Inside Crypto’s Liquidity Crunch | Romeo Ravagnan & Sonya Kim

Transcript

This seems like, you know, this is a beginnings of the bodies floating to the surface from the damage that we we've seen. Um, and it's not really in the spirit of DeFi, which is promoting transparency and the lack of need to trust people. But in this case, you know, the the the facade was, you know, wrapped in this yielding stable coin that's very DeFi native, but the back end was actually um something more like Stefi where, you know, users didn't know where their money was being managed. >> This episode is sponsored by Canton, the only public permissionless blockchain built for institutional finance. We'll hear more from Canton later in the episode, but for now, let's get started.

Hey everyone, quick disclaimer before we get into today's episode. Nothing said on Bell Curve is a recommendation to buy or sell securities or tokens. This podcast is forformational purposes only, and the views expressed by anyone on the show are solely our opinions, not financial advice. Our guests and I may hold positions in the companies, funds, or projects discussed. Welcome back to another episode of Bel Curve. Today I'm joined by Romeo Ravenan and Sonia Kim of 3F Labs. Guys, Marco, welcome. >> GM, >> good morning.

>> Uh, Romeo, how did I do on the Italian pronunciation of the last name there? You can feel free to grade me on a scale of >> Yeah, you you did a great job. Well done. You really went to your Italian roots there. >> Exactly. You can see the Sicilian. I feel like my skin is one shade more olive here already just from that pronunciation alone. Um guys, this is going to be a ton of fun. Uh one, we have uh two members of the most exclusive cabal in all of DeFi, excellence now, uh as eagle-eyed listeners of bell curve will will know. Uh but also because we've got um two of the sharpest minds in DeFi. And I want to unpack what happened over the course of this last week. So, uh, for folks who might not have been following along in an enormous amount of detail, this was a

pretty interesting week for DeFi because there was the first signs of, uh, something that looked like a liquidity crunch. Um, which hasn't necessarily happened on the DeFi side of things. We're very familiar with that happening on the CFI side of things within crypto. Um, and it kind of led to this very interesting uh, debate, which is an old debate in crypto around uh, pulled versus isolated risk. So this is kind of the a model versus the morpho model of lending which I want to unpack with the two of you. Um and then I want to also get to I think this even bigger idea of putting leverage or looping rwas which is we're just in the beginning of that uh kind of mega trend within DeFi. But before we even get into what happened this week, could we actually rewind back to the open interest wipeout that

happened I think it was, you know, a couple of weeks ago. This was when this was I just remember it happening in uh the week of D London uh which we're all at. There was a lot of very interesting talks on stage about that. Uh but Romeo um you're ex delta neutral of Braxus fame here. So can you give us the traders perspective on what caused that? Uh just remind listeners what caused that $30 billion open interest wipeout. >> Yeah. It's funny because it kind of happened yesterday but in crypto things move so fast so we feel like it happened an eternity ago. really was like just the other day that um you know you had some altcoins going to zero. Um but for the viewers out there, what what basically happened was

that the market started uh you know taking a hit after Trump's comments and then altcoins effectively went into this delever spiral, this liquidation spiral and there was no bid in the in the books across all the major exchanges. And what that meant is that effectively users started getting ADL on their short positions. Um and you know a whole bunch of of uh circuit breakers that were what essentially what PES have is this thing called auto deleverage which means that if you're short uh you can get your position forcibly closed by the exchange

if there's not enough bid liquidity in the order book. And this happened cross market um and and generally there was just the market makers were all pulling out and so spreads were widening and a whole lot of damage uh was being caused. Now there were a couple of different venues that were uh more materially impacted than others here, right? Which was there was a lot of focus on hyperlquid maybe because you had a lot of retail uh participants and maybe less sophisticated uh funds who didn't fully understand the risk they were taking on the ADL side of things. But there's also there was a little bit of nuance here around Binance and I'm bringing Binance and specifically Athena up because that's going to introduce another concept that we're going to talk around talk about around these yield bearing

you know stable coins which might not actually be uh you know stable coins uh in full effect here but there was a little bit of nuance around the oracle mechanism that Binance was using and Athena specifically. So can you just unpack kind of that level of detail and then yeah we can get into the ADL and who's actually managing risk properly on the delta neutral side of things. Yeah. So, so Binance has this really awesome um margin mode for for traders called portfolio margin mode, which essentially allows you to cross marginalize all of these different assets um in your portfolio. And they um they consider that as collateral for all of the leverage positions that you're taking.

Um and in the case of uh the occurrences on the 10th of October u Binance were using their own books as the price oracle for which that collateral was being valued on. And what happened was is that as the collateral started essentially plummeting and there was no liquidity in the book you had this spiral effect where um that collateral was worth much less. it was finance then had to liquidate that collateral on their own books and effectively you have this cascade where if there's no bid liquidity I mean the assets can literally go to zero and the biggest uh impacts were on these really

illquid coins things like USD from Athena and Binance staked ETH uh which are really really efficient for traders because they're yielding And if you can use that as collateral, your entire positions can can be much more efficient and your your net interest that you're extracting from the market is is higher. Um and so a lot of funds were using Binance ETH and USDE as margin in their portfolio margin mode and it the oracles were tied to the Binance books which are incredibly liquid even more even less liquid sorry than things like Curve and you just had this essential uh implosion of of the Binance

system >> and uh by efficient you mean because it's yielding there's a carrying cost right whenever you like margin margin, you know, one piece of collateral to fund another trade, there's a carrying cost that's associated with that. If Ste is yielding even 3% or something like that, it helps offset the borrow cost in general. Right. >> Exactly. and having an asset like Ethereum or any yielding asset uh even even Bitcoin actually to be honest as margin when you're going short perpetuals is really good because if the market goes up you know you're losing on your short position but the asset which you're using to collateralize that position is increasing in value and so you're much safer when you do so so a

lot of traders they'll short ETH and post staked ETH But in this case, it's Binance state Eve because you can effectively post much less collateral and trade much more and then earn more yield. Um, but the problem here is that if that oracle to which Binance value your ETH at is their own book, uh, if the price essentially gets destroyed on their book, you know, that collateral that you thought was really efficient becomes valueless and you get liquidated. M um Sonia, I want to kick it over to you here in a second, but one more question for for you, Romeo, is I saw this theory that, you know, first of all, when um there was actually a really

interesting debate when Hyperlid ADL a bunch of their traders that actually this was net good uh for traders because they took them out of the market before it really dipped. Um let listeners form their own opinion on that. You can basically just tell who has exposure to Hyperlid and who doesn't based on what they think about that line of reasoning. But um it did. >> What do you think? >> It just doesn't make sense because everyone that got ADL was short. So they so they would have much rather been in their position as the market was crashing. So I don't know who said that but you know it's probably uh in line with the general crypto intelligence over the last two weeks.

