#267 Nadav Hollander: Dharma -- A protocol for tokenized debt

Transcript

[Music] this episode of epicenter is brought to you by Microsoft Azure configure and deploy a consortium blockchain network in just a few clicks with pre-built configurations and enterprise grade infrastructure spend less time on blockchain scaffolding and more time building your application to learn more visit AKA EMS slash epicenter I and welcome to epicenter my name is Brian Pavan brain and my name is Peter week and we're here today with another off Hollander so we're gonna go into the

conversation in just a big piece of founder of the dharma protocol which is exciting new lending marketplace and lending protocol on etherium yes and they've just started building a first application on that protocol namely Dhamma lever for imagine lending and we'll talk about that and the business model and where they're going to go okay with that let's go to the conversation if not off we're here today with Nadal hall and Erna Dolph is the founder of Dharma protocol and Dharma is a protocol for lending loans and all kinds of debt instruments Oni theorem or on blockchain so the interesting project I've actually

met Nidal together if may her in in February we visited him in his apartment and there were just two people at the time just starting out and in the meantime they've made really incredible progress and and as I was checking out a little bit what has been built on it and what people are doing with it it's they've common enormously long way in a year so it's definitely one of those interesting new design choice finance projects and I'm really excited that you're joining us today enough thank you so much Brian appreciate that so tell us how did you first become interested in I guess there's blockchain and then there's dead like which one of those

came first yeah definitely watching first let's talk about that so hope so I was a student at Stanford studying computer science in 2015 and I had heard about Bitcoin and had like many in the space sort of dismissed it initially as just being kind of like a bit too fantastical or I didn't really see what was particularly like interesting about it or what was particularly useful about it and it you know I never really dope that deepened it but in 2015 I took a class at Stanford called Bitcoin and crypto currencies that Dan Bonet and Joba know

taught and I just completely fell in love with the space and in particular learned a lot about etherium which was you know at the time a very new project and got really really excited about that actually ended up meeting Fred err some from a coin base in that class because he came in and gave a talk Fredersen being the co-founder of coin base and eventually like that led to me working at coinbase as an engineer I actually started off as an intern there and it's it's been down the rabbit hole ever since pretty much so um and then you you became interested in debt after that

yeah so I think like where where I got into where I started kind of reading a lot into the history of debt and kind of got interested in the topic in general was as a result of starting to think about like the fact that coin base is a company sits on a tremendous amount of cryptocurrency that's just like undeployed it just sits in its coffers not accruing interest for their users in any way and I just thought that the idea of having like it wouldn't it be nice if your Bitcoin when it was sitting in coinbase was earning you some sort of interest rate like it would in a bank like that's a really powerful concept to have a bank that is effectively kind of

globally accessible that if stateless that anybody with an internet connection can access um and started to get like really jazzed about the idea of you know interest accruing debt instruments in the context of crypto currencies and I was surprised to see that there's really a lack of formal credit markets or credit market infrastructure in the cryptocurrency space at the time and so really that kind of led to me both trying to learn a lot about how credit infrastructure has gotten built in the you know legacy financial system over the years but also kind of understanding you know like what are sort of the early green shoots of a

formalized credit market um in the cryptocurrency world and where it likely will start to go and eventually end up in the future and so how did you go about learning about traditional credit market so was there any exposure you had to this beforehand um in a formal setting no so like definitely and I didn't work as like a loan officer in a bank or anything like that if that's what you're asking but I picked up a lot of it from osmosis just in terms of like basically like going around to a lot of the smartest people that I knew that either worked in the financial industry or worked in some sort of like ancillary

financial services and kind of just like picking their brains and kind of shopping around the idea of what it would eventually become Dharma to them to kind of see what they thought of it and you know any conversations like that you learn things like oh you know like you know some point a of this thing that you're coming up with doesn't make sense but actually some point be like you know solves like XYZ problem for us and just kind of doing a lot of conversations like that until I kind of picked apart more and more of what are the real gaps in the existing sort of credit market infrastructure of the world and what are the problems to which blockchain tech is actually applicable and something that was very influential on me from you know from a standpoint of getting educated on

how you know like on the history of the world's debt markets was a book called debt the first 5,000 years very very popular book in the cryptocurrency industry often for actually different industries ins than my reasons it's not necessarily like people are excited about it because it affirms certain narratives about how money came to be but yeah I think it's a fantastic extensive treatise on the history of debt and how its evolved in the modern world good so this led you to to found Dhamma before we actually deep dive into what the protocol actually does what does Dom I mean I mean the name yeah yeah so so Dharma at least in the the Hindu concept is essentially and

you know I always worried that I'm doing a bit of a butchering job of translating it but as far as I have understood it is effectively like the concept of like obligations or things that you like ought to do and I thought that in constructing a kind of universal canonical system of debts or obligations that it was sort of a fitting concept in many senses so let's dive into the Dharma protocol he's first can you unlike a very high-level describe how does it work and what are the parties that make up you know the main players in the protocol right so I think the

