On-Chain Derivatives & Liquidity | Tristan Frizza, Uddhav Marwaha

Transcript

I think the flagship number for U.S equities is a crypto or options trade 35x spot um I mean we have to remember that traditional equities launched in like the late 70s so we've we've had about uh 50 years uh to get to that that growth level to that multiple I think that's something that crypto or T5 specifically can do in in less than 10 years [Music] elker baby what's up we're back at five all right we've been talking to today I feel like you're setting me up for like a two-shar like intro where I like royally the two jar anyways we're talking I talked to I was talking to Julie in the office today about the episodes like I listened like with Jason

goes too sharp baby too truly messenger she's like she's like are you having a baby a child I was like oh no what she's like I was listening to velcro she's like Mike was making jokes about your impending baby and I was like oh my god well it just made my day that Julie listens to bell curve I know me too Julie at it again yeah so uh okay no we've got two really uh really interesting guest for this episode talking about options um right like fixed rates like I think the reason we wanted to do this episode is the uh we've been talking a lot about fixed rates like the 30-year fixed rate mortgage like when you go out and get that on the you go out to your bank or something and you get that like that the 30 the 30-year mortgage is not a beast

that exists in nature that is created with like uh there are variable rates and then folks use options to lock those rates in and so we wanted to do an entire uh episode just on like decentralized options and decentralized derivatives we brought on Tristan uh who's running Zeta markets which is on-chain derivatives and options and uh and then udav uh who's one of the co-founders of uh friction so uh building these like different yield strategies and options vaults basically uh built on Solana so exactly yeah so and we we kind of got into exactly you know it took us I think about we really started the interview talking about just the current state of the market for decentralized derivatives and then we kind of connect it with our overall thesis and uh don he really he got there without using even prompting or anything

so a really great episode we cover a lot of super interesting ground hope you enjoyed this enjoy see you on the other side all right everyone welcome back to another episode of bell curve this is episode what is this Mike I think five episode five and this is all about uh I don't even know freaking season one I'm already losing the episode so we got uh this episode's all about uh decentralized options decentralized derivatives uh again one of the ideas of this of this season is that uh fixed rate uh like one of the big unlocks that comes from the ability uh to borrow and lend fixed rates is could kick off this next bull market uh fixed rate uh fixed rates are not actually something that exists in traditional markets um you really have these like variable

rates and Trad five and then you use options uh and derivatives to lock those in so today we have uh udov uh the co-founder of friction Labs we have Tristan who's building Zeta markets uh on-chain derivatives and options so Tristan would have uh welcome to strogas yeah thanks for having us on maybe we could just kind of start uh from a high level in general um I think when you're talking about something like decentralized options or derivatives you almost can't get too high level so you kind of just walk us through like architecturally how is like an on-chain derivative kind of built how is it different from maybe like it's C5 equivalent and then kind of talk about the state of D5 derivatives today like how large is the market what do you kind of expect it to be yeah I can kind of uh

jump in and give some thoughts I mean we've tried to model a bunch of our stuff off how it's done traditionally uh in I guess the traditional Finance industry so we've gone initially with our first product around the kind of audiobook style model and we also offer under collateralized trading which we think is like a big unlock for a bunch of these D5 platforms I think historically you've seen fully collateralized over collateralized platforms and that's kind of stifled uh I think uh defy historically with a lot of these platforms and so I think that was a pretty big innovation there enabling a lot more Capital efficiency um and then yeah what was the second part of the question sorry just walk us through like

the state of the market today like what sort of different derivatives kind of exist what's the market size yeah good question so I think uh D5 as a whole is still 50 billion tvl roughly plus I checked maybe that was a while ago things have probably gone down since um but from I think the split of market share I think 10 was roughly dydx which is like the majority of purp stuff uh that was before I think GMX became pretty big which was more recently um so I'm not sure what the exact split is now but it usually sits around that like no more than 20 of market share is down to derivatives um and that's in pretty stark contrast so I think what you see in CFI and traditional Finance in C5 I think the numbers lost they checked in this jump

report were 57 of all traded volume on uh C5 crypto is derivatives and that's obviously very much driven by the demand for perps on a lot of these really liquid purpose exchanges FTX finance and like um and then traditional Finance I think it's more like 95 is really down to derivatives trading Futures and options just being you know the bread of bread and butter of the industry there so um that's pretty interesting in terms of yeah the the D5 stuff I would say uh most of the market yeah as I mentioned is is still kind of spot trading lending stuff like that like pretty simple Primitives we're seeing more in terms of the derivative side coming up there are some good players in the in the kind of uh decentralized uh what do you call it uh

pubs trading space so if you want Solana a few kind of on ethereum as well dydx GMX like I mentioned mango and Solana and then we're seeing I guess the early signs of some of the option stuff uh coming to light so you know obviously what we're building what what the friction guys are building as well on the kind of Vault side as well um but it still feels like pretty early days on that side hmm who are the who are you guys seeing as the primary users of these products right like who actually wants exposure to the options and derivatives markets today yeah this is an interesting question because there's probably five or six buckets of fusers um if we if we go all the way from kind of dgen crypto defy native to institutional wealth manager family office everywhere in

between the appetite obviously comes largely from the left side of the spectrum but I think a big big part of people seeking real yield is kind of the meme for this cycle uh which actually is quite true in some sense since most of the the returns coming from the Futures and options and prep spaces is actually just from the inherent Rich property of an asset whether that's the implied ball of the asset or whether it's the funding rate or whether it's an Arbitrage between uh the funding rate and a spot Market I think those are the people who are looking for more sophisticated forms of yield but also understand a bit of the risk I think as we see kind of Normie by education increase it's quite important to make sure people understand that like there are different risks you're taking with us versus farming in

a uni V3 LP or unav2 um I think traditionally the market has been really defy native something that we're working on a lot with friction institutional is kind of bringing in this wave of family offices I know worth customers and institutions who are more like custodian heavy so let's say you're a normal family office and tribe you want to onboard into D5 you need a custodians help you on-ramp partnering with custodians like fire blocks copper Anchorage make life a lot easier for these guys to get in to the to the ecosystem and then they end up knowing the fundamental principles of financing that the products that they trade in their markets and they can carry them over into D5 they just obviously need to understand how the rails are a little bit different than when they're they're