>> Well uh yeah there well interesting. We'll we'll let some who people can form their own opinions but I tend to be in your camp there Romeo. I don't think getting forcibly ejected from the market is ever a desirable action from from that your exchange or your broker puts on you. But um I did see that part of the reason maybe uh maybe as a theory for even if you got one leg of your trade blown out, right? Like let's say you were delta neutral here and you got u the short leg blown out, then you actually had to unwind your longs over the course of the last couple week in that couple weeks and that might actually um contribute to what we're seeing in terms of uh market instability here. And um this is also the the the reason for the audience why we're going

back and relitigating this point is whenever there's a massive open interest wipeout. And just for scale here, this was a almost $30 billion wipeout of open interest. The FTX wipeout was about uh I think it was on the order of like four or five um billion. So this was a this was a really really large within the scale of crypto biggest ever. Um, and so whenever something like this happens, you see these tweets that say, "Hey, it's going to be a little while before we start to see bodies float to the surface." And as a reminder, uh, when the first real deleveraging event happened in crypto back in 2022, it was actually Luna. And it took us four or five months to understand that the whale that really blew up was FTX, right? So these things take a little bit of time.

And the reason why we're going back and discussing this open interest wipeout is because we're starting to see some bodies float to the surface. I don't want to be, you know, overly sensational there. I don't think there's another FTX in the market today, but we are starting to see at least a couple of bodies float to the surface. So, I'm curious, you know, for maybe to open it up to both of you, you know, do are we starting to see the impacts of this unwinding? We're going to talk about stream finance in a second here, but, you know, just that thought that thought of, you know, people getting one uh leg of their trade blown up and maybe that's causing an unwind in the market here.

Well, I'm curious because it seems like the results have been very bifurcated between the the managers who had really good risk management and Romeo will know better than me on this but this market volatility was actually an opportunity for those to make good performance and then there are the others who you know completely blew up. So I'm curious like what was the difference between you know say Arais or some other funds that actually came out on top here in the midst of heightened volatility versus the ones you know associated with the likes of stream finance. We don't know who that market maker or external fund manager was but that have done gone

completely belly up. What's the difference there? Yeah, I mean I can't really speak on any individual entity's behalf also because you sort of have to wait and see for their navs and and and and accounts to be formalized. But you know the the true professionals in the space, the people that have been doing it for almost a decade now, uh they know these risks and they know that liquidity it's, you know, seldom spoken about, but it's actually incredibly important, especially when you're trading derivatives that have these mechanisms, you know, encoded in in the market. So, if you're going to be a delta neutral arbitrageer, let's call

it, and collect all of this awesome per funding that you you now flex as is your amazing idea, but that per funding is on like Farcoin or a bunch of different >> Hey, let's not disparage Farcoin. That's still a sensitive subject for members of Excellence D. >> Yeah. I mean, I'm a I'm a big fan of Farcoin but >> that's a risk manager in you speaking with me. >> Let's just say let's just say a bunch of different uh you know, altcoins that have smaller market caps and less less trading liquidity. Um, you know, the the the implied risk in those assets is is

much higher, right? If you're waiting your deployments towards these high yielding opportunities, uh you should be very you know conscious of the fact that you know for example you can get ADL in about uh two seconds and then the market can dip down another 50 60%. And if you haven't rehedged yourself uh that's all a negative P&L that you have to you have to stomach. Um, and the best players >> speak of rehedging when you're not no longer delta neutral because you've been liquidated.

>> No, you've been ADL, right? So, your short position no longer exists. You're now long. Uh, you need to become delta hedged again and and either reshort or sell your long. Uh, usually you just reshort it because that's the easiest thing to do. Um, but sometimes there's no liquidity, right? And so if you have a $10 million position and you want to reshort that that that market, you might, you know, just essentially bleed yourself to death. So the best players know that they can only allocate a small amount to this to these sort of assets.

um and they're actively monitoring their position such that if the ADL occurrence does in fact happen, uh they're quick to, you know, hedge their exposure as fast as I can. >> Yeah. So, it seems like just a pretty basic check, right? If you're, you know, delta neutral and you've got a a long and a short leg, it really matters what the underlying asset is and the liquidity is there because even if you're looking at something that looks like a pretty conservative LTV on your hyperlid long or short, if you're doing it on an asset, well, not bismerch the name of Farcoin anymore, but maybe something that's, you know, got $5 million of liquidity, you know, the the risk of you getting ADL is actually much

much higher there. And if I'm interpreting you correctly, you know, good fund managers that have been around for a very long time just have a longer, you know, kind of checklist of risk and they're the pros that know that when there's because this is what the criticism of delta neutral funds has always been, hey, these things are supposed to not take market risks, but then the market happens and then these things blow up. So, uh, what I've heard you kind of describe here is that there's, you know, the people that have been around for a long time and have a demonstrated track record actually do quite well during these periods of volatility and they're in the market harvesting and, you know, arbitrageing.

But then there are folks that uh maybe this can um, uh, lead us into stream finance um, and XUSD and some of the stress that happened there. But then it also exposes, especially in crypto, maybe some of the more um less experienced folks who might not have that as long of a a checklist of risks that they're going through. Before we get back into the episode, here's a quick word from our sponsor, Canton, the only public permissionless blockchain built for institutional finance. >> Tradfi wasn't built for 24/7 markets. Defi wasn't built for regulated institutions. But Canton is where the power of finance meets the promise of blockchain.

