DeFi's Interest Rate Opportunity | Simon Jones

Transcript

is London Clearinghouse it's an entity in London is responsible for about 90 of the world's interest rate swap clearing they have to employ thousands of people to maintain that exchange right and kind of it still is extremely opaque and it's regulated the hell out of in order to make sure that it kind of works as it should do for society but why does that need to exist I don't think it does like I think the entire thing can be replaced with smart contracts all right everyone welcome back to another episode of Empire uh we are joined today not by Santi but my uh my trusted co-founder Mr Mike ippolito and we are very lucky to be joined by Simon uh Simon Jones CEO and co-founder of uh volts protocol Simon welcome to the Showman hey nice to be here yeah yeah great to have you here so for folks who

don't know volts volts is uh an amm for interest rate swaps we had Simon on another blockworks podcast called bell curve really highly uh listened to and just enjoyed episode talking about like interest rate swaps episode uh what Simon is building at volts is kind of sitting at the intersection of really how do we build this like large uh and transformative uh fixed income uh uh ecosystem in defy and um we want to bring Simon back on the podcast because volts just published this really interesting research paper exploring the relationship between Trad fire rates and defy rates which is a really interesting topic that Mike and I talk about uh and Santi and I talk about all the time right if you think about the bull market

a lot of folks got pulled into D5 because these super high rates right like people there's the meme you know what what what interest rate you get in your bank account it's like 0.001 and then like on Ave you can get like 10 or something that Meme has kind of gone away as rates are actually lower in defy now than they are in tradfy um on on the lending side so anyways we just want to bring Simon on to explore that paper um and explore really this idea of how do you build this colossal uh fixed income ecosystem in in D5 so Simon I think my first question for you is can you just explain like the why behind why you guys put in so much work on this paper and and what really what you're looking to get out of it yeah say I mean

I guess it's pretty helpful just take a massive step back like why why does vault's labs as a team even exist um and I guess they're the most macro level kind of what we really hold as our North Star is that we want to try and help um D5 become the financial system for the whole of the world and frankly in doing so completely change at the way in which kind of society works all around the world and ultimately changed the lives of billions of people um which holding that as our North Star like 12 months ago we kind of spotted a very clear problem that needed to be solved um which is actually something which I think we talked about in kind of previous podcast around um the fact that the ecosystem like the byproduct of the technology is that it

only produces uh variable rates of return um and not only were those rates of return at variable they're also at times extremely volatile which if we want D5 to become adopted by the whole world like clearly that's a problem that needed to be solved and the solution to that really is a kind of an interest rate swap Market um which for anyone that's not familiar with it it kind of sounds small and then you look at traditional finance and it's the biggest Market in the whole of traditional Finance uh in fact it's cartoonishly large um there's a quadrillion of notional traded each year in Trad Phi interest rate swaps because it is such an important kind of part of a financial system

and from our perspective we kind of launched the protocol uh kind of or the community actually deployed the protocol first of June this year and trading volume on the protocol has been growing about 25 week on week so there's kind of clearly kind of need for this type of instrument in D5 which is pretty exciting um but clearly as a team who are kind of spending all our time looking at raids one of the other things uh which Jason you just touched on which is so Stark like like just kind of Stark really is that 12 months ago interest rates in defy used to be kind of high yield high cost borrowing and in Trad fire it was kind of the reverse it was that kind of low yield but also low cost of borrowing

to the point that actually in Europe um you had negative rates so you got paid to borrow which is insane and then if we kind of fast forward 12 months is completely the opposite um where D5 yields have come down D5 borrowing costs have come down uh but Chad fire rates have gone up uh both cost and borrowing but also now the yield you get in your bank account is actually better than you can get in D5 so so we found that just kind of theoretically interesting um and we kind of wanted to understand why like why is there this Behavior where these two different rate markets behave in such a different way and that's basically the purpose of the analysis is we're exploring that we're exploring the relationship between the