best way the best way to think about what Dharma protocol is this I I like to think of it as like a shared settlement infrastructure for peer-to-peer lending so so what does that mean right let's take an analogous example I'm sure many of your listeners are familiar with the 0x protocol which has kind of gained a lot of prominence over the past couple of years the 0x protocol can be thought of as a shared sort of settlement infrastructure that is like a public set of smart contracts on the etherium blockchain that takes kind of like a standard order schema that defines like you know like party a wants to sell token X to party B takes that like

message and then executes some sort of action on behalf of those two parties in the case of 0x the kind of action that it's facilitating is you know a trade between two parties so it takes a you know magic signed string of text that says I you know token holder I want to sell token X to token holder B and then it like swaps those tokens out from their two accounts once it validates the message is correct okay it settles the actual trade Dharma is a similar concept but for loans rather than trades right so it's basically a shared settlement infrastructure for executing lending transactions where instead of that order

essentially saying I you know took a holder a want to sell token older x2 took an older B and it says instead says like I token holder a want to lend token X to token holder B and when it executed that transaction it both pulls the tokens out of token holder Hayes account and sends them over to token older B but also kind of like initiates the loan agreement and kind of creates the contracts that can be used to administer the loan agreement over time and we'll dive a little bit more into that in a second but so that's at a high level kind of the way to think about like what the like whole system is you know what

the goal of the system is what its mandate is now there are several actors in the Dharma protocol that are worth defining so first of all we have what are known as real Ayres so what real Ayres do in Dharma is extremely similar to what real Ayres do in the 0x protocol ie they essentially host centralized order books that borrowers and lenders can post debt orders and offers onto in order to find other counterparties so you know I gave the example earlier of like token holder a wanting to lend like X tokens to token holder B and them kind of coming up with

some sort of like a magic string that if you give it to the Dharma smart contracts it would settle the actual loan transaction that's not particularly useful if token holder a and took an older B don't already know each other right they need some sort of way of finding the counterparty and so that's where real layers come in and you know a very naive model if I am trying to take out a loan I can go onto a relayer I can you know craft one of these signed messages and basically post it on to the relay or order book so that effectively other cryptocurrency users can go and kind of browse through the etwork that order book look at different debt orders and choose which one they want to fill and

the reason why these real layers do this is because they earn a fee every time these loans are actually these loan orders are are actually filled so again very akin to the concept of real ayres in the 0x protocol now there's another class of actors in Dharma which are called underwriters so what do I unders do underwriters essentially earn a fee for for playing a few roles one they originate borrowers so they actually like you know in some way shape or form get the borrower to the doorstep of the relayer be that like programmatically or be that like quite literally you know

like linking them over there and then be they they underwrite the risk of the loan meaning that they they make some sort of prediction as to the likelihood of the borrower repaying the given loan and they cryptographically commit to that likelihood in a message so they basically say like I believe this borrower has a 0.9 you know you know 0.9 percent chance of defaulting in this loan and not repay um and crucially the reason why they are held accountable to this prediction is because if that loan is ever actually filled so if you know if somebody eventually does come around and take the

other side of the order then their prediction gets sort of like immutably recorded into the blockchain so that you could you know empirically evaluate over time you know the degree to which an underwriters predictions have been accurate now there's some caveats around this and we'll probably discuss this a little bit later but that's the basic model and so essentially the the nth end flow when you have both an underwriter and a relay er goes kind of like this so imagine I go on to you know like WWE loans calm and that like you know the operator of that website is is you know in the backend acting as an underwriter so

effectively I just went there I don't know anything about Dharma protocol I don't know anything about crypto assets I just want to take up some sort of loan I you know like fill out some sort of form that it says like I want to borrow you know a hundred thousand dollars what loans calm is I'm going to do is they're going to you know run their sort of proprietary algorithms that are going to determine like you know what my creditworthiness is they are going to then sort of like display some sort of like you know a sample sort of like term sheet right it's going to say like okay we can give you a hundred thousand dollars at a 3.14 APR interest rate at like XYZ terms and if I am on board of

this then I'm going to like consent to that and then they in the backend are going to like they're going to assign a message that like essentially is one of these debt orders that I described earlier but they're going to attach they're sort of prediction of my creditworthiness onto there so you can see that they think that I have a point nine percent chance or whatever of defaulting then they are going to go and broadcast that order on two different relays order books so that like therefore a lender can come in and look through those order books and essentially choose whether or not they want to invest in my loan and so effectively all in all you have what is

what is basically a decentralized distributed credit market with different actors who are kind of facilitating the pricing and the counterparty matching of different loan issuances this is decentralized very much on this on the site of the creditor and on the relayer the underwriter and the debtor you have to know something about them right if this can be a purely unchain reputation system that you're bidding up yeah yes I would definitely say I view kind of this first version of the system that we built as being like heavy on mechanics light on reputation right and so so we

