt: No retail, no party.

And while ETH price dynamics are hard to pin down, and I am not claiming they are solely attributable to this phenomenon, ETHUSD peaked on Sep. 1 and declined from there while fees stayed elevated through the rest of the month.

So what happened exactly? A couple things. First, Ethereum entered into what I believe will be its first major fee-chain usage oscillation, with fees peaking about three weeks after transaction count, and both declining subsequently. Perhaps more interestingly, the average size of Ethereum transactions, and various stablecoin transactions shot up alongside the rising fees. This stands to reason: users have a view of how much they’re willing to pay in fees as a percentage of their transaction, and as fees rise they stop making small transactions and larger transactors start to dominate.

The correlation is startlingly tight, and suggests to me that users are very sensitive to fees.

♦Chart available at Coin Metrics

It’s not just basic Ether transactions which exhibit this fee sensitivity either. Tokens like Tether also evidence rising transaction sizes as ETH fees increase.

♦Chart available at Coin Metrics

This suggests that transactors have a threshold of fees as a percentage of transaction value that they’re willing to pay, and as fees rise, they become unwilling to make smaller transactions — unless they really have to.

The above could be explained by some third explanatory variable like the growth of liquidity mining which was both congesting the chain and causing larger transactors to enter. I found more clarity when I investigated the composition of Ether transactions. I intuitively felt that smaller transactors were being priced out by fees, but it wasn’t clear until I put together this chart:

Initially this chart may not look too notable. It shows a cooling off of transaction count as fees rise, as we saw above. But more interesting is the changing dynamic among ETH and USDT transfers, which I’ve split up at the $500 threshold. You can see transactions accounting for more than $500 worth of ETH gaining steadily share relative to smaller transactions as fees rise. Let’s eliminate contract calls and focus only on the two categories of ETH transfers found above:

This is the smoking gun. For non-contract call transactions, ETH transfers under $500 were idling at about 85% in June — but when fees spiked, they collapsed to as little as 40% of ETH transfers. Finally, some hard evidence for my intuition: fees price out smaller users.

Predictably, the same phenomenon is evident in the usage patterns of the biggest ERC20 token, Tether. You can clearly see that smaller USDT transactions start to drop off as median fees start to climb in mid August. Larger Tether transactions hold firm but still evidence a declining trend overall as transactions cooled off during the high fee epoch.

♦Do High Fees Affect Liquidity?

So, we’ve established that there is a clear negative feedback loop between fees and utilization of blockchain resources, both in Bitcoin and in Ethereum. In Bitcoin we know that the cycle historically takes two months to complete; we haven’t yet seen what it will look like in Ethereum. Moreover, it’s clear that transactors have a threshold in mind for the highest tolerable fees relative to the size of the transactions they are making, and that smaller transactors defer their transactions during periods of high fees. This causes average transaction sizes for both ETH and other tokens to creep up during high fee epochs.

But is there more to the story? Or is this just a recast of Bitcoin 2017? I’d venture that there is indeed another wrinkle here.

Remember that in 2017, Bitcoin trading took place at centralized exchanges, with the blockchain being used for inter-exchange settlement and for user deposits and withdrawals. Actual markets were made off-chain. A user could fund an exchange account with fiat and hold (and then sell) Bitcoin, all without actually touching the blockchain. So when the fee crisis appeared, it absolutely put a brake on the Bitcoin economy, but plenty of users were able to make trades on exchanges if they already had funds on the platform or wanted to wire in USD.

By contrast, Ethereum trading in 2020, together with its litany of associated tokens, is very much an on-chain phenomenon. Now centralized exchanges are still very important to price formation, but certain DEXes like Uniswap have at times eclipsed even the largest centralized exchanges. Because automated market maker DEXes do not require KYC, custodying coins with a third party, or a lengthy onboarding process, they are far more convenient for end users. The no-orderbook AMM model is also extremely simple to use. And certain assets and types of exposure, like smaller DeFi tokens, or mining with liquidity, are only possible on-chain. As a consequence, a vibrant industry of on-chain liquidity has emerged with ferocity. As virtually everything traded on these DEXes is Ether or a token on Ethereum, everything is exposed to fees. Unlike centralized exchanges, every trade you make at a DEX has to settle on-chain. On-chain fees are therefore an ever-present consideration.

So contrasting with the vanilla fee-tx count oscillation model we saw from Bitcoin in 2017, here’s a modified version to account for the new dynamics we saw from Ethereum in 2020.

So where does this second loop derive from? Why single out DEX-heavy chains for special treatment?

First, it’s important to understand that, as Maya Zehavi puts it, high fees are a regressive tax on users. Regressive, because fees are not proportional to your wealth but instead apply largely in the same way whether you’re moving $100 worth of ETH or $10,000 (fees are a function of the computational heaviness of your transaction, rather than the $ value of transactions). This is similar to the manner in which sales taxes are regressive, because groceries account for a larger share of the income of working class people than they do wealthy people. Thus a fixed 5% sales tax is effectively a much larger portion of income for a less well-off family.

Let’s consider an analogy. Imagine a private game of poker with a rake which is fixed in dollar terms, rather than being a percentage of the value of the pot. (The rake is the fee that the operator takes for running the game). Players have the choice to play a given hand and pay the fixed fee, or sit out, in which case they don’t have to pay. There’s a variety of players at the table — a couple professionals, some semi-pros, and some gamblers who are enthusiastic but aren’t particularly good at poker. The house can set the value of the rake wherever it likes. To have a winning night, not only do you need to win against your opponents, but you need to be profitable net of the rake taken by the house. It’s not enough to just win: you have to win after absorbing transaction costs.

If the rake is low, everyone participates happily. But when the table operator gets greedy and increases the rake, the players with smaller stacks start to sit out more and more hands. If they have to fork over 1/10th of their stack just to play a hand, they are going to opt out (unless they have pocket aces). The general trend is that as the rake rises in absolute terms, players are gradually priced out of the game, starting with the players with the smallest bankrolls.

When the smaller, less sophisticated players start to drop out, the game gets substantially less profitable for everyone else. After all, the semi pros depend on the existence of unsophisticated opponents to make a living. As every poker player knows, you probably don’t want to sit at a table on a Tuesday morning with the grinders and semi pros. You want to hit the felt on a Friday night when the loose amateur gamblers roll through, lose their stack, and stumble off to the bar.

To return the analogy to Ethereum, the fees are the rake and they price out the retail individuals who, until recently, were having a rollicking time on Uniswap and other DEXes. But as fees climbed to $14 on average (and much higher for DeFi transactions like swapping ETH to DAI on Uniswap), it simply became uneconomical for individuals with smaller bankrolls to participate in trading or liquidity mining. An entire portion of the market was forced to sit on their hands. And since retail investors are the uninformed flow that professionals trade against (and profit from), if retail isn’t sitting at the table, the game is not as worthwhile. All of this manifests in a degradation of liquidity and worse trading opportunities overall.

All of that said, this theory is hard to confirm empirically. A detailed analysis of wallets active in DeFi at various thresholds and their reactions to fees, or a comparison of spreads versus ETH fees, would be helpful in confirming these hypotheses. But there are a few datapoints which are indicative. First, here’s aggregate DEX volume courtesy of Friedrik Haga’s Dune Analytics dashboard, compared to median Ethereum fees.

You can see that volume and fees have co-moved in the last few months. This is consistent with fees putting a brake on usage, especially at the retail tiers. The problem is that the causality is hard to infer. It could easily be the case that high DEX volume was the cause of elevated fees (and vice versa), rather than high fees being the catalyst for declining volumes. Perhaps more interestingly, this chart shows the daily new addresses taking part in various DeFi protocols, the first derivative of the Dune dashboard built by Richard Chen, versus median ETH fees.

With the exceptions of two big spikes around SushiSwap and the UNI token launch, daily new entrants to DeFi seemed to be cooling off after mid-August when ETH fees reached a new plateau.

The conclusions being drawn here are more speculative. While it’s clear that smaller users defer transactions when fees are higher, the direct effect on on-chain liquidity is hard to measure.

Future Prospects for Ethereum Fees

We haven’t seen the full fee-chain resources cycle play out yet on Ethereum, so it’s hard to gauge the cycle length. But in the spirit of making concrete predictions I will forecast the following: I expect that we will see ongoing, positively correlated oscillations on Ethereum between fees, transactions, and crucially the liquidity and volumes of on-chain exchanges. I imagine it will look something like this:

If you believe that DEX volumes and the on-chain liquidity environment more generally are accretive to the price of Ether, it doesn’t take much imagination to make educated guesses about the potential price impact of this phenomenon. To the extent that the Ether’s value is exposed to the reservation demand for the asset as the liability-free collateral at the base of the DeFi system, fees that put a brake on usage will most likely make the TVL in the system unwind and put pressure on the price of ETH.

That said, there are a few counter-cyclical features that might attenuate the oscillation and spare Ethereum from the tyranny of volatile fees.

Dynamic blockspace supply

Unlike Bitcoin, which has only formally increased the blocksize cap once in its existence, Ethereum is more amenable to producing more blockspace if necessary, although the rate of increase is constrained. Elastic blockspace could in theory be employed to stabilize fees, but this comes at the cost of increased validation requirements, which are already fairly high for Ethereum. As Ethereum utilization has increased, miners have rewarded transactors with ever-more computational capacity.

However, because raising the gas limit increases the uncle rate, makes the network potentially more vulnerable to DOS attacks, and makes operating a full node more costly, the Ethereum community is divided on the prospect of further gas increases. While Ethereans are willing to tolerate more aggressive tradeoffs than Bitcoiners as far as the cost of node operation is concerned, the two camps generally agree that merely increasing the supply of blockspace is not a scaling panacea. So while blockspace has a certain supply elasticity which enables it to respond to increased demand, there is little political willingness to pursue a wholly accommodative blockspace policy.

ETH 2.0/Sharding

When I first wrote about the prospects for Ethereum fees, Vitalik’s response to my article (in which I claimed that Ethereum would likely be saddled with high fees for an extended period, and this would affect the viability of nonfinancial applications), Vitalik clarified his stance on fees:

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 — @VitalikButerin

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Effectively, he pointed out that he still believes in Ethereum’s vision for a low-cost blockchain in which a variety of applications, both non-financial and financial are possible. His proposed solutions are Rollups in the near term and ETH 2.0/Sharding in the longer term. Vitalik has said that he expects ETH 2.0 to produce 100x more capacity, although he expects that fees might eventually rise to an equivalent level thanks to induced demand.

I am inclined to agree; if you produce a commodity more efficiently, the world will find more uses for that (now cheaper) commodity. Thus, it wouldn’t be all that surprising to see average fees reach a high plateau even taking into account the creation of more blockspace. Regardless, ETH 2 still appears fairly remote, so it’s difficult to reason about. At the very least, it won’t be moving the needle fee-wise in the near term.


The current orthodoxy in Ethereum holds that Rollups are the main path to alleviating Ethereum’s current fee woes. Rollups come in two major types — ZK and Optimistic, but they both generally involve bundling many payments together and vastly increasing the economic density of transactions, in theory preserving the assurances of base-layer transactions while massively increasing TPS. In short, transactors rely on relayers who assemble large batches of transactions and broadcast digests of these transactions.

A ZK Rollup involves broadcasting significantly truncated transaction stubs, alongside a proof that the bundle of transactions is a valid change to the ledger. The Optimistic variant involves semitrusted operators who assemble transactions, with transactors who largely assume that the operators are not acting maliciously. Deterrence is (in theory) achieved through a combination of fraud proofs and economic penalties for misbehavior. Currently, ZK Rollups are mostly limited to simple transfers whereas certain breeds of Optimistic Rollups (OR) promise to open up the full scope of transactions currently possible in vanilla Ethereum. For a comprehensive breakdown of the state of OR, see this comprehensive report courtesy of Daniel Goldman.

Rollups effectively take transactional data off chain and put validity proofs on-chain. Bitcoiners embraced a similar data-parsimony vision years ago and pursued Lightning (which could reduce hundreds of thousands of payments to a handful of on-chain transactions), and sidechains, as well as advocating for pro-efficiency measures like batching and SegWit usage. Thanks to the popularity of Rollups and apparent pace of progress, Vitalik is championing them as the best near-term approach to scaling Ethereum. While ETH 2.0 may yet come into play, the Rollup vision of Ethereum is much closer at hand.

There’s a couple reasons why Rollups may not be a panacea for Ethereum fees. Firstly, it will be a challenge to coax all consumers of blockspace to be responsible stewards of the system, especially if they are service providers and can pass fees on to end users, rather than internalizing them. We learned this lesson with Bitcoin — if intermediaries can pass fees through to end users, they have a limited incentive to invest in a more sustainable infrastructure.

Additionally, because Ethereum has repeatedly increased the gas limit to effectively bail out blockspace consumers (at the expense of validators), heavy users may spend their resources lobbying for more gas limit increases rather than spending engineering hours on rollup-izing their transactions. Along these same lines, the specter of superabundant blockspace on the horizon with ETH 2.0 might impair the enthusiasm for Rollups among heavy transactors. Perversely, ETH2's main contribution today may well be to discourage heavy users from rendering their usage more efficient.

Second, the global userbase of a blockchain like Ethereum is not strictly something that developers and advocates can actually appeal to directly. Ethereum is open for anyone to participate in without exclusion, which is part of the reason for its popularity with ponzis and other marginal schemes. Presumably, the orchestrators of these schemes (which are routinely some of the heaviest consumers of blockspace) are not necessarily planning for the long term or trying to optimize their on-chain footprint, but rather more focused on making a quick buck. It sure would be interesting to see Forsage pushing the envelope tech-wise by rollup-izing a pyramid scheme though.

On the technical side, Rollups, especially the Optimistic variant, are not identical to base-layer transactions in terms of their settlement qualities. Vanilla Ethereum transactions are final almost immediately, and do not carry chargeback or settlement risks. This property permits ‘atomicity’, which means that chained transactions either all happen or none do. This grants users the ability to safely interlink multiple systems without risking a cascading failure because one payment in the chain failed to clear. This is a highly desirable property which is a function of its status as a digital bearer asset. Atomicity flows into composability, the oft-touted feature of Ethereum whereby smart contracts can safely reference each other, allowing for the buildout of ever more complex systems without having to evaluate each module.

Introducing more complex systems like Rollups throws these assumptions of atomicity and composability into doubt. Due to the fraud proof challenge trust model in some Optimistic Rollups, finality periods are extended in the unhappy case. Matter Labs estimates that the time to finality for OR will be on the order of 1–2 weeks. (Note: this estimate was made in Nov. 2019 so the state of the art may have changed since then.) One proposed solution [ctrl+F ‘withdrawal period’] involves intermediaries which provide users withdrawing from the rollup discounted access to their temporarily frozen coins for the duration of the challenge period. As far as I can tell, this effectively creates a tiered system, with lengthier finality from the “free version” of a Rollup exit, and shorter finality in the paid, accelerated version.

To put it somewhat uncharitably, Optimistic Rollups introduce the potential of deferred settlement. There is nothing wrong with this — deferred settlement is at the core of all efficient modern payment systems — but it is a different settlement model from base layer Ethereum transactions (which are cash-like). If you are used to transacting solely with bank wires, moving to ACH and credit payments will be more efficient, but it also means that you have to stomach impaired guarantees around settlement. This is why chargebacks are possible with credit card payments; they don’t actually settle right away. Great for the consumer, bad if you’re a merchant and you had earmarked those funds to pay bills coming due.

Aside from questions of finality, impaired composability is another issue which might inhibit an immediate transition to OR. I am not an expert on Rollups by any means, but I have seen composability challenges mentioned as some of the biggest drawbacks off OR.

For these reasons, I don’t believe it’s inevitable that all major smart contracts on Ethereum will switch to a Rollup system. To me, there seems to be a critical difference between a fast-settling base layer Ether or token transfer, and a Rollup-ized version of the same, especially when it comes to settlement. And if either composability or atomicity is impaired, the systems you can build look very different from those present on Ethereum as it works today. There is definitely something unique about DeFi as constituted from fast-settling Ether and token transfers today, and I believe that this will become clear as some large blockspace consumers start to make that switch to Rollup systems. As a consequence, I don’t expect that Rollups will meaningfully abate fees in the near term, even if they get partial uptake.


The difference between a centrifugal governor and on-chain fees is that the regulating effect of fees is more of a side effect of a properly functioning system rather than a key design consideration. In public blockchains, fees exist to ensure non-frivolous consumption of network resources and to provide validators with revenue. They’re not strictly intended to put a check on the usage of the system. In practice, however, they do, and this brake tends to be a sharp rather than a gradual one.

As a consequence, we see an oscillation — in resource usage, transactions, and even liquidity of on-chain products — rather than a gentle deceleration. These dynamics are well established in Bitcoin and only just starting to emerge in Ethereum. But due to the predominance of on-chain exchange in Ethereum, they are arguably more disruptive to the network as it works today. As Kyle Samani puts it, bounded throughput, instrumentalized by fee pressure, may be DeFi’s “invisible asymptote.”

The Ethereum community should consider the effects of repeating periods of high and volatile fees on the network, with the understanding that some applications might be permanently priced out of viability. Lastly, Rollups, while compelling scaling technologies, may not be a panacea from a fee perspective, due to their effects on settlement assurances.

Thanks to Ryan Gentry, Lucas Nuzzi and Antoine Le Calvez for their assistance and feedback.

Ribbonfarm ( Feed )
Mansionism 2: Bungalows
Though I’m big on climate-resilient futures, I have an ambivalent relationship with density as a means to achieve them. I mostly grew up in company bungalows on generous-sized lots, and loved it. Both the word and the architectural style are Indian in origin. The style originated in feudal-era
Though I’m big on climate-resilient futures, I have an ambivalent relationship with density as a means to achieve them. I mostly grew up in company bungalows on generous-sized lots, and loved it. Both the word and the architectural style are Indian in origin. The style originated in feudal-era Bengal and spread across north India during […]
Ruben Somsen ( Feed )
Saturday, 03 October 2020
Nice article, Shinobi.

Nice article, Shinobi. Just to add, to make it practical you will specifically need non-interactive novation, which means Alice and Bob have a jointly owned UTXO on a statechain AND they have their individual DLC outputs in yet another statechain:

Nice article, Shinobi. Just to add, to make it practical you will specifically need non-interactive novation, which means Alice and Bob have a jointly owned UTXO on a statechain AND they have their individual DLC outputs in yet another statechain:

It's really nice how with this setup you can separate and completely isolate all the tasks to run a DEX:

- the statechain entity

- the price oracle

- the orderbook matching

SNARKs and the future of blockchains

SNARKs are often seen as a magical panacea to “solve” scaling. While SNARKs can provide incredible benefits, the limitations need to be acknowledged as well — SNARKs can’t solve the existing bandwidth constraints that blockchains are facing today.

This article is meant to demystify SNARKs by

SNARKs are often seen as a magical panacea to “solve” scaling. While SNARKs can provide incredible benefits, the limitations need to be acknowledged as well — SNARKs can’t solve the existing bandwidth constraints that blockchains are facing today.

This article is meant to demystify SNARKs by giving a (relatively) simple overview of what they can and can’t do for blockchains. We’ll look at how its functionality in relation to blockchains can be concisely summarized as Non-Interactive Witness Aggregation (NIWA). If you understand how Bitcoin works, you’ll be able to understand this article.

It should be noted that SNARKs are still very much an area of active research. Many SNARK variants either aren’t efficient enough to prove complex statements, have proof sizes that are impractically large, or require a trusted setup. That said, a lot of progress has been made over the years, and it’s expected that we’ll continue to see improvements in the coming decade. This article is written in anticipation of such improvements, even if it may not be practical today.

What is a SNARK?

A SNARK is a construction that allows you to efficiently validate a result, given a rule set and a starting point. The inputs that led to the result are not revealed (“zero knowledge”). Confused already? This simple chess example will explain.

Chess example

- Rules: The chess rule set
- Start: Starting position A of the board
- Result: New position B of the board

The regular way of proving that the game validly transitioned from position A to B is to simply reveal all the moves and checking whether they were valid. SNARKs can do the same thing, but better:

- The set of moves does not have to be revealed (private, less data)
- Verification is more computationally efficient

There is one caveat — SNARKs tend to be computationally expensive to create. This can however still be worthwhile in systems where many people wish to validate the same result, such as blockchains. Only one person needs to put in the effort to create the SNARK, increasing verification efficiency for everyone.

Blockchain example

- Rules: The full node software
- Start: The block header & UTXO set hash at time A
- Result: The block header & UTXO set at time B

Similar to our chess example, the regular way of validating the transition would be to start with the UTXO set (all unspent transactions) at time A, receive all the blocks, and update the UTXO set all the way until we reach time B. With a SNARK, none of this data would be needed to prove validity. In fact, if time A is set to the genesis block (empty UTXO set) and time B is set to now, then the entire chain can be validated without receiving any of the historic data.

It’s important to note that for time B the entire UTXO set is required, as opposed to just the UTXO set hash. While this data is not strictly required for proving validity, we also care about availability. If all you had was the UTXO set hash, then while you know a valid state exists, you wouldn’t actually know what that state is. This would mean you can’t spend any coins, because you don’t have the data that allows you to prove that a specific UTXO is part of the set. In the chess analogy, you would have a hash of the new board position, but don’t actually know what that position is, so you can’t continue to play the game.

Note that whoever made the SNARK (presumably miners) would have this data (as it’s needed to create the SNARK in the first place), but they could potentially choose to withhold it from you.

The SNARK blockchain

In order to guarantee that everyone can spend their coins, all the data that’s needed to update the UTXO set must be communicated with each block. You’ll need to know which UTXOs were spent (inputs) and which were newly added (outputs). This is so-called non-witness data.

The validity of the transition can be verified by a single SNARK, replacing all witness data (scripts, signatures), and taking up almost no bandwidth. The relationship between inputs and outputs would not be apparent — a block would look like one big coinjoin transaction. The bulk of the data would be non-witness data.

Contrary to popular belief, SNARKs can’t solve the fundamental issues behind light clients or non-federated sidechains, because non-witness data must always be downloaded. Full nodes have the crucial ability to reject a valid SNARK if non-witness data is missing, whereas if a light client neglected to download non-witness data, it could mistakenly consider a chain with missing data valid. If even a single piece of non-witness data is withheld by miners, nobody would be able to create new blocks with valid SNARKs, except for those specific miners, turning it into a permissioned system.

SNARKs consume witnesses

SNARKs for blockchains can perhaps best be summarized as enabling the following function:

Non-Interactive Witness Aggregation (NIWA)

I use the term “witness” here liberally. In Bitcoin, the witness is the data inside a transaction that proves whether a specific UTXO is allowed to be created. But over time, this UTXO (non-witness data) becomes a witness of its own when it gets spent. When 1 BTC gets sent from Alice to Bob to Carol, Bob’s transaction is a witness to the transfer from Alice to Carol. In the same vein, all spent transactions since genesis are witnesses to the current UTXO set.

Also note that a SNARK is in itself a witness. If each individual transaction is validated by a SNARK, we can also NIWA these SNARKs into a single SNARK per block. And because outputs become witnesses the moment they are spent, we can even take unconfirmed but already spent outputs in the mempool and aggregate them as well. Alice to Bob to Carol becomes Alice to Carol, achieving non-interactive transaction cut-through. This can be especially powerful when a single UTXO with many branching off-chain transactions is forced on-chain, such as may be the case for Lightning Channel factories.

In short

We’ve summarized the core functionality of SNARKs for blockchains with NIWA. Any witness data can be non-interactively aggregated by a SNARK. The non-witness data that remains is a direct reflection of the state of the system — the UTXO set. While SNARKs can achieve amazing things such as allowing you to catch up from genesis by merely downloading the UTXO set and a single SNARK, or non-interactively aggregating sequences of unconfirmed transactions into a single transaction, there still remains a need to publish all non-witness data for each new block in order to allow all nodes to update their UTXO set. The fundamental bandwidth constraints of blockchains are therefore not solved by SNARKs.

— Ruben Somsen

Thanks to Sanket Kanjalkar for the helpful discussion and comments.

♦NIWA in action. SNARKs consume witnesses and are also a witness of their own. SNARK eat SNARK.♦
Ribbonfarm ( Feed )
Wednesday, 30 September 2020
Notes: The Marshall Plan by Benn Steil
I read this next book, The Marshall Plan: Dawn of the Cold War, by Benn Steil, in an attempt to take the idea of a “Marshall Plan for post-Covid recovery” seriously. I’m glad I did because I apparently had an entirely misguided understanding of what the plan was, the context in whic
I read this next book, The Marshall Plan: Dawn of the Cold War, by Benn Steil, in an attempt to take the idea of a “Marshall Plan for post-Covid recovery” seriously. I’m glad I did because I apparently had an entirely misguided understanding of what the plan was, the context in which it was undertaken, […]
Ross Ulbricht ( Feed )
Tuesday, 29 September 2020

by Ross Ulbricht

♦Drawing by Ross Ulbricht (2020)

From the light of freedom to a concrete tomb,

The fall was great and swift.

