Is DeFi Ready For Fixed Rate Lending? | Season 1 Finale

Transcript

All right, buddy. This was a fun This was a lot of fun as a season. I think when we're recapping this last season, I think it might be good to just Why are we doing this show? What's the purpose of it? I think part of like Bell Curve is supposed to explore parts of crypto that might not otherwise get the spotlight. I think not necessarily we're just trying to be right, although obviously you and I do believe the stuff that we're we're talking about here and the thesis that we put forward, but it's more of an exploration, right? Of this one specific idea. And it's also kind of a call to to crypto to Look, you know, say you believe in something, stake it, and then say, "Hey, I was right or I was wrong." And I hopefully when you're listening to the show, it

encourages other people to say, "Hey, I was right or I was wrong." And it's That should be a part of the the discovery process, I think. And we could use a little bit more of that. I mean, there's also I don't know if you ever heard Kobe on Up Only talking about this maybe a year ago talking about the folks who end up doing well in crypto crypto or the people who find interest in something through the bear market. And I think one of the other things you want to do with this show is there are all these really interesting things that happen in the bear market, but because the prices are depressed 90% often times a lot of people lose interest. And then the next bull market happens, and you're like, "Holy where did these things come from?" You're like, "Oh, they were all built in the last 2 years." So, one

of the things that I think is interesting about Bell Curve is it should give people a look into the interesting things. And I'm it's given me a look into the interesting things that get built during the bear market. So, this I mean, this was a great season exploring exploring DeFi, but specifically some of the nuances of like fixed rate lend fixed rates, lending and borrowing, uncollateralized lend and borrow, a bunch of stuff that I honestly didn't know too much about going into the show. And yeah, I don't know. I learned a lot. Me, too. I think if I had to sum up this this season, I think this was I think it was a pretty bold ambitious thesis. And where we I think the what where I ultimately ended up coming down after talking to the guests that we did

over the course of the show. I feel very vindicated that fixed rate borrow lend 100% going to be a thing. On-chain credit markets, 100% going to be a thing. I think the timing aspect of this and all of the different markets and products that need to get built out in order for this to become a thing, that's what what we might have missed a little bit is just on the timing. And you and I were flagging that by the second or third episode, right? Like all of the different things that were going to need to happen uh in order for fixed rate borrow lend on-chain markets, that's going to need to be a while. I I also think one thing one one more thing I'll turn over to you. I thought the other thing I thought that I didn't understand quite well enough going into

the beginning of the season was the degree through which you need to be looking at this through the lens of regulation, basically. And more and more in my conversations with other founders in crypto, especially ones who are building out protocols, the specifically the US regulatory environment is driving an enormous amount of actions right now. I think Yeah. we need to look at it through that lens. I mean, even when we were thinking about setting up season 1, there were protocols and companies and founders that we wanted to invite on the show that had that they didn't get brought on because they had shut down their companies or they had pivoted because of regulation. So, I think you're spot on.

I mean, the the the thesis going into the show, let let's revisit it, right? The thesis going into the show was that basically all all lending borrowing crypto right now is variable. Uh if you look at traditional capital markets, only like 10% of lending borrowing on these variable terms, like 90% is is is on these fixed terms. Um but in crypto, that that's not how things look. The fixed rate, like if you take a 30-year mortgage, that's not like a that's not a beast uh that exists in nature. That's not a thing that exists in nature. You have to go create that through different uh mechanisms, like interest rate swaps and stuff like that.