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technology involve risk. Terms and conditions apply. Do your own research. Can we get into uh Sonia? Can I pick on you to give us a uh give us an explanation of what's going on with stream finance and XUSD? And then that'll lead us into a a pretty interesting part of the debate here around kind of the underlying uh market structure that's now supporting um credit creation within crypto which is now more on the DeFi side of things than CFI side of things. >> Yeah. Um so stream finance um they had XUSD which is labeled as a yielding stable coin and I think the the um mistake that our industry has um created is the nomenclature of what's a yielding

stable coin. I think um it historically comes from you know a which you know has a USD um it's relatively safe. It's overcolateralized lending. AUSD um you know holders have yield associated with it. And then Athena when it rolled out its you know delta neutral strategy that backs the um you know USDE um SUSD is basically the the you know passing on the yield that is generated from this delta neutral trading strategy. And then uh over time we've created a lot of different stable coins stable coins um that are yielding based on you know various combinations of lending and trading strategies. Um I think in this

case it was um pushing this sort of nomenclature to the extreme. You know XUSDC which is uh a stable coin is basically as we realize um you know contracted uh trading strategy that uh was to an unnamed manager who lost something like $93 million um presumably related to the you know the liquidations that we saw back in October. So this seems like, you know, this is a beginnings of the bodies floating to the surface from the damage that we we've seen. Um, and it's not really in the spirit of DeFi, which is promoting transparency and um, you know,

uh, kind of lack the uh the lack of need to trust people. But in this case, you know, the the the facade was, you know, wrapped in this yielding stable coin that's very DeFi native, but the back end was actually um something more like CFI where, you know, users didn't know where their money was being managed and the result of it was just massive confusion um as the the news of loss came out in a tweet. Yeah, this is, you know, this this is super interesting because over the course of the last month, we've revisited, I think, some of the oldest debates that have that have been going on for multiple years in crypto and

DeFi, especially one that we glazed over here, didn't really discuss was the hard coding of um USD within uh bar lend protocols like like a right and uh there's a long this is a long-standing debate. Um this is uh not picking on a at all. is pretty common practice especially when you're spinning up a new asset uh for the first time generally you know because there it's very inefficient to provide things like secondary liquidity right so you just kind of hardcode it and in the beginning and the idea is that you'll get off that eventually but sometimes that doesn't end up happening so hard coding um one that uh actually the original season of bell curve on fixed rate borrow lend under collateralized borrow lend was actually on this idea of do you actually

have transparency in DeFi I mean people say this all the time right if you listen to Twitter, you'd say, "Oh, I completely understand all the risks that are happening in DeFi." And then these things blow up and it's like, "Oh, there's an off-chain agreement here." Oh, actually, because these things are on different chains, we can't really fully understand all the risk. And so there's a I think that this is going to continually you know we're going to challenge the parts of DeFi which are actually working in the way that we thought versus what's a little bit more of a narrative because you know now there's a great um there's a great graphic from Galaxy which shows the uh the credit infrastructure that exists in crypto and you can see outstanding loans being it was mostly CFI lenders like the Genesis and the BlockFi and the Celsius

of the world. Now that credit complex is being rebuilt within DeFi, which I love. I think everyone on this podcast would be super supportive of, but it is going to show the cracks in terms of what's actually possible and what's not. So these situations where there's a little bit of stress. It's super interesting, right, to see um you know, what's super real and functioning well versus maybe what isn't quite as much. And um yeah, I also one one other interesting thing about stream finance. Uh just for listeners who might know who Wes Casaris is, uh this is actually his son Dio uh who was involved with stream finance. So not to throw Dio under the bus at all. I'm sure he'll you know he's a smart guy and everything, but that's just an interesting little uh tidbit here. But um

>> do we know who that undisclosed manager was? I mean it's crazy that even after you know when did this happen? three days ago that oh probably haven't before. Um we're just out here just wondering who who it is. >> Yeah, I'm so curious. There are some rumors but I haven't heard like any definitive guesses as to who that was >> because you know in in the in the grand scheme of the market 93 million is is is not that much. But for for crypto and crypto arbitr it's quite a lot of money. So, I'm surprised I'm surprised no one's come out here with a with any with any answers. Maybe that's >> and it's a big loss as well for people who thought they were buying a yielding

stable coin, right? And this is the issue with the nomenclature. I don't think we should be calling trading strategies that are um backing, you know, some USDC or stablecoin denominated um rapper a stable coin because that really creates a mismatch between risk expectations and what's happening under the hood. >> Yeah. What's your I mean, how do you see this market playing out? Because there are, you know, with the approval of the Genius Act, you know, you now have even Secretary of Treasury, you know, Scott Besson saying there's going to be $3 trillion worth of stable coins on chain by the end of the decade. So I

think that you know those those funds moving on chain they're going to look for yield and I think you have um a bunch of different strategies um which those those dollars are going to look for to generate yield and yeah it's kind of interesting that we first got maybe this was originally the USD model which originally I think positioned itself as a stable coin but has since backed away from that but it did it it kind of led with this idea of a stable asset which yields which yields something which is which is actually a pretty good form factor. You do just want a dollar that yields like a high yield savings account. The problem is this is this is still new enough that we don't have a great understanding like there's nothing that really helps the user understand or the holder understand what the risk is

that's associated and you know as we've seen with the XUSDs of the world some of these things can be quite risky right so >> but it also seems like we're just going to let this experiment play out do you agree I mean I don't know what's it just feels inevitable >> I think it's tough I think it's really tough because if you take Athena for example, if you were to have to disclose every single risk that's associated with Athena, I mean it would literally be like a 20page document. Uh, and you know, if you go to a regulated fund, they all have these 20page documents.