two we're then actually more importantly in the second part of the report we started going into right yes okay D5 yield has come down but that also means that the cost of borrowing has come down and what does that mean from an opportunity perspective for D5 rather than viewing this as some sort of negative because like you said the yield you know we used to have this meme where the yield in D5 was so much better than the EOD Chad fi right obviously that's changed but what are the opportunities that come off the back of it um can we start with the like there's a lot to unpack there can we start with maybe like the very tip of the iceberg so to speak and can you tell us what you sort of found when you were trying to suss out what is the relationship in

between these two different rate regimes like the Trad fire rate regime versus what's going on in crypto yeah so I think there's kind of two major points that really came out of the analysis I think the first which is kind of somewhat obvious but actually um only feels so obvious once you've done the work is that the two different rate regimes are anti-correlated so as one goes up the other goes down um and you kind of feel that that you kind of sense it all you've got to do is look at the yields in D5 as a child find you can kind of tell that's the case but actually when we did the analysis we didn't expect the relationship to be as strong as it was um so it kind of as the first point we found that kind of pretty interesting but then the second point which I think

is by far the more interesting point out of those two is when we're exploring like why is it anti-correlated our initial thought was that is at tradfy rates went up that would bring defy rates down but actually D5 rates come down before tread fire rates even start moving so before the Central Bank start putting the rates up the default rates are coming down so so we started trying to explore what we thought the driver of that was and the kind of hypothesis that we have which we're kind of explore in the report is that it's inflation and and this is the kind of where the second Point gets really interesting because we then started looking at like the time lag between inflation data

being announced versus rates moving and in defy the rates came down on average 12 Days After inflation data was announced whereas in tradfy the central banks changed their rates around 100 days after the inflation data was announced so it took them almost three months so and the reason I find this so interesting is obviously kind of we all recognize the benefits of defy in terms of building a Global Financial system in terms of removing intermediaries and inefficiencies and all this type of stuff which is extremely important but actually what we've seen in this analysis is it is also as a mechanism uh

kind of kind of programmatic market-driven Protocols are a lot more efficient at converting Market data and changes in Market data into those markets than centralized entities that are run by human beings right and that and actually the difference there is almost 10x right 12 days versus 100 days so if you think about if you really zoom out kind of I think pretty much every Central Bank around the world is criticized for how slow they respond that work how slow they responded to changes in inflation and if they had responded faster who knows where all the economies in the world would be right now we might not

even be in recession right so it sense and kind of if you kind of go into that even further central banks has anything actually changed at a central bank for the past like 50 years have they ever changed the way in which they make their decisions I'm not sure that they have um and I'm not necessarily saying a central bank is going to be displaced by a decentralized protocol at least in the short term I don't think central bank's going to give up monetary policy uh kind of control over monetary policy but but at least we now have like really clear data that shows kind of uh centralized entities using humans as those decision makers are kind of way slower than kind of market-driven protocols and what

could that mean right if we were to kind of adopt this type of mechanism right for that type of decision making process like could it mean that actually um that data was kind of absorbed a lot quicker such that the rate raising change faster and potentially maybe global economy wouldn't even be in recession Simon I have a kind of 101 level markets question here for you so you were talking about how the Central Bank in traditional Capital markets the Central Bank changes the interest rate and it took them 100 days and in D5 it only took 12 days this is my 101 level question what what changes the interest rates in defy Market forces so so we we and specifically what we're

looking at is we're looking at borrowing costs costs on uh stable coins on avian compound um so as people stop borrowing more which so basically your borrowing cost is driven off the utilization of the pool so if there's loads of supply and loads of borrowing if that's ultimately only 10 of the total Supply the cost for everybody who's borrowing is going to be low but if you end up at kind of close to 100 which actually we saw in the build up to the merge um those borrowing costs are going to shoot up massively based on the kind of interest rate model that exists on avian compound so it's ultimately like the utilization is basically representative of um like supply and demand Dynamics right

so if if um the supply and demand changes then the cost of borrowing is going to change and that's what we saw kind of in that data I I'd be curious Simon like how do you like let's go back to this uh in this negative correlation that you found and I I sort of understand it at a high level right that the fallibility right of how interest rates are set in traditional markets at least at the short end of the curve is it's all based on central banks right which is just small collections of people that are very opaque and don't have very much accountability can you walk me through what is the transmission mechanism here like how actually do how actually did defy respond more quickly to changes in inflation than the central banks were