So, we were exploring how things like fixed rate lending lending borrowing could get could get built out and specifically I think one of the core thesis was that the fit enabling fixed rates in crypto and like a booming fixed rate market would kick off this next would would kick off a debt-driven credit boom in in crypto and I think that we were right that fixed rate lending and borrow is going to be big but I don't think that we were right that it'll kick off this next bull cycle. I'm I'm curious to get your take on that. Yeah, I agree with that. I also think if you go back to even the first remember the the first part we kicked off the season with Michael and Vance not on the roundup but the first episode that we did DeFi's dead long live DeFi is we're

going to see a renaissance in on-chain infrastructure and I do think that. I think that the way the infrastructure space is going to play out over the next year year and a half you rewind to the bear cycle that you and I started Blockworks in that was that's all the birth of all these great you know, I guess you'd call them off-chain right kind of centralized capital markets type companies the fireblocks is the blockfi's of the world. I think there's going to be overall probably consolidation in that space especially on the exchange layer that feels that feels we've been talking about that forever but I think regulation is probably what's going to kick that into gear. So there's going to be consolidation especially in the exchange layer and I think probably what's going to get funded and a lot of the new infrastructure projects are going to be

on-chain type infrastructure products right to replace some of their centralized or or in some places not even replace but complement their centralized counterparts. So I think we got the catalyst right. I think that's I think that's totally correct. Then when it comes to borrow and lend one thing that at least I learned throughout the season we kind of had an idea about this going in but just the tremendous amount of things that need to happen in order order for there to be fixed rate borrow and lend right like what you need we talked about kind of midway through the season options like a deep and liquid options markets that in and of itself is just going to take a long time I think and I think one of the big question marks for me is how like the perp versus decentralized option markets are going

to play out. Right now, perp markets have decentralized perp markets have a big advantage in that they concentrate liquidity. If you're trying to make markets for options with different expiries, suddenly the way the math kind of works out is like, all right, if you've got an option on ETH, right, and you need one that ends, you know, September of this year, you know, December of this year, midway through next year, midway through next year, suddenly you're making you have to make liquid so many different markets just very challenging, especially in a bear market. So, I think that part of things is going to take a long time. And then you just need term structures on your debt. What is crap? I mean, we don't even have everything is like rolling in terms of debt. That's insane for our capital I mean, like that's just such a

wild concept. So, there are just these very basic building blocks that need to happen. I think when we talked to our guests and said, "Hey, it makes sense that most of the variable rate debt today is going to become fixed rate tomorrow." Everyone says, "Yes." But then when you start to dig into what that actually means, and the amount of on-chain infrastructure that needs to get built out, Yeah, we're a little ways I think we're a little ways away from it. So, so so here's one of my takeaways. I think that you're going to have this booming debt market in crypto, but it's going to be at the next cycle, actually. Um I think we're one cycle too early.

Because um I thought that when we went into this deep bear market, we were going to have come protocols were going to fund raise with uh we're going to fund raise with debt instead of equity, but I mean, we're a year into the bear market, we're seeing companies just raise capital equity uh raise equity at just lower valuations. Um Like we we just had Uniswap raise um at like a much lower valuation than than they would have gotten in the bull market. And I think one of the reasons that that's happening is there aren't baked out on-chain debt markets yet. Um And and the second is I don't think protocols will turn on their fee switch and they'll max I don't think they want to maximize fees in the bear, actually.

I think what's going to happen is uh most of the tier one protocols are just going to keep fees off. They're going to try to like basically gain a bunch of market share, watch the other folks who are less well funded start to dissipate, and then in the bull market, that's actually when they're going to turn on fees. Uh, and I and I don't think I don't think they go to the debt market. I don't think the debt markets end up looking super similar to how they look in traditional capital markets. I think it's a I think they end up looking kind of like what Ben Foreman was talking about where these protocols are spitting off a bunch of revenue, and then uh, the debt is coming from the smart contract, right? Where you're actually baking in uh, the payback period into the smart contract. So,

yeah, but I but I think that happens in the next bulls bull cycle is some of this stuff starts to really get like used, and then in the next bear market, that's when companies turn to the debt markets. So, what do you think about that? Yeah, I think the important dynamic that you're getting at there is that there's two ways of raising capital, right? There's equity and debt financing. Equity is more expensive, but it's variable, right? So, you or it's it's a non-cash expense. So, that makes sense for early-stage companies where there's a lot of upside, there's a lot of risk, and and most early-stage companies don't have access to a lot of capital, so it makes sense.