They're called the fund EVQs, and they list every single risk associated with those products. But you can't really do that in in in crypto. But also, even if you did, I reckon 99% wouldn't even read the first page. So, um, I think it's tough. I think it's really tough. I mean, I can see the appeal purely from a marketing perspective and distribution perspective why you would want to call a hedge fund strategy a stable coin because the total addressable market for stable coins and, you know, dollars is way bigger, right? So, it's a very ambitious take for a a hedge fund strategy essentially to market it as a stable coin. Um but I think like because

this has happened, I think the industry will now learn that um you need to do a little bit um better DDQ and um due diligence on these underlying strategies and uh not completely outsource this role either to risk curators of these modular lending protocols because um yeah the industry is maturing and these are not you know necessarily all professionals who've done extensive of DDQs on hedge fund strategies. There's a whole cohort of, you know, uh, professionals for that and they're called, you know, fund of funds and Cambridge Associates, uh, things like that. So, um, it's interesting that the

market is professionalizing for sure, but we've still got a really long way to go for these risk creators to fully understand and disclose the risks associated with the the collateral assets that they're bringing into their vaults. >> Okay. Can we get into the underlying the borrow lend infrastructure and isolated versus um, you know, conjoined risk? And I I would this is a really this is quite a long-standing debate as well. And the reason that it's interesting to bring up right now and I think people are talking about it again is because for the first time uh at least in in my memory you guys correct me if I'm wrong here but there were you know pools on let's say Morpho where uh depositors could not um withdraw right because there was simply

no liquidity and uh you know to to set up for folks who might not be quite as familiar with uh you know sort of the different models that exist out here you know a is obviously the 800 pound gorilla in the borrow lend market. Um and you know they started with a model which is kind of everything is the risk is being managed by the protocol right so you have depositors you have lenders there are parameters which allow you know b borrowers lenders to create markets and act in a certain way uh but you are trusting in the risk management of you know the governance structure of you know kind of a labs and um you know Mark Zeller as well is probably involved in that and it's done extremely well so

far I think that's one the core competencies of a that they have extremely strong risk management. Um and then on the you know the the model of newer entrance to the space like the morphos and the oilers of the world uh it's their their point was that maybe that ultimately doesn't end up scaling and we should have isolated markets that have isolated risk right so you have actually a more modular structure where curators um can come in they can spin up a vault permissionlessly um and they can kind of make their own markets around borrowing and lending and I think to many that has seemed maybe a little bit more uh scalable and makes a little bit more sense. There's a there's a bunch of benefits that you get from kind of

pooling the liquidity of um different markets into one into one uh one asset like a but also maybe it seems a little bit more scalable on the on the modular side. However, uh there was a really great tweet from Stani um that I want to bring up here because I think this is probably the strongest criticism or valid criticism at least in the current instantiation of uh the isolated borrow lend market that we see today on let's say morpho. Uh so I'm just going to read this out. I apologize guys for the essay because this is a little bit long but uh this is from Stonyie. The core issue with the curation vault model lies in the illusion of isolation. Curators are meant to manage distinct strategies and segregate risk. Yet in practice, they all end up supplying liquidity to the

same underlying lending markets. What is designed to promote diversification instead concentrates exposure, turning one curator stress into everyone's problem. Despite being framed as a modular and independent, the model inherently links all vaults through shared borrower pools. Liquidity from multiple curators merges into a single system, so the decisions or withdrawals of one can ripple instantly across all others. As we've seen with recent issues with XUSD and similar assets, even a cautious curator cannot escape the fallout from a more aggressive participant operating within the same pool. When confidence falters or withdrawals accelerate, these shared markets seize up. Utilization shoots to 100%, redemptions grind to a halt, and borrowing rates spike to unsustainable

levels. A localized liquidity crunch quickly transforms into a protocol-wide freeze, a DeFi version of a bankrun. Essentially, this creates a design paradox. A system built for isolation that in reality amplifies interdependence. Every vault inherently risks every vault inherits the risk behavior of the weakest curator, making the entire structure vulnerable when liquidity is most needed. This model is even amplified by the economic design of these protocols. Lower fees or take more risk to great business otherwise become commoditized. In contrast, A's architecture achieves the risk segregation that curator models only promise. Each market operates in true isolation with conservative collateral standards controlled listings and transparent onchain governance. Market shocks remain contained. Liquidity

remains accessible and the protocol's record of zero bad debt across billions in total value supplied underscores its resilience. For vault creators and users, this difference is decisive. Shared liquidity designs magnify contagion while isolated market frameworks contain it. A's conservative design ensures predictable yields, reliable redemptions, and the ability to sustain confidence through volatility. And of course just use a wouldn't be an a post without that. Um Sonia help me unpack what Stani means here. And uh you know maybe if we could kind of steelman the argument from the a side of things and what their current architecture supports but maybe first if we could actually go through what he's talking about because you know when I you know even before this week thought of you

know the a versus morpho model I was thinking the risks are much more isolated in morpho but as as we've seen actually in the data there is at least some validity to what Stani is actually saying. So can you just kind of walk us through how that actually works? Um yeah, I actually prepared a little diagram because um I thought that for the viewers it would be much easier to to understand this. >> The viewers is me. This was this diagram was prepared for my 5-year-old brain here. So, thank you. I appreciate it, Sonia.

>> Um yeah, of course. So, I actually made a very like simplified example. So, I use Smokehouse um USC, which is the higher yielding vault cured by Steakhouse um my former employer. and then Mabe Capital uh which I think was implicated in the XUSD uh drama a little bit but um these are you know very hypothetical examples here. So um just to step back I think every lending protocol basically tries to pursue some level of capital efficiency right. So, A does that by um you know they enhance capital efficiency by having a single pool um which means all borrowers can you know dip into with the same like

different collateral uh from the same pool um which does create in times of stress uh potential credit contagion risk but it's it works and you know it's it's um kind of been battle tested through different uh market stresses the way um Morpho tries to create capital efficiency is through the um concept of shared markets. So I'll first explain um if they didn't have shared markets um if they had truly isolated markets what this would mean in terms of capital efficiency. So let's say Smokehouse USDC has 100 million in TVL and they very aggressively allocate you know all of