able to do foreign it's not I mean it's ultimately it's not clear entirely what the relationship between inflation going up and default rates going down is so you can it can only kind of build hypotheses right and I guess there's there's one perhaps which is that um uh you know there's a lot of retail activity in defy um uh is inflation actually started growing up people had less disposable income um there was less Capital therefore to come into the ecosystem um so therefore there's less perhaps Supply there's less demand for borrowing

that all starts to suppress a lot faster than in a non-market-driven environment um that I guess is one hypothesis um with a central bank the way that that works is um they collect loads of data I do know honestly there's a part of me that doesn't even know because it's so fake as well but they collect they collect load of data um uh kind of with regular Cadence they have monetary policy committees um where they discuss that data and they make a decision on what the kind of Base rate should be um and the time lag from kind of inflation changing versus those decisions are being made is way longer versus kind of obviously what we observe

to defy where you immediately start seeing the market forces kind of play out in the rate data of the ecosystem why does this matter Simon like why does it matter that it takes 10 times longer to change interest rates well I think it's the economy ultimately like if if just if you can really zoom out um uh uh imagine if central banks had responded 10 times faster like honestly there's a there's a reasonable argument to say that we wouldn't the global economy wouldn't be in recession and and what does that mean it means that um we've got like the technology improves over time and and I kind of find it

I find the opposite I mean obviously the opportunity of D5 is um transformational but there's also an opportunity for some of these old Legacy structures if they don't get displaced then they can evolve too so why do they not look at more efficient ways of um making these decisions and and kind of kind of adopting technology right um because I don't think a central bank has changed for the past 50 years yeah I have a I have a the way that I was sort of thinking about this I mean I'd love to get your your sort of thoughts here before I read the the paper that you guys published was the reason why there might be this sort of anti-correlation is if crypto is in like one way to think about monetary policy and economic

Cycles the way you read in your textbook right which is the what the FED raises interest rates and that impacts the cost of borrowing and then fewer projects get funded and then that slows growth that way but you could sort of make an argument this weird like Keynesian economic uh experiment that we're running here that largely the way actually monetary policy gets transmitted is when you raise interest rates it has an impact on the price of financial assets and financial assets go up or down based on interest rate sensitivity and then that actually ends up dictating economic policies this weird backwards way of transmitting monetary policy and that that was kind of how I was thinking about what happened in crypto right we raised interest rates or even before we raised interest rates that had

signaled that they were going to raise interest rates their forward guidance which is kind of more important than the actual raising of the interest rates the market believed them and then and then one by one we've seen risk assets collapse and crypto is kind of at the very tip of the the frontier of risk assets and as crypto prices collapsed then all of these opportunities for generating yields right that there was that the basis trade right which is collapsing that spread in between forwards and spot uh our futures in spot then there was like the grayscale Arbitrage which like is now pretty infamously exploded in the wrong in the wrong direction so that was the way I was kind of thinking about it is that does that kind of fit into your theory is that you know maybe you don't think that's the way that it the the

transmission would actually occur I think so right but I think that what we saw is that defy responded faster than that I mean that's kind of what we expected to see we expected to see Trad fire rates go up or at least expectations of Chad Harris go up right and then defy rates to come down off the back of it um but actually the what the hypothesis is is that inflation was the cause and uh actually as inflation started to change people stopped kind of spending money on crypto assets right so the prices got suppressed a lot quicker than the kind of the FED even had begun to react in terms of expectation setting right and that meant that the rate

regime came down so the whole ecosystem actually responded um uh well like around 10 times faster than the FED um and that's that I think that was the most interesting because before we did the analysis I I completely agree with you that's the that's exactly the way in which um we expected it to play out like fed uh kind of uh kind of raises rates or kind of raise expectations of a rate rise change um and then at the most macro level that has an impact on the kind of proportional Capital that's being allocated to higher risk assets of which crypto has won and therefore D5 gets affected but that's not what happened it was we think it was inflation first D5 came down and then the FED reacted