used to in the traditional world how would you outline I mean uh I don't know if you guys follow uh Z Prime at all but they wrote a great blog post a little while ago on just the state of decentralized derivatives um and there was you know something that really stood out interest and I know you did a podcast recently with Delphi where you kind of talked about this but just like the op like right now the market for C5 options while small like notionally compared to tradify and everything it largely dwarfs right it's like a I think it's like several orders of magnitude larger right now than the market size for defy uh derivatives like what do why is there such a difference in Market size there and then how do we get like what do you ultimately see as the as the Tam kind of being for

decentralized options let's just say decentralized derivatives but we can mostly refer to options here yeah yeah um so I think it's just the majority is down to I think it being a really hard problem to solve and then probably the second bit is also um where the majority of users are in terms of their experience with on-chain trading uh so on the first kind of point this is really what I think spurred us to to start Zeta we saw a lot of the platforms that were out there maybe a year and a half ago um and I don't think they were super satisfactory in the product that they were offering so I won't name any names but you know a bunch of these ethereum protocols um they were trying to do on-chain options trading it would be to put on a call spread you'd have to pay like 200

in gas fees say um and it was just really expensive uh you know they were just like massive uh you know massive spreads on their order books no liquidity it was just like completely unusable um and so we saw that as a big opportunity to kind of step in there and start providing those products the thing that kind of enabled that for us was building on Solano given that you know it had higher TPS guarantees it had order book Primitives and all these other kind of core building blocks that we needed um and so that's allowed us to actually be I think the first people to build out you know an actual viable uh on-chain options exchange and currently we are on on our kind of altcoin stuff like uh Solana options markets we're actually doing uh more liquidity uh more

size uh than derabit which is pretty cool as well as like tighter markets which I think is is pretty impressive uh still don't quite compete on the on the BTC and its side we only just launched that like a couple of weeks ago but obviously going to be working towards that um but the simply the fact that we can process a bunch of this stuff uh sub seconds so we can do Oracle updates really quickly I remember with I think Hedrick back in the day um they would basically manually plug in the IV values once a week which I don't think is super satisfactory given that options move very quickly intraday so it was pretty funny and so ours obviously is pith under the hood very quick price updates we can update all our Mark prices and kind of liquidate I think very efficiently and given the

non-linearity of options I think that's that's super important and then the second bit on I think where the D5 user base is at so it would have kind of alluded to this already but I think the majority of it is is retail kind of focused at the moment and most people are in that bucket of yield farming yield generation so people can't kind of quite haven't quite got their heads around I guess you know options trading stuff like that even even perhaps I think people are you know that they can kind of grasp that but then options you know you have theater Decay and you know time aspect of all that it just becomes a lot more complicated so you know hopefully over time we we get there but I think it's gonna require some simple simplifications in the ux and what we're kind of hoping for as well as this gets

integrated as the back end for a bunch of services and hopefully eventually at the end of the end of the day people are doing impermanent loss hedging and they don't even know they're using options I've got a I've got like two maybe different lines of uh question I'd love to get your guys opinion on which is one just like what's the proper like ecos like both of you guys are building on Solana I know but like recently there was the announcement like say which is a you know Central limit order book which is its own dab chain that's leveraging the cosmos SDK so I'd love to get your thoughts on just like general purpose blockchains supporting D5 protocols for maybe like versus app chain specific and then um Tristan you just kind of mentioned perps which has been the dominant structure for derivatives in crypto thus far so I'd love to just get

your thoughts ultimately on instruments but maybe we can start with different ecosystems right like Solana I think in terms of was kind of Leaps and Bounds uh quicker than ethereum certainly uh like a year ago like much faster much cheaper all that kind of stuff recently uh you know Cosmos has attracted dydx right and then say it's its own it's almost like a mix of a app Chain versus a general purpose blockchain it's like a general purpose blockchain with some stuff built in right that's supposed to be it's a central order book uh almost purpose blockchain so I'd love to get your thoughts on just like how where you guys see D5 building out is it going to be mostly on Solana Cosmos eth L2 like some mix of all three like what makes for a fertile environment I suppose for uh D5

yeah I couldn't jump in on the on the Chain stuff because yeah we are built on Solana primarily now but we've actually been working with the sega's for quite a while I've been talking to them for quite a bit when uh they were kind of building out the early designs for their protocol and so we're actually launching very imminently on say as well they were helping us kind of build out our protocol over there as well and um pretty big fan of their team I think they're they're great actually just met up with them in a Stanford blockchain week over in SF so you know it's good to kind of touch base and see how things were going there and definitely like pretty excited for what they're building out I think the fact that they can get the finality and block times down you know pretty low makes for a pretty

compelling case for kind of audible based blockchains and what I really like about app chains I guess is that you can tune the parameters of it and so if we're trying to build something that's very specific to high frequency derivatives that seems like a great way to go um the only thing you kind of forfeit I guess is somewhat of a level of composability which I think is is probably what is somewhat holding back Cosmos in the long term is you have to kind of Bridge assets to everything that's what Solana being this kind of uh monolithic chain I think uh probably does a little bit better on in terms of composability you have all the Primitives on the one layer it's very easy for us to compose with any other kind of financial primitive without having to worry about any kind of into blockchain communication

um but I guess there's this trade-offs everywhere there the the kind of trade-off that's been happening for Solana that you know I'm sure everyone as a D5 founder can uh share my pain with is nfts kind of clogging up the chain uh bring the chain down and having all kinds of problems and I know there's been some talks of like hey can we build a Solana L2 or a fork of Solana and just ban nfts and just keep it D5 only um so that's pretty funny um yeah I think the question is interesting because the answer is honestly just how how do you price a market fairly and why would anyone ever want to price a tighter spread on chain then off chain doesn't matter where it is um I think the idea that we get like continuous liquidity for these

complicated products on chain at tighter spreads and off chain is just fundamentally um broken right now in D5 I don't think it makes sense for a maker who comes into a defy world to price anything tighter on chain because a they need to hedge this if they're hedging it with a different product then they're probably doing that off chain as well if they're edging with the same product let's say you're having a sole option with a sole option somewhere else um both menu and any venue really for Salon options right now is Pretty Tough continuous liquidity wise I think when you think about it like blockchain versus blockchain the maker is going to ask them so the same question like how did serum get bootstrapped well there's there's five people who've gone to room and said okay we're going to quote really tight on serum spot markets and

