Jeff Wu & Teddy Woodward: Notional Finance – The Fixed-Rate Lending Protocol #413

Transcript

Welcome to Epicenter, the podcast where we where we interview crypto founders, builders, and thought leaders. I'm Sebastian Miconcio and I'm here with my co-host Frederick Earnest. Today we're speaking with Teddy Woodward and Jeff Woo, who are respectively co-founders and CEO and CTO of Notional Finance. Before we talk to Teddy and Jeff, uh I'd like to tell you about our sponsors this week. With ParaSwap you can beat the market price every single block. It's fast, highly liquid, and they just launched the V5, which has brand new contracts and APIs. It has a modular infrastructure, which is more gas friendly and now supports free approvals using Ethereum's permit messages. They also recently added support for Avalanche, Polygon, and BSC.

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Chorus One also just helped launch Lido for Solana, which is really exciting. Uh Solana's liquid staking solution that allows you to stake and participate in DeFi at the same time. So head over to chorus.one and start your staking journey. So hi Ted and Teddy and Jeff, thanks for joining us today. Thanks for having us, Sebastian. Yeah, thanks for having us. So before we get started uh and dive into Notional Finance, uh tell us a bit about your backgrounds and how you became interested in crypto. Uh okay, I'll I'll start. So um I uh started my career I was I was I was actually working in banking. So, I was a interest rate swap trader.

Um, and uh, you know, basically, you know, I I I started there for for about 4 years at Barclays. And, um, I really liked trading, but uh, I kind of hated working for a bank. And, uh, it seemed to me that it was very much, uh, the way of the past. And so, I was sort of trying to figure out, you know, what, you know, what the new thing in finance was going to be. And cryptocurrencies just seemed like an obvious sort of next step. Um, whereas, you know, cuz I was working in in sort of finance post financial crisis, and there were all these regulations that were making it very, uh, almost impossible to do anything new or interesting or creative, um, which, you

know, there's reason why those regulations were in place they were in place. Um, but it was a lot more boring to work uh, in that environment. And, um, you know, so stuff like cryptocurrencies were just completely new thing. And just like um and it just seemed to me to just be like super exciting and intellectually interesting. And so, I wanted to be a part of it. And, um, I left uh, my job to trade crypto, uh, for a family office in 2018. Uh, and then sort of towards the end towards the end of that, so end of 2019, um, I wanted to get into DeFi. And, uh, uh, I started Notional with Jeff um, in January of 2020. So, that's that's

me. So, Jeff, what about you? And how did you guys meet? Yeah, so, uh, so my background is more in tech. So, I, you know, started my career in the Bay Area working for, uh, tech company doing data science and working with distributed systems. So, in around like 2011, I, uh, you know, that's when I started my career and back then kind of the hot new distributed system was Hadoop, which maybe some people remember, but that was sort of like the beginning of uh like big data like the big data kind of movement, right? And so um yeah, so I spent a lot of time doing data science, data engineering, um

and you know, that type of work. Um in 2016 and 2017, one of my coworkers introduced me to to Bitcoin and uh I just kind of naturally like became fascinated with the technology. And really at that same time, it felt like it kind of felt like the early days of of like big data again, you know, this is like a cool new distributed system. It works at a much larger scale and so it kind of got me excited again about some something new. Um It didn't really like click for me as like why someone would want to use blockchain or crypto until I started reading about MakerDAO. And that's when I was like, "Okay, this is like there's a natural kind of product market fit

here with uh with financial products, right? Like this this really makes sense to me." And so in 2018, I I left my job and I took a took a new job at uh Splunk as the product manager for their blockchain uh for their blockchain team. So, Splunk is uh it's sort of a data analytics firm here in San Francisco. And um you know, I worked looking sort of at the blockchain crypto industry in general uh looking for like business opportunities for for Splunk. And so, in the course of that um in late 2019, I met Teddy actually at a Cosmos hackathon uh here in San

Francisco, where actually we met we met Sunny. Uh so, this is kind of a story at the hackathon, too. Yeah, all right. Yeah, yeah. So, we met I was I was I was just walking around taking pictures and like, you know, like putting stuff on Twitter. I wasn't actually doing anything, but I was there. Oh, awesome. Yeah. Yeah. It was actually a surreal experience cuz I'd been listening to Epicenter a lot. And I was having trouble with the Cosmos SDK and like Sunny sat down next to me and started helping me and I was like, "Oh, wow. This is like kind of surreal." But yeah, Teddy I met there just actually very serendipitously.