their TVL to a single uh market. So MF1 is the FNAR's uh private credit fund that was tokenized and uh the convention here is that MF1 is used as collateral to borrow USDC from um from this vault. So let's say they um allocate all of the 100 million capacity into the borrowers. Here the borrower demand um at the time is 40 million. So utilization is only 40 million at 40%. So the rates are fine. Um simultaneously let's say me capital also has 100 million in TVL. The risk curators decide to allocate 50% of the capacity. So um in this particular

example there's borrow demand from MF1 holders who want to borrow at USDC of 30 million. So in this example utilization is you know 30 over 50 which is 60%. Let's say you know in this market the MF1 borrowers want a new borrower demand of 30 million more um but there's only 20 million of capacity remaining. So if they max out on 20 million of um the further borrow demand then utilization spikes to 100% and you know you breach the kink which means the rates uh for these borrowers spike up. But actually you know here there's plenty of liquidity um in in this other market. So this example um shows that isolated

markets are not ideal because you could have idle liquidity in different places but you know in this example the MF1 borrowers suffered a huge rate spike um and as a result of that uh you know you you don't create a very efficient capital efficient markets. So I I think the Morpho team realized this. Um, >> and Sonia, can I actually can I actually hop in and just see if I'm uh can repeat back to you what what you just described, which is >> I want I want folks to to imagine there's the lender and the borrower side of these markets. So on the lender side of things, just imagine there's a whole bunch of basically USDC which wants to get lent out and then there are people

that want to borrow that USDC and they're going to pledge different forms of collateral. So that could be MF1. It could this is the that's the that you said the Finanara uh fund, right? There's also steath, you know, or you know, Ethereum type markets or all these different types of collateral markets. And uh and yeah, this is actually something I didn't fully understand before this is that those markets are shared. Um, and so instead of Yeah, I I love this example here of if you had true isolation, then the lenders in the the the lenders that uh or the people that want to lend USDC as controlled by the stakehouse curation market here, if they could only provide to one market, it would be very capital inefficient.

And guys, remember that these are this is an overcolateralized uh lending model. So when the utilization rate that Sonia was talking about that is like up to a certain point you can borrow you know 90% or get like 90% of the collateral in that market but then the pool doesn't want any bad debt. So over uh 90% utilization it skyrockets to a very high rate to protect against that very neg like adverse you know scenario right of of um the pool getting bad debt. And so yeah, if you have this more isolated risk where one lender can lend to one market, you're risking that utilization rate spiking. So if you allowed multiple different uh vault curators to provide to the same

underlying borrow market, then you can avoid that. However, >> maybe we can get to the the drawbacks here is we actually did start to see utilization rates spike right this weekend even within this model. So, sorry, just correct me if I'm wrong there, but just >> I will I I I will, Michael, because there's just one thing that that I that I would add, which is that the utilization curve isn't to pro uh protect against bad debt. It's to protect against lenders not being able to have instant liquidity because bad debt is a function of the collateral ratio, not the utilization. So it's to make sure that any lender can come in and out of that pool uh without any problems. And so as the utilization

curve gets maxed out, the protocol incentivizes either new deposits or re repayments of borrows to allow for this, you know, liquidity layer, this instant liquidity. >> Thank you. That's absolutely right. Um okay, sorry I interrupted. Uh Sonia, continue. >> No problem. Okay, so uh just going back to the isolated markets. So here um you know you max out on the utilization, the borrowers get wrecked because you know right now the borrow rate on MF1 is skyhigh. Um so the better the better solution is the shared markets where you know the different vaults actually have exposure to the same underlying market.

So in this uh same example, you know, same borrow demand for for the amount of capacity that has been allocated from different vault curators. Um so total borrow is 70 million. You've got 150 million of capacity. So um you know 47% utilization. Um as above let's say there's new borrow demand against this collateral of 30 million. So then the total borrow is 100 million uh over 150. So utilization is still safe. Rates are stable. This is in inherently under normal circumstances a better rate or better model for the borrowers >> actually for lenders as well. This shared uh markets model in normal

circumstances is better too because you know in isolated markets here um if you're a lender and for uh lender into this 100 million uh dollar vault and only 40 has been consumed then you've got 60 million uh of uh liquidity that you can instantly withdraw. But here if you actually share the liquidity um of the underlying markets then in both instances you as a lender you have uh the ability to withdraw more. So, you know, in normal circumstances, um, and I think this is what Stani is not portraying in his, uh, tweet is that shared markets are definitely the better model because they promise better rate

stability for the borrowers because they can tap into the shared liquidity um, provided by the vulcurators and also for the lenders um, because you have better instant liquidity to pull out from each of the markets. >> Okay. Well, let's uh let me try to defend Stan's point of view here because yeah uh what happens here in stressed markets and when can this work against cut back against you because >> you know despite you know understanding the inherent advantages here we did see utilization rates spike and there's a there's kind of a if I had to boil down his core criticism here it actually is that the weakest link in in in a shared market model the weakest link can actually sort of poison um right or negatively impact even curators and

markets that have uh good risk management. So, can you describe a little bit about how that actually played out this weekend and maybe take the other side of the argument too? >> Yeah. Um I've kind of unfairly portrayed MEB Capital here, but this is completely hypothetical and example based. So, apologies. Um no, you know, no insults here, but let's say, you know, MEB Capital had um allocated to some dodgy collateral. Um but smokehouse stakehouse USCC was okay. Um because they're sharing liquidity you know MF1 so first of all when there's panic lenders withdraw liquidity from all the vaults so utilization of each of the markets goes up rates go up and for liquid collateral what would happen naturally

is for the borrowers to pay back their loans because their loans are too expensive and the system sort of readjusts. In the case of RWAS um and MF1 is one um there I believe there's some liquidity sleeve that Midas offers for instant redemptions but the natural liquidity cadence of this collateral is monthly because it's a fund. Um so what happened was you know utilization goes up because lenders withdraw liquidity but the borrowers despite the higher rates did not have the ability to redeem their collateral to pay back their loans. So the um at some point I believe MF1 was uh like borrowers were borrowing

at like 50% APY which is very very high but there's no self-correcting mechanism on the borrower side. Um on the lender side, you know, uh stakehouse had the ability to say uh reallocate some of the liquidity to this market to lower the utilization rate and therefore lower the rates, the borrow rates for the MF1 holders. But the issue is that um you know, let's say MB Capital had this dodgy collateral. So uh the the lenders into Mub Capital Vault are withdrawing. Whatever incremental liquidity that stakehouse can allocate to this market is now being withdrawn by the the

lenders who are skittish about you know persisting in this vault. So essentially what could happen in stress situations and this is what Sonni is getting at is the stakehouse um lenders are the ones supplying liquidity to the redemption request from the ME capital um uh lenders which means that you know they the stakehouse lenders are stuck in this illquid position. Um, yeah, that's kind of the the crux of the I guess Sony's argument.