then serums can open up to allow anyone to build perps like mango which provides some unique benefits that don't exist on other places like the uidx right you can cross margin against any asset on Mango well which is a leading purpose Texas on Solano while on dydx you can only use DC margin and I'm sure this will change with dydx chain but I think a lot of these things have been thought about when initially kind of serum was rolled out um in terms of kind of being competitive versus other just app chains um but yeah generally I think being being aware of how a maker is going to price something is is probably the thing that most D5 protocols don't do is like is is there a reason for a maker to want to price this product really tight and if so is this is this type of liquidity

providing actually the best source I mean generally we we think that rfqs or request for code models are pretty Superior form of pricing for large size non-linear products like options because you get everyone in the same place for a short period of time this is the same way the treasury is auction and large commodity Windows like the plots auction work in tradify and we've seen you you need to aggregate players in the same same time same window in order to get large size done which is a cool take I think some options or some app chains will be built with this idea too um but I think saves building some exciting stuff exciting to see uh that whole world develop what what is the incentive I I think maybe I'm not understanding something fully like what is the incentive then

for market makers to quote incred like to get these incredibly tight spreads in D5 like what what will drive that if you're saying that that that's that there is no incentive today like what will change that oh guess guess what the incentive has been historically it's been it's been token emissions right like look at the idea look at dydx look at dare a bit right derivat gives Equity Paradigm gives Equity these are all the largest traders of derivatives in the off in the C5 world and even even on-chain protocols have to give token or some form of compensation because otherwise the maker has no real reason to take on unnecessary risk right and this is I think one of the things that turned a lot of market makers into VCS early on in crypto is like oh shoot well now we suddenly have these giant bags of

early stage protocol tokens what are we going to do with them well let's try to get an agreement with them to trade their token against the purp so it opens up this weird flywheel um that I personally think is is a little bit confusing and really tough to price these incentives I mean yeah I look at all the work done on dydx incentives and um a lot of a lot of stuff going on there that I think the industry has learned from hmm do you guys have a thought on uh you know because say is really leaning to the central limit order book model uh do you guys have like what's the correct model to provide equipment right we've got amms which is super novel uh invention of crypto I think overall there are obviously some problems with that how do you guys kind of weigh the

benefits of a central limit order book versus an amm model and then how do you see that kind of breaking out into the future volumes wise yeah I think we kind of tossed up both in the early days we actually wanted to build a hybrid model and maybe maybe we will build that initially I think they kind of solve almost two different problems so I think amms are fantastic for this innovation of liquidity bootstrapping so getting yourselves zero to one um but I think then they kind of getting one to end and getting uh really deep liquidity um that is where they struggle a bit they always tend to be a price lagger and you tend to always get kind of adverse selection and picked off as the liquidity provider there um maybe that's like a bunch better in unib3 but I need to kind of obviously

look into that a bit more deeply but with the order books I guess then you're you're that's basically the gold standard for what people use in traditional Finance that's where you get the best price Discovery but the problem is someone needs to be an active liquidity provider that's obviously been probably the single biggest challenge that we've had to work with is uh paying up for market makers and getting them integrated and getting them to pretty much like 99 uptime on our exchange on D5 which is really hard actually because I think D5 is not super favorable to make us as kind of would have alluded to it's very easy for them to get picked off if the chain performance uh kind of starts to drop you know they get all these orders that are left open on the order book people kind of snipe those

and they lose a bunch of money so it's really not favorable for them it's really suited for the taker so I think those are the kind of two models there we wanted to build something eventually hopefully that kind of hybridizes the two where you can use an amm I guess to kind of bring that initial liquidity and then kind of uh have that run through the order book I think protocols like radium try to do that with with serum to kind of I'm not sure like how effective that was and then I guess the last primitive that was also mentioned were rfqs which I think also give pretty good pricing and we've seen some good examples of that out there as well hmm I think amms um have evolved a ton since the OG bouncer Union Schwab launch I

mean all they are really is is a way for Passive liquidity providers to try and generate Market maker p l and I think quickly it was figured out that passively could be providing in the long term is not plus CV um I think it was pretty challenging for people to figure that out because the incentives were what were driving participation in some of these pools I do think that tweaking the constant product marketing model and for example the stable swap invariant that curve use is is unquestionably very powerful right like look at the volumes going one curve still today um it's it's quite useful for stable stable stable pairs uh and I think it's it's really a that's probably what's most exciting to me in kind of the historical mm world I mean if you look at unib3 it's an amm but really it's an

order book right range orders just look like showing orders on multiple levels and I think we've seen um to for aims to scale they have to adopt some properties of order books such as allowing active LPS more flexibility and concentration I mean these are these are terms that you just talked to normal where I can make and they're like oh yeah I put it up I put in a limit bid or a limit offer at some level it's it's irreplicable with the univ3 position and I think people naturally realize that um would definitely contend that the newest um participant in in this world is rfqs or or just auctions as a system actually there's a really interesting article that was published by the Paradigm research guys about gradual Dutch auctions which is the auction style that we use at friction we think

that's a really effective way of pricing things that are very illiquid in the first place options are one example um I mean you can see things like super swap there's a lot of people that are going to start using this because I think assets that are tough for an individual to price continuously become a lot easier when you only have to price it three times a week five times a week or on demand when a bunch of takers show up this also helps make flow a lot less toxic and hope some of the adverse selection problems that Tristan was talking about earlier with the amounts so yeah excited to see that develop more I mean cool things like cash flow out there working on it one inch has an RFQ API I believe too so yeah we're also seeing other pretty cool models where people are building

automated trading strategies which are basically like an amm um so this is a team that integrated with us called uh selfie and they basically run grid trading strategies um this is really nice because I think retails obviously probably not at a sophistication level where they can you know become an options Market maker that's obviously pretty hard or even you know like a futures or purpose Market maker it's pretty difficult but they have a nice model you basically Chuck money into a into a vault essentially they they take that capital and then they run this or like simple automated trading strategy that provides uh liquidity to order books and I think uh last time I checked with them they were doing 80 of the kind of order flow on Mango markets and I think they were doing 70 of our futures which is pretty impressive I would say um so looking