And we we we just I like I had wanted to do I We had both seen Compound come out like that very recently then. And we were I think we both just wanted to do a fixed rate fixed term version of that because we felt like that was like I was like like variable rates are cool, but like a fixed rate product is something that is more compelling to like a a mainstream audience. And so and I also think like from when we first met at that hackathon like within the first 10-15 minutes we just hit it off. Like we have a really good rapport in terms of like the kind of skills and expertise we bring.

And that I think they complement each other really well. And and I think we also get along really well on a on like a personal level. So Were you guys building anything at the hackathon? Mhm. Yeah, we built a very early version of Notional. It's a fixed rate fixed rate kind of thing using the Cosmos SDK. Actually we we took first prize there and that that kind of encouraged us to to keep going. So Okay cool. And so then you switched over cuz you were building it originally I mean the prototype or like proof of concept was on Ethereum on on Cosmos.

And then you know, what made you decide to pursue it on on Ethereum? I mean I think in so that was late 2019. You know, at the time you know, DeFi was still quite young then and and all the activity was on was on Ethereum. So this seemed like a natural fit for us. Okay, cool. Actually, I think this t-shirt I'm wearing now and I got from the conference and I like my my daily water bottle is like the the water bottle from that hackathon. I have like lots of swag from that conference for some reason.

I was going to wear the t-shirt, but I couldn't find it. I I guess I had a question for for for you, Jeff, about your sort of Pax experiences and something that I often find myself thinking about because I'm not at all sort of like familiar with you know, the the the the big data industry or like that sort of like ecosystem. And I wonder if there's anything that you know, you you What are the things that you took away from that experience like working in that industry that apply to crypto? Because like I I think in many ways they're similar, but like in many ways they're also different like the types of infrastructure on which you know, blockchains operate like totally different from the types of things you were mentioning earlier. So, like what's the parallels there and how does that apply in the crypto space for you?

Uh I think I think one is just like uh they're both distributed systems like uh big data computing is uh it's distributed across, you know, I mean uh kind of a cloud environment, um but sort of the general principles of like state um across multiple machines, uh message passing, you know, consensus. They're applied in similar ways. Um so, there's like a lot of like kind of low-level kind of technological uh kind of analogies between the two. Um so, that's one. I I do think from an engineering perspective, working in blockchain is is both fun and frustrating. I mean, if you're in the big data space, you sort of always have like at your fingertips unlimited

compute and unlimited storage uh sort of endlessly. Uh and but on the blockchain, right? Like that's not the case, right? Every byte you use like costs money and there is like a lot of congestion. And so, uh kind of flipping from like one like, you know, endless supply to like very limited supply is like it's an interesting engineering challenge. I think it's quite fun. I would say that's kind of the big difference, yeah, for sure. Cool. So, let's talk about Notional. So, you're you already alluded to it. So, Notional is a fixed rate lending and borrowing protocol.

Maybe let's talk about this at a high level first. So, why why is the fixed rate something that's desirable for customers? I mean I think that you know the fixed fixed rates are really desirable because they give people stability and certainty and the ability to plan for the future. You know and and you can sort of if you look at traditional financial markets you see that the amount of fixed rate debt compared to variable rate debt is just like overwhelming. I think like something like 90% of the US the US debt market is fixed rate as

opposed to variable rate, which shows that you know empirically it shows the importance that both borrowers and lenders place on sort of stability and certainty. And and you know just like if you know if you think about it it's it's very challenging to do anything beyond you know a very short-term time horizon if you're working exclusively with variable rates. Like if you want to take out a loan even just use a an example from sort of your everyday life. You know if you want to take out a loan to buy a car and the rate that you're the rate of interest that you're paying on your loan fluctuates between 2% one month and 10% the next month

it's it's very very difficult for you to plan and you know know if you can afford that, right? So so know, if you extrapolate that forward to like you know, if if your rate of interest is fluctuating that much every sort of every day or every month or it has the potential to, I mean, it's very, very difficult to like commit to I'm going to borrow something for five year, you know, take out a loan that's like with five year maturity. Um just because like you have no idea. I mean, it it it's it's just makes it very, very difficult to do anything but something that's, you know, extremely short-term.