basically built like the various kind of like the very foundational mechanics of how this sort of decentralized credit market can work but it has a very loose and weak notion of reputation and what I mean by that is that like the only sort of reputation metrics that you have on a underwriter for how good they are at predicting defaults is kind of their historical performance unfortunately for a lot of reasons that historical performance can be fairly easily gained right so I for instance as an example attack like I as an underwriter could go and generate a bunch of like fake dummy you know borrower and lender accounts and then basically simulate a bunch of loans that are all just me lending to

myself and you know perfectly predict their accuracy every single time and kind of build a false sense of reputation that were somebody to you know kind of naively trust this reputation system I could use to them like defraud them of a certain amount of money so so really the the the sort of reputation system that exists in Dharma today is is a weak reputation system it's really just kind of a some sort of empirical signal that helps you evaluate what a trust and underwriter um but you know in all of our documentation we we always kind of heavily communicate that like we communicate two things a underwriters need to be kind of trusted entities like they're not this is not a

protocol in which you should be willing to trust an underwriter on the basis of simply their you know their public key and their their history you should also want to know kind of what sort of like social capital they have like what is their actual like brand their reputation are they like a trusted company are they related sort of jurisdiction things like that and the second thing that we emphasize is that for a lot of reasons unsecured lending in in Dharma is kind of an experimental feature set right now so we really we really really strongly discourage people from from doing unsecured loans and meaningful volume right now because kind of as you pointed out the sort of reputation system that

we built into Dharma is very naive at the moment the other thing that I would emphasize or the other the last point that I'd add with respect to underwriters being trusted entities is like the way that I like to think about it is if you were to invest into something like a token sale you would never just invest into like a blind address right you would never just go onto a website that just had like nothing but an address and you know said like these are the terms of which we're raising at you're always going to evaluate that investment on the basis of a lot of social cues and signals and you know like the quality of the white paper and the quality of the team and all this other good stuff and I view underwriters

as being very similar in this regard like they are effectively facilitating some sort of investment in which you are going to need to kind of like judge on a basis of a lot of social cues how trustworthy they are and and so I I view them as basically being the the fact that it is not a trustless system doesn't mean that it's not valuable in terms of the sort of distribution that it that it baguettes if you've listened to previous episodes with Marley Grey and Matt Turner you know that Microsoft is committed to providing enterprise-grade tools and infrastructure for blockchain developers well the azure blockchain workbench is perfect for organizations building consortium networks take the etherium

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blockchain workbench and how Microsoft is advancing blockchain usability and enterprise check out AKA ems slash epicenter and start building today we'd like to thank Microsoft Azure for their support of epicenter so you mentioned before right that the main focus today is to build these like mechanics of this decentralized credit system now I would love to understand how does that compare with you know the mechanics of the normal credit system so you know in particular why you mentioned on the writer of course underwriters do exist right in the traditional world mmm is there an that analogous thing to relay errs so so like on the one hand you know are there particular things that you add that needed in the central

server that do not need it in traditional world or maybe things are you able to remove and entire parties that you can cut out yeah so I think it's important to evaluate this from from two perspectives one is the perspective of the initial issuance and then the second is is kind of the context of like secondary markets and how these instruments get traded around after they've been issued so if you think about it like the the number of hops between you know like when you put your dollar into a bank account and when it eventually gets utilized by some sort of borrower um is fairly immense like there's kind of like a an insane amount of different like intermediaries that

kind of like stand in between your dollar in and like the dollar out that gets lent out to somebody and the problem is is that a lot of these intermediaries are not necessarily operating in like a highly kind of programmatic sort of efficient manner they're you know very old world financial types and so like you know to give like a super simplified crude example here let's just say your money is kind of accruing interest in some sort of pension fund and that pension fund that then goes and buys like a CDO or collateralized debt obligation which contains like you know thousands and thousands of different

mortgages packaged up until like a fancy instrument and the administrator of that in of the of the collateralized debt obligation is taking some sort of cut on that and then one layer down from there you have like some sort of like some sort of like Bank that is actually issuing those mortgages and they're the ones who sold the mortgages to the CDO administrator that Bank is similarly in some way shape or form going to be taking a cut from the dollar that that went in there and then like a layer down you have some sort of like originator that actually went and found the the borrower and advertised to them and got them to the doorstep and that originator

similarly taking some sort of pound of flesh and you know so on and so forth and so the point is is like um you know I there there are there are intermediaries in the Dharma credit market and there are intermediaries in the traditional financial system but our kind of hope and our goal with building Dharma is that um at least in Anand Dharma of those intermediaries we'll all be kind of entirely programmatically accessible from anywhere in the world and be like they will be like highly minimized and what they can do as in like you know like the the sort of trust that you need to place in them will be will be minimized or the kind of attack

surface of what the bad things they can do can be minimized and then three will be like almost entirely transparent as in like any sort of you know anything that they may do that is fraudulent or anything that they may do that is good will be kind of auditable on chain and so so that's kind of the way that I like to think about um the what the Dharma credit market does for initial issuance in comparison to the existing financial system now there's a whole whole other topic conversation about how about how Dharma factors into secondary trading of different debt instruments but that's that's a little bit of an esoteric