Debt financing is cheaper because instead of saying, "Hey, you get X percentage of ownership of the company, you get the money that you're lending me plus, you know, 5 to 10% or whatever it is." But, what you need there is you need steady predictable cash flows, and that typically doesn't occur until a company is is more mature. So, that's why that's another roadblock, I think, for for a lot of crypto companies which which aren't as mature. On the other hand, one thing that respi- surprised me probably to the upside, cuz I kind of came into it at least into the season thinking, "Oh, this is going to be kind of an out-there prediction that DAOs were going to turn to debt." I think that was actually a pretty consensus yes that that was going to be the case that eventually DAOs were going to add debt to the mix. I thought that

was going to be a kind of out there prediction, but there was pretty broad consensus about that. Um again, with just the hold up being probably two biggest hold ups being one, they don't have those steady predictable cash flows, at least a lot of them don't. Um and then two, again, looking at this through the lens of regulatory through the lens of the regulatory landscape in the US, you can kind of make the case that these tokens might not be securities. Probably going to make a very strong case that they aren't. When you raise something like debt, I don't know. I would quibble with you actually on the fact that I I don't think anything I don't think fee switches get turned on in bull markets. I think unpopular bear markets are the time for unpopular

decision-making, right? Because you're kind of like, "Well, what do I got to lose anyway?" You know, they're they're they're So, I think unpopular decisions actually get made during during bear markets. So, I I don't think I don't think the bull is when when you see a fee switch end up getting turned on. But, I I again, I I think that I think that's going to come kind of hodgepodge, and I I don't probably the decision to turn on a fee switch, start earning revenue, raising debt, that that will probably be less of a reflection of any specific market cycle and more of when the infrastructure is ready for it, I think.

Mhm. Yeah, that that's fair. What what um one one other takeaway I had was just thinking about like what the yield curve could look like in crypto. Um and this season came at a really interesting time, right? As ETH moved from proof of work to proof of stake, you get this like base yield spit Yeah, that's getting spit off from from the system. So, that's something that I I wasn't even really thinking about going into this season, but that intertwined really nicely. So, I'm curious how you think about now that this season's over, how you think about like what we were exploring and how that ties together with the move to proof of stake.

Yeah, I think that if a yield curve ends up getting built out in crypto, I wonder what ends up being the risk-free rate? Uh because the other interesting thing that happened as we were filming the season is there was an inversion, right? In TradFi and crypto yields where previously for last year, crypto yields have been maybe not for last year, but you know, during the last bull market, this whole narrative about yield being the Trojan horse is going to shepherd institutions in, drag them in because there are these juicy, you know, 20% yields all the way up to 100 crazy percent yields and there's no yield in TradFi. Well, the opposite of that is happening right now. The two-year yield at the time of recording this on October 16th like 4.5%

on the two-year for and that's basically as risk-free as you really can get. So, does a risk curve end up does a yield curve end up getting built out? Yeah, is ETH the risk-free rate? Part of me wants to say yes because that would just work so beautifully, a crypto-native yield curve. But the other part of me that was like if I actually put on my like if I was managing money hat, no. I think the two-year is still yield and I think what the like the the 10-year two-year like US Treasuries still set the risk-free rate. So, probably what you'll see more of there is is crypto finding ways to import TradFi yields. You're seeing that with MakerDAO

and other large protocols right now. But I do think but I do think one thing that we in the future what I could see is ETH being a risk-free rate and I do think that yield products are going to get built out around that, 100%. It seems like a no-brainer to me. Yeah. Yeah. Oh, you're seeing that blow up right now with Bitcoin mining. What is that's kind of what that is too. It's like, "Hey, uh proof of work, right? There's going to be Bitcoin that you are earning, let me pull forward some of those earnings." Like so, here yeah, here's some cheap credit for you to buy miners. Oh, you can you can mess that up as it turns out. Yeah.

You you out over your skis. Uh so, yeah, does that principle still hold with first takers and validators? Like, hey, you're going to earn this ETH out into the future, right? Like, now with MEV boost as well. That's like another opportunity to generate yield. So, yeah, am I going to get some future revenues and should I be able to pull that forward with credit products? Probably. How do you underwrite that, though? That's the question. Um so, Yeah. Yeah, I think it's going to happen, though, for sure. I'm sitting here in London. I have 1% battery on my computer and I cannot get this damn converter to work. So, I don't want to uh cut this off too early, but should we talk about season 2? Should we talk about what's coming next for the show?