forward to that kind of uh becoming more of a um I think that we see in D5 these days can you um can you talk a little bit in one of the one of the challenges about creating on-chain markets for options just the fragmentation of liquidity across different expiries so that's one of the reasons why the perp has just been so dominant in its model is just liquidity concentration you can kind of walk through how you think about perp versus options and like again just because you know some of the multi-coin they're I've read this some of the stuff multi-coin hotel are very very bullish on the future of the perp uh maybe some others not so much so I'd love to just get your your thoughts on that whole dynamic yeah I can start a bit on um so I mean the biggest difference as you mentioned

is just like the the expiratory nature of the option and the idea is to select like a discrete strike and then I'll get to this concept or this product called a power Perpetual which I think is like one of the most Innovative things Diva has seen in the last um year and a half which really combines the convex even option with a lack of strike and expert of a Perpetual which um yeah it's a product that we spend a bunch of time thinking about and built out on Solana and we think it's it is very young and it's very tough to to say how exciting it can get um but yeah just a high overview I mean perks have um the power because they allow someone to basically speculate on the price the difference between a price of an asset um through a a index and then that that

comes from let's say an aggregate of spot prices on a centralized exchange and a marked price which comes from an order book and I think it makes it very easy for a ton of liquidity to flow in like if you look at dydx still trucking along trading like half a billion two billion of volume a day and purpose and they they I think for for many reasons didn't want to launch options I think it was a very early design decision on their part to say we're not going to the option space because they realized that this fragmentation is is like it's kind of ridiculous even if you compare it to darabit who has like two and a half options listed really to have products listed for options um and just for makers who come in they want to see a minimum amount of size so

you have the cold bootstrap problem like you do with any exchange right and if if these places aren't going to incentivize liquidity providing and prove that there's not going to be out of perception for the maker then it's going to be tough to bootstrap much in the options World which is why the funding rate's such a powerful Innovation right like it allows the the price of the perp to converge the price the underlying asset and now now to into the the part about power perpetuals like the idea of a power perk essentially says that instead of tracking an index of the spot price you're tracking the index of the spot price squared let's say right and that gives you a really cool property that you normally don't see in in any option or in any per right it combines the two essentially so think of a normal

purpose giving you returns that can be modeled by like one plus r the power give the returns that are modeled by one plus r squared so that has this really cool R square term to it which gets you what options provide versus convexity um and then you can hedge your 2R which is your Delta which is a normal perp so you essentially create a a straddle position with a power perp and now your challenge is how you bootstraply coding for that power per because everyone looking at this instrument is like how do I price this thing and then once they understand how to price it they're like oh okay it makes sense now why should I price this like where's the edge I can get if you're only trading a couple million bucks a week on on the product um and I think that's something that

really gets me stoked about options and D5 generally is like we can create things like this that don't exist anywhere else I mean we don't have purpose much less power perks and these power perps are a very great strategy for like harvesting volume volatility yield because if you're short this power perp uh and your Delta Edge your base collecting wave us like the the volatility premium for that time in which you're selling this because the funding rate for power group's always positive as kind of alluded to earlier with that that r squared term um but yeah really really cool Innovation that combines purpose and options that we uh we see in crypto today yeah I think that was an awesome breakdown the the kind of yeah the the main three ways that I see options used these days yeah it's obviously uh leverage speculation I think that's why

it's so popular on Robin Hood and kind of In traditional Finance that's why people love to buy their Tesla calls is because that's like the easiest way to get leverage I think in the traditional space uh less so in the crypto space I think because because perps have really nailed that niche of high leverage trading um the second one that I think is like the the primary use case in institutional is obviously hedging I think that's that's really important and and that's what options are great for obviously if you want to buy puts on your you know portfolio that you might have it's basically buying uh fixed price insurance which is which is very powerful but I think as of yet with uh kind of uh where most of defies at with these kind of uh you know ape Traders

going 100x leverage on a bunch of their positions people really want to go full risk on and don't actually care about hedging too much yet um and then the last bit is this yield Generation stuff which I think the volts Market has has catered through pretty well you see yield typically coming from a lot of these uh quote-unquote kind of Ponzi products so a lot of these like own forks and stuff like that advertising you know a million percent apy people go in there 99 chance they get rugged um uh you know there's obviously some some better alternatives to that that are a bit safer but at the end of the day I think for the most part people are kind of just printing tokens and giving away free money to people and when it comes down to options I think that is where you've seen in traditional a bunch

of these Structured Products and you know like private wealth uh kind of products that that's where people actually generate their yield is by selling options and kind of scooping up the premiums there um so so that's kind of what we've seen Tristan you mentioned at the beginning of the of this episode that your guys's volumes on some of the long tail of assets uh exceeded the volume on dare bit what's it going to take for which is just remarkable by the way congrats on that um yeah that's really impressive what what's it going to take or like will will your volume on bitcoin and eth ever exceed dare a bit obviously I'm assuming you say yes so like maybe the better question is what what's it going to take and like how when do you see that happening

uh yeah good question so I I think it's definitely uh going to be tough that's obviously what we're striving for I think really where we will find our Niche is is that that altcoin stuff I think that's where uni swap obviously differentiated versus like why would I buy my tokens on FTX and binance versus UNI swap it's because you can kind of list those markets very quickly um and I think it caters to the the kind of long tail of of assets uh and I think given that there bit took a year to push out their Solana markets uh I think we can definitely spin out new markets a lot quicker so for example this eighth merge was coming up uh we pretty much only had Salon options we were able to spin up each within basically a week and now that we've done all that

infrastructure I think new markets can come up in a day um in order to get us to more liquidity I think it's basically doing what dydx has done um so I think given that we are a D5 platform the interesting bit that probably centralized players and traditional players can't do is do stuff with the token I think that's pretty powerful and that's obviously kind of the the kicker for a lot of these D5 protocols so running sort of a market maker program as well as incentivizing a bunch of kind of uh takeover liquidity I think will be really important we've seen that work really well for dydx I think they went from 40 million volume before they launched their token to about 4 billion overtaking coinbase and a bunch of the other major exchanges

which is pretty mind-blowing to be honest and obviously a lot of that was very incentivized volume I remember chatting to the wintermute guys and they showed me essentially the difference in volume after the epocket ended and it was pretty significant um and so yeah I think that's a good tool for us we also received like a grant from serum recently so we're looking to to use that as well for rewards on the take a side so I'm doing a bunch of the kind of rewards engineering side on that um so yeah I think those are some of the ways what up can I can I throw like a similar question to you which is maybe just like are there any kind of breakthroughs or like big demand sources that you're keeping your eyes on right now that you think will catalyze like the options and derivatives Market on D5