rabbit hole that I think maybe maybe we can say for how the time and that's super interesting and so in principle the dama protocol is pretty bare-bones as it is so in principle the the any loan can be structured as a debt and an underrated together see fit as long as the predator actually buys it and so in principle I don't actually need to collateralize my loan at whole or maybe with my reputation so basically basically if I if I borrow money from Brian Brian will know that that we work in the same office and we will see each other many days and there will be really awkward if I don't pay back but what what collateral is he actually expect to

see first and this is kind of moving into the into the dama so you pioneer this dama lever that actually works on top of dama so right right right so yeah I mean the way that we see Dharma evolving is that we we think that the first use cases for decentralized lending that are really going to take off are those that have like the least sort of external dependencies on the real world and those at the moment happen to be kind of collateralized on chained by other crypto assets so you know they don't really rely on any notions of off chain reputation or identity and you know the reason why we think that these are the

most relevant or useful in the short term is that it's you know as we discussed earlier like the the reputation system for underwriters is fairly undeveloped it's fairly primitive in many senses so though yes in theory today you could go and take out an unsecured loan via Dharma it's it's not an extremely scalable sort of system for that right now you know it'd be really it'd be really hard for there to be like you know thousands of different underwriters that we're all doing on secure loans and it would be hard for a creditor then to be able to evaluate which ones to actually trust so with that being said our focus in the short term is instead to facilitate to essentially like evangelize Dharma's

usage as the sort of canonical credit market for for collateralized loans just to like get the actual distribution mechanism kind of embedded into the cryptocurrency ecosystem and then over time to start to layer on kind of more sophisticated notions of reputation that enable things like unsecured loans and so you ask kind of what sort of things would be used as collateral in the context of these collateralized loan and basically farm beyond the biggest category here is just other crypto tokens right so like really um you know a classic example would be like I hold a bunch of ether and I don't want to sell my ether I want to like keep holding on

to it or I don't want to incur you know some sort of tax liability or what-have-you but I want some sort of stable liquidity so what I can do is I can basically post an order on to the Dharma credit market saying I am willing to put up you know X amount of ether as collateral and get you know like some amount of USD coin or die or what-have-you lent to me against that and the value of that USD coin or die would be less than the total notional value of the collateral that I've put up and so there's this really like the the lending use cases that are enabled by this

primarily fall into the category of like like speculative like borrowing like it's basically like taking on margin positions like if you want to like lever up your position in a certain crypto asset or you want to short a certain crypto asset like this is this is a great mechanism for doing that and this is kind of what we see as being like the primary beachhead for decentralized lending today and this is this is what we are primarily focused on the moment and if you like I'm more than happy to kind of dive into lever and our efforts there ya know it would be great and of course it's pretty and some of them I mean I totally agree it makes perfect sense as a use case on some level it is quite funny that you

know in this hyper volatile space right now you can like lever up more yeah I mean I I think so um I think that's a wrong way to think about it them and and and the reason why I say that is that so first of all like yes like you know like it's kind of wild that people take on leverage in the crypto ask the crypto currency space and they do it a lot um and you know I can't necessarily say that's like you know sound investing strategy to do that and how in an extra volatile market azov but you know teach their own but I think it's also important to realize that that like margin loans can be used to to short

assets as well right so to basically like bet on them going down in value and that's really really important for kind of bringing maturity to a market because if you kind of like if you don't have kind of like short pressure on an asset um then it is more likely to be like extremely volatile whereas like if if traders have a means of actually doing things like shorting you know denta coin or what have you they will do so and that's going to pressure the price down and that's going to kind of add another price signal to the market that's going to help make things more rational and so so I I think it's a bit more nuanced than saying like you know this is like providing like you know hot dice to a like it's like gambling addicts it's

really it's more it's more about like building kind of like the the basic fixtures of a credit market or a basic pictures of a sophisticated trading market so that prices can become more rational so I talked about lever right so you can I would it be possible to kind of borrow any aquarium asset and put up any term asset as a collateral or how does it work yeah so really quickly what what is lever so lever is the first underwriter in the Dharma ecosystem that we are building and so to be clear anybody can build under

and Dharma that we don't gate that in any way but we in particular for reasons that we can discuss perhaps later when we're talking about things like business model um have chosen to to build this first underwriter and the market that this underwriter is focused on is basically like high volume margin loans for anybody in the world that has an internet connection and so I the way I like to think about what lever is is a product is is kind of like a shape shift for loans almost where you you can kind of show up on a website you say I want to borrow eath collateralized by you know dye will give that example again lever will then go out and kind of scan