Yeah, I've got one more I've got one more um thing that I want to uh do it. Hopefully, your computer holds. Basically, I think what we're going to see over the coming years is a period of experimentation in crypto. So, if you want to look at, you know, this is two Tsarouchis' observation that we've seen innovation in new token distribution mechanisms. And another way of saying that is equity financing. It was ICOs in 2017, then it was IEOs, kind of Binance launch pad, then it was yield farming, then it was NFTs. Basically, it was getting equity-like interest token interest in the hands of user/investors, right? Um and that's been a great form of financing for these crypto projects.

In over the coming years, I think we're going to start to ex- see experimentations in on-chain credit markets, debt markets. And that's probably going to come uh you know, there'll be two catalysts for that, which is maybe three. One, more in the form of on-chain activity, so check, we're we're already getting that. Two, you need borrowers that have predictable cash flows, so you need more mature borrowers in the form of DAOs. And then you need a way to speculate on it. And and that actually probably like is that is pretty easy to do, right? Almost all leveraged speculation that happens in traditional financial markets happens in debt markets and derivative markets.

So, I think we'll get that in crypto, but you know, we need and and along with that we'll get a whole bunch of different experimentation of of different things, right? Clearly, you could hear right from from this season that we think we're going to collateralize debt offerings with tokens. I I think there I think that's a really interesting experimentation. I also think there's probably a good cause for worry there. But I I think whatever happens there's there's going to be a whole bunch of new experimentation. I I think the worry is fine, by the way. Like I think um I think how most things end up getting built not just in crypto, but in history is these basically bubble cycles. And the bubble drives a lot of capital, the capital drives a lot of human talent, human talent builds cool things. Get

into a big bull bull market or bubble, whatever you want to call it, things collapse, but the innovations some 10% of that innovation carries through into the future. And so, we saw this with All right, like there's no arguing that ICOs weren't this like ridiculous bubble that capped out with a protocol raising $4 billion, but there are things from the ICO bull market of 2017 that have carried through to today, right? NFTs hit this huge bubble, but there are things from NFTs that are carrying through. And I think we'll see that with debt, right? Like token collateralizing things with tokens.

Probably not a great idea, like collateralizing things with very early stage tokens. There's something that will get formed there. It will probably lead to some bubble, but it but some part of that will carry through, you know. Yeah. So, now I think one of the the interesting things that you get from this by the way. For sure. Yeah. What What I think what you get from those bubbles is things that in the innovation will produce things that could happen in crypto that could never happen somewhere else, right? And we talked about a couple of those very specific examples this season. So, instead of right, the dynamic where let's say you and I went out, got some debt, and we used to fund you know, conferences, you know, new personnel, uh marketing, whatever that was. And then we're supposed to use that money

for those things and then pay a return. Instead, what you could do is basically say, you know, hey, this money only could be used to fund those things. And if you're a protocol, then it it's you get even more transparency on it because you could say, hey, I'm getting X amount of revenue. I will pay you back in some sort of royalty structure until you get all your principal back plus, you know, 10% a year or whatever you agree on. And you know, now that I'm saying this out loud, I I do wonder if a there is a connection in between the end of yield farming and turning on these fee switches and that debt structure. So, let me let me paint a picture for you here, right? Right now, companies build market share by basically giving away tokens, right? Yield

farming. We know we know that that's on its way out, right? Founders don't like that. They create sell pressure. They're giving away it's very very costly way of doing customer acquisition, etc. And people been afraid to turn on the fee switch. Now, what if what if there was some kind of proposal that said something to the effect of in the Uniswap, right, where they haven't turned the fee switch on? Hey guys, we um we don't want to give out I know they don't really do this anyway, but what like token rewards, right? We don't we we want to find a way to incentivize or or fund our our you know, the protocol here without necessarily giving out more rewards. And again, Uniswap's a bad example, whatever.