to go mainstream in the same way that like you know amms and decentralized exchanges kind of had their moment in the sun two years ago yeah I think uh there's a kind of Shadow answer here which fits with the theme of this this podcast actually which is collateralization so friction's next product line is is uh did the world of underclaughterized lending on fixed rate and fixed term uh we think this is super useful because you can now use this as collateral or you can use other positions on friction as collateral which means you unlock the capital efficiency of a bunch of products the same way you would if you were accessing a prime off chain uh traditionally the function of prime has been very tough because it's very relationship heavy and if we can bring that if we can kind of

remove the relationship part or quantify the relationship part and still build on kind of the existence of a bunch of individual products so the option selling the powerproof selling basis um and capital protection strategies we can kind of offer everything in one place once we do have this kind of fixed term fixed rate Market we're super excited for this because I think right now through the deleveraging we've seen in the first six months of the year um the the market for sophisticated lenders has changed a lot I mean look get bar rates today they're basically double where they were before I mean in pre-3 AC you you were basically only paying three and a half to five and a half percent to borrow uh fixed rate fixed term uh uncoateralized which is pretty crazy because if you go off chain like you may even see similar rates uh

which was confusing to a lot of traditional players who are getting to the market but we've seen that almost double triple uh today as the premium for um like default risk has gone up a lot and the way people are pricing these loans has gone up a lot but once you can bring in under polarization as a as like a Lego into a portfolio I think it makes it makes things a lot more interesting and it makes defy really competitive when it comes to yield I think in products like you can combine five different types of products and then the end user that sits there is like anyone who touches a prime broker in the first place because they it could be anyone from a corporate treasury a foundation a dow a family office asset manager and we're starting to see these guys come in

and say like hey we want to access D5 yield we need deep markets for these things or we need need like real sources of risk that's being taken in order to get something so yeah I think that's how uh I view a big innovation coming into D5 next is when we start getting underclass lending as a Lego into portfolios can can you um walk us through exactly just so folks are absolutely clear about because that uh that connection that you just highlighted is is super super important so like again kind of just walk us through the relationship there like let's say let's just make stuff up here and say uh let's in in the next let's say three or four years there's a bunch of demand for uh fixed rate fixed term debt right so maybe it's Dow start issuing debt um maybe it's you know whatever the

source of let's say the market grows from very very small today there is no term limit that for over a year anyway it's all like six months even if it is fixed rate so let's say it becomes like a 10 billion dollar market or something like that walk us through how that leads to growth on friction yeah so as you said I'm very aptly most of the fixed term fixed rate stuff right now is being done on a 30 to 90 day window and that's that's not very long out you can't really create a yield curve uh in D5 using that so one thing is that those maturities have to start to extend um but we're also seeing this blur between open term and fixed term I think we see in certain Market regimes certain uh like liquidity regimes that borrowers prefer open term loans but then when all

the lenders suddenly want to pull back which is what we saw when even uh winter was posting about this is a lot of lenders pull back and they as a market maker are very good and they can stay solvent but a lot of people can't which flushes out the market and kind of creates these Cycles but to go from where we are today to then when we were basically originated like two to two and a half billion in loans on chain today under collateralized which is Tiny I think we need a lot of people to come into this space and make lending very clear like the risks of lending very clear I think ux for underclaughterized Lending in D5 particularly is is really challenging today because you deal with all these like Windows of lookup and these cooldown periods and these unlocks so first thing is we've got to fix that

and make that more obvious for retail users and also traditionally um this underclass lending is permissioned on both the lender and borrower side which means that the borrowers are vetted to make sure that they can pass Financial due diligence so this puts them essentially creates them a risk score and that risk score can be used to determine what their um their kind of net bar rate should be and how that credit notice price itself but traditionally lenders have also been permissioned which means that you have to be an Institutional lender so some of the groups were talking about before say Dao's corporate treasuries even centralized lenders to access this product I think we have to become permissionless on the land side and we have to approach a world in which like

you can you can price these things and you can price duration mismatch which we shouldn't have at all I think and this one point of D5 is like you can see duration is is very clear when when you enter this loan you can see that there's someone managing that duration risk I think the concept of having what we call conductors or Underwriters of these pools who come in and use our infrastructure to basically match lenders and borrowers and match the duration and concentration risk of the Borrowers is is going to be super important and that role is something we'll see a couple of new entrants step into um on the way to 10 billion can you I'd be curious to get um your perspective here I think we've done a really good job of outlining you know some of the roadblocks for why this Market isn't bigger today and like what

needs to happen I'd love to get your thoughts on what is possible in the space of D5 derivatives that might not even be possible um in its its C5 sort of analog right udob you're kind of getting into this a little bit when you're kind of describing uh Power perps right maybe it's a structure that doesn't exist right in in the C5 world but I'd love to get your kind of thoughts because I think Structured Products um are a huge you know that's something that kind of gets built on everything that we're talking about the ability to borrow London to fix trade um uncoateralized lending you kind of get very popular Structured Products on top of that so I'd love to kind of get your guys perspective of what some of those might look like and specifically if we could lean into like what is

possible in this new design space uh that maybe isn't possible in within the world of C5 yeah I can kind of touch on that super quickly so I think where D5 currently works really well given uh I guess the performance of chains and what they cater to is it's a really fantastic settlement layer and I think much better than C5 at the moment um it's really good for that you've got the kind of transparency there uh it's pretty fast and it works really well um where it kind of struggles a bit more to keep up is on say high frequency trading obviously if you've come from an hft background you're used to like 400 nanosecond response times and people using fpgas and all this kind of crazy stuff this would obviously never be

possible in a kind of blockchain landscape given Network latency and consensus and all the other things that have gone in uh got to go into that and I think that's kind of unrealistic to expect that D5 will get to that stage where we're getting to sub millisecond confirmation and being able to trade um in that kind of fashion so I think that's why Vault specifically have done super well I think think even though some of the auction stuff is a lot lower frequency and a lot of it kind of happens off chain even like telegram auctions and that kind of stuff I think the fact that you had this uh kind of unified settlement layer for everything works really well and I think uh it's just like a much better infrastructure