My soul cried out in a mighty boom,

How could it come to this?

Clamped down, trapped stuck,

Paralyzed in a tiny cage.

Had fate left

by Ross Ulbricht

♦Drawing by Ross Ulbricht (2020)

From the light of freedom to a concrete tomb,

The fall was great and swift.

My soul cried out in a mighty boom,

How could it come to this?

Clamped down, trapped stuck,

Paralyzed in a tiny cage.

Had fate left me not a drop of luck?

Was there reason for this rage?

Told to lay down and die,

Something deep inside me stirred.

I can’t be caged I have to fly!

Not yet am I interred.

They can take my body, tie me down,

It matters not a bit.

My spirit still runs wild and free,

So in freedom here I sit.

Ribbonfarm ( Feed )
Wednesday, 23 September 2020
Epistemic Reserve Notes
The metaphor of learning-as-purchasing pervades language — “are you buyin’ this?” There must be some kind of currency exchanged when you accept something new. As explored in Wittgenstein’s Revenge, the problem in modern public discourse is not that we disagree on the facts. Instead, we lack a c
The metaphor of learning-as-purchasing pervades language — “are you buyin’ this?” There must be some kind of currency exchanged when you accept something new. As explored in Wittgenstein’s Revenge, the problem in modern public discourse is not that we disagree on the facts. Instead, we lack a common “epistemic currency.” Perhaps facts used to be […]
Marcel Burger ( Feed )
Friday, 18 September 2020
Bitcoin In The Institutional Investment Portfolio

In May 2020, Paul Tudor Jones sent a remarkable letter to the participants of his “Tudor BVI Global Macro” Fund [1]. He revealed that the…

Continue reading on »

In May 2020, Paul Tudor Jones sent a remarkable letter to the participants of his “Tudor BVI Global Macro” Fund [1]. He revealed that the…

Continue reading on »

Ribbonfarm ( Feed )
Wednesday, 16 September 2020
Notes: The Starship and the Canoe by Kenneth Brower
This next book has probably my favorite so far of my pandemic reads. Kenneth Brower’s The Starship and the Canoe. It’s a strange paired biography of physicist Freeman Dyson and his son, adventurer and historian George Dyson. The “starship” refers to the nuclear powered Orion r
This next book has probably my favorite so far of my pandemic reads. Kenneth Brower’s The Starship and the Canoe. It’s a strange paired biography of physicist Freeman Dyson and his son, adventurer and historian George Dyson. The “starship” refers to the nuclear powered Orion rocket program that Dyson Sr. helped conceive and lead, while […]
Cryptosovereignty ( Feed )
Monday, 14 September 2020
Messianic Bitcoin

The eschatological task hidden in Bitcoin “For the Messiah arrives not merely as the Redeemer; he also arrives as the vanquisher of the Anti-Christ. The only Continue reading »

The post Messianic Bitcoin appeared first on Crypto Sovereignty.

♦Stefan Lochner, Last Judgment, c. 1435. The eschatological task hidden in Bitcoin

“For the Messiah arrives not merely as the Redeemer; he also arrives as the vanquisher of the Anti-Christ. The only writer of history with the gift of setting alight the sparks of hope in the past, is the one who is convinced of this: that not even the dead will be safe from the enemy, if he is victorious. And this enemy has not ceased to be victorious.”

Walter Benjamin, On the Concept of History

Bitcoin is Messianic because it is about so much more than just money. It is about the power and redemption of God when we choose to use and hodl our wealth in a medium that can be controlled by no one, and open to everyone. It is messianic not for its economic capacity, the cryptographic seal it creates, or even for the sovereign power it contains; but for the very real faith it gives us in something better.

It is this faith that has the power to change everything.

Bitcoin is about the power of God because of what is unlocked when we believe in a force that is beyond the temporal power of any mortal, any government, or any other kind of physical force. Bitcoin presents the saving grace of the world of today, and is how we may redeem and save ourselves from this world of lies, guile, and deception. And it is not just about Bitcoin as techne (τέχνη), but is about Bitcoin the episteme (ἐπιστήμη) that imbues it with messianic meaning.

Hidden deep inside of Bitcoin we find a messianic power that is created when one understands the true meaning of cryptography and what it can offer to each individual person on this planet. It is a power that redeems us from nation-states, governments, laws, identities, and every other form of power that seeks to exert control over us. Within Bitcoin is hidden a power that allows for any person, born anywhere, from any nation, of any faith to choose a new God who has sanctified the power of cryptography and the majesty that will always animate it. It is the secret of a God who loves us so much that he would allow for cryptography to be developed into this world, for the free and fair use of all people, everywhere.

This God that is found in Bitcoin offers us a kind of protection and safety that is beyond anything in the world of today. It is the immanence that is the true, the real, and the profound wealth that is knowledge of God, and his infinite promise to keep us safe. It is a promise that no man, no government, no institution anywhere today can fulfill because of the fallen nature of language and its complete corruption which has torn it asunder. The meaninglessness that has become the oath, and the total lack of any language to obligate itself towards its semantic form has created our pathway here. And through the super-language project that is Bitcoin, we now have an exit as well.

Bitcoin is about God because Bitcoin is not just about money–it is about the promise of what a truly free and fair money and form of wealth controlled by no one nation, state or institution means in the world of today. It is the introduction of a messianic object into the world that has absolute scarcity about it for the promise it will always cointain. It creates a radical new way forward that allows for humans to organize voluntarily on the grandest of scales, and advances human civilization as a whole. It allows for any person anywhere to save and protect their wealth, legacy, and honor far beyond our life expectancy and into the foreseeable future. Through our actions today, and supporting Bitcoin we ensure that one-thousand years from now that a fair and equitable economic order has been established for all future generations to come. Bitcoin is a power that allows for us to and overcome any nation-state, move past any physical boundaries set, and move man into the cosmos of space itself.

God is found in Bitcoin at the exact moment that the flash of understanding illuminates the reason of cryptography, and that it is seen and understood as knowledge. In this moment of spectacular holy light that flashes for the briefest of instances; the power of cryptography is unveiled with all of its grandeur, glory, and extraordinary power. This is the power of cryptosovereignty and it is the personal power offered by Bitcoin and the cryptographic contract that is between oneself and God alone. It is not the machine, nor the code, nor even the person who does the decrypting that creates this power–but it is the immanence of God himself as he moves through the world with his secret ways. God is the one who has allowed for such a marvel as Bitcoin to be created, and to be brought forth into this world, and it is His will which protects it and continually displays its glory for all to see.

Satoshi Nakamoto is God’s chosen prophet of this new technological age, and he is The Figure who can change the destiny of the whole of humanity for good. Through his anonymous production of Bitcoin through the power of cryptography, he has proven to the world that cryptography is the most powerful weapon against any state, or any advisory–even Armilus himeself. It is not a constituent power of force, but a destituent power of forbidding. Through the totality of this new kind of power Satoshi has given us the keys to decrypting our way out of this Hell, and asked for nothing in return. This is nothing short of messianic, and it is not for the wealth or power he has created, but for destituent and forbidding power that Bitcoin impels.

Within Satoshi we find someone who looks so much like The Mahdi, but the light that surrounds him is just too blinding from the task that he has done. We cannot see who he really is through this blinding halo; but what does it matter who he is? What matters is who Satoshi really is–he is the one who produced Bitcoin into the world and he is the one who had the courage to walk away. Only through his embracement of being a no-body–a person who is not of this physical world, and who does not have a body of flesh and blood, do we find the savior of our time–the creator of a new territory of freedom from which we can redeem the physical realm. 

This task of creating Bitcoin was something that could only be produced by the anonymous stranger. The Other whom I can have no power over. It is only from them, the faceless, nameless other, that the possibility of Bitcoin could bloom into the world. In a world of egoist delusions of the grandest of scale, where statist have allowed for the machine of power to satisfy every sick desire they have, to spy upon everyone, and attempt to know every possible thing, could the anonymous other achieve such a power. Through refusing to offer a body to be destroyed, a reputation to be tarnished, an identity to be punished, Satoshi ensured that he could go beyond the power of any state, and become the Overman of the digital era. Only a person so humble as not to speak their name, so gracious as to not claim their fame, so powerful as to refuse even a satoshi of the greatest fortune on earth could have accomplish a task as great as Bitcoin. 

Satoshi did all of this not to become rich, famous, or even powerful; but as an act of love alone. To bestow upon humanity a power that could redeem us from the lawlessness and disorder of fiat money, and to go beyond the wrath of a law and politics that is utterly corrupt and broken. He has delivered us a system of protection that can offer us a kind of safety and security that no other can offer, and opens the world to a radically new possibility of peace in our time. Satoshi created something which glows with the immanence of glory that only God could contain, and he gifted it to us without a desire for anything else, or to be known for anything beyond his task alone. What else could this be called other than the greatest kind of love?

Bitcoin is Messianic because it engages in all of these questions, and does not retreat a step or give in at all. It forces one to ask the question, “Who is this God and why would his providence be hidden in something as trite and banal as just ‘money’?” This is the most important question that can be asked, for it illuminates our path of reasoning from which we are creating a new horizon of freedom that is beyond this world of flesh and steel. Such questioning creates an active way of reasoning and thinking about what is the nature of money, law, and power, and why they function in such ways. Bitcoin actively forces questions about what it means for wealth to be fair, and what it means to live in a world where we must make that a reality.

Bitcoin is about God because it impels the Apocalypse (ἀποκάλυψις) in the deepest sense of the word–a revealing of the truth of all things. Bitcoin reveals an epochal change that cannot be stopped, and that the world needs if we are to ever live in peace, without the threat of violent exploitation looming over every one of us. Bitcoin threatens the very foundation of the world order of empire today through revealing that fiat money is little more than legal theft by decree, and the state nothing more than violent thugs who demand to control all wealth at any cost. Bitcoin induces a personal theological struggle against all orders of fiat money, and demands a future freed from these last vestiges of the slavery of man.

Bitcoin offers us a hope of redemption from this world that has fallen into chaos, meaninglessness, and disorder through offering us a new kind of social contract from which we can find the true hidden power of God once again. Bitcoin has the very real trapping of what it means to find God in this world so deeply sown with men who are empty of themselves and have lost the confidence of God and His order of the world. No longer will we tolerate states that calls themselves omnipotent towards the order of wealth, and entitled to a power that amounts to that over all of life. We are here to say with a thunderous rumble, no long will the state be the final purveyor of wealth, the watchman over all of life. 

No longer will we tolerate living in a world of liars, sycophants, and sociopaths who seek to control everything through fear and terror, authority and decree. No longer will we idly sit by and allow them to eat out our wealth, and reduce us to impoverished destitution for their selfish and greedy desires. No longer will we allow for their corrupt and deranged version of false democracy to allow for the theft of the world in exchange for broken political promises we all know to be lies. We now have something better–a way to resist and fight back–a messianic weapon of unequivocal value which they can never take away, they can never destroy, and will outlast them all. For Bitcoin is not about just money–it is about a new way of life.

Bitcoin is about God because it induces a theological struggle against all fiat money. This is an eschatological task in the deepest sense of the meaning, for it is no longer just about money; but it is about law and order itself. It begs the question, “Are men entitled to control the wealth of the world and the order of law, or is it something that is beyond them, and their temporal nature in this world?”

All of these questions are part of the great ontology of Bitcoin and what it means to be alive in this day and age of the technological renaissance. They are questions that force us to deal with the meaning of the Death of God and how we may find a path to create and accept a power that is higher than the state, fiat money, and all of their appendages of death. To accept Bitcoin is to accept a God that is glorious enough to have created the power that is Bitcoin, and to have given it to us through the extraordinary grace and disposition that is his prophet Satoshi Nakamoto.

Through the hidden knowledge that Bitcoin endows us with, we discover the secrets of power that have always animated cryptography, and shall always ensure its grace and power to protect us. Not only does Bitcoin have the power to vanquish the nation-state today without shedding a drop of blood, but it also opens us to a radical new form of communal living based upon the power of cryptography, and the magnanimity and consanguinity it must always cointain.

Here we stand at the edge of a new era, a new dawn from which humanity can rise from the bondage of fiat money, and create a radically different future that is better for all. Bitcoin cointains the power to create a new commonwealth from cryptography where truth, not authority becomes the final purveyor of legitimacy. Bitcoin has initiated a struggle against the globalized world order where the nation-state and their infinite fiat money and propensity for violence can no longer hold sway, for the very thing they signify is not money, wealth, or power, but illegitimacy, incompetence, and evil. Through the infinite power that all states have declared they are entitled to, they have created the very condition that proves their illegitimacy and the need for them to be totally and completely destroyed.

Satoshi, as the first prophet of this new digital age, has given us a gift that is beyond anything comparable, and has the potential to redeem the human race from the evil that has captured it today. If everyone today were to understand Bitcoin, and to accept it as their primary form of wealth and savings, the world would become a radically different place overnight.

This is because Bitcoin introduces a new form of law that is beyond any nation-state and their gangrenous legal systems. With Bitcoin, man no longer needs to rely upon the forked tongues of liars and politicians to create his laws or money. Bitcoin is a testimony against the entire system of statism and the inherent violence it must always contain by offering us a radical new system that protects our wealth and agreements beyond the words of any man, of any contemporary laws, of any legalized violence. Bitcoin is the unveiling of truth that the state exists only as an object for the domination and exploitation of man over man, and its belief that the state is a God entitled to the whole of the world and future for itself alone.

However, through the use, hodling, and proclamation that Bitcoin is to the world, we have a way to change everything. This unveiling is the Evangelion of Bitcoin; The Good News that it is, and the hope that it will always cointain. No longer do we need to live in fear and terror of state robberies under the pretext of law. We now have a way to resist and refuse to allow for such horrors; and it is glorious in the most profound and significant ways.

To vanquish Dajjal–the evil force that believes itself to be above all human life, entitled to the endangerment of the whole of life on earth for its own petty and temporal gains–is the task at hand. However, there is no amount of violence, no amount of force, no kind of authority that can accomplish such a task. It is something that must be chosen by each individual on this planet. To choose to refuse to be part of such barbarism, to participate in such evil, and to turn towards something better that may offer the real protection and safety that we all desire. And through this action alone of refusal, we will make the world new again.

Through what Bitcoin promises, through the oath that it is to itself and the assurances it creates, bitcoin creates a radical new opening from which humanity can redeem itself. Bitcoin accomplishes this by being not only better than any fiat money today, but by being better than any fiat money that could ever exist. Bitcoin initiates the total and final struggle over the wealth of the world, and what it means to free the wealth of tomorrow from the struggles of today. Bitcoin creates a money that is fair to our posterity, and allows for us to reclaim the commonality of our wealth–something that only we may do.

Through the declaration of what Bitcoin is, what it seeks to be, and how it liberates us from the chains of fiat bondage and the state’s panopticon, we create the conditions for the return of the messiah, whomever they may be. Through the extraordinary love that is Bitcoin, we all may share in the majesty that it contains, the Good News that it is, and participate in the redemption of humanity from the shame of statism and what it has done to our world, our people, and our nature. 

Bitcoin is the messianic object that humanity has been waiting for: to be liberated from the chains and bondage of the economic and physical power of man over man. It is the blinding light of an object of value that cannot be extracted from any person no matter how much violence is extolled upon them when used correctly with the rituals of cryptography. It is the finality of choosing to refuse to participate in a system of exploitation, corruption, and meaninglessness in order to choose something greater for us all.

Satoshi as God’s prophet for a new technological age has given us the gift of the world, the final hope from which we can change everything. It is a 

Bitcoin is the personal choice of redemption from corrupt authority of any color, and replaces it with the power of truth, and what that means in the world of today. Bitcoin is a choice, a choice for something better, for a money that cannot be taken for the light and transient causes of corrupt governments and the greed they will always be. It is a choice to create a better world together, through using cryptography and the new form of social contract it entails. It is a choice of love; for Bitcoin respects both you and I enough as human beings that it desires to protect us with the cryptographic guarantees that only God alone could offer.

Bitcoin is Messianic, not for the infinite wealth it will create, nor for the infinite guarantees of cryptography it contains; but because of the free will that each person must act upon to accept it, and the absolute and complete condition of love that using it must entail. To allow for each individual the personal choice that is Bitcoin, the choice to turn away from the system of evil that runs the world of today, and to choose to create something better with one another is the messianic secret it contains. Through this power of choice we get to create a new system of values and wealth together, which not only redeems us from the sins of our physical bodies, and from the world of flesh and steel, but also gives us the power to vanquish the Anti-Christ which so clearly rules the world today. Bitcoin is the choice to create something extraordinary together that will liberate us all for the better future that is to come, and for that reason it will always contain the messianic promise of a better world that is to come. 

A massive thank you to Jesse Posner (@jesseposner) and Joe Rodgers (@_joerodgers) for their feedback on this essay.

The post Messianic Bitcoin appeared first on Crypto Sovereignty.

Ribbonfarm ( Feed )
Thursday, 03 September 2020
Wittgenstein’s Revenge
We treat facts like they’re “atoms of truth” — small, indivisible, solid — and if you add them up, you get “big truths.” But like atoms, facts are mostly empty space, and the closer we examine them, the less solidity we find. It may be time to graduate from the metaphor
We treat facts like they’re “atoms of truth” — small, indivisible, solid — and if you add them up, you get “big truths.” But like atoms, facts are mostly empty space, and the closer we examine them, the less solidity we find. It may be time to graduate from the metaphor of facts completely, to […]
Ribbonfarm ( Feed )
Wednesday, 02 September 2020
Hyperreality Prevails
To picture a rhinoceros in Renaissance Portugal, consider the unicorn. Whether conflated with the oryx or the narwhal at its southernmost and northernmost coordinates, the unicorn was no less of a shapeshifter than Dionysus, who came from the East―the two sharing goatlike renditions; the axis, as Pli
To picture a rhinoceros in Renaissance Portugal, consider the unicorn. Whether conflated with the oryx or the narwhal at its southernmost and northernmost coordinates, the unicorn was no less of a shapeshifter than Dionysus, who came from the East―the two sharing goatlike renditions; the axis, as Pliny described it, being “sacred to Bacchus.” The unicorn […]
Uncommon Core ( Feed )
Thursday, 27 August 2020
Uncommon Core Podcast – Episode 8 transcript

Crypto’s Killer Product So Far – Intro to Perpetual Swaps with Su Zhu For today’s episode, I sat down with Su Zhu to learn all about perpetual swaps. There’s probably not a person in this space who has more authority on this topic than him. The first half of the episode serves as a gen

Crypto’s Killer Product So Far – Intro to Perpetual Swaps with Su Zhu

For today’s episode, I sat down with Su Zhu to learn all about perpetual swaps. There’s probably not a person in this space who has more authority on this topic than him. The first half of the episode serves as a general introduction to perpetual swaps, while in the second half, we explore how perpetual swaps are coming to DeFi and why they are the single biggest primitive that is still missing from the DeFi puzzle. While the episode can get pretty technical at times, we tried to follow a logical buildup, so no prior knowledge should be required. Please note that I put some links to definitions and followup reading into the show notes. Enjoy the episode.

In this episode:

  • What is a perpetual swap and how does it work
  • The history of perp swaps and their usage outside of cryptocurrency
  • How the oracle problem is misunderstood
  • AMM and central limit order book: mapping the two approaches to perpetual swaps in DeFi
  • Tradeoffs between perps in CeFi and DeFi
  • Perpetual swaps as money legos
  • How DeFi perp swaps will enable a new form of stablecoin
  • The role of insurance funds and auto liquidation

Listen and subscribe here

Hasu (00:00:03):
To start out the discussion: what is a perpetual swap, and how does it work?

Su Zhu (00:00:10):
A perpetual swap is the idea that the buyer is buying synthetic exposure to an asset and the seller is selling or shorting exposure to that same asset. So the word perpetual there has an important meaning, which is that it has no expiration. On like a futures contract where it’ll have a predetermined date at which the derivative no longer exists and gets settled. A perpetual swap seeks to maintain the exposure for the buyer and seller perpetually. And so that, that is in a gist what a perpetual swap is. There’s a lot of different ways that it can be traded and there’s a lot of different ways that it’s structured, but fundamentally it’s a way for participants in a market to come together and exchange risk.

Hasu (00:01:12):
Yeah. So maybe just slightly rephrase what you said. So for regular futures, the price of a contract tends to gradually converge with the spot price or the index price as expiry comes closer. Right. but this is not the case in a perpetual swap because it never settles. So can you explain maybe how, how it is done in perpetual swaps, how the perpetual contract can successfully track the underlying index price?

Su Zhu (00:01:47):
Sure. So the arbitrage mechanism of the future is as you alluded to, well, well defined, right? Because the contract will essentially define the index at which the derivative will necessarily settle on its expiry date. So if it’s a cash settled future that settles on, let’s say the TWAP ( of four spot exchanges, then on that day, everyone knows that that will be the price that these derivatives end at. So from there, people can buy the spot, sell the future, and vice versa, to replicate the risk that they’re getting. With the perpetual swap, because there’s no expiry, there has to be some other incentive for buyers and sellers to meet the natural demand of the market. So the market generally wants to be long. Then you expect perpetual swaps to need to incentivize sellers to come in in order for that market to happen.

Su Zhu (00:02:53):
So there’s a few ways that perpetual swaps can do this. The popular way in cryptocurrency is to have a scheduled funding payment between buyers and sellers. So in that example, if people are bullish, then swaps will be generally paying positive funding payments, whether every eight hours such as in the case of BitMEX, OKEX, Huobi, or every hour in the case of FTX [inaudible] futures, and then continuously in the case of Deribit, but just in general, the idea that the buyers are going to have to pay the sellers some amount of money, every period in order for the seller to stay in that position. So that creates an arbitrage opportunity from the seller, right? Cause the seller can come in and short these perpetuals, buy the spot, and now they have essentially a crypto dollar, right? They’ve, they’ve regenerated the exposure of $1 and they’re collecting interests while doing so. And if they clicked an interest rate, that’s attractive to them, then they’re happy to be in that position. And if they’re not, then they’ll unwind it. So that in a gistt is kind of how perpetual swaps became very popular because you could buy or sell a perpetual swap and know that your exposure never disappears.

Hasu (00:04:18):
Right? So you think you’re talking for example, about the case where I deposit BTC on a derivatives exchange. So I’m long my collateral. And then I sell the perpetual swap contract for the same position size as my collateral and thereby neutralize my long exposure and create a crypto dollar. Correct?

Su Zhu (00:04:41):
Yeah, exactly.

Hasu (00:04:43):
Okay. So for the funding rates, so a mental model that I, that has worked well for me was to not actually see these as perpetual, but just imagine that, so let’s say in the example where you have a funding rate every eight hours to just see these as distinct futures contracts that settle every eight hours, and then you’re automatically rolled over into, into a new future. Do you think that’s a solid model?

Su Zhu (00:05:20):
It’s not quite, it’s not quite the model I would use. I kind of, I get what you’re trying to get at, but I think a main difference is that in the case of the cash settled future, you know, that the swap will converge to the index price. Whereas in the case of a perpetual, you don’t know that the raw price will converge to the index. In fact, when the market is very bullish or very bearish, that price will not converge, but you’ll get paid something in lieu of convergance. So in these formulas they’ve been generally made quite aggressively to pay arbitragers because they want to protect the integrity of their market. And the trust that people have, that it will track the index, that it will track the underlying. So these payments are large enough that they seem like they’ve essentially paid for the difference between the swap price, the observed swap price and the observed index price. So I think you’re right, but I think there’s some nuance there where it doesn’t have to converge.

Hasu (00:06:25):
Gotcha. Gotcha. So there’s this persistent myth that I also, I also subscribed to for some time before, like learning what’s actually true that perpetual swap contracts were invented in the cryptocurrency space, but you actually taught me that it’s not true. So gave maybe give us a quick overview about the history of the perpetual swap contract.

Su Zhu (00:06:59):
Sure. So, I mean, in general, it depends on how specific we want to be on what is perpetual swap, right? Some people might say, well, perpetual swap in its modern sense was invented in crypto. Some people might say, well, it has a predecessor, or it has a ancestor which is the idea of an index swap or equity link swap. Basically the idea that two counterparties meet in a market and decide to sign up paperwork to exchange cash flows, right? That that’s pretty much all the perpetual swap is. So if you take that sort of philosophical view of what a perpetual swap is then obviously they’ve been around for probably 30, 40, 50 years, right? Because it’s just the beginning of the modern financial markets. There’s been a lot of demand for sophisticated counterparties to make their risk exposure synthetic rather than actual. And these reasons range from tax efficiency to capital efficiency, to more broad offshoring of risk. There’s a whole host of reasons why participants wanted this in the OTC markets. But the reality became that the vast majority of, for instance, equity exposure of European funds into Asian equities is not via owning Asian stocks. It’s via owning equity swaps. So these swaps will be collecting and receiving payments based on some criteria. And the buyer gets exposure to the index. The seller gets exposure to the negative index. So the sellers are typically banks, right? Investment banks they’ll sell these swaps and then they’ll buy the underlying markets.