Uh and and so I think that like you know, fixed rates beyond just sort of bringing in sort of a a more, I I I use a base that values certain team stability can can also just really expand like uh the capability of sort of the DeFi system to enable use cases that are sort of more long-term and just like an enable like new kinds of behavior. Um yeah, so so I think that's what we're really excited about. So, Teddy, um can I ask something about legacy financial system? So, basically, I totally see that for consumers um having fixed rate loans um is highly desirable just because

loans that people typically have to um to satisfy often uh a significant portion of the money they have to spend, right? Um but what you're what you're doing in essence is that you're buying insurance or you're buying some sort of financial product that um that gives you a fixed borrowing rate. Um whereas if you actually got the the borrowing rate that was just the borrowing rate of the day, um you would probably on average pay slightly less, right? So, basically, if if you say 90% of our loans are fixed rate, um is that consumers or is that also um is that also uh companies? Because basically, if

I'm a big company and I kind of operate on that level, um, I can take larger financial risks um, and kind of shave off like a couple of tenths of a percent somewhere, right? Yeah, so I think that's actually not necessarily the case. So your assumption here is that um, essentially by by fixing your borrowing rate, you're paying away some some expected value, right? In return for getting this certainty. That's Yeah, exactly. That that's exactly what my assumption would be. Is that wrong? Well, I mean it it uh, it's not necessarily it it it sort of depends I guess in like really like super trading about this. Like it it's sort of like depends on aggregate who

values the certainty more, borrowers or lenders, right? It's it's possible that, you know, for example, the lenders may like value the certainty more than the borrowers and then it theoretically anyway, they would be sort of willing to pay away some expected value in return for the certainty. Right? So it's not necessarily um, but I think that, you know, in reality it's just it it doesn't quite work like that, you know? So like uh, for you know, for example, the ability to borrow at a fixed rate is not just a it's not just a uh, like a a bet on where the sort of variable rate is going to be over the

term of the loan because like for example, you know, if you borrow if you know what your fixed rate on your borrowing is, it gives you the freedom to pursue perhaps uh, a certain type of investment that you feel like only might generate this amount of return and the fact that you're able to fix your financing costs uh, gives you sort of the confidence and like the sort of minimal aggregate risk such that you will pursue that course of action, right? So it's it's less of a like, you know, there's there's a given amount that I'm going to borrow anyway and like should I borrow variable or fixed? It's it's also sort of like, you know, I want to borrow fixed because that will allow me to take on, you know, this other

investment opportunity which maybe has a capped upside return and and I'll know that because my borrowing rate is fixed, my profit's going to be positive, right? Or like I'll have a reasonable expectation. So I I think it's it's honestly just like more complicated than, you know, just you're speculating on what the variable rate is going to be over the duration of the loan. It's it's just more complex. So walk us through the product. I'd like to start with, you know, what the product looks like from the user perspective and then maybe we can dive into, you know, the more technical aspects.

But first actually I'd like I'd like to ask you how much liquidity is on Notional? Uh yeah, so so right now we're we've had, you know, kind of fluctuating liquidity. I think like right now we're in in the order of 10 million TVL. Um so kind of, you know, what we've been doing as as a company. So I'll give you a little bit of background. So we we launched Notional V1 in January of this year and we've had, you know, I think between 10 and 20 million dollars of TVL since the launch and and what we're doing right now is we're, you know, kind of got our heads down building Notional V2 and we're we're just getting set to launch that.