than what we currently have on uh centralized do you think this uh basically the business model pioneered by high frequency Traders is that like is that a one-way linear direction for do you think it has to necessarily be like that or you know because there are kind of two schools of thoughts on high frequency Traders which is and maybe the truth is somewhere in between which is uh one maybe the most positive way you could look at it is they provide much more liquidity than has previously existed in markets and like all else being equal more liquidity is definitely a good thing then there's also kind of another way of looking at it which is these guys are basically just doing some sort of legal version of front running right or certain maybe they're extracting more than they're actually adding in terms of value right so

sometimes you hear these arguments about like why it needs to be a central limit order book because basically prioritization of high frequent you need to subsidize or give cheaper pricing to high frequency changes for for providing liquidity I'd just be curious to see if you guys does it have to be like that necessarily it's a good question I probably don't have the uh best opinion but my co-founders would because they they all worked at hft Market making firms um but it seems like that's where everything was made yeah pretty much pretty much I remember there were a lot of stories about how they would run underwater cables and run all these you know different uh kind of radio frequency Towers essentially to to slice off nanoseconds from their their timings and it seems like that was where a lot of these guys were winning was on the kind

of tech Side by just optimizing that kind of stuff and less on like directional trading and strategic stuff um I mean we are seeing similar stuff starting to pan out in D5 as well right Mev is becoming this massive business uh it's obviously massive in uh ethereum given the kind of mental there we're seeing it also on Solana assigned to become a big thing you know people will sign to do more sandwich stuff we're getting more funky stuff happening with with order books and a bunch of other things there um so I think similar things will play out in both chains and Mev seems to also drive a huge amount of the volume on I think derivative Texas at the moment especially from what I've noticed on Solana especially probably more on like the Arbitrage side I would say though

yeah I think I guess I'll take the view that hft is only exists because there is some efficient inefficiency in the market and that inefficiency can exist on a microstructure level in the order book it can exist on an infrastructure level between exchanges and and then it can exist in other worlds like regulatory worlds too so I think hft has existed and continues to do well because it just finds these natural efficiencies and as you said it provides liquidity when other people don't um yeah most of our team comes from this this world Commodities equities treasuries and I think we we've seen that without these type of actors in the system it becomes really tough I mean the whole point of amms was to replace this right so at some point like we understand that there was a needs to

have liquidity um continuously and the previously owner of that function was an hft firm um I think it's yeah I think it's quite interesting that D5 has taken a view that hft was not as important or is isn't that important I think it's going to change as we see traditional players coming to the market but your initial question of like where do you think where do you think the Innovation at the fighting is from I mean the power purpose is an interesting one academically very cool product um fundamentally implementing it has has been pretty challenging I think we don't need continuous liquidity for defy to scale necessarily right like friction as as a platform has traded to 2.8 billion in volume across options and perps uh without a single continuous or Without Really any continuous liquidity

provisioning right we use an RFQ model which people are used to they could come in they can participate in an on-chain auction and then they can kind of go about their their day and even hfd firms are some of the largest participants in the treasury's auctions let's say because they know that they're pricing these things and they can deal with that flow once the auction finishes I think we'll continue to see that that happen in D5 these guys come in and participate more yeah I would love to um maybe we can almost you know uh start to gently wind down here I guess with your thoughts of um you know the future of just how big this Market can get right like to use a very uh middle of the bell curve type analogy right like if you look at the Trad Phi analog right of let's say the

market size for derivatives versus spot right it's orders of magnitude larger right so just in U.S equities this year options volume surpassed uh spot volume but then if you add in like Futures and swaps and all sorts of other types of derivatives I mean it's like not just one order of magnitude but I'm pretty sure several orders of magnitude uh larger so I'd love to get your thoughts just on on how like big you see this Market getting for crypto um because I think thus far right like I think we we do we do have derivatives volumes like Futures that are traded on centralized exchanges like binance right like we've seen Futures flip spot uh but so far again it's just been and I know we've talked specifically about what some of the road the roadblocks are but I'd love to get your your thoughts let's

say in like the next three to five years right like let's say we do start to solve some of those challenges just how big can this Market get and how big can it get relative to maybe to spot specifically yeah it's a good question I mean I guess althesis is that it's going to go a similar Direction I think there are just so many advantages to derivatives especially on the capital efficiency side of things I think you're already seeing that on on C5 perhaps to become the dominant product um a bunch of my I guess Nomi friends who who get into crypto the first thing they trade is actually like the uh kind of hope for Bitcoin rather than Bitcoin itself which is a pretty interesting observation I think in pretty stark contrast to more like the 2017 days when it was a lot more spot trading um and

then I think I think since like bitmax obviously pioneered uh the kind of perp stuff and FTX is really focused on a lot of their derivatives trading as their kind of uh primary focus I think that has been uh pretty massive and we've seen like this massive over leveraging uh events that that's all coming through kind of purpose and a bunch of these other um kind of Highly limited products I think that's going to keep growing uh given the kind of demand there and how how much people love to to try them I think that will eventually flow into into defy um especially when we start to kind of unlock other stuff like uh under collateralized lending like I've kind of mentioned I think that will be pretty important and I think once obviously chains start to to improve and we can

start building more complex systems that will kind of flow in there as well so we think the the Market's definitely pretty massive I forgot what the the real number is in traditional Finance I don't think people even have a number for the market size but it's it's probably in the tens of if not hundreds of trillions of dollars is the kind of global derivatives Market um whether kind of crypto grows to that that remains to be seen but I think there's like massive opportunity there and I think there is definitely uh kind of orders of magnitude growth I think crypto still has as a whole orders of magnitude growth to go and then I think that the derivatives vertical within that kind of slice of the pie that we're in I think has a lot more room to grow as well without any closing thoughts