through the Dharma credit market and find like the best sort of offer that fits your parameters it will then sort of display that offer to you you will then be able to go and send your crypto assets to some sort of address and then instantly receive the your principal kind of sent to you and all the sort of complexity of actually you know like filling the loan on the Dharma smart contracts and interacting with theorem nodes and all that sort of thoughts stuff is abstracted away from the end-user so you have this like very simple web 2.0 style product that wraps around the entire experience and so that's what lever is so just on labor

let's say I wanna I'm gonna want to put in some dye as collateral and borrow some ether and then just I gets held in a smart contract good yeah that's correct yeah so the collateral is like sort of trust lessly escrowed in a smart contract the only conditions on which it's like released is either if the user defaults in which case like the collateral kind of automatically gets liquidated for the principle and kind of like the the remaining principle is sent to the to the lender and the remaining collateral is sent to the borrower or in the case of a a margin call so if the

kind of if the the price of the underlying collateral drops to a certain point where the loan is no longer over collateralized then there is a sort of liquidation mechanism for making sure the lender doesn't doesn't lose their capital so so so all in all like the system is is still kind of the crypto assets are collateral to buy smart contracts and not kind of custody by some sort of arbitrary trusted third party okay so you're talking about two ways of closing the loan presumably as a borrow I can also just return the loan right right right right so yeah the third way in which you can access your collateral is just

making kind of repayment in full in which case the your entire going to collateral deposit is returned to you that would that makes complete sense and so so let me go into the liquidation process so presumably if if the value of the asset I have put up as collateral drops in value and well I affair to make interest payments and my asset gets gets liquidated so how can you take me through em how this liquidation actually happens yeah sure so basically there is a price speed that is kind of kind of periodically informing the chain of what the price of the two assets is with respect to each other and effectively

look what the smart contract is doing is it is using that price feed to keep track of what the loan-to-value ratio is of that given loan the loan-to-value ratio being essentially the ratio of the value of the principle that's been lent out to the value of the collateral that's that's underlying it and once that out like the LTV loan to value ratio crosses a certain threshold the loan becomes eligible for liquidation so what happens then is that anybody can come to that smart contract with a amount of the principle that is sufficient to repay the lender and basically purchase the collateral in the

smart contract with that principle at the current price so essentially like you know if to give a quick example if if we're if we have a zero interest rate loan that is for $100 USD and is collateralized by a hundred and fifty dollars worth of ether and for some reason we have now kind of liquidated this loan then I as a liquidator can come in and I have like $100 and I got hundred dollars in USD and I can purchase $100 worth of ether from the smart contract in USD or USD Quine or whatever and then the contract is going

to take that USD coin return it to the lender it's going to take the remaining collateral and send it back to the the borrower and the reason why I as liquidator would want to do this is is kind of twofold like either a I am the like underwriter so you know in the case of like lever you know like we are initially going to be doing a lot of this because you know we are underwriting these loans we have an interest in seeing them be kind of service correctly we have an interest in making sure that lenders aren't going to lose money etc and we're also earning a fee as an underwriter so we're being compensated for this or there's some sort of optional liquidation discount on the actual underlying collateral in which case like there is a sort of like

arbitrage opportunity here where we can go and you know use our hundred dollars to purchase you know like the hundred dollars worth of ether at some sort of discount and then immediately sell it at the real market rate so that we make some sort of Delta there and so so that's kind of the the basic liquidation mechanism because that's how it works in Meiko know that you have a discount or a basically penalty that gets paid like whoever gets liquidated so but here it's not yeah I'd say that we yeah the the system maker system is it has a lot of kind of parameters to it that are sort of optimized for creating a stable point and like really disincentive defaults to

a really big degree because it kind of like chips away the stability of the stable coin every time that happens and so so really like you know like I think maker has like a default penalty of penalty of like 13% or something like that and so like in the case of Dharma we don't have these same sorts of constraints like we don't need to we don't need to impose these sorts of like very very sort of draconian rules and so you don't see those same sorts of mechanisms used and in the context of Dharma so basically the discount that that you're given for practicing this loan does this depend on the kind of collateral that I put up because basically there there are many kinds of tokens that if you actually purchase them you're influencing price quite

heavily so basically they just don't have a good market depth right so basically if it's a large position and you go on to any decentralized exchange or often even ten choice exchanges you move the price a lot just by actually purchasing that amount of token at market price is that factored into that somehow so yeah that's an excellent excellent question so basically the liquidation discount or the fee that the underwriter earns which again they're kind of interchangeable for how you want to compensate a liquidator for coming in is absolutely like you know if so it's parameterize Abul right it's like part of the order

that that gets like broadcasted on two different relays so you can it can go from zero to infinity right and or at least in the case of liquidation discount zero at 100% and so and so yeah what you described is exactly accurate right like it's like if a big factor and that goes into deciding what that discount should be or with that C should be is the liquidity of the underlying collateral because in particular if it's if the system is based on the liquidation discount in order for you to like execute that arbitrage you have to like cross the spread twice and basically like you know like purchase the