um so walk us through what the implications of this are right like if you look at a little while ago there's basically no concept of risk-free rate in in traffic right they brought fed funds down to zero percent during March of 2020. now that's not the case right and the terminal rate is over five percent as of this week's fomc and even like the two years I don't know off the top of my head but around three and a half or so percent so uh and at the same time you're seeing almost like negative those negative borrowing costs that we were talking about with European sovereign debt we're now seeing in in crypto so what are kind of the implications of switching that Dynamic on its head yeah and this is kind of um what we

started to explore just just as more of a thought process more than anything in the in the second part of the report and it because I think um clearly as defy yields has come down there's been a lot of defy projects to have been kind of destroyed as a result like that that the business model kind of fall under the phras was designed around like the fact that yield is higher in D5 than it was in traditional Finance so I guess there's some bearish sentiment around the fact that that flipped um and actually what we wanted to kind of talk about in the report is well like flip that on its head what's the opportunity right instead of being bearish what's the opportunity now that these have changed um and one of the things that we think

at least exists in the short term is at the opportunity to use d5s and low cost to borrow or source of low cost to borrowing um which can obviously exist across various different uh kind of products the one which we talk about just because I think it's I could the most interesting is a fixed rate mortgages and and the reason that we kind of bring this up in the report is um there's something really interesting that happened a couple of months ago where somebody bought an nft on openc where the nft represented ownership over a physical house so they effectively brought board a property by buying the nft and why I

find that so interesting is that um I kind of I haven't got into all the details of the legal structure that exist around it but but what we have in principle facilitators is we have facilitated the purchase of a property on chain so that the next step is to finance Finance purchasing property on chain and what we kind of lay out is again it's just thought provoking more than anything is is like what are the steps to enable that well the if the NFTA represents the kind of physical property then the nft clearly has intrinsic value right so if you can use that as a collateral on a money market protocol such as Ave for example right then in

theory you could borrow against it um and if you do that then effectively you have financed the purchase of the property on chain is someone going to do that at a variable rate I I don't know I think that's pretty risky because you don't want to get liquidated on your house purchase so clearly what we talk about within it is you you'd want to compose that with an interest rate swap so you're borrowing a fixed rate at which point you effectively have a fixed rate mortgages on chain which is pretty cool and and why is that why is that so exciting well with the difference in the rate regimes you could borrow at a fixed rate of two percent versus borrowing a fixed rate of say six percent in traditional Finance

at the moment so you're getting a 3X Improvement on your cost of borrowing by doing it through D5 versus doing it through track 5. I'm not saying it's about to happen like I I honestly I think it's possible for it to about to happen but if it's ever going to happen it's going to happen now and I think it's pretty exciting as a thought process um uh can we talk about the inverse of that as an opportunity as well and the opportunity for D5 protocols to import yields from tradify so we were talking about this a little bit on you know you you just mentioned that most D5 protocols had built their business model around having higher yields in crypto Jason we covered this quite a bit but we also talked about a lot off air uh we watched maker basically divert some of the usdc in their Peg stability

mechanism into coinbase and start earning some of the yield that Center which is the Consortium between coinbase and circle or earning right and suddenly that's a non-trivial stream of income that makers generating for itself and they're just taking some of the assets that they have Dollar assets right usdc and earning some of the yield that's in traffic it's a pretty significant stream of income so do you what opportunity if any do you see sort of in reversing the business model yeah this I think there's definitely opportunity there I think one of the things that we talked about is if you were to have um trying to find rate markets like sofa rate markets or Sony rate markets if anyone's not familiar with Sonia if you've probably

potentially heard of Libor markets like kind of Sonia is replacing Libor um uh if you were to have them accessible in the same exchange there's defy rate markets then actually in the short term while that opens up is it opens up a huge amount of Arbitrage opportunity based on the fact that those rate regimes exhibit anti-correlating Behavior um So for anybody that sits across both defy and kind of tranfi every time say the transfer regime kind of moved out to whack with the one in the D5 based transfer regime moved out of whack with One In traditional Finance you could basically just add that away um and that kind of what we kind of kind of discussed in in the research is the