I think the flagship number for U.S equities is uh crypto or options trade 35x spot um I mean we have to remember that traditional equities launched in like the late 70s so we've we've had about uh 50 years uh to get to that that growth level to that multiple I think that's something that crypto or T5 specifically can do in in less than 10 years um and I'm pretty optimistic as as we kind of see um the big layer of equity distribution Equity options distribution comes from structure products the same way I think we'll see that in in the D5 world but we're going to see these products built a lot differently on different rails and on Rails in which people can understand all the risks they're taking behind them so I think the biggest thing is like we didn't chat too much about this as as

people find new ways of getting yield in defy that really come from just like Rich properties of an asset whether it's the option or whether it's the perp we'll see these things scale up a lot more I mean we're the largest provider of basis strategies on Solana right and this is a oi Mark the oi in this market is like 15 million we which is pretty crazy right I think that's something that we need to see grow as as you liquidity providers come in and we kind of work as data friction mango all these protocols to kind of scale how people can access D5 strategies actually I got one more question for you here because the the top thing in crypto and this is a this is a difficult question to answer right but like it's just trying to assess like product Market fit Tristan you're kind of

outlining like some of the uses for options markets in general and I think we can all uh you know kind of see everybody like yeah I mean options are used to like manage uh risk right but a lot of the times also used to speculate and I think especially in crypto if you don't allow for like the speculation use case you're really going to miss quite a bit of why things initially get adopted um so I guess like if you had to guess at like let's say these things um you know we get our our Market size by 10 billion or something in uncollateralized lending and we get to do it at fixed rates of more than just uh 30 to 90 days in advance um I I would love to I mean the growth of a decentralized derivatives Market I think is integral to that future

happening so I'd love to get your kind of sense of what do you think the initial what is initial kind of product Market fit on that side looks like if you had to kind of speculate like who is the the user ultimately yeah that's a good question I think uh popes definitely have already found product Market fit which is why given that we're trying to build out a fully fledged derivatives exchange we're going to be launching that within the next couple of weeks um we think it's just like a great product as kind of like the the gateway drug I guess for for retail to get in you know that's the the easy thing it's like you know perf goes up or down and you kind of know very easily if you're making money or not whereas with options sometimes people go like long the call and then they kind of lose on

the kind of time value of the option then they're like hey I got the direction right why did I lose money um and so stuff like that is still kind of confusing and I think it will take people time to get their heads around it I think stuff like the vaults have been great because it kind of takes a bit of the uh mental effort off in terms of picking the strategy picking the strikes doing all the kind of uh complex stuff there uh and then I think what I'm really excited for as well is we're really trying to be I guess the infrastructure layer for a lot of this derivative stuff we think like the infrastructure at the moment is still pretty poor and still pretty fragmented and I think where D5 really thrives right is uh the composability aspect and it's basically uh software as a service

uh anyone can kind of plug in and call Our Kind of on-chain apis and use it in the background um and so we're really excited for use cases like impermanent loss hedging for example is something that's definitely eventually going to be possible either through options or through Power perps I think these things have been explored other things that we're working on that I find really exciting are new ways to do liquidity mining so we're actually pioneering this with a bunch of uh protocols at the moment on Solana so instead of doing the typical pull two thing and giving away I guess uh Native token uh when you're trying to distribute it it gets insta dumped essentially as you're probably familiar with with most airdrops and token launchers so instead they're actually putting their tokens through our

platform zetaflex which basically mints a call option for their native token and then they distribute say two week locked up call options on their tokens so it gives their users a full upside but kind of reduces a bunch of the selling pressure and so we think that's a great way to kind of get this uh secondary use cases of derivatives that aren't you know flat out buying the options themselves on Market I guess I'll take the stab of what I was a vein of what I was going on earlier which the next set of distribution for defy has to come from the institutional category there's really this amazing meme in crypto where institutions are coming students are coming and and then we see Cycles um oi goes up leverage goes up they come and then oi goes down

leverage goes down uh they get rinsed right so for us a big Focus I mean we just launched an entire institutional team that's focused on this and we we're breaking it down into different segments of of the market who we see are very crypto curious but aren't really able to take that risk so a lot of the work that has to be done really is like explain to people how D5 rails work and the type of people we're talking to here are anyone who would normally be a client of a prime brokerage right so everyone from a minor to a hedge fund to a family office or anyone who wants to access lending rates right crypto lending is a world that's so siled like really the easiest way to access crypto learning right now is go to FTX and make an account and and use their marching system and lend it to

their marching system them essentially right but obviously that doesn't have fixed rate or fixed term and there's an entire like missing level of composibility that's possible on top of that with interest rate swaps and equivalent fixed versus variable rate products that we see will scale a bunch so yeah I think as we as we find these categories and we Define them more we'll see how uh how Prime businesses can kind of grow and I think under collateralized products will be a fundamental underpinning of this all right guys thanks you've been super generous with your time guys are both building super interesting things so um you know I'm sure this will be the first in in many interviews that we do but thanks for joining us yeah I appreciate it guys this is great awesome thanks for having us thanks for having

us take care guys all right buddy uh that was a that was a good episode I will say I uh let you pick up the bulk of that one I kind of backed out uh that was his new brother I was obviously I understood every single thing that they just said so I wanted to make sure that you understood things I let you asked the questions there that was obviously my strategy here I mean you know what I love that episode it's you're it's very clear that you're talking to two guys who have identified an extremely large Market opportunity that basically everyone agrees is a big Market opportunity but there are enormous technical challenges right as to why that hasn't happened yet so two you know Giga brain guys but I just have an enormous respect for for what they're doing and frankly both of

them both of them have found some initial success um yeah you know it was funny but before we started recording we're talking about Mike Green right who would have spoke of death and was talking about Mike Green and they were kind of going back and forth and was like yeah well Mike Green is the guy who in like you know February of 2018 was going long to vix when everyone was saying you should short the vix and short volatility it's like these are you don't build what they're building unless you love Market structure and you love markets right the ability to just be like oh and this month this date this time this was happening I know that actually was a big thing that everyone's shorting shorting Vol in early 2018 that was actually a big moment but like I yeah these guys just love markets they live and breathe

it and I think they had some pretty interesting takes that relate to the season so what do you think what'd you think of uh who does take kind of tying everything back I actually have to give a shout out to Mike Green who I also was one of the people that we just validated this this season's thesis with um he is he is I really like him as a person he's he is by far my favorite skeptic of crypto overall because I I find I find his skepticism highly useful actually as opposed to some of the other skepticism um before we get into I think udon made a very you know about 30 minutes into that interview he made it very enlightening he made the connection right without us even leading him to it which was this connection in between fixed rate borrow lend under

collateralized lending and the market for options which I thought was really interesting I I actually wish that if I could go back and do that interview again I would have spent a little bit more time on the central limit order book versus amm and building on an app Chain versus building on a generalized blockchain I thought it was really interesting to hear that Tristan is already speaking with the folks from say and potentially launching um on say as well I don't know if he just broke that as news or if that was public but uh I thought that was I thought that was very interesting very cool um and I know why that was interesting Mike is because I just got off an interview so we we just dropped an interview with starkware or we just recorded it um it's by the time this is out Bad