Uh you know, we we'd like to do that with debt. And and how the way we're going to do that so that it doesn't impact you guys or the treasury is we're going to turn the fee switch on and the fee switch, you know, half of the fee switch is going to be go go towards paying down this debt. You see what I'm saying? You see how those two ideas are sort of connected, actually. I wonder if, you know, turning on fee switches and actually accruing fees and revenue, you know, gets there's a connection there, obviously, in between debt as well. That's what I'm trying to say. Yeah, that's interesting. I That's a really interesting take. It was so interesting doing this episode doing this season while all this other uh bigger like crypto macro stuff was happening like uh moving to proof of stake. You've got this base rate um

uh what yeah what you were just talking about with like um uh talking like Uniswap and the fee switch like all these other bigger conversations around around just like revenue coming from protocols. I I I feel like it's all starting to tie together. And I think that's what usually happens in the bear markets. Bear markets are times for unpopular decisions. I think nobody There's there's a negative set of incentives or the game theory of doing something unpopular when you're growing your protocol and you might be gaining market share. Maybe you're just growing your protocol much faster than you ever thought possible. The risk reward in the mind of a founder is pretty unbalanced, right? Why would I give up all of this this growth that's happening on a week-over-week, month-over-month basis for something that I can probably do

later. Well, when everything's sort of crashed down around your ears, say, "Well, the worst has already kind of happened. I might as well rip the band-aid off, do this thing that I knew that that I should have been doing for a long time and and start actually earning revenue and accruing fees." And you know, I it's it's tough because this is the natural life cycle of companies in general. It's the Silicon Valley playbook in general, which is you subsidize your product for your early customers. You get that product market fit. What you try to do, right, the unsaid things you try to create a monopoly and then you can then you have pricing power, then you can raise and start generating cash hand over fist.

The the question is and this is where it's kind of an art and a science. It kind of just depends on what your investors' expectations are, but you you need to start earning at some point. And the question I think many are starting to ask in crypto is when do we feel it's appropriate for companies in crypto to start doing that. And the answer is it probably depends on each each different protocol. Yeah. Now that we're sitting here, so we've had these like seven great episodes and bunch of great interviews and explored these debt markets. When do you think that the debt markets I'm I'm trying to even put like what is the number that what what like what are you looking at to say like, "Okay, the debt markets in crypto have arrived."

You you would want right, the the rough analog is the amount of outstanding debt, right? Sovereign and in corporate debt plus, you know, compared to equity markets are like roughly the same as more the the debt markets are larger than the equity markets. I I mean, we're talking about this so early. It's very hard for me to get a line of sight into when that happens, but it makes sense to me that probably roughly that's where we end up, right? Equity and debt markets being around the same size. I think when you look at probably DAOs having a decent mix of you know, debt-funded capital, right?

Like that I maybe maybe maybe 25% DAO, if you're a DAO, why do you why why do you think again, now that we've had all these conversations, why do you think that they would tap the debt markets? Because it's cheaper capital. Yeah. Cheaper. Yeah, more way to relax. Yeah. Just feels like you we're we're deep into the bear market and people aren't even explo- Yeah, I Yeah. Yeah. I think when this gets big is the next bear market is the next bear market. Bear I I think it has less to do with like bear versus bull market versus just when the capital is available.

in bull markets. Right. Um Well, well, no. Equity equity's I mean, equity's pretty expensive during during bull markets. Actually, like that's I mean, that's a your equity's valued Your equity's valued higher. Right. So, yeah. I mean, I I I guess in the that point. Yeah, that's when you that's when you want to sell your equity. Yeah. Yeah. Yeah. Um I I I again, I think it It has less to do with that and more just when there were deep liquid markets that you can tap, right? I mean, like for example, Coinbase, which is one of the only companies in crypto that had access to public debt markets. I mean, they took out a 1.5 billion-dollar

uh you know, they issued a billion and a half dollars worth of debt right before the before the end of this bull market. And that was just to prepare. So, prepare for the bear. So, I don't know. I think it has less to do with there's probably some of that like playing around different timing, but I think mostly the the prohibitor is just infrastructure, uh the the infrastructure whether or not it's ready and just uh enough doubts having enough mature predictable cash flows. We just don't have any yet. I think. So. Um but ultimately, you know, what you can see is I think the the building block, the Lego building block nature of DeFi it lends itself extremely well to to debt markets. And a lot of what I think