idea that that is a kind of catalyst could enable could have more sophisticated actors to start coming into D5 because there is this ARB opportunity that essentially acts as like a carrot on a stick to get people to start coming in and then off the back of that that will enable um kind of more sophisticated kind of fixed income markets to essentially be bootstrapped in defy where they're taking advantage of kind of all the underlying benefits of of the infrastructure relative to these traditional financial markets let's um let's talk about a little bit about like that let's kind of transition here into the the second half of your report and talk about like what are some

of the other opportunities that this creates right um you know when I just kind of sit there and close my eyes and think about these two which I sort of knew beforehand but the way you spelled it out was really helpful for me which is there are these two different Financial systems with different rate regimes right and eventually there's going to be some opportunity in getting those regimes to sort of talk to one another so can you describe a little bit about what this opportunity kind of represents yeah so and I think the cancer is there is getting um like so far so say if you've got so for rate markets on chain such that they're accessible within the same trading venue then you there's a as a trading firm you start to be able to start taking advantage of the fact that

there are kind of differences in behavior in the way in which these two regimes behave so the most kind of macro level there's obviously an ARB opportunity uh and a kind of relatively simple carry trade for anybody that kind of knows what they're doing um uh kind of the kind of a further end of that kind of spectrum there's uh opportunity for people to take advantage of the fact that there is a lag or an observed lag in the way in which central banks react versus the way in which the D5 markets react but off the back of bringing in these more sophisticated institutions I think there's an opportunity to start creating like essentially more sophisticated products like Structured Products uh ultimately

long-term uh kind of interest rates what caps flaws non-linear derivatives like swaptions I could have kind of stuff that exists in traditional finance that doesn't yet exist in D5 but by having those two regimes in the same place it essentially enables you to bootstrap that market some Simon how do you import this might be a really dumb question but yeah like how do you import the 10-year yield into like to be on chain just a just a an article yeah I mean at least yeah in the short term I don't think there's any other way of doing it it's just an oracle but it's uh it depends what you're trying to do if

you're trying to create a synthetic like derivative Market um uh as long as you've got the Oracle feed coming in of the overnight rate then in theory you can create a like you can create a market on that vault at which point you'd have like a kind of three month point six month Point whatever different maturities exist within that ecosystem and you think this hasn't been done yet probably because there was no incentive to do it because rates previously were higher in D5 so there's no incentive to go buy a 10-year there's no incentive to do it and also I think that there's a lot of just opportunity there's a lot of white space that already existed in uh just defy on its own um and I think this is this is one of the things that we kind of sort of

discussed in in the report just because it's thought provoking it's like okay what could what could happen in order to bring like more sophisticated institutions in and bootstrap at like kind of relatively rich and uh kind of more sophisticated fixed income Market in D5 but then at the same time there's so much white space in D5 anyway it's kind of like does it does this actually even need to happen in the short term um or is there other stuff I mean particularly with the collapse of like C5 um uh you know there's an opportunity to build out all of that infrastructure that and trading kind of volume kind of can migrate from what was previously in C5 exchanges into D5 anyway

hmm can we talk about uh I'd like to go in a little bit more detail about so we talked about like one of the opportunities like a big bucket right being fixed rate mortgages uh that are native to crypto or D5 the other one that you sort of just just briefly touched on there a little bit is more complex financial instruments for tradify like swaptions and and those sorts of markets but then there's also uh products for for corporates and that was a section that you outlined in your in your piece I I'd love to you know when I think about corporates interacting with financial markets I usually think about them hedging raw materials and things like that right so they like if you're buying a whole bunch that is sort of my background before this but you know if you're buying a

whole bunch of steel or something like that right you don't want your gross that that's like an enormous part of your what makes up your uh gross margin you can't have that fluctuating 100 year over year so you've gotten to the market and you buy uh Futures to sort of hedge that out and same thing with like anything that you that goes into your product um and then same thing with interest rate swaps if you do business in you know multiple different jurisdictions all over the globe you don't want to be taking interest rate risks you can get slammed if like the dollar goes way up in a bunch of international business um how do you think about what are some of the opportunities or reasons why corporates would want to engage in some of like on-chain products and yeah let's start there actually