episode is probably out on Empire with Santiago and we recorded it with them and the Stark where the two star Court Founders Eli and Yuri they're basically making the argument that uniswap has only taken off because there's computational uh limitations essentially but once you unlock the computational like scale limitations for things like uniswap don't make any the amm model doesn't make any sense anymore and all of crypto moves just into a centralized uh into into into Central limit order books um and he's like either uniswap pivots or someone else will just come and run uniswap show and then these guys brought up I forgot forgot who said it that uniswap V3 it really looks kind of more like a central limit order book so that like I'm putting these pieces together

in my mind yeah uh there's a guy named Doug kolkit who who's building something called Croc swap that I think yeah that I think has really good takes on this which is you know I forget he tweeted something out which I really agree that resonated with me the other day which was you know something to the effect of maybe I it's not a totally a total dichotomy in between AMS and Central limit order books and maybe we get something new in crypto but it might feel a little bit more amm like than Central man order Bucky um and I I think there is the the need to provide continuous liquidity I also think I mean uniswap V3 cross you know any different price that's not that's not optimal from a market maker standpoint so they already have concentrated liquidity which I mean I forget if it would offer Tristan that

said this but that actually that has order book like characteristics to it so we probably it I don't think it's like one model totally ends up winning uh or the other it's probably uh maybe a little bit more of a gray area but we we probably also should I the question that I wish that I had asked when we were talking about just Cosmos in general is when you almost like vertical vertical integration of the app chain model and being able to extract value from Mev because that actually if we're talking about unit swap that's a big opportunity that they have they're still being uh you know on ethereum right all of the Mev transactions that flow through that chain that does that accrues to ethalidators not any of the you know as opposed to when dydx has its own chain that's going to flow to validators of

the do ID exchange to hold the way to monetize so yeah I kind of I wish that we had I wish that we had gotten into that but um but I mean I mean he really kind of summed everything up in the end when he connected this idea of everything that we're talking about this whole season which is the the unlock that I think we're waiting for right that the way that I would rephrase almost what he said is they in a way also are waiting around for a more traditional model right where you have uncollateralized lining and fixed rate lending because if you have a robust market for both of those things then their Market which is Structured Products right and options really takes off right so these are both interconnected markets and I think once we get it's kind of like a chicken in

the egg thing you kind of need them to to both happen at the same time but uh he he really did validate our our thesis about these things being tied together and he also sees that as a big driver for for friction again I'm a i and we knew that this was going to be a challenge heading to the season it's just calling when this stuff happens and uh yeah this one feels like one that like you know I will say it's this one feels like one that it could take a while uh Tristan Tristan did say you know that they've passed dare a bit on the options volume for the long tail of assets super impressive I didn't know that uh it reminds me a lot of uniswap passing coinbase uh for the for the volume of long tail assets right but that you still go to something like

coinbase to just buy spot on bitcoin or eth you still go to DARE a bit for the uh for Bitcoin and eighth but you go to something like Zeta for the long tail of assets but I still do think it's a very long time before uh something like this really takes off like compared to something like uh the episode with Teddy and Sid like uncollateralized or under collateralized lending like that feels like something that's coming sooner than like a huge booming uh decentralized derivatives Market I think the the very last comment from mood I've actually kind of cemented this in my head which is something that you and I've talked about various times but you know we even noticed this uh D5 has always been complicated but even you know from the beginning of defy summer to right around

where we ended remember where there's kind of like D5 2.0 and there were all these new sorts of D5 protocols I mean they all got very esoteric and very complicated to the point where at least for me I you know I trying to use some of these things I was like these are not re these retail is not the end user like it just can't be remember you remember you remember in Arizona and you were aping into those things that I was like oh my God I was like I know I know I'm getting fleeced here I know I'm gonna lose money I'm not sure how I was right because I did but uh I just think I just think they're they're wildly complicated and I think what I've said right at the end of the interview is like this this has to be an Institutional Market

eventually and the big the big roadblock for institutions getting involved is is just regulation I think so yeah you know one thing that this this season has actually said this was not the point of the Season at all but I have become I've gotten pretty red pilled on permission defy frankly as a as a as a market size I think it's coming kyc five I mean that's a good segue into our episode next week with Ben foreman right who's a huge permissioned permissioned D5 Bull and by the way like the episode next week if you guys aren't subscribed to the show already you guys should subscribe the episode next week with Ben is so so so good it really ties like everything that

we're talking about fixed rate London borrow under collateralized loans defy options permission D5 like it ties all that stuff together so kind of purify next week is very very good and we actually hinted at something as well that was going to be a source of Demand right because maybe if you just listened to this episode you could have fallen into this idea that okay there are retail and institutional Traders but especially when we start to talk about debt uncollateralized lending we also need to think about who is the borrower ultimately going to be so when we were talking about who's the customer here we were kind of talking about it from the perspective of who the trader is but keep in mind one of the ultimate sources for why options Market exists is hedging risks especially when it comes to debt so then you also need borrowers on the

other side of that and a cool maybe you know in in the future yeah like doused being issuers of debt that's something that we get into uh with the big episode as well but yeah I thought overall you know great episode I think validated the vast majority of what we were talking about but again just the the thing to watch is when all this stuff happens although again I will say just having been been to the last bear Market I mean very few people were predicting you know the imminent rise of vexes in general so all it takes is one Catalyst that's an unknown unknown right and it's always very difficult to just get on a podcast and say well it's unknown unknown and you have to account for that so maybe it'll be something but um yeah who knows this could all surprise us and it could come much much

quicker than we all think because the rise they said it right I think watching the rise of uniswap's volumes compared to remember when it flipped coinbase yeah yeah I remember that yeah yeah cool anyways good up excited for Ben next week um I just uh we'll call out we've started to get some messages uh we're starting to think about what next season looks like I've started to get some messages about sponsoring next season uh we're gonna keep that open for the next couple of weeks so if you guys want to sponsor if you are working a company that wants to sponsor next season uh you can just DM me on Twitter and we can chat about it so anyways thanks for listening guys hit the Subscribe button we'll see you next week [Music]