DeFi does at the end of the day by eliminating intermediaries and all this excess kind of built-up cost is makes things more transparent, makes things more capital efficient. That like lives off capital efficiency. It's a it's an enormous part of it. So, yeah, I think I think ultimately, DeFi is very well positioned to create these sorts of markets, but but uh the the question is just when and what's ultimately going to be the the catalyst. Who knows? It's often weird things. I was on a call, you know, we've got DAS London coming up uh this week. And this guy said to me I kind of knew at the time, but I'd forgotten. He's like, "2019 would save the bear market was uh was Facebook saying that they were going to build a lot of stablecoins." Like, where you know, that that feels obvious

in hindsight. You're looking at it like, "Yeah, but no one had that on their 2019 bingo card." You know, no one's like, "Yeah, the biggest social network in the world is going to say we're going to launch a stablecoin." So, a lot of times, you know, we can speculate on these things, but it'll probably be something out of left field that we're not even talking about. Similar to when I mean, no another thing no one had on the bingo card was like sovereigns and countries and corporates buying Bitcoin, which in hindsight it looks like it wasn't maybe the best idea, but that did fuel a map like that did fuel put put some juice behind the bull market, you know?

Here Here was another thing that was interesting that came out during this filming with Adam 2.0, right? So, Adam 2.0, one of the the interesting things so I I don't want to go map all this out yet, but they basically they were they're finding a way to they they want to create value, a value accrual mechanism on the Atom token, right? So, they've got Tendermint, Cosmos SDK, and IBC is kind of the base layer things. They've got um I it they but they kind of improved on this interchain security, right? So, they actually kind of rolled out some of the specifics there. Then they've got a um a market for MEV, I forget what the actual name for that is, and then they've got this allocator, this this uh this allocator kind of mechanism. That's like a hazy weird gray

area, but a lot of what it is is you know, you can do these weird sort of bonding exchanges, right? Between the Atom token and tokens that are built on the within the Atom ecosystem. That looks a lot like it looks something like debt financing, actually, in a weird way. So, un- unsure of what that's ultimately going to be, but that is definitely related to our our thesis as well. So, I think I mean, the Atom ecosystem in general is is definitely something to watch. Yeah. So, what do you think? Do you want to talk about next season or do you want to keep folks waiting?

I think next season's really good. Uh we we are we are very very close to finalizing what it is that we're talking about, but I think it's going to be near and dear to a lot of folks' hearts that have listened to the season 1. We're going to keep you guessing. I will say we've got some great guests coming on, so maybe this can hint at the the themes of the season, but we've got uh some of the folks from Reverie coming on, we've got Hasu coming on, we've got Chris on from 1 Ventures coming on as some of the early guests. So, really really strong lineup but you're going to have to wait for 2 weeks to hear what the thesis is. Yeah. So, here's the schedule folks. This is you're probably listening to us this the week of the 18th. Next week we're taking the week off.

A week off in between seasons. We're going to have a round up per usual with Vance and Michael from Framework. And then the week after the first week of November we're going live with season 2. That'll be a kickoff episode with Mike and me exploring the thesis for season 2. And then we'll the week after we'll get into it with our first guest guest episode. So, yeah we're really excited to roll this out. If you guys have liked the show, do us a favor if you could just hit the five stars, subscribe. I I got to be the hype man for the show. One of us has got to do it, you know. So, we got to get those five stars in there. Rate, review, punch that subscribe button.

punch that subscribe. Yes. Let's do it. Let's do it seriously. I vote you. We'll see for We'll see you for season 2. Yeah. Thanks for listening to season 1 guys. See you on the other side.