I I think the short-term opportunity is lower cost of borrowing um uh and it is I don't the short answer is I don't know if it'd be a corporate directly or be a corporate through some sort of institution I think it's probably more likely to be a corporate through another institution where they're packaging up the low cost supporting that you can get from D5 through to them um uh but then over time I think it's I mean there's a there's a whole variety of different Structured Products that can be built I think one of the kind of by far most interesting at the moment is that people are uh using State teeth I mean this is not D5 Plus Credit this is just kind of like D5 and what's native

to D5 people are using State teasers um effectively thinking about it as the base rate of the metaverse so to speak um uh and there is a kind of relatively predictable yield that comes off the back of that um if you start hedging that yield away um you can start building all sorts of Structured Products you can predictably buy options for example of the fact that you have a predictable source of yield coming off your steak teeth um uh and those types of at least even just having access to a diversified set of yield sources um for a corporate a very sophisticated corporate that can start to become pretty interesting

um uh but you need interest rates What markets in order for those types of Structured Products to exist do you think that off-chain entities end up doing this or do you think that we're basically just in a waiting game for on-chain entities to get because I can see this happening in the next cycle with protocols that are spitting off Revenue they go to these markets they take out a loan like that the corporate loan Market gets recreated and the credit Market gets recreated but only with Unchained entities do you think that we're basically just waiting for the like the on-chain world to get really really big or or do you think these off-chain entities in the next in in the next cycle are actually going to take advantage of this uh uh it's interesting so I think I think D5 is gonna my personal opinion is I

think that Defy is just um the fundamentals of the technology and the fundamentals of the ecosystem are so strong that like I think the direction of travel for the whole ecosystem whilst has kind of had a difficult second half of the year um actually coming out the other side we're going to end up with a much kind of like stronger set of Primitives um that kind of really facilitate kind of like the smart creation of financial markets so I my personal view is that by the next cycle I think that's going to be massive um uh I still think that you probably end up with Institute I mean institutions I don't think are gonna just completely disappear between now and the next cycle

um so I think you're still going to have institutions that are interacting with these very low level rails and much more efficient mechanisms of creating markets than a centralized entity um which means that they may package up products for corporates for example off these low-level rails or what's uh kind of amazing about D5 is if a corporate is sophisticated enough to be able to interact directly they may choose to do that as well um but yeah I think the short answer is I'm like unfortunately I think between now and the next cycle I kind of I don't think all institutions are just going to disappear but I do think D5 is going to essentially become the new set of rails which people are interacting uh through if that makes sense

this is a little bit of a callback to actually the season of bell curve that that you helped us kick off but do you ever see you know ultimately what we're sort of driving towards here right there's um you know these two separate rate regimes but ultimately we Jason I believe this is two and I know you do as well with building bolts that there's going to be a rich defy native uh interest rate uh but also fixed you know uh fixed income Market uh that's native to crypto and I think the question Jason was kind of getting at there but one that I've like spent a lot of time thinking about and came up in that season of bell curve we did was is the demand gonna be greater from corporates or institutions who seek this stuff on

chain or there are these on-chain entities thous right that could basically they engage everyone engages in equity financing right now but eventually you'll have predictable cash flows and you'll be more mature and seek to add debt financing so I'd be I'd be curious if you see that as a potential driver eventually yeah I remember I think there's there's one person that was like yeah it's Dallas boring I forget exactly who that was but it was it might have been Ben or I can't remember actually yeah yeah uh no I remember I remember listening to it like I think a combination I think by next cycle though I still think a large part of it is going to be institutions into institutions

um uh there is a and you kind of if you really zoom out um kind of it's actually more with kind of the C5 collabs but if you really zoom out like how do you create a financial system I kind of find that quite an interesting like thought-provoking question um because what we've had historically is we've had um like centralized institutions essentially acting as The Gatekeepers to the whole financial world and the issue with that in many ways is that those centralized institutions are extremely opaque