>> So, basically, and Sunonny, maybe I can share my screen here. I'll actually pull up the the MF1 because this actually h this ended up taking this ended up taking place in practice here, which is, you know, you have so the the argument for shared markets is it's higher capital efficiency so you can have multiple lenders stabilizing rates. The the downside of this again if you have a a a curator who's more stressed or has higher liquidity needs maybe from elsewhere in a totally separate market they can hoover up the liquidity which gets provided by you know another curator and therefore you know take it right out of the market and this is the this is kind of the criticism of the of the weakest link argument that I think Stani is that I think Stani is making

and Sonia could I actually share my screen here and ask you to just remove that Perfect. Uh, and there was there was there were some pretty interesting, you know, the reason why I think this is interesting to call out this week is because there were some instances here of real markets where the liquidity completely dried up and just for a short period of time, you know, you actually had rates spike on some of these markets to 40% or something like that at a time when depositors couldn't necessarily get out. Now the there's a couple aspects of this which I find super interesting. Um you know we're debating it really depends on kind of how you look at this because that 40% rate you know when that's actually going on that feels

extremely painful. That's an annualized rate. So at the end of the day it actually it it depends on if this were a market where there was liquidity and there were people that were looping the underlying asset you could just get out right you could unwind your position. uh this market especially because of the the second interesting aspect of this which is RW this was an a real world asset right so this was just the tokenized representation of the actual legal structure and you can only redeem MF1 on a on a monthly basis you actually couldn't unwind this trade uh but it kind of kept you in it and while it was painful for that 12 hours or whatever now you might not actually notice that really in the in the full arc of time and so how do you view that because on

the one And I think you would want the ability to be able to unwind that quite quickly. On the other hand, you know, you probably were your heart was beating very fast for 12 hours, but now it's kind of over and you might not actually actually notice it. Um, so I I'm just, you know, this is gonna kind of bleed into where I want to end this conversation on there's a big difference in between looping and putting leverage on onchain true you know digital bearer instruments versus real world assets especially something like a fund which you might not be able to redeem and sell into the market immediately. So yeah, I'm uh maybe maybe we can do the final word here on, you know, what you guys think about the isolated the pros and cons of isolated markets um from, you know, Stany's position here versus why

it might ultimately make sense and then we could get into the RWA angle here, which adds a whole other layer of complexity to all of this. >> My my my final word is that uh you know um the weakest link sort of you know theory is correct, Michael. I I like the the way that you called it the weakest link, but it's it's actually not representative of the real situ of the re of the of the reality of of lending in general in in this case because the problem here isn't having a weak link.

It's to uh you know what size is that weak link in your system, right? So if you actually have a huge diversification of lenders uh to one asset, this weak link problem doesn't really exist because that weak link represents a small percentage of that liquidity. Right? In Sonia's diagram, uh if MUV capital was just 1% of all the lending liquidity that was being uh lent to um the MF1 market, uh you know, this implied shock would have not been very large and and actually even on a you do have moments where one user squeezes the

entire rate of the market, right? you know, famously Justin Sun comes in and out every now and then with $500 million in tether or some other or some other stable coin and the rates go to 30 40% on ARB as well. So it's it's actually just you know a question of diversification and like single single lender exposure and I think it I think what you said as well Michael about you know the brevity of the situation it only lasted like one >> basically is is is important um because you know if you average out uh over time you know these shocks occur but are not

very very impactful. >> Also, I think it's really important to delineate between uh credit risk and liquidity risk, right? There was no credit risk um contagion here. We're only talking about depositors into these vaults temporarily not being able to withdraw because liquidity dried up. But the beauty of Morpho's design is that um it's individual markets against one uh you know one uh like lending pair. So unlike a where there's you know potential contagion risk because there's only a single pool of liquidity available for different collateral

borrows um these are isolated um uh by asset. So uh I think that for the viewers it's really important to understand and the users it's really important to understand that the morpho model does inhibit uh systemwide you know insolveny or contagion across credit risk. This was a temporary liquidity situation. >> Okay. Well I I know we've got a couple of morphobs here and I want to be fair to A. So, if Mark or Stani, if you're listening, uh, come on the pod and we'll get the we'll get the other side of this. But hopefully we represented both points of view in a fair light here. And uh I I will say, you know, as the least uh you know, as the least in the weeds

of anyone on this call, it does intuitively make sense to me, at least me, that yeah, you're going to need multiple, you know, I think you're just going to need multiple different um like having the entire risk infrastructure of the world on, you know, kind of governed by one set of participants is probably that doesn't totally foot with me. Although I think a their new V4 is also kind of leaning into a more modularized uh segregated infrastructure as well. So it seems like the entire world regardless of where you sit on the spectrum is going this way. Um >> yeah, I haven't seen the the code or design for a before, but very interested to hear about it in due course.