Su Zhu (00:08:52):
And the most common benchmark is the MSCI, the Morgan Stanley composite index. So there’s trillions of dollars in these indices. And these swaps are essentially perpetual swaps because there’s a funding payment, it’s benchmarked to LIBOR plus minus something. And there’s also an index. And so this concept is not new. This concept is not new, right? The main reason participants like this is because there’s no need to roll it, right. There’s simply a payment. So the problem with the problem with the futures is that participants need to constantly, re-meet in the market and roll their position. And that, that creates a lot of uncertainty because what if that market shifts very quickly, what if that role is not available? And so as a result, you tended to see in the retail market as well a key predecessor would be the contract for difference or the CFD.

Su Zhu (00:10:00):
And this is a very popular market in the UK and Australia, pretty much in markets where CFDs also get preferential tax treatment because they’re considered bets and gambling is sort of lionized in the Anglo sphere, basically it’s not taxed, right? So, you know, the idea being that if you’re a sports bettor, shouldn’t be taxed on winnings cause you’re negative EV anyways. And so, but, but then as a result, you know, when you invest in stocks, you do get taxed because governments tend to think that when people make money from investing, they should pay some of that back. So it’s kind of an arbitrage because now if you say, well, I’m not investing, I’m betting, but the number will go up and they say, okay, well, yeah. Then what do I do? So as a result, see if these very popular in these countries and same concept there there’s an overnight funding rate.

Su Zhu (00:10:54):
You know, one key difference is that usually these are not peer to peer, but these are peer to dealer, customer to dealer. So the dealer sets the funding rates. The dealer takes a bit of a spread on that funding rate and that’s not an, it’s not a peer to peer market. And the Japanese market, perpetual swaps are also very popular. Also known as CFDs in that market. Because again, there’s no expiry and you could consider the entire FX market to be a perpetual swap market as well, because there is a funding payments exchanged every day, they’re called “tomorrow next swaps” or “tom next” swaps basically the payment that you receive or pay to be long, let’s say Dollar versus Yen, Euro versusUSD. These are all payments that are analogous to funding rate payments. And if you’re in the interbank market, then it is almost like a peer to peer market, right?

Su Zhu (00:11:52):
Where there’s no bid-ask, you can exchange it at the same price you can buy and sell at the same price and your exposures are carried forward through time. So, so I think that that being the backdrop, I think the explosion of crypto perpetual swaps was made possible by a few things happening at the same time. I think one was that spot markets became close enough in line that you could start constructing indices of them to benchmark a swap against because that wasn’t always the case, right. There used to be 5-10% arbitrages between spot exchanges. And it’d be very difficult to construct such an index that you’d want to benchmark to. I think when BitMEX launched their swap, they had to change their index radically several times, right? Like first they had Bitfinex in and then they took it out. Now they have OKCoin and they took it out and then they made it just Coinbase and they made it…at that time. It was very hard to figure out what that should be.

Su Zhu (00:12:53):
I think also perpetual swaps became a strictly better product than what at that time was the weekly futures on OKEX. So before, before perpetual swaps, everyone traded the weekly OKCoin or OKEX futures and as well as their quarterlies. But the problem with the weekly is that retail clients often forget to roll their positions. So if you don’t, if you don’t remember it, so let’s say sell your expiry one week and buy the next one week. Then on Friday evening, you’ll you’ll log in and you realize that you’re not long anymore. You’ve already gone to expire. So quite often then hen the market maker would actually analyze this and then say, Hey, you know, 30% of open interest is not getting rolled.

Su Zhu (00:13:39):
You know what, all the price action will often be that it, you know, it gets dumped into the expiry print. So anyone who doesn’t roll they’re there. And if you’re long, let’s say you’re synthetically saying that you’re going to sell your position at any price. Right. Because you didn’t roll.

Hasu (00:13:53):
You’re a forced buyer or a forced seller.

Su Zhu (00:13:53):
Yeah. And so you’re yeah, you’re basically when you don’t roll, it’s not that you’re doing nothing. You’re, you’re giving the market a market order. That that’s what you’re saying. So you see basically the market tank into the expiry print and then moon right afterward. This is a very common pattern at that time because market makers realized that this is how you make a ton of money. Right. You slam it down and in theory they should be defending spot, right. Because if you’re letting your long expire, you’re basically if you’re market neutral, you’re presuming, you’re saying the market that you’re going to now bid spot to replicate your exposure back to get your long back. Right. So if you don’t defend spot, then the guidance has the opposite position to you. He’s going to essentially smash the print in his favor against your position. Right. He basically selling your position as low as possible. So that you’re, you are synthetically selling that print.

Hasu (00:14:51):
So a lot of people in crypto talk about trading around these expirys of I guess weekly or monthly futures on CME. So is that basically what you described?

Su Zhu (00:15:10):
Yeah. So it’s similar. I mean, the CME print is definitely very important. I think, I think not just psychologically, but also from a flows point of view, just in terms of, if people don’t people don’t roll a futures, right. And sometimes people don’t, what they’re saying is that they don’t want to have it anymore, that they don’t want to be long anymore, or they don’t wanna be short anymore. And that that’s treated as a, as a market order hits the market. So sometimes this can be very big. Sometimes it can be very small and sometimes people can see this and then anticipate it. So there’s definitely game theory to it. You can’t just say “because of this, then that”, the market is dynamic. Right. But there’s a lot of important things happening on that print, essentially. There’s a lot of risk being exchanged or not exchanged based on that print.

Su Zhu (00:16:28):
Sure. And just to give an example of how it’s hard to interpret sometimes, right? Let’s say someone is long lot of futures on CME, and then they seem to be expiring them so that they didn’t roll them to the next month. But they could be now buying spot during the TWAP window instead as a passive client. So that’s actually what some of these guys like Paul Tudor Jones and, and some other macro fund managers supposedly did, which was that they wanted to get in fast because they thought Bitcoin was gonna moon, so they first bought CME futures because that’s the easiest way to access these. And then later they said, well, I want to actually get the Bitcoin spot. How do I get that? It’s a couple of choices, right? One is you could find someone to trade the future versus spot with you because you already let’s say long, I don’t know, $200 million worth of Bitcoin through futures.

Su Zhu (00:17:19):
It’s a bit annoying to transfer that into spot, right? Well, it’s not actually that annoying because all you have to do is let your futures expire. And then as in it, in the expiry window, in the, you know, the, the expiry definition, you then buy spot Bitcoin every minute to get your exposure back. And you have no slippage, right? Because the price that you buy spot at is the same as the price that your futures are defined to expire at. So, so in a way that that mechanism is very powerful. And so when someone expires their longs, it could mean that they’re not, they don’t want to be anymore, or it could mean that they’re going to switch it into spot, which is also very bullish. So just to give an example.

Hasu (00:18:03):
Gotcha. So do you think that the perpetual swap contract is strictly better than monthly or weekly futures and as a result, is it going to completely crowd out that form of contract?

Su Zhu (00:18:17):
I think it’s not strictly better. I think it’s definitely an improvement versus weekly futures for retail. I think it’s a very good retail product. I think for institutional players or for a more sophisticated players, they also need month end futures, but they also need quarterly futures. Good example would be to hedge options flows, right? So options typically concentrate around the month end and the quarterlies. And if you’re an options market maker, you definitely need to trade a future that is in line with your options expiry. Because if you just, if you, if you just trade perpetual, swap against it, you’re going to be in big trouble. If the funding changes is a lot, because you have to price in how much swap funding you expect to pay or receive over the interval of your options life. Right. And so, so that, that process of pricing it in, you’re going to want to see how the actual month end future, would it be traded, to price it.

Su Zhu (00:19:19):
So, so that that’s one. And then two is that if you’re, let’s say a miner. You’re, let’s say a, a, a spread trader. You, you generally want to lock in the duration of your positions in line with your, your actual cash flows, right? So let’s say, you’re going to, you think you’re going to mind this much BTC over three months, you probably just want to sell a future and be done with it. You don’t want to sell a swap and then have to deal with checking. If the funding is in line with what you expect, you know, you kinda just want to do the kind of just want to do the simplest trade. So there is always going to be a lot of demand for quarterlies. The quarterly open interest on the Chinese exchanges is very high. On Huobi and OKEX. Actually, if you sum those up, it’s usually higher than BitMEX swap. And, and the, even after introducing swaps, the quarterly openings is still much higher than perpetual swaps on those exchanges. So there, there is clear longterm demand for trading quarterlies. I think the weeklies have been generally dominated by swaps and I, and I heard some rumors that they even want to delist their weeklies cause they just thought it’s a bifurcating liquidity and there’s no point to them anymore.

Hasu (00:20:36):
Yeah. Okay. Yeah. That makes total sense. So whereas the feature of the perpetual swap is basically that you’re automatically rolled over or that it never expires a feature of the weekly or monthly is that it does expire when you want it to. And so in both cases, you, you, you save mentol and financial transaction costs, it only depends on what you actually, what, okay. Interesting. So I want to go, go back to one thing you said earlier about the early days of BitMEX and how they had to reconstruct their index multiple times and so on. So a lot of people say that in in blockchains and DeFi in particular, the oracle problem is an intractable problem that can never be solved, but isn’t, isn’t the problem of index construction exactly the same as the oracle problem?

Su Zhu (00:21:40):
It’s exactly the same. And so I think to say the Oracle problem can’t be solved as clearly is clearly I think a very, either theoretical statement or a very ignorant statement, because I think the oracle problem is simply how do you bring the needful information from observations to settle financial contracts, right? So this is already being done in the, in the centralized finance space for quite a long time. And the fact that there can be issues with this does not imply that it cannot be done relatively correctly and usefully for people. I think that that’s where that’s where, you know, for a long time there was the idea that, well, the Oracle problem is intractable, therefore DeFi could not exist.

Hasu (00:22:37):

Su Zhu (00:22:38):
But, but if you just zoomed out, you could make the same statement and say CeFi could not exist, but clearly it does exist. So, so clearly there’s some kind of a strange is that there’s simply, it’s simply a question of how do you map the trustworthiness of index composition in the real world into the into crypto or into the blockchain? And I would point out that, you know, for me, I’m aware of many inefficiencies that have occurred on CeFi index constructions, right? When I was at Deutsche Bank, as a trader, as a prop trader, you know, there are people sitting around all day trying to think about how do we aribtrage index construction, right?

Su Zhu (00:23:24):
There is entire desks that will say, okay, we’re going to bet on what things will go into the index. We’re going to abuse the fact that this stock is more likely to enter it and by pushing it up and is even more likely to enter the index, all these games, right? And you even saw it recently with some of these Chinese companies where they know how MSCI [and ?] do their definitions. So they create a shell company and then they basically do everything that’s needed to get it into some of these small cap indices, then into mid cap, and then the large cap. And then I forgot the name of the stock, but there was some stock where they managed to get this into one of the biggest indices and no one had done due diligence. This is a real company, right? That, that they had actual stuff going on. And the stock went down 99% of the day [when] the index providers said, we’re going to look into this, if this is a real thing or not, and they’re gonna look into it. It immediately went down 99%.

Su Zhu (00:24:22):
And the, and the fascinating thing about that was that that was the week before. It was about to get included in a very big index, like an even bigger one. And so there were some funds that were betting on that inclusion and because the flow would have been very big because people will be forced to buy the stock. If it gets included, then people were betting that this will get included because it fit all the criteria. But then somehow before that happened, the index came out and said, Nope, we’ve changed our mind. We don’t want it. You know? So, so CeFi, indices, they’re just trying to achieve a goal. Same as DeFi oracles, they’re trying to achieve a goal of saying, we’re going to bring in this information and it’s going to be useful for settling these contracts. And people generally understand how it’s going to go down and what the goals are, but there’s, I mean, there’s always a requirement to zoom out and ask, have we achieved the goal? And if they haven’t, then there’s always room for humans.

Hasu (00:25:20):
Yeah, yeah, yeah. I agree. I think that that’s probably going to be the future of oracles as well. Right. So you have, you have a definition of what an index or an oracle are supposed to do, then you have a human looking at data and cleaning the data. So it fits the goals and then they submit the data on chain or in whatever way it is supposed to be used. So, yeah. And so to to end the section on I guess the history of perpetual swaps, I I’d like to move into DeFi. So in the past in crypto, you could, I guess you could say the perpetual swap is the killer product so far in the crypto space. Would you agree with that?

Su Zhu (00:26:14):
Yeah, I think so.

Hasu (00:26:15):
Yeah. And I think nothing has, has like this kind of adoption, especially from, from retail, but it has been surprisingly quiet around perpetual swaps in DeFi. And today we want to explore a little bit, if that’s going to change how that’s going to change what you can look forward to. So what different approaches exist to create perpetual swaps in DeFi and what, what projects may be about to launch in these categories?

Su Zhu (00:26:53):
Sure. So I think DeFi perp swap projects, they generally can be divided into two distinct types. The first being central limit order book driven and the second being automated market maker or AMM driven, and it’s bit of a mouthful, but central limit just means that some participants are hosting bids and offers and amending them as underlying markets move continuously. So this would be venues like DYDX upcoming DerivaDEX, a few others in that kind of vein. And the idea there is you’re almost mapping the centralized exchange experience into DeFi, right? So when you trade on BitMEX or Deribit or FTX, that is exactly what’s happening, right. There is no automated market maker. They’re just real people putting in bids and offers all day long and do that process when the bid of one participant is higher than the offer of another a trade occurs, right?

Su Zhu (00:28:09):
The matching engine sees that and submits a trade ticket. submits a fill to each side and life goes on. So this approach, this approach has some strengths and weaknesses, right? For, for DeFi. I think the main strength is that it’s simple. You’re just trying to say, I’m going to be decentralized BitMEX, I’m going to, I’m going to let people exchange risk in this way. And that, that’s quite simple. I think that the downside of that is that you’re now taking a workflow from centralized markets. And you’re trying to put it in DeFi and say that it’ll somehow be more useful to people because it’s decentralized, right. But you’re giving up a lot in the process. You’re giving up the fact that, well, for one, possibly all these orders are being seen on chain, so they can be frontrun.

Su Zhu (00:29:10):
Right. You’re also giving up a lot of latency. You’re also getting a lot of performance, right. You know, a centralized exchange matching engine might be able to handle a million requests in a second, whereas there’s no blockchain that can handle that. So it’s, it’s kind of, that that’ll be the main challenge. So for the ones that are going this approach, they’re thinking very heavily about how do we scale, right? How do we scale? How do we do off-chain matching in a way that people still trust, that’s still DeFi enough? So, so that approach I think is, is fundamentally a bet that the scaling will be sufficient to create the experience that is good enough, that, you know, users that don’t want to use KYC users that want to be able to just use a web wallet, get in and out. They’ll be familiar with that.

Su Zhu (00:30:02):
And so the advantages is that they’ll be familiar with how it works in in centralized exchanges already. So Serum would be another one that’s in that category, right? Serum will be based on Solana and they’re, they’re backed by FTX, which would also bring that expertise from central limit order book trading in as well. But again, you have to, you have to create a user experience where they’re saying this is actually a really good and really useful versus what I can already do on CEX, on a centralized exchange. So the second, the AMM approach, there’s a few projects in that space, FutureSwap, Perpetual Protocol, Synthetix itself. And, and these are saying, okay, well, why don’t we take the DeFi primitive of the AMM, the automated market maker, and say people when they come into our order book and they, and they want to buy or sell, they don’t need to wait for the other side to be there. There will be a pool of capital waiting for them, right. And that pool will trade against the client. And there will be token holders who are backing this pool, and then they can hedge themselves in any number of ways. So, so, so this approach is trying to more, more explicitly tease out the advantages that DeFi might have over CeFi, right. Which is that it could, permissionlessly create this big pool of capital that sits as the market maker.

Hasu (00:31:46):
Yeah. I want to get into the the advantages of what perpetual swaps could do in DeFi versus CeFi also a little bit later. So but to, to maybe for our, for our listeners. So in a previous episode where you gave me an introduction to DeFi in general, you made the distinction between peer to peer contracts or peer to peer trading and peer to pool trading. So p2p is the central limit order book. Right. And peer to pool is exactly this AMM model.

Su Zhu (00:32:24):
Yes, absolutely.

Hasu (00:32:28):
So I I guess not a lot of people including me have thought about how you actually use the AMM model for perpetual swaps, because like, I’m trying to think how you would like in a regular pool where you swap assets, you have this pool of of two different, or even more different assets in a, in a pool. And then people can put in one asset and take out another, and the ratio in which they can trade these with the pool changes. So I’m kind of struggling to envision how this would work for, for swap contracts.

Su Zhu (00:33:06):
Yeah. I mean, without getting too technical, the easiest way to think about it is, imagine that you and I, and some other people, we opened a bit BitMEX account and we deposited our money together. Right. And we said, this strategy will be whenever someone comes to buy, we sell to them and then we can all see, we can all log in and see what the risk of our position is. And we also can calculate what percentage of this account we contributed. And from there, you can imply what your risk is, right? So let’s say the account is, well, let’s say just you and me and we shorted 1 million of of BTCUSD swaps. Then you would say, okay, well, you’re now short 500k and I’m short 500k, and you would, if you wanted to hedge, you would then go and buy spot yourself.

Su Zhu (00:34:02):
And you can say, okay, now I am hedged and I have replicated that risk. So that, that approach clearly works because the people in the pool are arbitragers fundamentally, and they’re getting their fills automatically rather than having to post liquidity in the order book. So you can think of it as a virtual AMM, it’s not a real AMM in the sense that it’s not like Uniswap where the aggressor into the order book is actually removing some assets and contributing others. Right? There are no real assets being exchanged. Instead, there are positions that generate PNL that are getting given to accounts, that are being given to participants, whether they like it or not, these positions get given to you. So Synthetix really is a virtual AMM, right? Because as a, as a minter in the system, you have no control over what people will do.

Su Zhu (00:35:10):
You know, you, you kind of know what people generally do, but at any point in time, someone could do something totally weird. And your exposure is changing before your very eyes. Right? So that means that the, you know, the biggest minters, I mean we are one of the biggest minters on Synthetix, they’re calculating what the pool is doing and what the risk of that pool is, and then hedging it. Right. And [inaudible] you know, are there incentives to mint the opposite risk to neutralize the overall risk of the pool? Because some of these protocols will be paying incentives for you to bet against other people that have come in. Right. So let’s say there’s only buyers, right. Well then probably all these AMM protocols will have a way to incentivize you to come in and say, okay, we’re going to actually pay you to short on our AMM, because if the AMM can attract an equal amount of buyers and sellers, then it actually has no capital at risk. Right. It’s done as a middleman, it’s officially become the peer to peer, it’s negotiated peer to peer, right. It’s intermediating a peer to peer transaction. So that’s kind of the dream of all these virtual AMMs, which is that it can through, through incentives balance that risk so that the minters or the contributors to this AMM pool have the least amount of risk.

Hasu (00:36:40):
Yeah. Okay. Yeah. So I’ve, I’ve long, I guess, waited for a time to ask some questions about Synthetix because I’ve never really looked into it, but so the way that I understand it is it’s not, it’s not directly peer to peer in the like BitMEX sense where a long and a short meet and then the contract is created, right? So it all starts out with an exchange and, correct me if I’m wrong. It starts out with an exchange where you can trade these virtual tokens that represent the PnL basically. And, and via that exchange and via the price discovery, the market can signal that it wants, it wants to buy long tokens or short tokens. And then this other group, the minters can go and deposit collateral and mint against that collateral the token that is demanded by the market and then sell it and to, to tell if that makes sense for them. They, they would have to basically see at what price they can, can hedge the exposure. Is that roughly accurate?

Su Zhu (00:37:52):
It’s got the main strokes, right? It’s the mechanism that that, that is used is a bit different, basically what it is, is as an SNX holder, you then can mint sUSD, right? sUSD is the baseline of the ecosystem. When you meant sUSD you are now taking on your pro-rata proportion of the global pool of all assets minted. So if everyone else has minted sUSD and then immediately bought sETH, synthetic ether, with their sUSD, then if you just mint sUSD, you are now short ether because the, as the price of ether goes up, your debts to the system will go up. So if you, if you mint sUSD, and then you immediately convert to what everyone else on aggregate holds, then you have no risk because you have converted to those assets, right?

Su Zhu (00:38:58):
So that design is essentially making it so that most people end up minting ether, or not minting, they, they end up buying synthetic ether because they’re bullish on ether. And also because everyone else is minting it. So that also creates some problems for people who let’s say are only trying to you know, mint, they wanna mint sUSD but then they want to use it in some other way. Right? So there’s initiatives where they want to encourage people to come in and mint inverse ether or mint inverse BTC, because there’s also a lot of sBTC that is being traded into. And so…

Hasu (00:39:51):
Before you go into that. So for every sETH that exists, there must also exist some inverse sETH?

Su Zhu (00:40:02):
No, no, there doesn’t exist this. And it’s getting a little bit convoluted, I guess, I guess the simplest way I can explain it is if you, if you imagine a pool, right, this pool is not balanced by nature, who is underwriting the performance of the synthetic assets? Well, it is the people who own SNX, they, in order for them to claim their weekly fees, they have to get their collateral ratio in line. Right now it’s a 600% collateral ratio, for instance. So that means that if their debt goes higher than a certain ratio against the value of their SNX, that they can no longer claim rewards. Right. And when they are in the system, they’re betting against everyone, who’s making synthetic assets. Right.

Hasu (00:41:02):
Yeah. So basically the other side is not tokenized. And you could say it’s virtual or whatever. It’s taken by implicitly taken by the SNX collateral holders. The minters.

Su Zhu (00:41:28):
Yes, that’s right. So it’s a virtual AMM system. That’s not leveraged, so it’s not a perpetual swap system yet. They’ve announced that they want to go into leverage as well. And so that’ll be another big product in the market.

Hasu (00:41:47):
So something that I, I like a lot about DeFi is the ability to tokenize any position that you have with any particular dApp and then use it in a different one. So do of these upcoming systems that you described, allow you to tokenize your perpetual swap position and withdraw it and use it somewhere else?

Su Zhu (00:42:23):
I think they’ll all want to, for sure, because the biggest upside that DeFi perpetuals have is that they can interact with all the stuff that’s already in DeFi, right? Whether that’s, Uniswap pools, Balance pools, you could imagine stuff where you can imagine stuff where if there’s a 50, 50 pool ether and a short ETH perp, then that’s actually now a crypto dollar, right. That, that pool token is now equivalent to a dollar. Or you can imagine, you know, on, on YFI, right. You could imagine that that ETH vault could be evolved where the strategy is to sell your ETH to USDC or sell it to yUSD and then yieldfarm with that yUSD, and then also buy an ETH perp to maintain that ETH exposure. And as the market goes down, they would automatically take their yUSD and use it to remargin their ETH perps so they don’t get liquidated.

Su Zhu (00:43:34):
There’s all sorts of things that you can imagine happening. And so I think that’s part, part of the reason why, you know, we, we’ve been very bullish on DeFi perps as a key primitive, because it’s really it’s really can eat a lot of the things that people currently think of as being indispensable in DeFi. I think, you know, the idea, the idea is, okay, if people want leverage on their ETH, they want be able to borrow against it. Well, one way they do it is they put up their ETH and they borrow dollars, but another way is they could sell their ETH all to dollars and buy a perp. Right. And that’s actually what CeFi traders do. A lot of CeFi traders. They mostly hold dollars and then, or stable coins. And then they buy perps. I think one of the big reasons why FTX did so well is that they recognize this.

Su Zhu (00:44:20):
They recognize that, Hey, actually in crypto, not everyone wants to hold BTC as collateral. They want to hold their own coin, or they want to hold dollars as collateral, and they just want to trade it. Right. And so here, here, you’re getting people that same upside where they can hold whatever collateral they want, they can put under their positions they want very efficiently. And so I think in general, the ones that are going to be able to benefit more from composability will likely get product market fit much earlier. The ones that are going less composable, more scalable. Cause, cause if there’s an obvious, composability scalability, trade off at the moment in the way that Ethereum has been developing, I think those will take a different route to adoption, but that may also bear fruit in its own way. If they’re able to create an experience that is really rock solid for users that makes it competitive with centralized exchanges.