collateral and then immediately sell it thereafter um and in particularly illiquid assets that spread can be very very wide and you can be like losing you know like to 4% or something like that just by crossing the spread and so for that reason like the yeah you are hundreds incorrect and saying that like the liquidity is a big reason why that fee is parameter eyes'll because this this is super interesting that that leads me to my next question so basically how where do you get your price feed because basically if it's in principle liquidation then can be an enormous ly profitable endeavor so basically if you get a price feed and you can somehow manipulate the price feed as a liquidator that gives you a way to game

the entire system no yeah absolutely yeah and so so initially we are going to be like running our own price feeds as a sort of trusted operator and then you know in particular like like I mentioned earlier we are the underwriter of these loans and so you know I actually think this this is an excellent example of where you have sort of like earlier I spoke about how like underwriters are meant to be kind of like trusted but like trust minimized in a sense like how you how you like you want to minimize the amount of trust assumptions you have to make about them um and so I think Dharma lever is an excellent example in this sense because lever is the underwriter of these loans that it's

originating and for the moat like for for most aspects of the loan process you don't need to trust lever the underwriter right like you don't need to trust us with respect to making sure that the loan is actually collateralized you don't need to trust us with respect to making sure that the loan it has like some sort of liquidation mechanism that's going to happen to that all of these things are managed and administered by smart contracts the only thing you need to trust lever the underwriter with respect to is is operating this price feed correctly and accurately and so and so yes there is somewhat of a trust assumption yes there's a way in which lever could defraud you but you have some sort of auditable track record where you can see well ok the price feed that they've been

using for the past you know like two years has like always been accurate within like some sort of confidence interval and so and so I view this is like an excellent example of what what I think the first underwriters and the Dharma Network are going to look like ie like trust men mised actors they're really they they have some trust assumptions baked into them but they're there like you know either trust assumptions that can easily be verified you know ex post facto or like yeah and that's that's basically the gist of what I'm trying to say so you mentioned right that basically Dharma is a trusted party to some extent in this context and so

what does a regulatory profile look like for Dharma Libre is this going to be accessible to anyone or is it gonna be restricted to you know accredited investors do you guys need some sort of license to do this yeah so I think the with respect to accessibility at the moment we are planning on having the product be accessible to both retail and accredited investors with that being said like we're not going to go kind of like full you know anonymous decks style origination right like we are going to be KY seeing customers that come in because we're going to be accepting fees and if you know if you are domiciled in

the United States and you're accepting fee revenue from pretty much anybody you like need to make sure your KY seeing them and so the system will have at least a little bit of gating in that capacity now you you you asked an interesting question about you know what sort of licenses we may need to you know get in order to operate this business in a compliant manner and the what's what's interesting is that the lever is like effectively facilitating the the liquidations and is facilitating the origination of these loans lever is a noncustodial product right like we are never like actually like touching

people's principle and you know executing actions on their behalf in any way and so it's not necessarily like a pin to say like a Lending Club as a peer to peer lending provider where Lending Club actually like stories dollars and could you know in theory if you if Lending Club went out of business you cannot have access to your dollars anymore we are more so effectively like a kind of like interface for the underlying Dharma credit market from which you are finding your your credit liquidity and so what that means and you know I can't necessarily dive into this and a super sort of like deep manner on this podcast right now but it really creates a very nuanced regulatory

analysis of like what this product role is in from from a regulatory standpoint because it's it's not very accurate to describe it as a money transmitter it's not very accurate to describe it as the money service business because there's not an actual sort of component of it that involves us touching people's money so much is like us just acting as like a nice interface that that bundles up the operations of the underlying Dharma credit market in a way that's easy for users to interact with and that's interesting so that there are regulations that actually touch these time type of marketplaces but I think maybe this is not the place in time to go into that and their cup their couple

of projects that do very similar things that have sprung up in the recent months so such as compound dy/dx and box how do you how do you see yourself in relation to them where do you think your strengths are where do you see your position in the ecosystem well I think compound in dy/dx are on the one or two that I'll dive into right now because they're they're the ones that I'm most familiar with so they both are very different in in their own respective ways so if you look at compound for instance like compound is a money market and and not a peer-to-peer lending market and so what that means is that

like any lender that puts their money into the like compound market for a given asset is guaranteed the same rate that the all the other lenders have and that rate floats over time on the basis of like supply and demand and that what's great about that is that you know what compound like in one click you can like start earning your interest right away and that's really really cool but the problem with that is that if you have an imbalance in the in the market where there are you know a lot more lenders and there are borrowers which is exactly what the the crypto market looks like right now then there's this really uncomfortable situation where in order to make sure that all the lenders are

getting the same interest rates the lenders get like a really really low interest rate like sub 1% and then individual borrowers have to get charged really high interest rates in order to compensate like all of those lenders and so again it's really just like you have a sort of trade-off here in the in the design of compound as a money market where on one hand both the lend and borrow side have instant access to what they're trying to do which is awesome but on the other hand that lends itself to having often like less attractive interest rates so Dharma on the other hand is like an order based protocol so instead of there being like um you know you as a lender butcher like money up and immediately start earning interest