>> I'm really excited about it, too. Uh I mean we I think this was about a year ago or but Sonia I remember nerding out with you on umbrella um kind of the you know an improved risk model uh a had where they removed a as kind of the backs stop uh you know lender of last resort and actually you know made almost did like a perlike design where stakers um you know uh basically got extra yield in addition to you know being uh more risk capital to uh you know protect the protocol against bad debt. So yeah, there have been I I don't want to represent this as you we're not going back to the modular versus monolithic days. There's like a lot more nuance um in this debate and I think there's tons of merit to both models. Everyone in crypto loves to talk

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yield and sequencer fees routed back to DeFi users. Incubated by Polygon Labs and GSR, Katana is launching with notable ecosystem of primitives, assets, and partners like Morpho, Chainlink, and more. Katana's 1 billion KAT campaign is live. Bridge and deposit directly into Vault in one simple click and start earning immediately on your Ether, Bitcoin, USDC, and more. Follow the link in today's show notes to get started. As always, investments in blockchain technology involve risk. Terms and conditions apply. Do your own research. Okay, guys. Uh, and that that brings us to where I want to end this conversation because I think we're just at the beginning of the this very interesting new phase of borrow lend, which is our WAS have really kind of won. Maybe one

is the wrong framing, but there's going to historically when we thought about um DeFi, it's been based around uh digitally, you know, kind of native bearer asset instruments which had certain set of properties. If you're a nerd for borrow lend or crypto in general, you call these atomic assets. Now we have an influx of especially on the borrow lend side rwas where people want to borrow and lend us dollars is kind of the first one but increasingly we're starting to see other forms of assets that exist offchain get represented onchain. Treasuries are a good example of this. Um also I know you know we were just using the example of MF1 which is a delta neutral fund uh where their LP shares are represented on chain and so

>> it's a private credit fund private private credit >> I would I would call it a yielding product is probably the best way to describe it because uh if I'm not mistaken it allocates across a a wide range of um of internal funds at Fasinor and not just the delta neutral arbitrage one. >> Perfect. Okay. So, uh, but the what we're starting to get is these kind of tokenized representations of, um, of off-chain assets onchain. And one strategy that we know has, uh, have become quite popular in crypto is this idea of looping, right? So, you take you collateralize an asset like Ethereum, you know, let's say you have a million dollars worth of ETH, you borrow 600K of

USDC, you take that USDC, you put it into Ethereum, and you just run it, and you essentially lever it up. um let's say ste actually so you're kind of levering up the yield on that and the mechanics of that are fairly well understood at this point but this this changes when you have uh real world assets and Sonia used this phrase liquidity cadence right there there are certain assets where you can't actually sell it into the market because there's a there's an actual legal ownership of the let's say the underlying LP shares of a fund and then there's the tokenized version of that and that creates a lot of complexity so again you know treating me like I'm five uh Maybe Sonia, could I kick it to you? Explain, you know, some of the complexities as you start to create like looping strategies or levering up strategies for RWAs using

DeFi infrastructure. >> Yeah, so I'm surprised that there's a lot of RWA looping going on despite this uh duration issue. So um just for the viewers who are not familiar with the looping mechanics, normally what you would do is you buy an asset, you collateralize it on the lending markets, you draw financing against that collateral, you then invest more into the asset, collateralize it, borrow against it, and then so on and so forth. So for you know atomic assets like you said Mike um you can you can do this quite efficiently because you can mint and redeem you know the the underlying um any time but if the underlying is say a tokenized fund

with a liquidity cadence of monthly subscriptions then each loop is going to take one month and to lever up to you know 5x depending on the math but let's say you need to establish 30 loops to get to 5x leverage, then just to establish your leverage position, you're going to have to spend 30 months uh looping uh you know, loop by loop. Who would do that, right? That's like such poor UX. So, >> yeah, not Romeo. So, uh yeah, I think that people are still doing this, but there needs to be a better way for people to be able to, you know, um do this uh you know, yield spread leverage

trade. So this is actually what Romy and I are building at 3F. Um the project is still you know somewhat under wraps and in early stages but uh we have a really exciting innovative ways that um RWAS can be levered up using modular lending protocols. >> That's really that's super excit I should also disclose I'm a small but proud bag holder uh in 3F. Um but and and I want to unpack the I want to unpack the mechanics of how you're thinking about maybe making this market somewhat more efficient. Don't reveal any state secrets. Uh but you know curious a little alpha for the listeners but I I want to actually first just talk about why like just contextualize a little bit why this market might be so

large. And maybe it's, you know, from talking to the two of you, um, you know, in more in more detail these last couple months, but to me, the, you know, I hadn't really connected this idea of looping, which felt like this very cryptonative interesting behavior of levering up and trying to get um, you know, more, you know, like higher yields by putting leverage on a strategy that there is a a very well understood correlary or similar behavior in traditional markets where you might take a very safe strategy like a basis trade on something like treasuries and lever it up to take far more risk and generate higher yields on it. And so, you know, I had never really, you know, when I kind of think about the TAM here of one lending borrow lend of RWAs versus

digitally native assets in crypto, we're increasingly moving towards the RWA route and away from the digitally native route. But then when I kind of try to market sizes and think, well, how big is this? Then you actually look at the way that finance behaves and there's a gigantic market for taking relatively safe uh trades or you know trades that might generate a little bit of yield and levering it up. So putting this together, it's like, wow, this is actually a massive market and a huge opportunity, right? Um because we know that there's this, you know, enormous, you know, this this very well understood analog and behavior, but it just hasn't been solved in crypto because of these, you know, kind of the nuances of looping and why that hasn't made sense historically. Am I thinking about this right?

>> It hasn't even been really solved in the real world either. And Romeo has like a really interesting anecdote here because banks basically gate what can be used as collateral to do this trade offchain. Um so people with interesting yielding collateral can't really draw financing against it through banks or other other means. Um, so the total possible TAM for this trade hasn't really even been tested in the real world because of this the gating mechanism and the the increasing risk management u that came generally post GFC global financial crisis.

Yeah, alternative assets in general uh just aren't very well serviced in in in the real world because alternative assets are alternative, right? And so uh it takes a huge effort for these big banks or even you know smaller but still really large private banks to underwrite some new collateral like a you know private credit fund or a yielding product or a crypto arbitrage fund. um they just won't do it and uh also don't really know have the knowhow to do it you know in the first place. So modular lending, you know, tokenization, RWA are really building the building blocks for what can be a world of alternative asset

financing um in a much more curated, tailored, but also appropriately priced way people who have these interesting um assets and collaterals can get financing and therefore leveraged access to those um in a very very beneficial way. Uh this is really what we're what we're trying to conquer here. Um and there's a ton of demand within the blockchain ecosystem for leveraged access to these products.