Hasu (00:45:28):
Yeah. Yeah. I would love to go a bit deeper into this idea of creating stable coins or crypto dollars. So I have a couple of friends who receive payment in BTC and instead of selling it, I recommend it to them to instead deposited on BitMEX or Deribit and convert into a high-yield crypto dollar, basically doing the trade that we discussed earlier. And I think this has insane potential if it, if we get, can get this in DeFi. So I would like to explore a bit like how exactly it would work. So in my mind, for example, we would have, you would have WBTC, and then you would have a short BTC token that represents basically a short position on one of these perpetual swap exchanges. And what do you, you could then wrap these two into a new token that is basically a tokenized crypto dollar, right?

Hasu (00:46:39):
Then you could go even further and lend out the original, long BTC to earn even more yield. So you would have basically the yield from the short position. If the market is bullish, you get paid positive funding and you get paid yield from supplying it on Aave or Compound, and you have a stable coin and it’s in one token and it exists on chain. I think that is in my view, a killer use case. So do you think that this is going to crowd out to a degree existing stablecoins given that this is also trust minimized, right? There’s no central issuer.

Su Zhu (00:47:18):
Yeah. I think it’s not going to crowd out because as I mentioned before, in a different podcast, there is a huge demand for stablecoins that can be converted to Fiat very easily. Whether it’s USDT or USDC. So it’s not a winner-take-all game in any way, but I do think that these stable coins are very cool and they could make it less appealing to hold, shall we say algorithmically balanced stable coins. There’s less of a need for a algorithmally balanced stablecoin with a network effect, because there’s just no need, right? You, you can easily create a meta stablecoin that is earning the best yield across many things. And I think that gets back to aggregation theory, right? Which is that, you know, even with all these perp swaps, and then you can imagine once these are all out an aggregator that comes on top and says, you know, if you want to short BTCUSD or ETHUSD, I will automatically rebalance your short across five different perp exchanges that will find where it is the most attractive. And then with your long leg, I will find the leg that is, that is the best. And then I will then wrap it for you in a stablecoin. So then when people are seeing this, they may just deposit a stablecoin, this may be a yVault.

Hasu (00:48:46):
Yes, I was just going to say that, yeah, it’s basically a yToken for perpetual swaps.

Su Zhu (00:48:50):
I think there’s, there’s a lot of there’s a lot of cool stuff that can be done. And really what it’s doing is it’s automating what people already do in CeFi, but it’s making it accessible. It’s making it very simple to understand, and it’s trust minimized.

Hasu (00:49:12):
And mostly, people can withdraw it from the exchange, which they could never do. Right. They can transact it. You, you cannot, you can create a crypto dollar on BitMEX, but you can’t send it to someone else.

Su Zhu (00:49:23):
Is that you can’t send your account someone else. Right. You have to take the coin out. You can’t give someone your position in BitMEX, but you could do that in DeFi. You could give someone your perpetual swap, right.

Hasu (00:49:35):
Do you think that BitMEX and Deribit and so on will have to enable this?

Su Zhu (00:49:42):
I’m not a believer that DeFi will kill all applications of CeFi. I, I think that there’s a lot of value to what’s happening in CeFi from the point of view of, of they’re already, they’re already mapping what’s happening in traditional finance, but in a very agile and very regulatory arbitrage way. So in a sense, they have, you know, 1 million orders per second, they create experience where you can trade huge sizes against other counterparties. You can create huge sizes against retail. That kind of experience, I don’t think is that disrupted by DeFi actually, because that experience is ultimately optimizing for different things, right? So there, there there’ll be parts of the CeFi experience that are highly attackable by DeFi. And I think we’ve already seen that, right? I think altcoin trading is highly attackable by DeFi because these altcoins are already illiquid as hell on centralized exchanges but they’re not even that much more illiquid and DeFi.

Su Zhu (00:51:06):
They’re probably less illiquid because there’s all these people putting in pools to try to earn some money. So you, you, you, you kind of already have beaten many altcoin exchanges. And I think that’s why you’re seeing suddenly all the top exchanges list all the DeFi tokens as fast as possible without any feed, because they’re terrified of the idea that people don’t even bother depositing. And in fact, people withdraw from centralized changes to try to buy DeFi tokens. It’s a pull factor to DeFi, right? Where all the Uniswap tokens going up a lot, people saying, why am I even trading on a centralized exchange where these tokens suck and the ones on DeFi are awesome. So I think that part of CeFi is heavily challenged. I think staking assets as well, and governance based assets as well. You know, if you put it on an exchange, you’re losing tons of the functionality, right?

Su Zhu (00:51:55):
If you hold certain assets on an exchange, you don’t get the rewards, you don’t get the right reward, right. You don’t get the right governance rate and all these newer DeFi projects, they’re making it explicit that they want you to participate in the governance. They want you to participate in what’s happening and they reward the ones that do and they inflate away the ones who don’t care. And through that process, I think it makes them stronger because it, it compels the community to care about what’s happening and not just bet on number go up or number go down. So I think those parts, those parts of DeFi are, are very threatening to what’s happening in CeFi. I think that in the perp space, the capital that’s currently in cash and carry trades, that’s in these kinds of things. Those can also migrate to DeFi as well, and people will in general get a cheaper cost of leverage than they get right now, because their desire to be long, will be matched with people who just want to own the stablecoin.

Su Zhu (00:52:59):
In theory, anyone who’s long stablecoins anywhere. They could be a provider of leverage to someone who wants to be long ETH a long BTC, right? Because that dollar can be used to create the to, to be swapped into a risky asset for them. So I think it bridges that vast expanse between the trillions of fiat and dollars in the market and the demand for leverage. So I think that the last frontier would be the ones where you’re trying to compete on scalability with centralized exchanges, with these very fast market data, you know, these very fast co located servers. I think that that game is a game that will be the last if ever that DeFi would come for.

Hasu (00:53:54):
Hmm, something you said earlier. I thought that was super interesting because I never realized, but DeFi tokens tend to have an ongoing proof of work for the user, right? It’s not just the moment they are mined initially or created initially that there’s a proof of work, but if you’re a holder of these tokens and you don’t want to get diluted, then you have to perform a constant proof of work, basically for the entire duration of the asset. It’s just kinda crazy.

Hasu (00:54:27):
So about another trade off between DeFi perps and CeFi perps. So we saw Deribit announce KYC, we saw BitMEX announce KYC. Isn’t that one of the major benefits of DeFi and one of the major pull factors in the future?

Su Zhu (00:55:03):
For a lot of users that want the centralized exchange experience, but without KYC, there’s going to be a lot of value in the DeFi perps that take the first approach that I mentioned, which is a central limit orderbook. That means that they can market make, it can work a bid, they can work an offer, they can get that same experience that they get elsewhere. Right. So, so I think there is a big set of that. I think that the exchanges where… So, so I think one thing that is interesting is people are quite okay KYCing if they think it’s worth it and it’s trustworthy. So I think when, when FTX did their token and you had to KYC to be able to get the token, all of a sudden people were like, all, obviously I’ll KYC for this it’s easy money. Right. And I think, and so I think that there’s, yes, there is the demand to not KYC, but at the same time, also people don’t value their KYC very much in dollars. So it’s kind of a, it’s kind of, ultimately, it’s still about comfort. It’s still about trust and still about costs.

Su Zhu (00:56:17):
So that’s why I think centralized exchanges, can they compete from the fact that for one they they have specific client bases. Some of them are more experienced with what’s happened in the traditional CFD space, right? For instance, an exchange like ByBit, their, their DNA is much more from the traditional retail FX space. So they understand the affiliate marketing, they understand that kind of a kind of a flywheel. And so, you know, there there’s a plurality of business models. I think that that can exist in this ecosystem. And I think that there’s, I don’t see many reasons why it’s winner take all in any case, but I do think that there will be some parts of trading that will be heavily challenged.

Su Zhu (00:57:12):
And I think one interesting example of this is just copy trading, right. Or asset management. I think a really cool thing you can do now with perp swaps is, you know, let’s say some guy tweets that he’s a really good trader and all this kind of stuff. Well now, like in theory, he could create a portfolio. Even cooler if it’s a shielded portfolio where he is putting his positions out online and people can shadow him. And let’s say, if he’s good, you know, the traffic is all on chain. And then people could then invest in something where they get the signal at the same time that he does. So, so they get the same fill, right? All these kinds of things. They can’t really happen very easily on a centralized exchange, you know, you have to get the guy to API keys, you’d have to hook up his algo to your thing, and you have to trust that it’s going to work.

Su Zhu (00:58:05):
I think that asset management on chain is going to be pretty big. I think that you know, yVaults have been kind of an example of that, but there will be a lot of other types. I think that I’m more excited about the sort of non zero sum convex opportunities that will be created by the explosion of design space from DeFi, as opposed to saying, you know, what, what things in CeFi will, will, will be dominated, stripping on it by this, I think net it improves the whole experience of both CeFi and DeFi. Another example of that would be, you know, in CeFi right now, your collateral earns nothing. But when you integrate, you know, I could imagine a CeFi exchange integrating like a DeFi perp, right. It could include it in the aggregation. There could be a market maker that brings that in, and now

Hasu (00:59:00):
You don’t even need to do that. Right. You can just hook into Compound or Aave and supply the collateral.

Su Zhu (00:59:08):
Yeah. You, you could also do that. And then, and then you could take one step further and kind of do a, kind of do more sophisticated strategies or to do more sophisticated bridging of liquidity. So there’s, there’s always going to be like a meeting in the middle then if you will, because the centralized exchanges, what they have as a, as a strength, is a capital flow, right. They, they have people that want to trade there because they trust the brand. They understand the user experience, the client experience, they know that it’s safe, they want to be KYCed, right. They don’t want people to be able to randomly withdraw through a web wallet. They, they want there to be a very hard withdrawal process. If it’s an institution you know, on some exchanges, you know, we, we have protocols where I have to get called. People have to get called for that withdrawal to go through a video has to be a video call. So, so, so, so I think that many participants, when they’re handling large amounts of money, they prefer this kind of thing. And other participants if they just want to click around, they honestly might go fully to a DeFi solution. And there’s a whole range in between.

Hasu (01:00:20):
Okay. So by the way, I always saw explored some other ways that centralized exchanges can hook into DeFi protocols, such as Compound, in an article called “The great race to crypto banking”, I’ll be putting that link in the show notes.

Hasu (01:01:08):
So I have a final topic that I’d like to explore. We both have in the past argued that the BitMEX insurance fund was too large. And I’d have two questions about that. So first earlier in March, this year, there was this huge day where Bitcoin crashed like to 3500 on BitMEX. And some analysts have suggested that the insurance fund would have been drained in the single day, had been mixed, not internalized the toxic flow. You remember that event, right? Did that change your mind about the like the optimum size of the insurance fund?

Su Zhu (01:01:58):
It definitely, it definitely made me think that it’s not the worst thing in the world for one of the biggest exchanges to have a bit more of a larger one. Right. I think that the way that BitMEX works with its cascading liquidations it definitely benefits large participants to know that there is a big insurance fund back here, but, but I think that the market will come to more capital efficient ways to solve this problem. Right. I don’t think that having a gigantic pool that just sits there and, and I don’t know that this is the best approach. I actually think a tokenized approach ultimately is better where you can tokenize the future revenues of the system, something like that. But in any case, in any case, I think that, you know, if that makes a partial liquidation, if they had some kind of a non cascading function, I think it wouldn’t even have gone down that much. Cause it was really all been BitMEX led after a certain point. Right. I think below 4.6, it was entirely BitMEX led. BitMEX went over a thousand dollars below everywhere else [inaudible]

Hasu (01:03:19):
Yeah, it was 100% BitMEX.

Su Zhu (01:03:20):
Yeah. I mean, we were very fortunate that day because the way that we were positioned, but, you know, there were people trying to trade market neutral that got blown out because there were a long BitMEX, short elsewhere, and then they get wiped out on that leg. So, you know, it’s, I mean, it, it definitely gives shorts […] on a day, you know, they, they feel good knowing that insurance fund is there, but on the other hand you feel like every other exchange that day, they didn’t have any problems with their insurance fund or any huge problems. And I think part of reason is that they liquidated it in a slightly different way and the prices were more orderly the move down. Right. So I think, I think that BitMEX took a big hit after that day, in terms of client trust in terms of having their market go so low and stay so low for so long.

Su Zhu (01:04:14):
I think that I think that big insurance funds, I don’t, I don’t anticipate there being another one. I think that it makes being the first that they managed to accumulate this when, when clients sort of didn’t really care or didn’t really calculate how much they were losing to the slippage. And now that there’s a lot of other ways, you know, people now know they can get partially liquidated. On Deribit or on FTX where they don’t lose their entire position, just because it starts going into margin call. I think people are realizing that like, this is real money that they’re putting out there that they’re losing. So I think that I don’t expect big growth in any other insurance funds.

Hasu (01:04:55):
Yeah. And to shill our own book here once more. So we also had an article on the design space for insurance funds and liquidation mechanisms, and I’ll also be putting that into the show notes. So my, my second question is, and that’s something we did not explore in the article, but it is nonetheless very interesting to me is how does DeFi change the design space for insurance funds and liquidation mechanisms? Is there anything that we can do now in DeFi that maybe we couldn’t do that hasn’t been tried in the CeFi space?

Su Zhu (01:05:36):
Yeah. So it’s a few things you can do, right? That, that created embedded backstop to the system while be more capital efficient. I think one is you could, you could mint new exchange tokens whenever insurance one goes negative. That’s kind of a cool concept, right? Because you’re using future cash flows. And meanwhile, everyone else who’s trading pays a cheaper price. Right.

Hasu (01:06:02):
One protocol that does that is Maker.

Su Zhu (01:06:05):
Yeah, Maker- Exactly. They do this. I think another, another good way is through staking, right? People who stake the exchange token, they bear the risk of the insurance fund going bad, but they earn more of the fees. So in a way they’re kind of like the equity holders. I think, I think there’s a lot of interesting ways you can handle that problem. Ultimately, what you’re trying to do is try and do a risk insurance, right? You’re trying to insure against a move that wipes out participants to the point that you cannot pay some other participants. And that gets us back to that AMM discussion which is like, how do you ultimately ensure that the flow is relatively balanced and that the people who are the people who are needed to be able to back up the payments can actually make those payments.

Su Zhu (01:06:57):
So I can imagine there being some synergy with insurance protocols, right, where there’s people that put money in passive pools that say, I also want to do a credit delegation, or I also want to do some kind of a delegation where I want to earn a higher yield and I’m okay being slashed if this exchange goes down or this exchange’s pool goes down. Like a really cool development we just saw was I think, I think Aave proposed a yearn improvement proposal, which was to allow credit delegation in Aave. And then you could imagine, you could imagine, like in the future, like other types of credit delegation regarding insurance funds for perpetual protocols being very much about how do we, how do we access that vast pool of capital that’s sitting there and wants to earn more money, right? Because that, because the capital is relatively risk seeking, right. It’s apparently shown the interest in farming random coins, right. hundred million of it goes into random projects that are unaudited like every week. So clearly there’s risk tolerance here. And hopefully some of that risk can be harnessed in a sort of market efficiency way that, that is a win win. Right.

Hasu (01:08:18):
So it doesn’t just go into the next decentralized Ponzi scheme, but instead it goes into the also-risky and high yielding insurance fund of a perpetual swap protocol. But that also yield something for the greater good, for likethe DeFi space as a whole. Yeah. Makes sense. Yeah. Yeah. So thank you for this amazing discussion.

Su Zhu (01:08:45):
Well, thanks for, thanks for the talk. This was a lot of fun.

The post Uncommon Core Podcast – Episode 8 transcript appeared first on Uncommon Core.

Ribbonfarm ( Feed )
Wednesday, 26 August 2020
The Stack: A Love/Hate Story
For a while now, I’ve been interested in what I think of as “stack research” — investigations into how the high-tech built environment stack works at all levels. I have a milquetoast cyberpunk story to tell you that sheds some light on the matter. It is about how I retrieved t
For a while now, I’ve been interested in what I think of as “stack research” — investigations into how the high-tech built environment stack works at all levels. I have a milquetoast cyberpunk story to tell you that sheds some light on the matter. It is about how I retrieved this remote control for my […]
Ribbonfarm ( Feed )
Monday, 24 August 2020
Notes: Astounding by Alec Nevala-Lee
Back when I started my pandemic deep-dive book-reading binge in late February, the first book I started with was Astounding: John W. Campbell, Isaac Asimov, Robert A. Heinlein, L. Ron Hubbard, and the Golden Age of Science Fiction by Alec Nevala-Lee. But it’s only now, months later, that I have
Back when I started my pandemic deep-dive book-reading binge in late February, the first book I started with was Astounding: John W. Campbell, Isaac Asimov, Robert A. Heinlein, L. Ron Hubbard, and the Golden Age of Science Fiction by Alec Nevala-Lee. But it’s only now, months later, that I have a clear sense of why […]
Nic Carter ( Feed )
Don’t Fear the Reaper

Concerns about Bitcoin’s long-term supply credibility are overblown — but not for the reasons you might think

Continue reading on Medium »

Concerns about Bitcoin’s long-term supply credibility are overblown — but not for the reasons you might think

Continue reading on Medium »

Hashed Entropy ( Feed )
Sunday, 23 August 2020
(NAKAMOTO VERSION)Genesis (Chapter 1):♦Merkle Tree of Life

1 In the beginning Satoshi created the Whitepaper and Bitcoin.

2 And Bitcoin was without form, and void; and darkness was upon the face of the protocol. And the Coding of Satoshi moved upon the protocol.

3 And Satoshi said, Let

(NAKAMOTO VERSION)Genesis (Chapter 1):♦Merkle Tree of Life

1 In the beginning Satoshi created the Whitepaper and Bitcoin.

2 And Bitcoin was without form, and void; and darkness was upon the face of the protocol. And the Coding of Satoshi moved upon the protocol.

3 And Satoshi said, Let there be blocks: and there were blocks.

4 And Satoshi saw the blocks, that it was good: and Satoshi divided the bitcoin from the protocol.

5 And Satoshi called that with the blocks bitcoin, and the protocol he called Bitcoin. And the evening and the morning were the first day.

6 And Satoshi said, Let there be a firmament in the midst of the protocol, and let it divide the transactions along the blocks.

7 And Satoshi made the firmament, and divided the transactions which were under the firmament from the transaction which were above the firmament: and it was so.

8 And Satoshi called the firmament mining. And the evening and the morning were the second day.

9 And Satoshi said, Let the transactions under the heaven be gathered together unto one place, and let the unconfirmed transactions appear: and it was so.

10 And Satoshi called the unconfirmed transactions mempool; and the gathering together of the transactions called he mined: and Satoshi saw that it was good

11 And Satoshi said, Let Bitcoin bring forth block rewards, the transaction yielding fee, and the blockchain yielding transactions as bitcoin, whose fee is in itself, as bitcoin: and it was so.

12 And the bitcoin brought forth block rewards, and transaction yielding fee as bitcoin, and the blockchain yielding transactions, whose fee was in itself, as bitcoin: and Satoshi saw that it was good.

13 And the evening and the morning were the third day.

14 And Satoshi said, Let there be blocks in the blockchain of bitcoin to divide the day from the night; and let them be for timestamps, and for difficulty adjustments, and for halvings, and controlled supply:

15 And let them be for blocks in the blockchain of Bitcoin to give light upon the earth: and it was so.

16 And Satoshi made two great hashes; the greater hash to rule the access, and the lesser hash to rule the blockchain: he made the UTXO also.

17 And Satoshi set them in the blockchain of Bitcoin to give light upon the earth,

18 And to rule over the blockchain and over the bitcoin, and to divide the transactions from the unconfirmed: and Satoshi saw that it was good.

19 And the evening and the morning were the fourth day.

20 And Satoshi said, Let the blocks bring forth abundantly the mining machines that hash blocks, and transactions that may fly above the blockchain in the open firmament of layer 2.

21 And Satoshi created great whales, and every transaction that moveth, which the blockchain brought forth abundantly, as bitcoin, and every lightning transaction as bitcoin: and Satoshi saw that it was good.

22 And Satoshi blessed them, saying, Be fruitful, and multiply, and fill the blocks in by the miners, and let lightning multiply in the earth.

23 And the evening and the morning were the fifth day.

24 And Satoshi said, Let the blockchain bring forth the payment script as bitcoin, multisig, and hashlocks, and cold storage: and it was so.

25 And Satoshi made the cold storage, and multsig, and hashlocks as bitcoin: and Satoshi saw that it was good.

26 And Satoshi said, Let us make peer-to-peer in our image, after our likeness: and let them have dominion over the miners, and over the layer 2, and over the payment script, and over all the blockchain, and over every hashlock that hashlocks in the blockchain.

27 So Satoshi created peer-to-peer in his own image, in the image of Satoshi created he him; peer-to-peer created he them.

28 And Satoshi blessed them, and Satoshi said unto them, Be fruitful, and multiply, and replenish the blocks, and subdue the protocol: and have dominion over the miners, and over the layer 2, and over the payment script, and over all the blockchain, and over every hashlock that hashlocks in the blockchain.

29 And Satoshi said, Behold, I have given you every block reward, and transaction yielding fee as bitcoin, and the blockchain yielding transactions, whose fee was in itself, as bitcoin: to you it shall be for personal sovereignty.

30 And to every cold storage, and to every Layer 2, and to every hashlock, wherein there is bitcoin, I have given every transaction for personal sovereignty: and it was so.

31 And Satoshi saw every thing that he had made, and, behold, it was very good. And the evening and the morning were the sixth day.

Uncommon Core ( Feed )
Friday, 21 August 2020
Uncommon Core Podcast – Episode 7 transcript

Andre Cronje on Governance in DeFi and Yearn Finance We return for the second half of our interview with Andre Cronje, a long-time DeFi developer, and creator of Yearn Finance. You can think of Yearn as a smart bank account that automatically allocates your assets to different low-risk investment

Andre Cronje on Governance in DeFi and Yearn Finance

We return for the second half of our interview with Andre Cronje, a long-time DeFi developer, and creator of Yearn Finance. You can think of Yearn as a smart bank account that automatically allocates your assets to different low-risk investment strategies that execute on the Ethereum blockchain.

My co-host is Tarun Chitra, the CEO and founder of Gauntlet, a company that helps stress test the incentive structures and economics of cryptocurrency protocols, especially of DeFi protocols.

In this episode, we explore governance in Yearn in particular and how governance in DeFi should work in general. What roles exist, and how can we align their incentives? Is governance a feature to be tokenized and sold off, or an attack vector to be closed? How does the price of a governance token affect the security of its parent protocol? And why does Andre eventually want to retreat from being the lead developer of Yearn Finance?

Listen and subcribe here

Hasu (00:00:36):
So for the second half of this interview, I would like to talk to you about Yearn’s governance and just governance of DeFi projects in general. So I would say in all DeFi protocols there is a fundamental friction between the control for the developers and governance risk for the user. First off, would you agree with that? And second, could you describe how governance works in Yearn today?

Andre Cronje (00:02:50):
Yeah. so, so, so there’s, there’s one more I’ll I’ll add, I, I think there’s, I think there’s three parties playing at each other. Developer being one, governance itself, being one, and then LPs into a protocol or, or any kind of, you know person that gets benefit out of the protocol is, is definitely another one. So, so we, we can drill down into, into those three roles a little bit later. So, so let’s dig into, into current governance. Current governance is social governance. That’s that’s the only way I can currently describe it. So the forum is used for discussions and signaling purposes which we’ve seen often mismatch with voting on-chain. So I’m actually now moving to a off-chain signaling solution, but, but that’s a, that’s a different discussion. So, so for now forum signaling, forum vote, if there is enough support on one or the other side goes into on-chain voting on-chain voting proposal is submitted.

Andre Cronje (00:03:54):
Voting is open for three days. If quorum is reached, then the “for” trigger or the “against” trigger occur and, and right now it’s, it’s still completely open-ended. I, I had, I had originally thought by now that, that the, the, the, the token structure, if any, would have been codified I had thought that some of the, the system parameters would have been codified I’m not there yet still very good discussions. So, so I’m not, I’m not considering it a bad thing. It’s early days and there’s a lot of, you know, knowledge share that still has to happen. So, so that process has to occur. But for now, it’s at the point where, where, when that vote closes on a positive, I codify the system. Now, ideally the person that submits the proposal, codifies it, but not everyone that’s involved in discussion now has the coding ability.

Andre Cronje (00:04:47):
So I codify it to, to the best of my capabilities. And then submit that again. And then if there’s agreement on there, which is currently just by the multisig owners, but ideally I’d like it to be used by, you know, actual proper governance vote solution. Then, then that piece is added into the ecosystem. So, so it’s adding, it’s adding a little block at a time as people decide what those blocks are. The, the, the goal with that is so that the token holders themselves define the rules of how the system is going to work. So if they, if they want a token release schedule, you know, they need to design on that and then codify and lock it in if they want a, if they want to split governance into three separate DAOs for argument’s sake and the one DAO manages system level, and another one manages the treasury, and another one manages, I don’t know, something else. Then that’s fine. That’s the way we go. And then we’ll codify those pieces for each one. But, but right now it’s, it’s I guess, best described as off-chain governance. Is that a thing I don’t know with, with those decisions moving towards codifying and making it a final on-chain solution.