um and have got massive capacity for incentive misalignment um which basically means a society like our solution to make sure that that doesn't happen is we just regulate the hell out of them um uh but inevitably um by definition regulation lags innovation so every now and then we've had these instances where The Regulators haven't understood the risks that exist in the sector and we've had these like spectacular blow-ups um in centralized institutions um so we saw that I think most noticeably in 2008 Global financial crisis and frankly what's happened in C5 is just in my opinion it's a repeat of that it's just opaque systems incentive

misalignment regulation isn't there a blows up um so long term well so so then that kind of brings you on to what's the other way of creating the financial system and I think the thing that's so exciting about D5 is in many ways it's polar opposite of that instead of having this really opaque kind of Institutions you actually have transparent open source protocols instead of having kind of the capacity for incentive misalignment you actually have these trustless systems which nobody is in control of um and then kind of ultimately it kind of instead of having the need to regulate arguably because of the rules of the system are known to everybody right like arguably the kind of infrastructure regulates itself so really long term kind of coming back to the original question I'd love like all

institutions to basically kind of disappear and to be the financial system to be built off um at kind of these open source kind of permissionless protocols um in the by the next cycle where do I think it's going to get to I think there's opportunity for I think particularly trading infrastructure to completely displace kind of every form of centralized exchange right like uh and a good example of that in relation to what we're doing is London Clearinghouse San entity in London is responsible for about 90 of the world's interest rate swap clearing they have to employ thousands of people to maintain that exchange right and kind of it still is extremely opaque and it's

regulated the hell out of in order to make sure that it kind of works as it should do for society but why does that need to exist I don't think it does like I think the entire thing could be replaced with smart contracts um but by the next cycle there's still going to be institutions I think ultimately sat on top of that driving a lot of that volume through those through those new rails long answer but I find it interesting yeah no I I do as well um and maybe we can even you know I I would love to I know we've we've talked about this at length and I know I've heard you if you've talked about blockworks podcast and other podcasts but it would be good to maybe get back just so we like provide context for listeners who might not have that

background just about why what volts is doing is so important and uh why we need uh the ability to borrow at fixed rates because and I think it could could we actually start with like mechanically because you you started this episode by saying look there are structural reasons in the technology why we only have variable rates I actually also found when doing that season of velcro all there's no such thing as a 30-year fixed rate uh Mortgage in the wild either those also get created by interest rate swaps right even if you look at Libor which uh preceded Sonia that was variable too and the reason was these Bankers in London called them you know called each other overnight they were like hey how much would you theoretically like loan me for and they got in a lot of trouble for manipulating that eventually but it changed based on

what not the technology but the Banker's feelings and then that has to get hedged out with people that want to speculate trades but could you could you just describe why sorry why structurally the rates are variable in crypto right now and why it's important for us to to change or give people the ability to borrow uh you know in fixed rates yeah so it's kind of and I guess this goes back um 12 months ago to the problem that we're looking to solve unfolds um this this mental framework sometimes that I use which is just if we look at the stack that that the entire stack that exists in D5 if you go right to the bottom of the the stack essentially right at the bottom you have nodes uh

that are validating blocks and the plot by block basis um and at the kind of yield that effectively comes out of those nodes is variable in nature so right at the base of the ecosystem you have variable rates coming out um on top of that you essentially have your protocol layer and the vast majority of protocols that have been built at in defy rely on supply and demand Dynamics whereas supply and demand changes the rates that are produced out of those kind of protocols changes so again at that layer you have variable rates of return and then at the very top you kind of have uh your kind of Institutions who are building trading strategies and perhaps Market making but even the most sophisticated even if

they're kind of following some Market neutral strategy that is still going to produce variable rates of return so the entire ecosystem produces variable rates and there have been times in the past where those rates have been extremely volatile like there's actually been instances where borrowing costs have jumped from two percent to 40 back to two percent again in a few days um which clearly if we if we want the whole ecosystem um to be able to serve the financial need of the world right like that can't continue to be the case um and there had not been until we kind of created faults there had not been an efficient mechanism to move something from a variable rate to a fixed rate which you know if you think about what