Uh currently it can't be matched because of this problem of recursive looping. uh we're hoping to solve that and and and and effectively open up um this this access and unlock a ton of value in doing so. >> So what are some of the so I I feel like maybe if I had to articulate the the value proposition here from the lender and the borrower side here, right? Like let's say you know let's say because I think the 3F is starting with um you know delta neutral funds, right? So the the value proposition here from the uh borrower side uh is that uh hey I actually you know there are some very

the the ones that aren't getting ADL right um they actually generate you know very reliable yields with very little um you know down months or anything like that like somewhere between let's say 8 and 15% on an annual basis. if I'm very comfortable with, you know, the risk management that happens there. Maybe I'm maybe I want to lever that up a little bit and get more risk. So, you know, the I can take that 15% yield and make it 30% yield. Um, and as a borrower, I should have the ability to do that. On the lender side of things, this is essentially a distribution channel for them, right? Like this is saying, hey, I can now, you know, take these shares and, you know, actually pledge it into a market and, you know, take liquidity against it or do any number of things.

But is that like roughly the right way to think about this >> on the issuer side not lenders? >> Yeah. >> Sorry. On the asset side. >> Yeah. And the amazing thing about taking leverage on a yielding asset, you know, external to to the asset itself is that you're not increasing the risk, you know, internally to that asset, right? Just because you're leveraging a yielding product or the shares of a yielding product doesn't mean that that yielding product now becomes more risky or is at a greater chance of losing or having a down month. Um, so it's two ways of doing it, right? I mean, you can have a fund that is like 10 times

leveraged internally or you can have a fund that's one times leveraged internally, but then you leverage it up 10 times. It's really funny. We actually have a friend um who goes by an anon name in the Xerx research chat and his uh day job is lending to big hedge funds to do exactly the off-chain equivalent of what we're trying to do. So he would lend you know like I think the average check size of the loans was like 250 million and his counterparties would be like Citadel um you know Blackstone and these reputable hedge funds. Um and the construct of leverage there is that you know within those funds they would take

something like 25x leverage and then with the lender they would take 2x leverage. So the the overall leverage is basically 50x in crypto we have the opposite. So if you know 3F is successful and um the platform allows users to take up to say like 25x leverage on certain assets but then the underlying you know asset at the at the fund level is either ungeared or you know very modestly geared to like one to two% or 2x leverage. So I guess yeah interesting that the overall leverage in the system might be shaking out to be the same but the construct of it is very very different. So TRDFI seems actually

more den than than crypto in some ways. >> In many ways is what I'm learning. Yeah, in many many ways. >> Yeah, anywhere we can 50x anything in crypto, but you know there should be. So >> that's the world I want to live in. I completely agree. Yeah. Uh um >> and long that's the world I want to live in. >> Speed strips financed and subsidized by Farcoin Long games. Yes, I I want to live in that world as well. It's a shame. It's like the meme of like this is what the future would look like.

Could you 50x long uh your farcoin position where he's link crypto? So, um guys, maybe in in closing here, yeah, I you know, the way that I think about the opportunity here is there's there's alternative assets. Um but there's also just moving a lot of um a lot of this activity that exists in you know if I were to look at the existing setup for how do you you know put leverage on a uh you know on a basis a treasury basis trade you're kind of leveraging prime brokers and you know one thing and again you know no need to get into super secret sauce here but I think you're innovating on the concept of looping in in general so I actually think about this as you know through protocols like 3F but blockchains in general you can provide financing where it's dated um

from banks that for whatever reason might have you know biases or not be underwriting risk uh correctly here. But there's also just an opportunity to move a lot of this uh this basically this entire trading strategy onchain kind of innovating on you know in the trady side of things you get prime brokers to provide leverage here versus in crypto you'd kind of utilize other systems. So help me understand, you know, kind of um what that migration might look like and maybe just like the outline of the protocol and then we can kind of wrap it here because I know you guys have already been super generous of your time.

>> Sure. I'll I'll happily take this. So if you want to leverage some some asset, you know, in your in your private bank account, you know, you can ask your your you can call your bank and say, you know, can you please give me three times leverage on the S&P 500, whatever it is, and the bank doesn't recursively loop the S&P 500, you know, they just extend you the credit line, buy the asset, and then that immediately becomes your collateral. Um, and we're trying to make a similar system uh happen on chain where you don't have to recursively loop because that would take you forever. You can just buy and get exposure with leverage in one go. And that bridge that

banks extend you when they buy the S&P 500 uh is something that we can replicate actually on the blockchain if you bring together a bunch of institutions to extend that facility and you can then as soon as you're issued you know the receipt of your purchase which is in this case the tokenized representation of that position in the RWA you can immediately collateralize it and then repay that bridge facility on Morpho or Ave or Oiler or whatever it is. And so what you have is now a leveraged position that instead of taking you, you know, 30 months or years, you know, depending on the cadence, the liquidity cadence of that asset, you have it now in one go.

And then the same thing is applied on the unwind, which means that suddenly all of this demand can be matched because the friction to to building is is no longer there. So this is what we're trying to do. Um there's uh there's some exciting things coming in the in the pipe, right? So do so do uh do keep following and yeah. Awesome. Well guys, if uh folks want to um find out more, maybe follow the two of you on Twitter for more uh RWA, DeFi, you know, generally looping or leverage type takes. What's uh what's the best way to to do that?

So my Twitter handle is Sonia Sunkim and 3F Labs also made a Twitter recently. Um it's 3F Labs. So follow for more uh loopless looping tips on our Twitter account. >> Yeah, just just follow I I'm sorry I forgot my Twitter handle. I don't actually know what my Twitter handle Okay. So, I think just by that alone, you know who to follow here. So, uh yeah, follow. >> Oh, I know. It's it's 3F Romeo.

>> All right. We'll get you we'll link you in the in the show notes, buddy. We got you. Um guys, this is this has been a ton of fun. Um and yeah, we'll have to do it again sometime soon. >> Thank you, M. Cheers all. Bye. >> Bye, guys.