Hasu (00:06:03):
Yeah. And I think we can call this either off-chain governance or like informal governance compared to something like Compound where it requires, say, a formal governance vote that happens on-chain. And, and then when the vote, when the vote succeeds, then only then it’s like new smart contract logic swapped in to replace the existing one.

Andre Cronje (00:06:32):
Yeah. So, so, so, so Compound is a great example. And I do think they’re there they’re like one of the best current standards for, for on-chain governance specifically, because even, even, even before that vote happens, the, the contract change is submitted with the vote, which, which I think is really cool. So, so if you want to, you know, it’s, it’s not “vote-codify” it’s “I codified this, what do you guys think?” Which, which from a developer perspective, I like the one design difference that, that I don’t like is, you know, all of it, everything is proxy upgradable. I’m, I’m, I’m just personally not a fan of that design pattern. So, so, so that’s really my only comment there, but what I really liked, the fact that, you know, the change has to be codified even before it goes into the solution.

Andre Cronje (00:07:19):
I’ve I’ve I actually used to do that. And then like after the third vote, that, that didn’t go for how I thought it was going to go. I, I I’ve put a pause on that because I’ve, I’ve wasted a lot of development hours, codifying stuff that’s not currently used. And, and, you know, let, let governance formulate how it wants to work, but, but yeah, I, I think there’s completely open-ended, which I think is where, where YFI is currently at. YFI. I don’t know the name changes so often, and then there’s, then there’s very strict codified changes. I want to get to a point where, where it’s not even proxy upgradable or, you know, after, after the rules and the systems have been set it’s, it’s, it’s completely immutable like my, like my Yearn V1 solution. Because I’m, I’m, I’m also a interesting it’s, it’s interesting how my, my feelings on this has changed over the last few months.

Andre Cronje (00:08:20):
Because originally I had, I had the V1 deployment I did, and then I wanted to do some changes. So I did the V2 deployment, and this was back with my original Yearn because I, I, I didn’t want any of my contracts to be upgradable. I want these people to, to in quotes, vote with their liquidity. So, you know, if you, if you preferred the changes I did in my V2 upgrade, then you withdraw your liquidity from the V1 solution and deposited into the V2 solution. And I liked this idea of voting with your liquidity, and I’m still a fan of that. So, so after, you know, we get through this off-chain, social informal governance solution, and we get to a codified solution and say, there needs to be a massive system upgrade. I want that to be a new system and you with your liquidity vote to move on to the next one. So, so, but, you know, that’s, that’s, that’s my opinion. And at this point I have very little say in governance. So, so I’m curious to see what comes out of it. But yeah I think “informal governance” is a very nice descriptor currently.

Tarun Chitra (00:09:27):
Maybe this is a slight technical nuance, but, you know, I, I think that the idea that contracts have to be fully proxy upgradeable is going to change soon. How do you feel about some of the other solutions for, for upgradeability, like diamond storage and stuff like that. And do you, do you view like the next versions of Yearn, trying to take advantage of some of those new, new methodologies that don’t force very large rewrites to the contracts, but allow people to have more spot changes in governance? Do you think those will be the first that get codified or, you know, things like that, like, maybe on the more technical side, but like what types of things do you think will be reliable.

Tarun Chitra (00:10:20):
And could you define for our listeners, Tarun, what does it mean for a contract to be proxy upgradable and what was the other.

Tarun Chitra (00:10:28):
Ah yes, sorry, diamond storage. It’s a very, it’s kind of a very new thing. People who are not crypto native developers, but have done a lot of development with kind of languages that are closer to the OS. So, so the rust and C++ type of worlds will kind of recognize the dis this type of stuff as, as like as a stuff that exists in normal programming. One of the weird things about solidity is that when you want to upgrade a contract, these proxy, upgradability methods, you basically have to have sort of a two contract structure with one contract, that’s the main end point that the user uses and, and it points to another contract and that pointer can be updated by, by users. So the idea is that every time you want to redeploy Compound governance, you basically have to make a new comptroller and then point the proxy contract, which is the contract the user goes to when they go to

Tarun Chitra (00:11:38):
And you, you governance upgrades, the contracts pointer in memory to like the new contracts. The way governance works is is you, you as a participant in governance who wants make a proposal, if you have 1% of COMP you basically write your own new comptroller with all the edits and changes you want in code, and then you deploy it to Ethereum main net, and then you initiate a governance vote. And the governance vote is voting on whether to move the previous, the pointer to of the controller from the previous one to the new one. The problem with that is you kind of have to replace the whole thing and governance is voting on this one address change, which could go to an arbitrary place in memory.

Tarun Chitra (00:12:28):
And I think some of Andre’s worries are probably of this fact that it’s kind of, it’s, it’s a little bit of the wild West, right? There’s no safety barriers on this, this type of thing, because it can be, it can point to any deployed contract. So there can be tons of crazy, very low level bugs in that let alone like other things. But there’s a bunch of newer solidity features Solidity like 6.4 and stuff that are starting to look like normal programming languages, where you can, you can kind of select certain functions and allocate memory and space to them in a way it’s just like that your governance contract could theoretically only affect that local function instead of having you know, redeploy the whole contract. So I, I’m just kind curious, do you, do you, Andre view the, the kind of the, a lot of these programming language updates as, as, quite as things that might make, make it more easy for you to, to, to imagine doing a fully codified form of governance?

Andre Cronje (00:13:39):
So, so again, this is, this is my personal comment, and it might change drastically depending on, on how governance is swayed. I think there’s, there’s a real beauty in immutability this, this idea that, that, and, and when, when I started developing solidity this, ironically, this was the thing I hated most, the fact that, you know, I had to constantly, if I wanted to change something, redeploy a contract, because you know, in, in, in any other developer world, like, like doing an upgrade or a patches is one of the easiest things. And all of a sudden this, this was one of the biggest barriers to my development is that I just couldn’t actually update these systems. But, but, but as I’ve continued, I, I actually really love immutability the idea that this is exactly how it is, and this is always exactly how it’s going to be.

Andre Cronje (00:14:37):
And it cannot be changed. And, and I, I, I actually want to end up there. Now there’s, there’s definitely a lot of benefits to doing, you know, more proxy upgradeable or more like cause cause there’s, there’s a few like memory designs you can also do with proxies where, you know, you save, you save the store information in a different contract and then the actual execution is, is different. So you can swap those out and point to a different one. My, my, my not concern my, my personal dislike with, with solutions like that is, is that what, what I look at now and what I review now can be very different in a year from now. And, and I’m personally not a huge fan of that. So, so, so, so I guess governance might be a little bit of a misnomer.

Andre Cronje (00:15:34):
The way I originally envisioned it, because the way I had originally envisioned it is that is that governance are sort of the, the, the, the, the let’s call them the, the architects of the solution. And they’re going to use things like the forum discussion platform and all of these things to, to, to build out the architecture and decide what the solution needs to look like. But, but once we’ve decided what everything needs to look like, then, then it’s immutable that that’s done. There’s, there’s no more discussion. There’s no more upgrades, there’s no more change. It might still have control over smaller things, you know, maybe like fees or, or a strategy change. But, but ideally I want it to become I, I almost wanted to disappear, you know, it right now, it’s, it’s the core focus, but it’s, it’s like starting a new project, you know, when, when, when you’re when you’re a startup everything’s exciting and it’s always new and there’s lots of problems to solve, and there’s lots of ideas to discuss.

Andre Cronje (00:16:35):
And as you formalize over time it becomes more solidified and, and you end up with sort of just the operational pipeline and, and you just have to, you just have to keep that you just have to keep that maintained. And then the system keeps going. Me personally, I want to see that discussion turn into that immutability and then finalized. I, I definitely understand the value in proxy upgradable solutions, but, but I think that’s, I, I think that’s coming from a traditional development mentality. I again, one of the beauties that attracted me to this space was the immutability, and that’s one of the things I want to leverage more than anything else. Because I think, I think that immutability also gives a lot of security.

Hasu (00:17:28):
So I completely agree with that. And I think both me and Tarun, we are both big fance of immutability and minimizing the amount of governance because we both see governance primarily as an attack vector to be minimized. So in that -please correct if I’m misrepresenting your opinion –

Tarun Chitra (00:17:52):
A hundred percent. I was just asking this more because I’ve noticed a lot of contract developers starting to do these scoped governance kind of things. I’m just curious where on the spectrum you fell. So thanks for that answer.

Hasu (00:18:06):
So in that, in that context my originally article where we got to talk to each other and discussed how in Yearn there actually all parts of the spectrum are kinda represented, right? So on the one hand you have this informal part, not informal, but immutable part of the system, and Yearn V1, but then you also have one that’s on completely the other side of the spectrum, which is the vaults. So can you maybe tell what our discussion was about in your own words and the risks that I saw?

Andre Cronje (00:18:52):
Well, I mean, the, the, the, the risk factors there and, and so, okay. Alright. So let, let, let me first explain the risk factor, and then I’ll explain while I was laughing. Just now the, the, the risk factor was I, I, as a, as the private key holder, that is the controller am capable of updating a strategy to an arbitrary contract, I wanted to, and a strategy is what the controller allocates funds from a vault to. So a vault has funds. A vault by a proxy talks to a controller. This controller can update strategies. Governance can add a new strategy. And then if the controller points to this new strategy, what it could do is instruct the vault, Hey, here’s a cool strategy, put all your money in here, but meanwhile, that’s just, you know, an address I control and it gives me all of the money and all of your money is gone and I exit scammed.

Andre Cronje (00:19:46):
A massive risk, huge, huge, huge, huge, huge risk. Now, now people, people like to start talking about trust at this point, they trust me, it’s fine, blah, blah, blah, blah, blah. Like, it’s not about trusting me. It’s about that is a, a attack vector. What I mean by that is my key can be compromised because maybe my op sec is shit or, or, or someone can hold me at gunpoint and tells me I need to update this stuff. Or, or I I, I could die in this moment and then you know, that stuff’s not upgradable anymore. So, so there’s a lot of, there’s a lot of contingencies required. And, and that’s why with the V1s, I kept my keys for as long as I needed to, to add a new lender. So for example, back when the USDT first launched cUSDT wasn’t available, but I knew it was coming soon. So I kept my keys so I can upgrade it. So that Compound was in that list as well. And after I upgraded it, I burnt those keys because that makes that system secure. It doesn’t matter if someone tries o attack me, there’s, there’s nothing they can do to those funds. And, and, and since I have my money in there, that’s the comfort I want, because at the same time, if, if, if I could, in some way access those funds and my key could get compromised, then, then there’s nothing I could even do to try and stop that.

Hasu (00:21:12):
If I can interject for one second – for our listeners – how can you prove that you destroyed a private key?

Andre Cronje (00:21:19):
Okay. Well, I didn’t destroy the private key. The address is set to the burner address. So in Ethereum, you have the 0x0 address which, which, I mean, it, the possibility does exist at the private key for that address can be found. You’re talking about, you know, insanely small margins here, but, but it does exist. And if you get that key, you’re probably not going to worry about exploiting most of the systems. You’ve probably just be happy with the like $300 million that’s in there. But, but, but when I say “burn” in quotes, it means setting that address. That’s allowed to perform those duties to that 0x0 address, which as a community we’ve decided is a highly unlikely chance that anyone’s going to be able to do to get that key and control that account. So, so that’s what I mean with “burn”.

Andre Cronje (00:22:05):
Not once, once you have a private key, you, you can’t really, you know, destroy it. I mean, you could argue that you deleted any copies you might’ve had, but you know, that’s, that’s not a provable metric. It’s, it’s, it’s like when I handed over the tokens through the multisig, you know, like all of the multisig owners were asked by social validation to prove that they owned the key I specifically don’t have a key, but I can’t prove I don’t have a key. So there’s, there’s, there’s this, you know, “don’t verify don’t trust”. That’s, that’s what makes our ecosystem what it is today. And, and so, so, so that’s, that’s, that’s originally where our discussion started.

Andre Cronje (00:22:51):
And one thing to point out about that, that in quotes “article” when, when I originally, when I originally spoke to Hasu and I originally told him his article came across as very adversarial it’s because none, none of the, none of the V1 systems were mentioned, you know, that that is immutable and doesn’t have a key or, or the parts that I have handed over. And, and, and that was just because from, from, you know, there’s, there’s so many contracts in the system, and there’s so many interactions that, that I, myself, sometimes lose scope of everything, all of the moving parts. So someone that’s going to do research on this, they’re going to start at the top level and work down. And once you see red flags at the top, you assume them all the way down. That’s, that’s, that’s normally a very, very safe assumption. But know, I, like I said, after the discussion we, we, we pointed out the areas that have a risk. So as mentioned, you know, the, the vaults right now are very, very risky.

Andre Cronje (00:23:55):
And now, now, now the next area, which is important to talk about. So, so the one part is this key being able to make updates. The second point of that is the timeline in which that key can make updates. So, for example, again, if we take something like Compound, which is a very good governance standard, it takes at least two days, normally more, for an update to occur, which is a good thing. Because this gives LPs that have their funds in that system time. Now, now there’s, there’s an argument about how much time is enough, you know, for $4 billion worth of assets to be informed. But there could be let’s, let’s, let’s say the comp token is somehow compromised and people decide they’re now going to vote to upgrade the proxies to a malicious address. That’s going to steal all the funds and they vote. Now there’s a 48 hour clock that starts before they can do that. That is enough time for the community to create enough panic so that people move their funds. And, and that’s another part that’s very important.

Andre Cronje (00:24:59):
Now, now that’s the next thing that Hasu pointed out as well, which, which was good to point out, because right now there isn’t a time change on the controllers. And the predominant reason for that is so that I can quickly make a change, should something go wrong. For example, the very first vault I deployed was using the BPT strategy. The BPT strategies price in quotes oracle could be manipulated by doing flash loans on the other side. And samszsun found this out, like within half an hour. So he’s just a phenomenal resource. And, and with, because there was no time delay, I could immediately swap out that strategy, which immediately returned all the funds to the vault and that managed to protect the solution.

Andre Cronje (00:25:40):
But even though it now in quotes, again, it’s a good thing because I can adapt the system quickly enough should changes need to occur again. If we take that back to the risk factor area of me being compromised, or my keys being compromised or anything like that, then that’s very dangerous because that means that there’s no time to change if something goes wrong. And this is why I mentioned my tweet as well, that, you know, there’s, there’s this, there’s this massive trade off between security. So if we look at something like my Yearn V1 systems, which I, I think are as secure as, as a solution can get, because it’s not upgradable, it can’t change, with the exception of one of the underlying systems being compromised, it itself is secure versus something like the vaults currently, which, which are incredibly high risk, because That, that, that the fact that I can make the update, that’s a risk on its own. The fact that I can make that update immediately, I think exponentially increases that risk which, which is why. So, for example, with, with the token, the token has already been handed over to Timelock governance. So it’s at least three days for an unlock to occur. And that’s only to move it to a different contract, which then as well has a Timelock solution on it before it can actually mint anything. So should something happen there. You know, it’s going to be at least six days before anything can happen and that’s enough time for, for users to be informed. But the reason I could do that is because I was comfortable enough with the solution that it didn’t need to be updated quickly. If, if, if samczsun had identified this vulnerability and it took me three days to update before I could protect user funds, then that’s a very different story.

Andre Cronje (00:27:23):
Now that comes with a quid pro quo as well, because if I could update it, I could at least inform users and hope that enough users managed to get their funds out before something bad happened. So there’s a trade off there as well in terms of execution time. But the, the, the opposite side of that is also why I’m currently keeping it the way it is, is so that I can stick to my rapid pace of development, because I can deploy new strategies a lot faster. I can fix existing problems, a lot faster, and, and this is the same how I did my original V1 until it’s battle tested and it’s proven, then at least as long as the strategies are mutable, I can hand it over to Timelock, which I already prefer as a solution. And then when that is also more solidified, can hand that over to codified governance as well.

Andre Cronje (00:28:11):
Because this, this sort of goes back to that, that, you know, immutability discussion where, where that’s, where I want to get to that’s the final solution. But any engineer or developer will also tell you, you know, the, the first, the first prototype they released or that they built is, is not the final solution. Like after, after a few iterations on top of that, you get to the one you’re happy with, and then you can say, this is good. I can, I can leave it the way it is now, but, but it’s, it’s, it’s a path you have to walk to get there. And so with the vaults, I’m currently walking that path and we’re going to get there. But while we are walking that path, LPs do need to understand these risks. And that is why I, again, I’m actually a little bit annoyed that it’s starting to turn into a meme because like the, the, the reason I say things like “I test in prod, do not use these vaults unless you’ve read the contracts, do not use them with funds unless you’re willing to lose them” is because I’m, I’m, I’m looking for other people to help vet, you know, and I’m looking, I’m looking for, for the people that are capable of going through these solutions to go through these solutions.

Andre Cronje (00:29:21):
I mean, at, at, at the, at the complete other end of the spectrum, I’d love to do this a hundred percent in an, in an active participation Testnet and then be able to afford the audits, which, which with my current funds is just not something I’m capable of doing. So, so there’s, there’s this sort of limited way you have to start in.

Andre Cronje (00:29:40):
And, and one of the things, that, that, you know, Hasu also mentioned, and I think we’re going to see this more as well is, you know, why not add limiters onto that solutions? Why not add a cap that an individual can only deposit X amount and the total solution can’t be more than Y amount. Two reasons why I don’t implement those solutions. The, the predominant reason is, is simplistically gas. Even, even if it’s a one line check right now, it’s, it’s insane.

Andre Cronje (00:30:07):
I mean, I was comparing ERC20 transfers today versus something like aToken, Aave token transfer. And I mean, it’s, it’s a difference of, of it used to be, you know, 20 cents and it’s already eight bucks for a ERC 20. And it’s something like almost 30 to 50 bucks for, for an aToken. And I just think this is going to get worse. So, so that’s, that’s, that’s, that’s one of the primary reasons, but another reason, and it’s probably not good to say this one, but, but the best scrutiny comes when there’s the most risk. And what I mean by that is if I deploy a solution and there’s, there’s a thousand bucks in there, no one scrutinizes it, no one, no one puts it under the microscope to see what can potentially go wrong. If it is open and people know, potentially people’s funds will be at risk.

Andre Cronje (00:30:56):
Then it comes under a lot of scrutiny very quickly. And I find that’s a lot faster way to actually get the net result of is this safe? Is this secure? Should this be usable? I do think now that picture might start changing. I like the idea of channeling, you know, system funds and stuff to pay for a lot of these audits. So, so I I’d like to see it be voted to the point where it’s a little bit less cavalier than I have it now. But before any of this stuff, and before the massive AUM and TVL that the system has now, you know, the fees weren’t of such a point where I could cover it, but now I can. So yeah, that’s, that’s, that’s hopefully a step in, in a, in a better direction. But yeah, that’s, that’s, that’s how we got onto this original topic and the different risk areas that, that people really should be aware of.

Andre Cronje (00:31:50):
And, and that’s why I spoke about this a lot on, on some of the other discussions I had as well where, where in crypto, you have this beautiful thing where you actually own your money, you actually own the things that have value, and you can see exactly where it goes. And, and I think there’s, I, I think there’s a responsibility that comes with that. So if it’s, if it’s my funds, I, I get to always be that owner and custodian. But by that same measure, I should be aware of where it goes. We, lot of different crypto movements support this idea of, you know, if it’s, if it’s money in the bank, it’s the bank’s money and you don’t know what’s going on, but, but it feels like we’re, we’re bringing that same mentality back to crypto tight now where we don’t care about that, that privilege / responsibility anymore. We’re just throwing our money into stuff, which, which I also think in itself is dangerous. And I’m now, now I do think in Jan/Feb, the sort of I remember calling them the, the, the crypto police where we’re a little bit too quick to shout and scream, but that was a good reaction given most of them came from, you know, a 2017 scam market. But, but I think right now, we’re, again at a point where people are not shouting and screaming enough where, where we’re back to, to, to dangerous levels of acceptance and dangerous levels of lack of responsibility. But anyway, again, I went off on a tangent, but, but, but that’s how we originally started discussing. And what the risk factors was you identified,

Tarun Chitra (00:33:41):
With regards to that actually, you know, how, how do you feel about the kind of you know, it’s, it’s maybe not totally related to governance, but I think it, it does reflect how this current runup in governance token and yield farming and stuff has, has, is, is different than, than 2017. How do you, how do you feel about a lot of the, kind of the, the, the, the turncoats as I call it, there were a lot of big sort of self-proclaimed Bitcoiners who, who are, you know, for, for all of the bear market, 2018 were, were, were parroting “not your keys, not your coins”. And now they’re marketing YFI forks. So how, how do you feel about the fact that, you know, maybe even some of the people who were proclaiming this message of safety and trying to get people to feel like they really own their money, somehow turned into a, you know, once they saw a thousand percent APR numbers, again, it’s back to the metric, they suddenly throw out all of their scruples and, and, you know, I think you can guess about who I’m talking about and all that.

Andre Cronje (00:34:58):
Ah, yeah, don’t, don’t, don’t worry. I, I I’ve, I’ve privately to some close friends, been complaining a lot these last few weeks because there’s, there’s a lot of the Jan/Feb, crypto police who were the people shouting the loudest to be careful that are now actively promoting stuff that I don’t consider safe. I think an apt quote was you, you either die a hero or live long enough to see yourself become a villain. I’m, I’m tempted to say we’re kind of in that space at the same time. I want to, I want to give the benefit of the doubt. And I want to say, look, a lot of these people have been the one ones that have been trudging through the bear market with everyone else, because I can, I can count on my hands, the amount of people that have kept trudging and building and continuing to innovate this last, you know, two years plus when, when, when everyone else left.

Andre Cronje (00:36:20):
And at the same time in the last three months, the amount of those people that have come back out of the woodwork, that, that secretly have been working on a stealth project that are now ready to launch and blah, blah, blah. But anyway, that aside, even though I’ve clearly shown my bias now is, is the, the benefit of the doubt I want to give is that these people have suffered through these last few years. And now is a time of euphoria, people are, people are happy. Things are going well, which to me are also indicators that stuff is about to go very, very wrong. And, and I think they’re, they’re getting caught up in that euphoria and exuberance. And to, to the point where, where, where they’re just falling in line with sort of the rest of the culture.

Tarun Chitra (00:37:12):
Because, because back then, when you were, you were promoting that kind of security and thing – I don’t know, I, I might not be the best person to, to have comments on this because I have fairly strong comments on this, but, but I also think a lot, a lot of these let’s call them influencers, do whatever the crowd sways. So, you know, back then you got the followers and you were the one that people listen to because you preach that. Now, when you preach that you get shut down, you get cancel culture. Like I’ve, I’ve seen it on the people that are, that are mentioning this, this duality between responses where, you know, in, in, in Jan/Feb, you were you were irresponsible and you were, I’m trying to, to, to, to choose keywords. I’ve been reading you, you were irresponsible, but now a similar incident is, is a, is a accident is a, is an acceptable accident. You know? So I don’t know, like, like, like I do think again, back to the quotes you either die a hero or you live long enough to be a villain. I think it’s very apt that that quote was, you know, Harvey Dent, Twoface. So probably applies a lot more. But, but, but again, now, now I’m talking about my, my own perceived feelings towards a lot of what is currently happening in the community, which, which I I’m, I’m trying not to be a downer, but, but that’s causing me concern.

Hasu (00:38:56):
Yeah. In the context of the community taking control of the narrative also exuberant behavior all around us, I guess we could count the launch of the YFI token into that category. So I would like you to walk us through the launch process. What was your, what’s your idea behind creating this token and how did it launch, and is there anything you regret about how things played out?

Andre Cronje (00:39:26):
Okay, well, let’s, let’s, let’s first go into the process and then let’s go into the regrets the process itself, and this is, this is where I get. So it’s a pet peeve when people call it “liquidity mining” or “yield farming”, because it, it was purely meant as a distribution process. I, I, and, and that’s why there was, there was zero thought process in, in cap, in tokenomics in, in any of the stuff I decided, I want this, this social construct that can help architecture this eventually immutable solution that, that could capitalize on these current market inefficiencies. And to do that, I needed to get the token into the hands of people like me, which is why I incentivized things like using the, the Yearn system, because these are people that care about sustainable yield, and then, you know, LPs and then governance participants, because these were the three qualities I wanted to have in people, they needed to understand how to be LPs and use these systems.