volts does at the most macro level it enables you to transition from something that is unstable to something that is stable and because that can be applied essentially synthetically across the entire stack right it means that there is the opportunity for the the whole stack in many ways um to become stable for those that want it which uh kind of what that means is it means that we have kind of massively expanded the use cases for the ecosystem um which we're starting to see play out like obviously we've since we launched we've had about 25 growth week and week um uh which a lot of that is people trading

um and also like hedging risk associated with say kind of like steak teeth um uh but we're actually also now what's called exciting is we're starting to see teams coming in and building new products on top of the fact that this new market exists in D5 so the in the end State as well just to give like Trad fire analogs for why like to just complement your sort of intuitive statement about why two percent to forty percent to two percent is a problem is because if your mortgage rate worked like that right if you look at the you could never do it I mean no one would own a house if that was if that was the case or companies could never borrow like that companies could never borrow right right that's the important that's the important thing

um so I guess like this for these relationships that you've outlined in in this paper assignment do you expect that to to continue like one of the one of the difficulties right is like first of all correlation doesn't necessarily equal causation right we know that from like statistics and stuff like that but also one of the things that is so hard about inflation uh trying to even in traffic like people don't have great explanations for why inflation really happens because so few instances of inflation do happen so we just have not very many data points so how are we going to kind of continue to track this relationship should we expect it to repeat and this anti-correlation to be sustained into the future it's do you know it's a really interesting question because I think the

closer that the two worlds become the actually they start to inverse they start to go from being anti-correlated to being correlated if the entire world is borrowing on D5 rails then you'd expect there to be some sort of correlation between Chad file and D5 rates right like heavy correlation um I guess the real question is what happens in the short to medium term um and that's where we kind of call out the fact that anybody who's able to operate across defied trading rate markets um if you have child fire rates existing in defy such that you can trade the two in the same venue then that opens up a huge amount of ARB opportunity which clearly over top like if you just really

zoom out like over time that ARB is clearly going to disappear as all apps do um uh which the other way of saying that is over time you'd expect the two to become correlated if enough people are are about that opportunity then yeah I mean like honestly and then they go from anti-correlation to correlation but if we didn't like just if we didn't have if we had an absolutely zero friction between on and off Rams yeah with regards to on and off rounds everybody would be boring with people right right which is so funny you say that because I think that if you follow that to its like logical conclusion every big business in crypto has been built off of bringing something in from Trad Fire or

the real world right like exchanges are the best example of that kind of like they import capital from The Real World but a really interesting business that has also done this is circle circles done a phenomenal job of importing dollars into crypto as well and it's a structural Advantage right that like you have to imagine people are looking at that business being like okay we would also like to do that or maybe it's importing instead of dollars it's uh treasuries maybe maybe it's on chain Treasures right someone just puts that on the chain and it could be as simple as a circle like they just put a box in and they buy a bunch of treasuries and then they issue treasuries and there's an on-chain Oracle and Bob's your uncle I don't know do you know what I think the pro

I mean I wish it was that simple my feeling is that it's regulatory it's the the competition right yeah yeah that makes sense um otherwise otherwise we'd have done it already yeah yeah you would guess so um well Simon I mean this has been uh first of all we'll we'll link the you know the report that you published in the show notes do you have any just you know closing thoughts for for our listeners here on you know anything that we might not have covered or anything that you want you know folks to know about volts and what you guys are building that I think I think the thing that I would say is that it is um unbelievably straightforward uh if we wanted to to create sofa rate

markets on chain and to trade that through vaults um we haven't made a decision in the short term as to whether we're going to do that or not I think if you actually play out that medium and long-term view of course we're going to do it right like it like it has to happen these two worlds have to come together um uh but if there's anyone that's listening um that is thinking kind of wow if those two things existed right now there's all these things that I could do obviously we'd love to be talking to them cool awesome man I appreciate you coming on man yeah thanks for coming on always fun always fun yeah good chatting with you I'll talk to you soon [Music]