for it instead you as a lender sign a debt offer and broadcast that offer you basically say I'm willing to lend as much at this rate I'm kind of like you would post an order on to an exchanges order book and then if somebody else eventually comes around and says I'll take you up on that that rate sounds great to me um then your assets start earning interest for you and so you know not all lenders in the Dharma system are guaranteed to earn some sort of interest rate it's only those whose orders get filled and so and so what that means is that um you know again going back to this sort of like trade-off analysis you don't necessarily have like at least from like the lend side a instant access to earning interest rates but because

there's like there isn't a sort of guaranteed interest rate for all parties that are in the system that means that lenders can get higher interest rates on the Dharma credit market and similarly borrowers can get lower interest rates on the Dharma credit market so it's really kind of like a trade-off space between those two those two different projects now with respect to dy DX do I is much more similar to to Dharma in this regard in that it's based on like an order protocol and and many different elements of the system are are very very similar to how we designed how we designed lever but I'd say like the biggest difference is that the

underlying smart contracts of like the of Dharma lever are just like the general Dharma credit market which is built to be like a generic credit market that can be used for things other than just margin loans and so we view that as like a sort of strategic differentiator where we can do margin loans and also you know a crypto kitties back loans and things like that and use the same sort of underlying infrastructure to have that be served by a unified credit market but with that being said you know at this point in time where everybody is using decentralized lending the only thing people are using the centralized lending for is for you know speculative loans I'd say that the projects do look

very similar interesting so um as the space matures I I assume you will move into into you move away or you will move to other projects than Dhamma lever and such as applications that are looking at that look into more illiquid assets so for instance say I want to take out a loan on my company or a mortgage on my house that are not as easily gauge abour as as the tokens that I have to put out I have to put out as collateral on Dharma level and if I they know you guys haven't actually done an IC o---- what

what's your business model going to look like and how is it going to be different for those very straightforward Dharma lever type applications and for other applications building on top of the Dharma protocol yeah so so we definitely we took an approach where we decided not to do an IC o---- during the kind of 2017 craze and in particular right now we're quite happy with that decision because it frankly we have enough sort of regulatory issues and analysis that we need to worry about in our day to day operations I think adding you know like the whole world of securities law and you know unregistered securities assurance is that - that is just another reason not to sleep at

night and so the way in which we plan on making money is kind of building out ancillary services and businesses on top of the Dahmer credit market the first one being lever right and so like lever is an underwriter in the Dharma credit market we think that it's going to bring a lot more volume to the Dharma credit market we think that's going to incentivize a lot more real Ayres to join and it's going to incentivize a lot of other underwriters to join and that's going to be great and that's going to you know continue to bring more liquidity to Dharma lever and make us more money in etc and so so really like the the short-term business model like in this immediate like year is very much focused around like lever and making sure like you know we are earning fee

revenue through lover and that fee mind you is like the underwriter fee that we're taking which is baked into the protocol but in the future I think that we want to kind of start like spinning up taking the lessons that we learned from building lever and spinning up like other types of underwriters in other sort of related industries and so you can imagine that looking like us spinning up an underwriter for lending to miners for instantly for instance or spinning up an underwriter for lending to you know various like crypto protocols that need credit liquidity like for instance like like layer to scalability protocols and that's that's

a whole subtopic of its own that I can back and cover and so there's a lot of really interesting kind of businesses that can be spun up around it but but at the moment our focus is on um you know like we've built and deployed the underlying Dharma credit market we are now building the first underwriter in that credit market it is an open market there can be many other underwriters but we you know like our goal is to kind of earn our our pound of flesh by earning fees as that underwriter you think at some point is going to be a role or a necessity to have some kind of token in the Dharma protocol yeah so that's an excellent question I think that you know we spend a ton of time thinking about like token

models and which ones do and don't make sense I think that the two categories so first of all to give the quick game so the quick answer is like maybe I don't know no like you know there's always there's there's definitely a possibility that at some point in the future it will be become clear that you know there's a gap in the protocol in xwy and that a token would help solve that gap and if we truly believe that like you know there's a good model that would add value to our ecosystem and also like capture value to some degree then we probably would pursue something like a token so what are the models that we think potentially make sense in this regard and I will heavily caveat by saying like this is highly highly

speculative like we don't have any plans of doing an IC o---- right now we don't have any plans of issuing a token or anything bad like this is just totally just the kind of hand-wavy speculation so those two models are either like governance tokens or what I would kind of define as like almost like an insurance token and I'll talk a little bit about what I mean by that in a second so so the first is you know like kind of the same but when we're talking about governance tokens in the context of a sort of public settlement infrastructure like Dharma then the best sort of analog to think of is 0 X right so CRX is the governance token of the like the 0x settlement infrastructure and it can be used or you know in theory