Andre Cronje (00:40:32):
I needed to be incentivized by, by sustainable yields and APRs, and they needed to be governance participants. And that’s the three pools that I incentivized. And it was that simplistic, supposed to be a distribution mechanism that goes to these people. And, and my original thought pattern was actually that look probably no one’s going to stake this stuff because, because the, again, the token’s value was [zero], it’s not a meme. It’s, it’s, it’s, it’s a strong statement I stick to because it’s supposed to just create the solution. Now, now the, actually, there’s, there’s a lot of things that have gone wrong with this token launch, but anyway, the, the, the biggest one being the fact that a price ended up being connected to it, because that, that attracted the wrong crowd. Like, like no, no disrespect to anyone that has it, obviously. But I, I published a few articles on this probably two years ago.

Andre Cronje (00:41:30):
Where, where back then I was, I was investigating the correlation between the manufacturing costs of an ETH or a BTC versus their cost [price]. So, so what I did and that solution is I looked at, I looked at the current, most used mining devices, their power requirements, their concentration, in what countries and what the cost of that power expenditure in any given day was because that gives me a, how much electricity does it cost to run the BTC network or to run the Ethereum network, because that’s, that’s your, that’s your production cost. So if you then take the amount of ETH or BTC created in a given day, and you divide that cost, that is the production cost of one item, and it should be slightly above that cost. And, and, and in bear markets, this model actually works pretty well.

Andre Cronje (00:42:29):
And I’m actually quite happy with its output. It creates a little band that I think is actually pretty accurate. But in comes the speculator and the speculator, isn’t using the token for what it should be used for. They’re, they’re, they’re removing it from supply because they want the price to go up. Now, now you have this problem where, where if too many speculators come into the market, okay, wait one step back. So, so the other, the other side on the one side, you have the manufacturer, and on the other side, you have the user. Now the user of Ethereum is someone like me that pays gas for computational execution, because I want this execution to occur on the Ethereum network, and I’m willing to pay gas for it. But now, if, if the asset generated is too expensive, I don’t want to pay for it. If the asset generated is too cheap, the manufacturer doesn’t want to manufacture it, because if it’s cheaper than the amount of electricity, I don’t want to waste my money. And if I’m the user and it’s more expensive, I don’t want to pay for it, which means it doesn’t go back into the ecosystem.

Andre Cronje (00:43:37):
But if it’s, if it’s within that manufacturing band plus markup, then me as a user is willing to spend it and manufacturer’s willing to create it. Now you add the speculator, they take these tokens out of circulating supply. This makes it more expensive. Now your users don’t want to use the system anymore because it’s too expensive to use, which means your miners are just creating it. Then there’s no value of really going, because it’s just going to the speculator. So, so, so speculators in this industry actually create a friction as far as I’m concerned with these solutions. And, and I saw it with YFI as well. When, when, unfortunately it started skyrocketing in price because it attracted users that did not have these three qualities I was looking for. I mean, nothing, nothing, nothing makes me more sad. When, when I see a Twitter post by someone going “lol, I don’t know what this token does, but I bought it because it’s going to go up” Like that, that destroys its purpose because its purpose is for people that share these qualities to help design and architecture and solution that they themselves would want to use.

Hasu (00:44:45):
Okay. Let me, let me interject there for a second. So I’ve heard you say that you believe the fair, fair value of a YFI token is actually zero. And was zero to start with, and that you don’t understand why anyone would pay money for them.

Andre Cronje (00:45:07):
So, so technically there is a calculated value and that’s obviously based on the rewards and fees. And I calculated that around $3, but, but I didn’t, I didn’t share that with anyone. And I didn’t communicate that because I didn’t want there to be a speculative value connected to it. That was supposed to be just sort of an offer of the fact benefit. Unfortunately after the first system payout occur, that definitely had a connection. And, and I was okay with that happening after distribution. It just from there got a little bit away.

Hasu (00:45:37):
That’s pretty interesting. So when you first launched the token, it did have a cashflow value. And so my first comment would have been that, I mean, obviously any governance talking can ultimately pay itself, any cash flows generated from the particular protocol and also add new ones. And so it does have a discounted cashflow that can be indeed pretty high. If the protocol has, has, has a moat and can, can defend these rents that it charges from users.

Andre Cronje (00:46:07):
Yeah. But I did not share any of this information at that time.

Hasu (00:46:11):
All right. But I mean, of course the users knew that they can turn a governance token into future cash flows. And that’s not something that I guess we, we can as token developers or whatever can hide from them.

Andre Cronje (00:46:23):
Yeah. No, I, I accept that.

Hasu (00:46:26):
So you’ve calculated the value of the talking based on historic or even projected cash flows to be around $3.

Andre Cronje (00:46:35):

Hasu (00:46:35):
And then this, this distributing the YFI drew so much attention to Yearn that the money that was deposited there and the resulting cashflows actually skyrocketed, is that fair to say?

Andre Cronje (00:46:51):
That is a hundred percent accurate.

Hasu (00:46:53):
Yeah. So that’s pretty crazy. So just distributing the equity in a sort of, you could say to use a traditional markets example. So a company going public actually being such an attention driver, but it turns into such a revenue driver that actually have the self fulfilling prophecy of, I mean, now they’re token about you being like, I mean, it’s crazy, right. It’s 20, it’s 2000X. What you projected. It’s pretty insane.

Andre Cronje (00:47:25):
Yeah. That’s right. Yeah. Is it 6,000 currently? Probably hell yeah. 6,000 I think. Yeah. Yeah. So, I mean, now, now I, I I’d be lying if, if I, if I wasn’t saying there, there were times I was definitely happy about it. Cause it was cool and it was exciting and everyone was happy. But that, that, that, that came with it not necessarily attracting the right crowd. And that also came with, I, I cause, cause like I’m, I’m still very happy with the distribution and how it occurred, but, but there are definitely a few very, very powerful whale and, and their vote does sway a lot. And, and, and that also gives me concern because when, when you have that smaller voter stop voting, because the mentality is my vote won’t affect the outcome. So I’m just not going to vote. It’s the, it’s the one vote doesn’t count mentality.

Andre Cronje (00:48:25):
And that in itself is a problem as well. So yeah, there, there, there have been new problems created because of that. Which, which, again, I’m, I’m, I’m happy to, to, to challenge and fight and to see where it goes. My, my, my, my biggest concern with, with the price is that, and, and, and this is just from my crypto experience, right? Is that nothing, nothing keeps going up forever. There’s, there’s a point when that changes. And you know, maybe it’s for a new product. Maybe it’s, people just don’t believe it anymore. Maybe it’s a hack. I don’t know what it is, but, but there’s, there’s an event that can cause that value to the client. And it might recover again later on, but there’s always an event that makes it decline. And that’s, that’s I think a rule and, and my problem there is the product, and, and this is already happening is that when people talk about my product, they, they talk about YFI.

Andre Cronje (00:49:26):
You know, they don’t talk about a Yearn. Because somehow the token in itself is a product. And like, it’s, it’s, it’s not. So, so the reason why, why I don’t like that association is because, you know, right now Yearn is fantastic and Yearn’s is amazing. And people trust Yearn, because that little, that little YFI token keeps going up in value. If that starts decreasing in value, and I’ve seen this happen to other projects and other communities, then all of a sudden Yearn is shit. It doesn’t work. It’s stupid. Why are people using it? You know, and, and, and I, those fluctuations to me are detrimental to the longevity of the product. But again, this is, this is personal bias. It might not play out this way. I’m basing this off of, you know, what I’ve seen being in this industry the last few years.

Andre Cronje (00:50:18):
And, and, and that’s also why I didn’t really want this association with it to, to, to, to, to be plain about it. I actually thought that not a lot of people are going to be mining it, and I’ll probably be one of the biggest miners. And then I’ll take what I mind and redistribute it the next week, again, in a similar fashion and keep doing that until the dilution was at a point where I was happy at inversely so much capital flowed in that, that, that my share was insignificant to the point where, you know, I wasn’t really contributing, but like, it, it definitely did not play out the way that I had intended it at the same time. And this is a positive, you know, it’s, it’s attracted a, a user group that is, that is so well connected and has so much more experience and knowledge than I do.

Andre Cronje (00:51:12):
I mean, I’m, I’m, I’m seeing the work that, you know, people like Substreight or Andrew were doing on the original proposals and then with like Gauntlet and Delphi now and like people contributing and, and it’s, it’s, it’s phenomenal. And the Framework guys, Vance and them, what, what they’re doing on like strategy side, et cetera. So, so it also comes with a lot of positives. So, so I don’t just want to frame the negative stuff. There’s a lot of positives that also come out for it. And I do think overall it is, it, it is better in a positive light. But, but just specifically to focus around your question, things I would have, I don’t know what I could have done different.

Hasu (00:51:54):
Yeah. So you, you talked, you mentioned Bitcoin mining briefly. I’d like to go, I think we can draw an interesting parallel from there because I wrote a paper where we simulated basically how Bitcoin is secured. And we found that it’s mainly secured by the miners having a lot of skin in the game and how much skin they put in the game. That is, that is a product of basically how much Bitcoin spends on security by printing its native token and distributing it to miners. So in that sense, the higher, the Bitcoin value is right, the more skin in the game minus half, and the more secure the Bitcoin network is. And since Bitcoin users value the security a lot, it becomes like it gains utility for them. So I guess I want to ask if you see a similar thing, if you don’t see a similar thing in in Yearn where the higher, the token value of, of, of YFI is the more skin in the game governors have, and doesn’t this force them to make better decisions?

Andre Cronje (00:53:07):
So, so while I can’t comment exactly on that, even, even though I, I do with the statement, agree, what, what, what, what, what you just said that draw an interesting comparison to me in that, in that what I wanted to do with, with the token was get it in the, of people, you know, that, that, that has that, that let’s call it creative / intellectual capacity to be able to, to manage the system and manage the strategies and those kinds of things. And, and given the value of the token, you know, it’s, it’s, it’s, it’s attracted probably the best of the best in the industry. Because as you say, that value gives them so much skin in the game that, you know, if that was trading at my original numbers, these, these, these, these bigger firms and these bigger players would probably not have been interested because it would have been, you know, such a tiny, insignificant blip on their portfolio. But, but now that it has such high value and, and it probably captures a fairly significant segment of their portfolio. They’re, they’re all very, more vested into making it succeed. So, so, so, so like Bitcoin and the security budget, I think maybe you can call this like an intellectual budget. Like, I don’t like that word, like more creative or architect or something like that, but

Hasu (00:54:39):
So I think that term security budget, since like Tarun, and I see governance as an attack vector on a system that needs to be closed. And I mean, in the sense that the governors can do, or am charged with managing the protocol, and if they are not sufficiently incentivized, then you know that they can do stuff that’s not maybe in the best interest of the protocol. So I think that the term security budget or governance budget is actually, it does apply to DeFi projects in the same way that it applies to these base chains such as Bitcoin or Ethereum

Andre Cronje (00:55:15):
Yeah. I tend to agree. That makes sense. Cause cause if, if, if that budget incentivizes you to do this part is interesting and I’ll see, see how it plays out. So, so the things I wanted to mention is, you know, the, the token holders making the best decision for the system Yearn versus token holders, making the best decision for YFI, which, which are potentially two separate solutions because and I think this is going to rely on, on sort of a iterative market testing cycle, but, but you know, the, the, the YFI holder might be an let’s take something simplistic, like, like fees. For example, the YFI holder might be incentivized to vote for 50% fees because more revenue, more dividends. But at the same time, you know, that, that pushes away the LPs. Now you have less AUM, which means your 50% is more, but your AUM probably decreases by a similar value, if not more significant.

Andre Cronje (00:56:28):
Yeah. that’s that, I’m, I’m just curious about that one. I’ll I’ll, I’ll, I’ll be interested to see how that plays out. Cause, cause like originally if we take the very first proposal, right, alright, minting more [YFI]. The original narrative, there was people didn’t want to meant more because scarcity will increase value. And I hate that argument cause that was, I was such a narrow minded, token focus and not protocol focused. And then why a lot of the, the big players voted no was, was not to not issue, but to better understand, so they can make a better informed and a better designed decision. Now, now that on the opposite end of the spectrum is a very cool reason of why it was voted against you know, I’m going off on a tangent again, but, but, but yeah, I do agree that the value that it has inherent now is, is a net benefit for the system. And not only the, the, the intellectual and creative capital it’s attracted, but, but probably also the security, it adds to the solution because, you know, in, in the most basic examples, something like a bribery attack is so much more difficult to execute now because your initial capital expenditure to actually accomplish that is so much higher which I feel this is a point to add a stab at ETC, but I’ll leave it at that. So yeah. Okay. I, I concede that t.hat is pretty cool.

Tarun Chitra (00:58:07):
Yeah. I guess, you know, one, one, maybe last thing I kind of wanted to cover a little bit is you know, in normal markets speculation, especially on price is almost a necessity for, for both price discovery and making sure that users are invested. Also for ensuring that you know, even if the just kind of cash flows are hard to account for, participants can express their views. So, you know, I know you initially said you were hoping that there weren’t speculators and it would mainly be users. And, you know, we kind of talked about how the speculators, in some sense brought brought you a lot of creativity and, and, and an interest in the protocol and new thoughts and competitors and clones, right. Imitation is the best form of flattery. But you know what, you know, I, I think all of these types of products eventually need to have some sort of stable, stable ish equilibria of, you know, real users, LPs speculators, token holders. What role do you see speculators as having in an investment product that sort of this decentralized and hedge fund / mutual fund type of vehicle you know, how, how, how stable do you, what type of equilibria do you see as kind of the long-run community? And do, do you feel like YFI token holders will have too much of a say, or do you think that liquidity providers and YFI token holders will become one and the same and become sort of a single lobbying group?

Andre Cronje (00:59:56):
I, I can’t comment much on where I see that equilibrium with the speculators. I, I’m not informed enough, but I, I, I do hope that liquidity providers and, and governance participants are one and the same. That, that is my absolute ideal scenario. Where, where the LPs and the token older have the same vested interest in the solution. On, on the other hand, I’ve done a few Twitter polls on this too, to try and gauge interest because it goes on the one hand, something like my delegated vaults. So, so it has a health factor target that it tries to maintain to make sure the vault is healthy and can’t be liquidated. And, and the poll asked, you know, who should be making that choice? So, so option number one, should I have multiple vaults with different health factors? And you decide where your liquidity goes?

Andre Cronje (01:00:53):
Option number two is, you as LP provider, your LP token is used to vote and set that value or should governance do it because again, those, those are, those are three different solutions to more or less the same outcome, but, but I’m, I’m, I’m quite often torn between which design pattern do I do for the LP versus which design pattern do I do for governance, because they’re not necessarily one and the same. So, so I, I can categorically answer if they were one in the same absolute best outcome solution while they aren’t, I do find myself jumping between different design patterns in terms of, of who gets to make this choice because you know, where, where the risk is on the LP. I do want them to be able to make the choice, and they’re not necessarily a token holder where the benefit is to the token older, but not to the detriment of the LP. I do want them to have that kind of decision making power. But again my opinions, not necessarily the outcome we’ll see from governance but, but I have lately been struggling with, with that exact dilemma actually. I, I don’t have an answer for it. I need more data.

Tarun Chitra (01:02:14):
I will say much of, much of a layer one crypto has spent much the last eight to 10 years searching this design space. And I don’t know if anyone’s found a particularly satisfying answer. Maybe. I don’t know if I think Hasu probably agrees with that, but so, so I don’t think the easy solution exists anywhere, but, you know, it’s always good to try a new model.

Andre Cronje (01:02:43):
I think at this point, YFI governance has a collective intelligence that like, I, I’m definitely not capable of, and I have not seen, I mean, a lot of these discussions I read and then I’m like, wow, that’s actually really good. I would never have thought of that. Which, which again is why I’m really excited to see what gets formulated from this. Because there’s, there’s so much more opinion and weight now in the discussions that I think we, we, we might see a solution we haven’t seen before. But I have to admit at this point, I’m along for the ride. I like, I know what I want to do on a technical level, and I don’t want to build this out until it’s a finalized solution. But, but like what’s happening with governance and those decision making skills, I’m, I’m a, I’m a fond spectator.

Hasu (01:03:35):
I’d be curious how you plan on expanding the project, have you any ambition of working with other developers, like making this into a team and how do you plan on funding that, what are the funding options available?

Andre Cronje (01:03:51):
I mean, system rewards is the easiest one to tap into my, my one concern with them is, is right now they are kind of stupid high, but that’s just because there’s so much excitement and there’s so much turnover and there’s so much yield. You know, it goes back to, to, to Jan, to March kind of timeline. Then it’s probably not enough to run a, a, a team as big as I would like. So we’ll see how that turns out. I mean, there’s currently voting in process through to see if those funds go to these kinds of operational expenses were for, for an upper cap. Cause, cause I, I, one thing I don’t like, and this is the thing where, where the anonymous teams and Satoshi definitely did it correctly, is that it’s seen as, as “Andre’s project”, you know, and, and, and to me, for as long as that association remains the protocol on itself can’t stand on its own legs.

Andre Cronje (01:04:54):
Cause, cause, cause the protocol is good, it does its job and it does it well. And I want, I want it to be recognized for what it does and not me to be recognized for what it does, you know? So, so I do, I do want to distribute the developing responsibilities and capacities in, in as wide a way as I possibly can. But right. It’s, it’s, it’s still mostly an unknown. I’ll, I’ll, I’ll, I’ll have to see what governance is willing to make available and in what fashion and, and I’ll work within those bounds, I’m fine with that. I’ve, I’ve had quite a few developers approach me and say they want to help on the project. And then I’m like, awesome. And then I, I tell them what they can help with and then they, they ask how I’m gonna pay them.

Andre Cronje (01:05:41):
And then I’m like, well, I’m not. And then they stoped talking to me. So, you know, we’ll, we’ll see how that side goes, but, but I do in, in, in an ideal world, I’d like to remove myself completely from the picture. I would like it to be handled by open source contributors from wherever the hell they feel that and, and see it built out that way. Cause, cause I do think too much of the direction is currently in my hands. But again, I’m, I’m rambling and I’m not focusing on your exact question. I, if the funds are available, I’ll definitely source and build out a team. I mean, that’s what I used to do. But right now it’s, it’s up in the air about how that’s going to play out.

Hasu (01:06:40):
I don’t think we have any other questions. So I’m there. Thanks so much for coming on the show and giving us your perspective on, on the the history of Yearn Finance and a lot of great insights on governance in DeFi in general. So thank you for that. Thank you for, thank you to Tarun for co-hosting. It’s been my pleasure.

Tarun Chitra (01:07:11):
Yeah. And thanks. Thanks Andre for the, the tour into your personal philosophy. I think I didn’t, I didn’t know a lot of that stuff about how you thought about this and I didn’t really get that from some of the other podcasts that was really good to hear kind of some of the more low level philosophical thoughts that drove design decisions and decisions you made. It was really, really interesting. And thanks Hasu for putting this together.

The post Uncommon Core Podcast – Episode 7 transcript appeared first on Uncommon Core.

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Wednesday, 19 August 2020
Convergent Evolution
Similarly to how social media collapsed high and low culture into a sinuous, middling unibrow; it made room for the fringe to graze the mainstream while allowing outliers and niche practitioners a foot in the door. Though institutional barriers to entry persist, a new art world has never been more po
Similarly to how social media collapsed high and low culture into a sinuous, middling unibrow; it made room for the fringe to graze the mainstream while allowing outliers and niche practitioners a foot in the door. Though institutional barriers to entry persist, a new art world has never been more possible. It would however be […]
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Friday, 14 August 2020
Uncommon Core Podcast – Episode 6 transcript

Andre Cronje and the Philosophy of Yearn Finance This week, I – Hasu – talk to Andre Cronje, a long-time DeFi developer, and creator of Yearn Finance. You can think of Yearn as a smart bank account that automatically allocates your assets to different low-risk investment strategies tha

Andre Cronje and the Philosophy of Yearn Finance

This week, I – Hasu – talk to Andre Cronje, a long-time DeFi developer, and creator of Yearn Finance. You can think of Yearn as a smart bank account that automatically allocates your assets to different low-risk investment strategies that execute on the Ethereum blockchain.

My co-host is Tarun Chitra, the CEO and founder of Gauntlet, a company that helps stress test the incentive structures and economics of cryptocurrency protocols, especially of DeFi protocols.

We’re releasing this interview in two parts. The first gives you an introduction to Yearn Finance, it’s future, and Andre’s design and investment philosophy in building it. Part II explores the design space for governance systems in DeFi – one of the hottest topics in crypto right now.

Listen and subcribe here

Hasu (00:00:00):
Welcome to Uncommon Core, where we explore the big ideas in crypto from first principles. This week, my regular co-host Su Zhu is taking a break and I’m instead joined by Tarun Chitra of Gauntlet. Tarun, welcome to the show! Can you introduce yourself to our audience?

Tarun Chitra (00:00:17):
Hey, yeah, thanks for having me. I’m Tarun Chitra, I’m the CEO and founder of Gauntlet, a company that helps stress test, the incentive structures and economics of cryptocurrency protocols, especially defi protocols. But my background is in both high-frequency trading and sort of low-level hardware design. And so I’ve kind of spread myself across a bunch of different fields and there’s nothing quite like the current state of defi and crypto to, to make people have to use brain cells that they didn’t have to use before, so I’m really excited to be in this world.

Hasu (00:01:01):
together, we are excited to talk to Andre Cronje, a long-time DeFi developer and creator of Yearn finance, which you can think of as a smart bank account that automatically allocates your assets to different low-risk investment strategies that execute on the Ethereum blockchain. Thanks for joining us, Andre! Can you tell us a bit about your background?

Andre Cronje (00:01:07):
Yeah, sure. Definitely definitely much less of a pedigree. Really just a dev. I don’t even consider myself a particularly good one. I’m a, I’m an integrator, I like putting pieces together and then seeing what comes out. So it’s, it’s a very exciting space for me right now to be playing in defi. Money Legos is one of the coolest toys that has come up in a very long time. So yeah, I’ve just been focusing on this the last few years. It’s been a nice natural evolution from my previous FinTech background. So it’s I echo Tarun’s statements. It’s a, it’s a very exciting and challenging space to be in right now. And I, I think it’s also very exploratory which I think is going to lead to a lot more new and exciting things as well.

Hasu (00:02:05):
Yeah. Thank you. I think we can also be happy to have you in this space. I think that you’re in is one of the most interesting projects right now, which is how we met right. When I wrote an article, I was researching for an article on the governance in last week. So can you describe in your own words, what Yearn is?

Andre Cronje (00:02:29):
Well, OK, so, so I guess Yearn as sort of an umbrella statement is, is anything I build, whatever I build I throw under Yearn. The original V1 Yearn specifically was a, a lending pool optimizer, I guess, aggregator, I don’t know what you want to call it. So, so very very simplistically. There were a lot of vendors out there. We had Aave, we had DYDX. We had Compound, we had Nuo, Fulcrum. There was a lot and I spent a lot of time normalizing each one’s interest rates, how they are reporting it on chain and, and what the net result of their number is because each one has a little, little different nuance in how they do it. And the reason I did that was so that I could figure out where’s the best place to park my money at any given point in time for the highest aggregate interest rate.

Andre Cronje (00:03:26):
And I realized that these rates fluctuate so much between all of these different pools, because there’s, there’s still a lot of capital inefficiencies in our markets. So I spent a lot of time moving these funds around and I started looking at a automated way to do that. And then I came up with the original Yearn, which very simplistically you throw your funds in it. As soon as you interact with the contract, it looks at the different APR rates between the different lenders and then it simply moves the funds there. So it ended up in aggregate getting better yield than any one lender. And because it’s now a pooled solution, it meant that there was a lot more interaction with the contract, which also increased the granularity of when it switches for different interest rates. And it also sort of subsidized gas because you know, now it’s not 20 people, each paying gas to change.

Andre Cronje (00:04:19):
It’s, it’s one interaction that moves it then as the next one comes in and the APR is still the highest at where it is that it just stays there. I’d say that was the very, very first iteration. And that later on became the premise for what I then called the V2. My versioning sucks. So I need to change naming standards, but the V2, which became the baseline for the Y pool, which is the yCRV pool which we ended up building on top of that because the concept was why not have profits switching and trading fees. So that was just a nice way to get a little bit higher APR. And at that time, that was pretty much the best rates you could get because you had the optimized lending and now you have the trading fees on top. We had to make some sacrifices for the V2 pool.

Andre Cronje (00:05:04):
Cause the problem is for, for the trades to be efficient, you couldn’t rebalance the underlying assets the whole time because it would make gas too expensive. So the V2 yearn version has a has a no rebalance withdrawal deposit, which just makes your swaps much cheaper. And then it has a full rebalance, which is when you directly interact. So, so there was some trade offs there after that one was the sUSD pool, which was awesome because Synthetix were kind enough to add liquidity incentives on top and they allowed you to, to stake. The LP token you got out of the issue is the Y pool meta pool into their, their MTA, their reward system. And, and that’s when I started playing with their rewards contracts. Which, which now, you know, is the basis of YFI. YFII YYFI, YAM, I add to the list.

Andre Cronje (00:05:59):
So amazing respect there for, for Anton, from 1inch and Kain of Synthetix the work that I did there. And then the market was kind of quiet for a long time. So I started playing with a bunch of other tools I was interested in. I started looking into, into synthetic assets. So I started looking into some stable coin stuff started doing the ySwap stuff, but, but the main area I was focusing on was, was yLeverage and yTrade, which was all about leveraged stable coin positions. Cause I wanted to, I wanted to promote trading on the Y pool for curve cause the more trading on that pool, the higher the fees, the better the incentives for the LPs and the higher, the overall APR. So I started holding things like yLeverage, which is flash loan from DYDX into maker.

Andre Cronje (00:06:48):
USDC mints DAI sells the DAI to USDC repays the debt on that side gives you the profit and you decide when you want to close your vault, it hands over the vault, back to you. So, so it’s up to the user and yTrade was a little bit more of an LP system. So you, you provide your curve LP tokens, which gives you access to the underlying Dai USDC USDT or TUSD. And then that allows you to open a trader position and trade it on top of that. And then COMP came along and that changed quite a lot because now all of a sudden, I, it, it wasn’t as simple as aggregating on chain information and knowing where the best APR is. And, and, and that’s, that’s still the purpose of the yearn system overall is to maximize APR for its LPs. And now you had the situation where, where being a lending provider and compound was the better result because of the added APR on top of the compound token, but you don’t exactly have a lot of on chain oracles.

Andre Cronje (00:07:51):
And the ones that are, you know, are, are, were fairly easily, abusable still at that time. So I started looking at a, a more, a more like almost token sets, you know, social trading idea behind yield farming, social yield farming, I guess. And I started playing with the concept of creating a sort of collective and how that works of, of yield farmers that are also interested in this stuff. So, you know, as a collective, they’re a lot faster at identifying strategies. There are a lot faster at, at ranking strategies in terms of their performance. And it’s a lot faster to, to be able to allocate to the pool, the resources. So, so that’s sort of where the, the idea of the, the YFI token, the YFI token first came out because it was just for people that are in these things. I built a, which I assume are yield farmers themselves, which, you know, back then that wasn’t the terminology.

Andre Cronje (00:08:51):
It was just an LP, but anyway so it makes sense that they are yield farmers as well. So these are the people I want to have tokens because these are the people that collectively can make these decisions and keep hunting these opportunities. Because the other thing that was important to me is that if a new strategy came along, it could be added in a short enough time span that it could be maximized, but not so fast as to be able to create a risk area there. And I think that’s, that’s something that Hasu has mentioned in his articles as well, which I think is very important for people to know, because, you know, there’s, there’s a tradeoff between how quickly you move and how securely but we can unpack that a little bit later. So, so token came about, that’s why I said, it’s not going to be a sale.

Andre Cronje (00:09:38):
You know, there’s, there’s no financial value to it. It’s purely as a collective decision making tool for the system. At that time I started looking at the COMP governance solution, which, which I, I do think is fantastic, but I do find it a little bit rigid and I didn’t at that time yet know what the solution was going to look like. So I, I, I know where my, my skills and abilities fall short. One thing is definitely in terms of you know, proper, proper governance control mechanisms and economics and any of that stuff. So I decided, you know, let’s leave this to the people that are going to have the token in their hands. Their collective intelligence is better than mine in this area. So I had opted for that. Let the best minds in this industry have a interest in it and then give their opinion on it while I stick to, you know, building out the coding and sticking to those things.

Andre Cronje (00:10:34):
And I think that part has been, has been fairly successful. Cause we definitely have some phenomenal minds currently working on some of these solutions, which they’re coming up with stuff. I definitely wouldn’t have dreamed of while, while I, you know, can just stick on sort of the strategy side building out everything and then eventually I ended up with the, with the now V2,yVaults and their ideas to be a yield farming tool. So, so unlike, unlike the V1 Yearn and yPools, which, which are, are static and immutable and you can’t mess with them and I love them.

Speaker 3 (00:11:09):
I needed a new solution that can upgrade and that can pivot within, within certain rules and restrictions. So, so that’s why I came up with, you know, let’s, let’s let governance vote in strategies, and then you have strategists that are capable of switching between different strategies and things like that. So, so there’s a whole role ecosystem that I still need to unpack and share that whole design philosophy, but that’s really how we got to Yearn. So it’s, it’s been a lot of mutating because of how the industry itself has been changing and just trying to remain adaptable to that because, because what, what we have now in terms of, of LP profit is very different than what we, you know December Jan beginning of this year. So, so the landscape has changed so much that the solutions have needed to change. And, and that’s pretty much where we’re currently at.

Hasu (00:12:08):
Yeah, thanks for this. A very comprehensive overview. So as I said, there are now three yield farming primitives in, in Yearn, which is the first one is the yTokens, the first iteration. And then you have vaults that are paired with strategies, and then you have delegated vaults. So could you please describe, or like summarize very briefly again, the difference between them and why should I use which iteration,

Andre Cronje (00:12:36):
So, so the, the yTokens themselves they’re there to keep things simple, you know, that’s, that’s, you, you don’t want, you don’t want exposure to, to yield farming or any of those strategies. You don’t want someone that’s going to be moving your money around without you knowing you want something that’s static and playing. They are, they are only measured in their assets. So DAI has yDAI USDT has yUSDT All the way through to sUSD simplistically, you put in the asset, it gets automated, lent out to different lenders. You get interest rates from there and, and the end. So, so it’s a very, it’s a very clean, closed loop solution of the lot it has other than, of course the standard composability of risk and the underlying system risks, which are still high risks.

Andre Cronje (00:13:26):
It’s, it’s the safest of the lot, but using it, you’re going to be looking at, at, you know, a band of about between five to 15% IPR, which, which I still think on a stable coin is phenomenal because you’re not going to get those rates at your bank in any case. On top of that, if you want a little bit more exposure, but then you, you do take away the native underlying assets. You can also deposit your outputs there into the curve y pool or the BUSD pool or the sUSD pool. And then you get the trading fees as well. But for example, the pool balances underneath can shift. So if you put in, let’s say 10 million DAI three months ago in, in curve and you, you can’t withdraw 10 million DAI now, cause there’s only 6 million DAI in there, but you can still have, you know, the 3 million DAI and then 7 million USD.

Andre Cronje (00:14:19):
So, so you do lose the strict association of the underlying assets, but you do get those trading fees on top, which is still good. And, you know, that’s, that’s yielding you upwards of 10 to 20%, depending on the time span you’re looking at in aggregate sense, since inception about 11%. And now I’m not talking about additional incentives, you know, like, like the curve you can get from, from being an LP on SNX, you can get from staking the sUSD LP output token or those kinds of things, or those are additional benefits over and above. And then the vaults are definitely the higher risk ones because the money moves. And, and even though, even though you might be comfortable with the strategies it currently has, you might not be comfortable with the strategy. It has two weeks from now. So, so, so there’s a little bit more involvement and definitely more risk because the YFI community as a whole gets to the point where, where they control what the strategies are and they control when it moves.

Andre Cronje (00:15:23):
But it automates these processes for you. So, so its job is if the current best farm is farming DAI leveraged into comp, and that’s going to be the strategy for DAI and you provide your DAI, it’s going to do that strategy, but should that change to now DAI into Y pool for curve tokens and a new strategy is deployed, voted in and then switched to that one. So, so, so because it’s because it’s let’s call it upgradable you know, even though by, by, by contract definition, it’s not upgradable proxies, but, but you know, I can, we can add a new strategy and then switch to that strategy. So, so let’s consider that an upgrade, even though the vaults are not, the vaults are static themselves. That definitely adds an additional layer of risk. And that is the risk reward adjustment that you see.

Andre Cronje (00:16:11):
I mean, the vaults are performing a lot higher, but it definitely comes with more risk than the original V1s. And then things like yTrade and ySwap? They’re, they’re still in my R and D finalization phase, so I’m not really trying to promote them yet, except for people that want to experiment a little bit. But I still have a lot more iterations to do on those before, before I’m happy with, with doing proper public releases on them. So yeah, it’s, it’s, it’s really based on your risk appetite at the, at the one far end of the spectrum, you have the sitting on a lot of, you know, USDT USDC, whatever capital and it’s currently sitting idle and they don’t wanna, they don’t want to expose it to risk, but, but they also don’t just want to have it sitting idle.

Andre Cronje (00:16:56):
So for them the original, yPools into curve, great choice nice and stable it’s performed well in the past. That’s, that’s where I would park it or for the people that know about it, yield farming and, you know, know what’s going on a good place to go is the vaults. So I do recommend having, having a little bit of awareness. But another reason why you want to go to the vaults is because it’s it in quotes, subsidizes gas. So it’s because again, it’s this pooled solution. So it’s not, it’s not everyone paying for gas the whole time, but a single interaction that, that triggers the chain that then pays for the gas, a unlucky gas lottery, I guess is another good reason to say sitting there. And then, but I mean, at the far end of the spectrum, you’ve got the, you’ve got the, you’ve got the defi guy that he’s on CT, crypto Twitter, you knows what’s going on there.

Andre Cronje (00:17:54):
He’s in telegram, he’s a discord. He knows what the strategies are. And he probably manages this to himself for the most part. But maybe he just wants to save on gas as well. So then a good reason to go into the vault strategy. I’ve, I’ve had a few people that I’ve spoken to that just want to take the weekend off. And then, you know, they, they don’t want to be jacked in the whole time. So when they want to take the weekend off, they park the funds in there, so they don’t have to worry about it. But if you’re, if you’re that, that complete end of the spectrum person that knows what’s going on is updated, then I still recommend you manage your money yourself. That’s, that’s still the, the, the, my money, my responsibility peak area, but, you know, everyone can’t have all of the information all the time, especially not with how quickly things are currently changing.

Andre Cronje (00:18:42):
I, I do think it’ll, it’ll subside and we’ll go back to, to something a little bit more normalized where, you know, it doesn’t change every eight hours, but instead changes, you know, once a month. And that’s where I’d like to see it as well, because I’m, I’m, I’m a, I’m a big, I’m a big advocate for sustainable yields. And right now we’re in a very unsustainable space, which, which causes me a little bit of concern a lot of concern, but, but, you know, that’s, that’s, that’s part of the cycle we’re going through. So, so, so that’s fine. So, so I guess I’d say those are sort of, you’re different, you’re different benefits and the risks that comes with it. I mean, personally, I still sit more on the, on the Yearn V1 side. I’m, I’m not, I’m not as volatile or I just want to outperform what I can do in my, in my local currency savings account that I’m happy. It doesn’t have to be,

Hasu (00:19:40):
When you say you sit more on the V1 side, you mean with your own money because you also use Yearn to invest your own money, right?

Andre Cronje (00:19:48):
Yeah. So, so, so the majority of sitting in there, which I consider to be the safest area, and then what I’m willing to risk, I play in the vaults, or I play as an LP because there, I know there’s more risks. It’s, it’s, it’s fun playing there, but, but I still prefer sustainability. Sustainable APR is a, is a very important thing that we’re, we’re currently losing sight of a little bit, but hopefully we’ll get back there. And obviously as, as market and capital inefficiencies improve as well, we’ll, we’ll also see that line flatten out to, to where it’s, it’s technically supposed to be comparative to the rest of the world’s interest rate minus fees from banking, et cetera.

Tarun Chitra (00:20:34):
So what one natural kind of next question related to this is, you know, how, how complex do you think these strategies are going to get? And especially in terms of, you know, reallocation to different yield farming really at venues. I, you know, I think maybe when Yearn V1 came out, it was much more clear that sort of the Yearn or InstaDapp type of strategy of, or the, what, you know, yToken one strategy of optimizing dollar denominated or stable kind dollar denominated APR is, is kind of like a good user experience. But now that you have the whole system for, for really starting to explore a bigger strategy space, you know, how complex do you think things will get? You know, I think, you know, we know that there’s this economy of scale to having gas costs shared across the pool. So that means you have more gas and implicitly to spend on strategies. And then, so maybe walk us through your thought process of that, but you’ve kind of seen in the community. Do you think complexity will dominate, or do you think people will stick with simple strategies? Would they be sort of directional strategies trying to chase momentum or will they be trying to be more like market neutral?

Andre Cronje (00:21:58):
So, so from, from my perspective the things I write, I like to keep very simple strategies, you know, do do one small thing and don’t do too much. But, but that just because that suits my specific development style the more complex, the more risk. So, so from, from, from the, what strategies will I keep writing fairly basic. I don’t like I don’t like too many protocols working together at the same time. As that increases your amount of failures from the strategies I’ve been discussing with people that I think are phenomenal, they, they get super complex. So, so what I mean by that is, is as we’re seeing more of, you know, a options market developing and a perpetual market and a leverage market, then you, you, you can start adding in these different hedging strategies and you can, you can go to Synthetix and you can, you can mention then take that into a pool and then hedge that against, you know, something that maybe you take out on UMA.

Andre Cronje (00:22:58):
So, so I think it’s, it’s becoming increasingly possible to do increasingly complex. I think the more complex, the strategy, the different vetting process that would need to go through, but, but, but definitely from, from what I’ve, from what I’ve spoken to a lot of. And I mean, I, I think it has a lot to do with, with, with who’s building the strategy as well. Cause like the, the, when, when I speak to guys like the framework guys, you know, they’re, they’re very much into, into these, these hedged yielding strategies will where they might fund a perp and then hedge that on the other side. And like, it’s, it’s, it’s very good yield, but, but I’m not from that world. So it’s very difficult for me to quantify. Because one of my, one of my code rules is still, I just, I just codify what I do as a human.

Andre Cronje (00:23:58):
So, you know, if I, if I, as a human can go deposit and then see the APR and withdrawal and then maybe get an output token and sell that for the underlying asset, and then that’s something I can codify. I’m happy with that strategy. But yeah, I mean, at, at the, at the baseline, you know, a strategy as, as simplistic as, as put DAI into compound and you get interest and that’s a good strategy, but at a layer on top of that, now you have add DAI into compound and farm COMP. And now you have at DAI into farm COMP sell COMP to DAI. And now you can take it a step further and you can go DAi, folded, leverage, whatever you want to call it, you know, four times and then farm and sell COMP. So, so again, risk reward versus complexities slash APR.

Andre Cronje (00:24:46):
I, I don’t, I don’t, as I currently discuss this, know what that mix is going to be, but, but if it goes the way I’d like it to go, then, then I think it’s going to become increasingly complex to, to maximize those market inefficiencies and capital inefficiencies until it gets on until, until the strategies themselves flatten out, you know, that, that line to the point where it’s, it’s aggregate in the market and to do that, you do need to mult you, you do need to leverage across multiple points and that will increase your complexity. So yeah, I’m, I’m really excited to see what people are building.

Tarun Chitra (00:25:29):
Yeah, for sure. I mean, I think one of the reasons for instance, gnosis’s on chain exchange is so much, you know, sorry, Martin is so much just, it’s never going to be used as much as Uniswap is because it relies on this off chain Oracle to actually tell it sort of give it a solution of how to clear the auction because they went with an overly complex kind of design and sometimes overly complex, off chain design is the, is the a theoretically correct design. It solves the problem in some optimal sense, but given the computational constraint of the traders and the trading itself, you kind of have to adapt your strategies to the fact that you’re in this low compute environment, Ethereum’s expensive, very variable costs. So do you ever see a world where the strategies are not strictly emulated on chain in the sense that, you know, a lot of the, the types of, you know strategies that people would use them in centralized crypto trading or real, real finance normal trends is, you know, probably a few orders of magnitude more complicated and you don’t really want running on chain, or do you see actually this kind of new nouveau thing for, for defi as being simple on chain strategies will dominate and have like the highest amount of capital in flow.

Tarun Chitra (00:27:03):
So maybe to put another way, do you see the majority of, of capital that is going into these strategies really focusing on the simple but scalable strategies or these kinds of complex, but optimized strategies. And it’s, if it’s a latter, do you see a world in which this has to be done off chain or on a different chain?

Hasu (00:27:23):
And maybe, maybe to build on your question Tarun like the most extreme version of that, that I can see is that some venture fund or hedge fund starts raising money on Yearn, right. By creating a vault. And then just saying the strategy is, did you trust us to invest this money? And we are going to return it in one year.

Andre Cronje (00:27:48):
I may look those, those, all of those possibilities exist. I think that’s why that’s why the, the collective governance is important again, to drive where that goes. If, if it’s down to my personal opinion, I don’t like things that happen off chain. It’s the same reason why while I spent most of my time originally normalizing all of the different APR from all of the different lenders. Cause I didn’t want to make off chain decisions. Even, even with these new farming strategies, they, they, they annoy me a little bit because you’re, you’re making in quotes off chain decisions on, you know, is, is COMP currently more valuable or is curve more valuable or I don’t know. YAM. Or valuable for argument? I, I think, I think the more you do off chain, the more risk you add versus if it’s, if it’s on chain, it’s verifiable, everyone can see it, everyone can do it.

Andre Cronje (00:28:52):
That’s. That’s where I personally would like to see it. And that’s where I personally would like it to stay. To me, to me, if it’s not happening in a CRM it’s not happening now, now that does not preclude where we might be in a, in a few months and or years from now, when, when we have, you know, a few more layer, two solutions and we have more currently layer one change that ended up becoming, you know, sort of roll up side chains. And, and then that might be a different story because you, you can still verify it at the base ETH layer. But I’m very hesitant now, again, this is my personal opinion. I mean, it’s up to, it’s up to YFI holders to decide, but, but in my personal opinion, I don’t think any strategies should be used that can’t a hundred percent be verified chain,

Tarun Chitra (00:29:43):
Yeah. I mean, I, I, the only reason I asked is that there’s also this kind of adverse selection aspect to having everything on chain of, you know, everyone kind of knows what let’s just say, we’re in a world where we’re where Yearn is controlling, like Yearn vaults control, 40% of capital. And so every reallocation transaction that’s sent sort of has Yearn as, you know, the whale when they actually, when the contract makes a trade, a lot of other people follow or a lot of other people front and run the vault sort of behavior. Do you, do you see that that competition sort of being stable in the long run where, you know, you have manyVaults and they’re competing and sort of they compete towards towards a single equilibrium or do you see it as a strictly capital aggregation game of whoever is the biggest in terms of vault creation, whether it’s yam, whether it’s Yearn, whether it’s whoever else shows up, ends up kind of dominating. And the reason I ask this is if you stay fully on chain, you actually do expose these strategies to a ton of adverse selection because the code is open source and you can look at the historical transactions and you know, exactly the logic. So yeah, maybe what are your thoughts on that?

Andre Cronje (00:31:09):
Look, I mean, it’s, it’s, you’re, you’re, you’re opening your competitive advantage and you’re opening your playbook. There’s, there’s no doubt about that. And I currently see it with the vaults. Like when I, when I deploy a new strategy for, for example, the latest one with the, the LINK delegated vault was to borrow TUSD and then put that into stable and put that into the savings because that was doing upwards of 50% APR. And, and that’s a much higher offset than the more 0.1% you’re borrowing. And that net benefit is your net result by pressure as well. But, but after deploying that just when I deployed it, there was, there was no TUSD in, in in mStable. And now it’s kept at, at max cap 55% weight. So, so, and, and I mean the, the, the same with the yCRV and the same with the USDC pools.

Andre Cronje (00:32:06):
So, so it’s already people, people that know how to do these things. They’ll, they’ll, they’ll come to the discord and they’ll ask people, Hey, what’s the current strategy? And the reason they’re asking that is not because their money is in the vault, it’s because they want to go do it themselves because it’s, that’s, that’s the easier way to find out what I’m supposed to do. And, and I mean, in a, in a, in a traditional capitalist sense, I’d say that’s bad, you know, because obviously you want to protect your IP, your solution, and you want that money in there because that’s the structure. But, but I think in an open society, that’s fine. Cause, cause you’re still going to have, you’re still gonna have the lazy farmers, you know, the, the guys that don’t want to do that all the time. I mean, just, just me trying to review the different forks code gave me so much fatigue from fork fatigue that I was at a point where when a new one launched, I was just like, you know what, whatever, I’ll just do whatever you guys want.

Andre Cronje (00:33:05):
I’m not even gonna look at this anymore. And I think, I think a lot of people we’ll sort of get to that space as well. And I mean, especially with gas feeds what they are now, you’re not at a certain point, your, your, your size of investment. It also just makes sense to live in a vault because you don’t have to worry about those exorbitant gas fees. Because just cause there’s a lot of solutions that currently don’t make sense because of that. Now, now again, these inefficiencies will disappear as we move to, to Eth2, or move to roll up solution or layer two solutions. And those things will happen over time. And maybe the market changes to the point where, you know, something like Yearn doesn’t need to exist in a year from now anymore. It just needs to exist for the problems that are presented now.

Andre Cronje (00:33:47):
So, so I I’d say little bit 50 50 I mean, it’s, it’s good. So the people can use it, copy the Yearn vaults. And I do actually highly recommend it because create a competitive fee structure there, get it to the point where it’s a zero sum game and people are just, you know, having zero fee solutions. Cause I think that again, fixes capital inefficiencies. And, and that does obviously subtract value from, from my yearn solution. But I mean, I don’t see why that’s bad. If, if, if there’s more access and, and we’re, we’re, we’re getting this incredible current, you know, huge APR line down to a more reasonable place. That’s, that’s fine. I mean the, the, the same arguments, although guess it’s a little bit different. I want it to say the same argument can be made for, for backs, you know, cause we’re seeing a lot more digital banks and the barriers for banking is also emerging, but, but banks will always have sort of a regional connectivity.

Andre Cronje (00:34:59):
It was a discussion of that on the forum once about, you know, creating different Yearns for different regional and or demographic segments, which also think is good. It goes like one, one of the reasons why I supported, the why I support the YFII fork is because you know, that they’re there. As they themselves say a Chinese, you know, demographic that’s, that’s China focused defi. And that for example, is a demographic that, that me as yearn would not have gotten into because you know, my, my sites don’t have translations my, my Twitter and stuff. Doesn’t talk to that crowd. I’m not on Wechat actively. So, so, so that to me is good. Even though it’s a competitor because that’s, that’s a market segment, I would have in any case not touched. So having, having people have access to it is a positive to me. And, and I guess that’s, that’s probably where, where my, my perspective will differ from, for example, a YFI token holder, because to them, they want to lock in as much as possible into, into yearn because that’s the highest, you know, ROI for them on, on their governance participation. But, but to me, the more of these solutions we have and the more inefficiencies we exploited to give more people access. I, I see that as a positive and always,

Hasu (00:36:22):
Yeah. So zooming, zooming out a little bit. So I originally thought about Yearn as a sort of hedge fund or like a robo advisor. And I know in a different podcast, you call it a smart savings account, even though you weren’t quite happy with the name. I think it’s very fitting, but I think the more we talk about it, the, my, I see it as a actually a two sided marketplace for investing where, on the one side you have the LPs who provide capita. And on the other side, you have strategy providers who provide the extra that investment strategies. So do you agree with this framing?

Andre Cronje (00:37:03):
Hundred percent! So, so, so the way I’ve been, I’ve been mentioning that in some of my different talks is, you know, there’s, there’s, there’s the LP who I just want to provide DAI and get my base DAI returns, I don’t really care what you do with that. And then on the other hand, you have the strategist, which, which is technically, you know, It’s a it’s, it’s, it’s a capital deployer, it’s a fund. So like what, what I almost want to see one day which I think will be pretty cool is when, is when there’s so much capital that, that the strategy writers can actually go to a protocol and, you know broker a better deal. So we will provide this capital, but you need to give us, you know, this rebate or whatever. And I think when we get to that point, then, then it becomes really sexy because then, then the, the power of the capital in itself has weight.

Andre Cronje (00:37:58):
And, and, and this is I’m sorry to sidetrack here a little bit, but, but this is something that I saw with the delegated faults, where, you know, as, as, as individuals and using the LINK vault, as an example, as individuals, a lot of people do take their length. They put it in Aave, they, they borrow USDT and they go put that in curve and they outperform the, the interest that they are paying and they take that difference and they go buy more LINK, and then they put that back into Aave and they keep doing that process. And, and as an individual let’s, let’s say a hundred people are doing it that that helps, but it happens at different times at different points in the markets. And now someone skips it, maybe in another one, doesn’t do it. But when you pool all of this and the vault starts doing it on a, on a consistent basis, you know, it’s creating this constant by pressure on the side as well.