will be used in the future to govern upgrades to the 0x protocol now the the problem with this model is that it's it's it's unclear the degree to which it is valuable to govern upgrades to that settlement infrastructure even if it is entirely broadly adopted by like everyone in the industry because it's not clear that the switching costs between using say 0x protocol or using you know a forked version of 0x protocol are that high you give the suit the switching costs our super high then there'd be a very like compelling case to be made for why you know we need to have some sort of governance mechanism in place but if

it's just a question of like you know like setting my token permissions to like some other set of smart contracts then it's it's not entirely clear whether it's necessary for there to be kind of community governance of the actual like settlement infrastructure but again what I'd also emphasize is like you know it's very possible that I'm wrong here it's very possible that there is value to these sorts of governance tokens etc so so again all the more reason why we we have not rushed into building something like this into our protocol the second token model that I think is really interesting is what I would define it's kind of like an insurance token and this is a really crude word to describe it but the best analog that I can think of is is mmmk

are in the context of maker so mkr is is actually a governance token and also an insurance token in this regard and and what I mean by the insurance token is that like the token acts the token holders act as the sort of lender of last resort to the to the maker system so if the maker system in in basically in certain cases the MKR token will be like inflated and sold in order to facilitate some sort of action in the maker system or to like kind of compensate some people if something goes really really badly wrong and I view this as being kind of an interesting token model where basically a bunch of

people purchase like what is effectively kind of like a share in their belief that the smart contracts of this system are kind of soundly designed and that the economics of the system are soundly designed and it's almost like they are earning like some sort of premium on an insurance policy in a sense where you know in theory if the system is very very like is functioning very well the value of the token is going to go up and if the system actually ends up kind of like defaulting or breaking in some way then you know your token is going to get it to get basically inflated to zero and so I think that these are actually like very interesting token models that will probably start to see a lot a lot more frequently in the wild with maker being

probably the best proof point for it so in the context of Dharma the idea would then be that if I'm an underwriter I can opt in to use is some sort of you know almost premium insurance service by leveraging this token or or will just become like a mandatory yeah that's kind of the way I would think about it exactly it's like you'd have it sort of like opt in insurance policy that you could kind of like like be looped into again highly speculative I I really there's a lot of questions around like how would you how do you under it that risk how do you

like you know underwrite the risk of different under like how do you permission which underwriters can use that like you know things like that but I think that those sorts of models are very interesting because yeah I just think that it it's it's something that uniquely leverages the abilities of tokens to be like inflated and deflated programmatically cool well about coming to the end of our conversation but you'll be just good to hear from you a little bit what what is sort of the long-term vision you have for both Dharma and can be centralized finance in general like where these would impact

you see this having on the world in the next you know 10 years so I think what gets me really excited about decentralized finance is that effectively it really drastically lowers the barrier of entry to building and delivering financial services to people and so if you think about it like today if I want to spin up some sort of like financial services company let's say I want to spin up a lending company there's there's a lot of Hoops that I have to jump through right I have to not only get all the sort of the regulatory licensure that it requires that is required to be a lender but I have to actually go and like raise lending capital I have to go and get like a credit facility and I figure like knock on a lot of bankers doors and convince

them to lend me a bunch of money so that I can go and lend that money out myself and that's like a really bespoke and sort of like rote process um and if you look at what the internet did to most businesses that did what it did to like you know ecommerce what it did to kind of like social networks etc is it really really drastically lowered the the barrier to entry for building a business and delivering products of people all you have to do is just go and spin up a website you know have a little striped checkout flow and all of a sudden I can sell anyone in the world digital products and even deliver it directly that I'm through the internet it's a really powerful idea what I think decentralized finance is going to do is

going to extend that to the world of financial services where now all of a sudden it becomes very very easy to spin up a lending company or it comes becomes very easy to spin up like in a arbitrage hedge fund that like arbitrage is different like markets in the decentralized finance world or it'll become very easy to spin up like a internet-based kind of bank where people can earn their own sorts of where people can earn interest rates from anywhere in the world and the idea here is isn't necessarily to say about like each one of these financial services will be better than their analog counterparts so much is to say that there will just be a lot more competition like we will have so many more entrants into into the

financial services market that the sort of quality of them will go up and the prices of them will go down at the same time and so in my vision for what I think decentralized finance is going to be is is essentially a world in which the same sort of like hyper globalization that the internet did to consumer products and the sort of like massive increase in quality and decrease in price that you saw come from that when you kind of lower there's barriers to entry in the context of consumer internet products is going to happen in the context of financial services as well and so our hope with Dharma is to kind of build the canonical lending

infrastructure that slots into that broader decentralized financial vision and on top of which kind of the financial services of the future are built cool well that's vertically then yeah thanks so much for coming on adaptive is I think absolutely amazing project and great how much how quickly you progress I am I look forward to seeing what you guys have built in the years to come thanks Brian I really appreciate it thanks for having me on and thank you for Rica thank you thank you for joining us on this week's episode we release new episodes every week you can find and subscribe to the show on iTunes Spotify

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