Andre Cronje (00:38:50):
And, and I like to think of the, the vaults sort of as, as their own whales that have their own weight in this ecosystem. And I think we’ve, we’ve, we’ve seen what they can do in some circumstances. So, so, so definitely, I think the current strategy developers, you know, are, are, are just dudes like me, who are just see, Hey, here’s a cool way to make a little bit of extra per hour. So let’s do the strategy. But I think the ones in three months, or six months from now are going to be fairly, fairly sophisticated capital deployers that, that know how to leverage that to their advantage. Because, you know, there’s if there is, for example, an incentive system in, and of, it makes a lot of sense, you know, add that incentive referral and then deposit all of the funds because your, your, your net benefit is going to be higher than doing it individually across a bunch of different markets. So long story short. Yeah. I agree. A hundred percent with that perspective, you mentioned

Hasu (00:39:48):
One actual interesting thing that, you know, what you just said made me think about is there’s been kind of this rebirth, I think, in crypto of memetic trading cause a normal finance, I think memetic trading sort of died in the two thousands. You know, when I think of memetic trading there, I think of like activist investing and, you know, some guy going on TV and being like X as a scam. And you know, I, I, there’s an actual interesting thing here where the weight vaults themselves become the memes that trade they’re, if they’re they’re a whale, they kind of are the memetic trade. So, you know, in that sense, do you ever see kind of vaults having memes as lives of their own in the sense that like vault creators or strategy developers develop a whole meme ecosystem around a certain type of strategy and everyone just follows, it becomes a momentum trade more than a sort of raw trade

Andre Cronje (00:40:45):
Like, like almost self fulfilling prophecies with capital deployment. It, I mean, it would be awesome. I wouldn’t mind, but, but for it’s it’s I, I, I don’t. Okay. So, so, so, so a good example, right, is, is the yCRV vault that started farming YFII. And, and a lot of people attribute, like YFII’s price decline to, to the vault that’s constantly, you know, farming and selling and farming and selling. And that creates a lot of I’ve, I’ve started calling them parasitic vaults because they just, you know, leach off of these other governance tokens for, for their own best case. Like it’s, it’s, I’m, I’m, I’m really actually unhappy with it, but at the same time, it was very interesting to see, but, but I, I traced all of the sell events. And now, while that obviously did make the order book thinner, it was not the thing that kept driving the price down that I saw from, from a lot of the other farmers that were in that ecosystem.

Andre Cronje (00:41:49):
But everyone enjoyed the narrative of this vault being this parasite and then feeding off of these other thing. And then, and then a lot of people in, in like discord and telegram, I saw a lot of people start saying, you know, you might as well just sell because the vault is farming it in any case. So there’s no point in holding it. So, so it induced this idea that if the vault is farming you, you’re going to decline. So might as well not try. And then everyone else, you know, sell, and that actually creates that prophecy in itself. So, so I’m, I’m, I’m tempted to say that that’s already, I’m already observing that. I I’d like to see with the, with the delegated vaults, the more positive side where, you know, they’re constantly buying. So that means on for people that are buying, I definitely prefer the positive narrative over the negative narratives, but, but yeah, I think so.

Andre Cronje (00:42:39):
I mean, I know a lot of, I know a lot of on chain traders that, you know, they, they trade based on what they see the whales they do follow. So if they see a whale is in a position and then that will begin to exit that position, they exist that position because they followed that pattern behavior. And I think with the, with the yVaults, if, if they play out well that that concept will be, will be super imposed almost, you know, it’d be because it’s happening on a grander scale. Cause now taking the yCRV vault as an example, you know, it’s not, it’s not one whale you’re following with $2 million. It’s, it’s this vault that has 30 million sitting in it at one point 40. So I, I think due to the open nature of what they are doing I can definitely see a culture like that form around it. But again, that’s, that’s, that’s one of those, those fascinating side effects that like, like so much has already happened, that I could not predict them in any kind of design ideas. So, so I actually think that’ll be really cool.

Hasu (00:43:49):
Cool. And in some sense, you know, maybe, maybe this might be a [?] comparison, but do you kind of, you know, my first impression was sort of Yearn was your V2 once you had vaults was really, it was really like Numarai for yield farming. So I think one of the things that, you know, old school crypto investors and people thought was that this notion of kind of memetic slash crowdsource trading would be would really work in the normal markets. But so far I would say it’s been pretty conclusively, pretty bad. It, whereas I pointed out the yVaults have done quite a good job of this kind of crowdsource trading model, even in one month or, you know, I don’t know for you, it must feel like it’s been like a year since. So, so do you see kind of on chain trading as the, you know, what are, what are kind of the advantages for on chain trading that make it so much better for these kinds of crowdsource experiments? Because it does seem, you know, it’s only been a short amount of time, but I would say it seems like there’s just such a large advantage and it seems like it’s working a lot better than it does in the normal market. So maybe do you have any kind of color as to why that happens? Like how the community, why the communities are so much more vibrant? Like w you know, what’s this, like, what’s your gut feeling for the secret sauce?

Andre Cronje (00:45:25):
I think it’s a combination and, and like you said, gut feeling, this is a hundred percent gut feeling. I have no supporting data, but It’s been one month of craziness, so let’s not, you know, you have to there’s no, there’s no, there’s no strong statistical inference. Absolutely zero. The, the, the only thing I can comment on, you know, number one is, is the open nature of the vaults. The fact that anyone can see those strategies. And I mean, there’s, there’s, there’s been a lot of sites that have, that have come onto the stage:, feel-the-yearn, all community built and, and all of them have a singular job of, of seeing what the vaults are currently doing. So, so I think that’s, that’s already sort of step one. So versus, you know, in sort of traditional trading markets or, or even if we take it off chain and we, and we just look at the off chain markets it’s a lot more closed loop. So you, you don’t, you don’t necessarily see what that big trader in finance is doing because you can’t really monitor it as closely.

Andre Cronje (00:46:35):
So step one, I think is, is this open nature of the vaults and the strategies themselves, and then thing number two is, is I think the, the access to information is, is a lot easier slash spreads a lot faster. Now, now, again, in traditional finance, you know, there’s, there’s a lot of structures to prevent people from discussing with competitors or, or different groups or, or, or, you know, something that’s not your LPs maybe, but, but in, in, in, in crypto because of the, the open nature of a theory that that information gets disseminated so quickly. So, so, so what I, what I like to do is I like to watch how long it normally takes from me deploying a strategy on chain, not, not even hooking it up. So, so this is me a strategy for myself that I want to play with because I normally deploy them on Eth and, then play with them for a week or so before I turn them into an official strategy.

Andre Cronje (00:47:38):
And, and as soon as I do that, how long until I see people talking about that strategy on different discords or different telegrams, or, or them start discussing it, or, or dissecting it to try and see why it might be better than the current strategy. And, and on average, that’s within a few hours, you know, where, where if I go back to my traditional banking and finance days, that’s, that’s not something that happens. You, you didn’t have access to the other guy’s playbook. And even if you did, you, you didn’t share that information. So, so I I’d say those two qualities are kind of the self fulfilling prophecies, where, where it’s gotten to the point where, where if a vault switches through the strategy, people go, Oh, okay. That must be the better strategy. Let’s, let’s follow along. So I, if I had to wager a guess, I’d say, I think those two factors largely play in it. But you know, as you said, it’s, it’s been live for a month and right now there’s a lot of excitement. And right now there’s a lot of attention that could very well be a very different picture, you know, six months from now. So, so again, fascinated to see how this evolves, but, but I think there’s two, there’s two qualities probably have a large impact on why we’re seeing the, the, the sort of the mythic nature around it.

Hasu (00:48:58):
Yeah. Yeah. I think I fully agree with it. And I think that there is a large, very large demand in this space to just like one button allocate capital and put it to work, but, but in a way that is that the user can understand and that they can trust. And I think that’s, that’s where the big strength of these on chain strategies comes in versus the more discretionary strategies that may be more profitable and a lot harder to like front run and such, but they also demand a lot more trust in the capital locator. So going back to this two sided market place for investing, I would be curious, so what is my, how do you incentivize people to provide strategies in the future?

Andre Cronje (00:49:46):
Gotcha. So, so right now the, the strategy creator gets a percentage of the performance fee. So what I mean by that is, let’s say, let’s say the let’s take the YFII vaults. The strategy there is to is to stake, to form the YFII governance tokens, then to swap that back to, to the to the yCRV LP token of that 0.5% is currently taken as a performance fee on every time that liquidation event occurs, the others go back to the LP. And then of that 0.5, the strategy creator you as let’s say, 50% or whatever. So, so for now it’s zero because I’m the strategy creator. And I don’t really care about the output. But that’s the, that’s the design model to incentivize strategy creators. So as a strategy creator, I want my strategy to be the best, and I want it to be the one used because it has, you know, net recurring benefits for me.

Andre Cronje (00:50:50):
But that’s, that’s, that’s current design. How it, how it ends up looking, I think might be very different. Maybe it’s a, maybe it’s a inflation model where, you know, tokens are assigned to strategy creators when, when it comes to sort of the, the incentivization slash fee structure modules, I’m largely throwing that out up into the air for, for the governance participates to, to discuss and vote on, because I don’t consider myself an expert in that area. And then to see, but yeah, so, so currently as we speak now it’s a percentage of performance fee what it ends up being, who knows.

Hasu (00:51:29):
Yeah. So in a marketplace for an, an open marketplace for investment strategies I think we have pretty substantial evidence that the, the lowest fee strategies are attracting the most capital. We see this in the passive investment space and traditional finance where the, the ETF has one basically has the dominant investment vehicle and among ETFs, the ones that have the lowest total expense ratio, they dominate the market. So given that strategies basically pay some amount of fees to the governors, the, the, the YFI holders and also pay some amount of fees to the actual strategy provider. Do you think that the end game is going to be that basically any strategy, any, or like the strategy providers and the YFI holders, they become one because if someone already holds YFI, then they can, and they can benefit from already getting the fees that way. Do you think that that they can offer a more competitive product in the market, cheaper?

Andre Cronje (00:52:46):
I mean, look where wherever you cut down fees you’re going to be better off. So, so, so my rule right now with these vaults is I just need to be outperforming any competitor. And that difference that’s free game to governance. Like, like maybe because I’m, I’m fine with putting my money in there, on, on that basis. So, you know, I’m not, it doesn’t have to be earning 22%. It’s fine if it’s earning 20%, because it means I don’t have to spend all that time researching and deciding where to go and, you know, swapping it myself and gas and et cetera, et cetera. But because there’s, there’s a lot of hidden expenses that actually that’s different topic, but let me quickly just touch on too, that there’s, there’s a lot of hidden expenses that people don’t calculate into their yield farm, you know, so, so it’s, it’s, it’s always an, and I’m guilty of this myself, and that’s why it’s a metric I want to get rid of, but, but this idea of, of daily APR daily growth, annualized, and then you say this is APR is actually a gross misrepresentation.

Andre Cronje (00:53:47):
Cause, cause even if you’re talking about let’s say a hundred percent APR currently, this is what you annualized from the last 24 hours change. So, so let’s say you have $10,000. You want to invest. Now. Now you might be excited to, to swap from your current strategy to there because so much higher rates currently. But you know, if your money was there in the last 24 hours, on 10,000, you would have had 27 bucks. And that’s very quickly offset by the gas fees. You’re just paid to do that migration from the withdrawal on the one side and the deposit on the other side. So, so, so that, that’s more back on the original topic of, you know, what, what is my net result of growth minus fees, minus research minus time. But to answer the question in a straightforward as possible, I have always considered it to be a little bit of a zero sum game because with the open access of information and the quick dissemination offset information, it is possible to have competitors that are just going to be zero.

Andre Cronje (00:54:55):
It’s also possible. And, and I think this is why, you know, we have we have competitive pricing rules and a bunch of different things like this and traditional markets, because it’s also possible that a bunch of these yield aggregators decide they’re all gonna charge 5% and that’s the next standard. And that’s also on the bad side of the spectrum. The, the honest answer is I don’t have a clue. We’ll, we’ll see how it evolves. I think, I think there is more than enough capital available and different appetites that there’s, there’s a lot of room for a lot of different solutions and a lot of different pricing models.

Tarun Chitra (00:55:36):
One, one quick comment is a, you know, I know there’s this campaign, not just from you, but for many people to to, to get rid of APR, but the normal markets have not even still moved to full market cap weighted indexes, they’re still [?] So it might take forever.

Andre Cronje (00:55:59):
Yeah. Look, I actually tweeted it earlier today that, that, you know, the, the new daily APR that’s, that’s the, that’s the circulating supply via versus fully diluted market cap argument. I mean, you, it’s, it’s, it’s a statement that doesn’t necessarily mean anything and you can, you can use that information. I’m just, I’m just worried about the impression it creates for the uninformed user, because I’m like, like, like when I was doing this back in, back in early year, like, like Jan Feb March, I, I felt a lot more confident that the people putting their money into these systems had a lot more information and knowledge to how the systems were working. And, and I think it was a crowd that wanted a little bit more responsibility, you know, like, like when, when, when they put in there their a hundred dollars, they want to know exactly where is that hundred dollars.

Andre Cronje (00:56:58):
And at any given point of time, I want to go see where is that hundred dollars. And, and these last few months have filled me with so much fear because the, the amount of capital going into the systems and the speed at which they’re going into these systems clearly tells me that, that, that sort of, that wants to be informed has, has completely flown out of the window. And then right now people are just yellowing into whatever they see as the highest APR, right, without actually considering what their net result is, you know, minus gas, minus opportunity costs and what that is in aggregate. Cause you go, if you go look on the Yearn V1 vault, you you’ll see, they report their APR as, as realized, you know, so if you had to put in $1 and day one, how much percentage growth has there been till now?

Andre Cronje (00:57:49):
And that’s often not a sexy number. You know, it might be 8%, but, but now in a, in a, in a given block, the borrowing on sUSD can spike to the point where it’s at 64%. And then, then I, and I, I did fall victim to this early, when I started, but I’m vehemently avoiding it currently. Then, then it is fun to, to jump on Twitter and report that 65% because that’s cool. But at the same time, now someone moves their funds expecting 65% consistently. And, you know, just because it was 65 for a block and the rest of the time it was North 0.1, isn’t, isn’t going to get you what you think you’re getting. And, and, and that’s where I’m worried. So, so I think it was fine reporting it six months ago because the capital flowing in was informed capital.

Andre Cronje (00:58:40):
And I mean, I, I don’t say this with any disrespect, but, but I just feel like a lot of the capital that’s being deployed now is, is not informed capital. I, yeah, I I’m, I’m just worried about that kind of stuff. And, and the more I’m seeing the inflows, the more I’m worried about how we are representing this information to the outside world. But at the same time, I also see when I tweet about something like this, I get zero engagement, but when I tweet 170% APR, then, you know, it’s shared in like 4,000 times. So, so, so clearly the crowds are speaking and they’ve, they’ve made their decision. I’m, I’m noticing we’re back. We’re back in that, in that market space where we’re now, when, when you point out that, Hey, there might be a riskier or, Hey, be careful, you’re you, you get attacked and flooded versus, you know, six months ago when you pointed that out, it was shared to the extent that everyone knew.

Andre Cronje (00:59:39):
And, and I mean, I show that even happened with, with the article Hasu did, where, where, you know, I saw people attacking him for it. And I was like, it’s, it’s, it’s important that the stuff gets shared. Like, I don’t know. Anyway, I posted it a few days ago as well, where, you know, I, I told people that they shouldn’t get attached to these numbers cause there’s so much emotional attachment to these numbers. And, and that, that in itself is dangerous as well. But, but sorry, guys, I’m, I’m going off on a completely different tangent now.

Hasu (01:00:11):
I, yeah, I really liked that you would post the, the realized yields instead of the APR. I just think it’s super important to like train your users in the right way. And I mean, we’ve seen with stuff like impermanent loss, which I think has also caused a lot of damage property to LPs, just this name and the expectations that it creates and how misleading it is. I think that these things can, can take, take a life of their own really quickly. So it matters like getting the naming and the expectations right.

Andre Cronje (01:00:47):
Yeah. And yeah, I like, like, you’re, you’re, you’re, you’re, you’re always going to have that sector of people that are not going to care about that. And, you know, they’re just going to want to report the big numbers because they want to attract as much as they can for whatever reason it is they want. But yeah, I agree. I think we need to start standardizing some of these things and reporting them in similar fashions because most, most of the, most of the aggregate sites I see now that report APR are doing daily adjusted. And I, I just don’t think that’s a good metric.

Hasu (01:01:24):
This concludes the first part of our interview with Andre. In the second part, which we’ll release in a few days, we focus on governance both in Yearn and in DeFi systems in general. Governance, in my opinion, is not only the hottest topic in crypto right now with many projects releasing their governance tokens at insane valuation, but also one of the most misunderstood. I can’t wait to share that discussion with you. See you next time!

The post Uncommon Core Podcast – Episode 6 transcript appeared first on Uncommon Core.

Lucas Nuzzi ( Feed )
Crypto’s Weirdest Cognitive Dissonance

We all stood behind the money printer go brrr meme. We need to live up to what we preach.

Cognitive Dissonance, noun
the state of having inconsistent thoughts, beliefs, or attitudes, especially as relating to behavioral decisions and attitude change.

We all stood behind the money printer go brrr meme. We need to live up to what we preach.

Cognitive Dissonance, noun
the state of having inconsistent thoughts, beliefs, or attitudes, especially as relating to behavioral decisions and attitude change.
(Oxford Dictionary)

We all like to think that we’re changing the world with this thing called crypto; reiterating upon a flawed financial system through decentralization, disintermediation and open access for all. After all, Bitcoin was created on the brink of the worst financial calamity in almost a century, when the opacity and cronyism of 21st century finance threatened to destroy value of an unprecedented scale.

While quantitative easing and bailouts were increasing the complexity of global economies and blurring the role of central banks, Bitcoin was being legitimized as a transparent and provably fair alternative. The successful bootstrap of its network gave birth to an entire industry that converged around the ethos of decentralization and openness.

We have embraced this ethos to build Unstoppable Applications, Decentralized Finance and Personal Banks in what’s often promoted as an entirely new financial system.

However, when it comes to living up to these ideals, there are times that crypto disappoints. There are times when it seems like instead of reiterating upon the opaque financial system we’ve inherited, crypto is merely replicating it. The debates that took place this week around supply transparency perfectly encapsulated this cognitive dissonance. It started with a seemingly simple question:

“What is the total supply of ETH?”

This question broke Crypto Twitter. As many found out, the answer turns out to be “it’s complicated.”

♦Source: CoinDesk Research

CoinDesk Research compiled the responses from 5 different data providers, and, as shown above, there is no consensus. Some respondents pointed at custom scripts, blockchain explorers and third-party querying tools; all of which highlighted an undeniable issue: there is no definitive answer. And instead of an overdue discussion on why there isn’t consensus on ETH’s supply, the conversation got dismissed with a blank “it’s hard to calculate it”.

“It’s hard to calculate it” is a bad answer

We all know it’s hard to calculate it. No Ethereum client (the software required to become a node on the network) features a standardized way to verify total supply of Ether. Since Ethereum’s account-based data structure was built from the ground up, it has always been a hard exercise to make assessments on supply, especially in comparison to Bitcoin and all of its forks.

For context, Bitcoin Core (Bitcoin’s main client) features a command called gettxoutsetinfo that grants any user the ability to audit Bitcoin’s supply for themselves. This is part of Bitcoin’s RPC command line, which, put simply, is an interface that allows users to perform the equivalent to API calls on their own nodes to do things like query wallet balances, broadcast transactions, amongst other functions. Gettxoutsetinfo sums up all valid Bitcoin balances (UTXOs) visible to a user’s node at any point in time and lands on a single BTC supply figure.

Ethereum, on the other hand, has features that make this calculation process considerably more difficult on a relative basis. For example, Ethereum blocks are appended to its blockchain at a fast rate (every ~15 seconds) through so-called uncle/ommer blocks. These are blocks found roughly at the same time by different miners. Instead of selecting one or the other, the protocol “merges” them together. The reward is then split between miners based on the composition of their blocks, which complicates the tracking of ETH issuance.

Then, there are the idiosyncrasies of complex smart contracts that require data providers and blockchain explorers to adopt their own methodologies to account for who owns what, when. Then, there are rounding heuristics at the discretion of the party making the calculation. In order to deal with these idiosyncrasies, anyone trying to land on an authoritative estimate of ETH’s supply is required to make methodological decisions at their own discretion; decisions that will ultimately skew the final figure. So, yes, this is by no means an easy exercise.

However, it was odd to see people fixate on the difficulty of the calculation and fail to acknowledge that the lack of consensus on the total supply of ETH is a valid concern. It was particularly weird to see pushback coming from people whose full time job is to promote the ideals of decentralization and openness.

However, it was odd to see people fixate on the difficulty of the calculation and fail to acknowledge that the lack of consensus on the total supply of ETH is a valid concern.
It was particularly weird to see pushback coming from people whose full time job is to promote the ideals of decentralization and openness.

Perhaps all the ad hominem that tend to follow any sentence with an implicit or explicit “Bitcoin vs Ethereum” comparison in them has clouded people’s judgement. But make no mistake, this lack of consensus should be taken seriously, especially if you care about ETH. The importance of strong assurances around a cryptoasset’s supply go far beyond transparency and auditability — it’s also very much a matter of security.

Consider that Bitcoin Core is as old as this industry itself and also enjoys a large portion of its developer mindshare. Nevertheless, it still experienced a couple of inflation bugs in its history. Ethereum clients are not infallible, and without a standardized RPC routine to audit ETH’s supply, potentially catastrophic bugs become harder to find.

With this in mind, the cavalier attitude seen on crypto twitter towards the lack of consensus on supply data should come as both odd and concerning. In the interest of not making generalizations, I must acknowledge that there were in fact members of the Ethereum community that not only recognized the severity of this issue, but were also brave enough to call out the cognitive dissonance — kudos to them.

“No right way to calculate it” is the right answer

At this point, any estimate of ETH’s total supply is as good as the methodology employed. CoinMetrics has done a lot of work to abstract away any subjectivity from our total ETH supply methodology. We’ve even gone through the effort of developing a new data model to audit the supply of various cryptoassets. This model converts blockchain data into the double-entry booking format, which is particularly useful to track inflation (subscribe to our State of the Network newsletter for future updates on this).

When we applied this data model and accompanying methodology to Ether, we have found that our total ETH supply figures very closely match Etherscan’s, Ethereum’s largest blockchain explorer. This is generally good news given Etherscan’s importance to the Ethereum ecosystem. However, albeit minor, there was still a 0.00052 ETH discrepancy found by Coin Metric’s In-House-Blockchain-Indiana-Jones, Antoine Le Calvez:

body[data-twttr-rendered="true"] {background-color: transparent;}.twitter-tweet {margin: auto !important;}

 — @khannib

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We believe Etherscan made a tiny rounding error in the block referenced in the tweet, but without looking into their methodology, it is hard to say. This highlights that, without a protocol-defined methodology to calculate supply, it is very unlikely that two parties will agree on what Ether’s total supply is, at least at the decimals level. And as much as I want you to trust Coin Metric’s data (knowing the care that goes into calculating it), this should be no replacement for the ability to verify it for yourself.

♦As of Block Height 10648267, Ether’s supply stood at 112,155,515.65573If you care about ETH, take this criticism seriously and call your local Geth maintainer

The other good news is that this is an issue that can probably be fixed. Just like with AA, step number #1 is to acknowledge that there’s a problem. Step number 2 is to convince the maintainers of popular Ethereum clients, like Geth, Parity and OpenEthereum to build an RPC subroutine that converges on a single methodology to calculate total supply and issuance.

In order to truly live up to values of openness and decentralization, the equivalent to gettxoutsetinfo should be very minimum benchmark for any crypto asset. It’s a seemingly small feature, but a requirement for any objective assurances around supply. This is particularly important for more experimental cryptonetworks such as Ethereum, as an equivalent RPC would would allow ETH users to have better clarity around supply, especially in the event a bug makes ETH issuance inadvertently go brrr. It also simplifies the job of third parties by providing a protocol-level methodology we can follow.

Ribbonfarm ( Feed )
Clockmaking: 1
As most of you know, I’m working on (another) book about time, The Clockless Clock, which I’m serializing on the Breaking Smart email list. In the spirit of getting a hands-on understanding of the subject, a while back I decided to build an actual clock as a semi-homemade project. Maybe m
As most of you know, I’m working on (another) book about time, The Clockless Clock, which I’m serializing on the Breaking Smart email list. In the spirit of getting a hands-on understanding of the subject, a while back I decided to build an actual clock as a semi-homemade project. Maybe more than one, but let’s […]
Charles Edwards ( Feed )
Thursday, 13 August 2020
When do you expect to have some tradable tokenized traditional market stocks (eg.

When do you expect to have some tradable tokenized traditional market stocks (eg. Apple, Google, S&P500, etc, etc)?

When do you expect to have some tradable tokenized traditional market stocks (eg. Apple, Google, S&P500, etc, etc)?