So Notional V2 is going live in three to four weeks. Fingers crossed. But that's going to be, you know, I think that that'll be a big step up for the protocol because we're sort of making some significant changes to the protocol as well as launching our token and our public liquidity mining program. And we anticipate that, you know, this set of changes is going to really be a big step forward for for Notional. Cool. So, then walk us through the product. Like what what can I do as as a user of the of this product? You know, if I'm a lender or a borrower, what does it look like for me? And maybe, you know,

contrasting that to what people may already be used to, which is, you know, Aave or Compound or some of these other lending platforms. Uh sure. Yeah, so so basically, like the core concept in Notional is is what we call fCash. Um and that is kind of like a zero coupon bond in that it is defined by a currency type and a maturity date. So, for example, December 1st, 2021, uh USDC is is an fCash token um that matures on December 1st, 2021. Okay, so this fCash token is transferable, it's tradeable, and on December 1st, 2021, it can be redeemed for 1 USDC on Notional.

So, effectively, uh December 1st, 2021 USDC represents USDC at that specific future date. Okay. Uh and the way we enable fixed rate borrowing and lending is by allowing users to trade between USDC today and USDC in the future as sort of represented by this fCash. So, if you're a lender, uh you can sell your USDC today and purchase USDC on December 1st, 2021.

And the exchange rate at which you make that trade between USDC today and USDC on December 1st implies a fixed interest rate over that period of time. So, that's like the basic way that this works. And and the way we sort of facilitate that trading is we have liquidity pools uh on chain, where we have, you know, USDC on one side and US or December 1st, 2021 USDC on the other side. And you can sort of trade between them. And and we have liquidity pools for different currencies and different maturities. So, you know, we'd have USDC December 1st liquidity pool, you know, a USDC March 1st, 2022

liquidity pool for example. And so, we have as a user you have multiple options. You can, you know, borrow and lend die and USDC at at several different maturities. Um so, in a way you're not actually So, the protocol doesn't fix an interest rate, but market mechanisms do kind of like they would in traditional financial systems. That's correct. So, and the way I think about it and and, you know, for everybody listening, I'm a trader. So, so it's probably not the way that everybody else thinks about it but I think about it less as borrowing and lending than it buying and selling cash in the future. That's that's the way

that I think about it. And and yes, it is market determined, right? So, we have these liquidity pools. As people borrow and lend, they move the prevailing you do you guys have basically liquidity providers or market makers that kind of emulate what a currency market would look like on a legacy system? I I suppose. It's it's it's it's it's interesting to to compare this to the sort of traditional financial system, but but yes, we we we do have liquidity providers. So, so the system relies on liquidity providers to put their capital into these liquidity pools so that borrowers and

lenders can actually use the protocol. Yeah. And the liquidity providers, um, what's in it for them? So, um basically, and I'll talk a little bit about Notional V2 here because we've sort of changed the way we've changed the way that this works a little bit, but basically, the liquidity provider earns interest on the capital that they put into the system. So, in Notional V2, liquidity providers actually provide C tokens instead of the underlying token like DAI. They'll put in cDAI. So, they earn interest on their capital plus trading fees. So, anytime someone

borrows or lends, they pay a transaction fee that goes to the liquidity providers. You know, very similar to Uniswap. So, so the liquidity provider is going to earn interest on their capital via Compound. They'll earn transaction fees from borrowers and lenders on Notional, and they'll also earn sort of, you know, in Notional V2 anyway, liquidity incentives in the form of our governance let's talk about the governance token in a bit. But, does that mean that the borrowers and lenders effectively get the same rates? So, basically, because there's no spread?

So, there there is a spread and the the spread but that's a one-time thing, right? So, it's not That's correct, yeah. So, it's it's a it's like a true market rate and borrowers and lenders get the same market rate. As opposed to something like a Compound, where there's structurally a spread between the lending rate and the borrowing rate, that is not the case in Notional. There's there's like one interest rate that both borrowers and lenders get. So, what are the I mean, there must be trade-offs to using Notional as opposed to another, you know, lending platform.

What would you consider those trade-offs to be? Okay, so so I guess uh so you know, I would compare it to something like uh to something like Compound or Aave. Uh and the trade-offs, I mean, I think from my perspective, I think that the most significant trade-off is going to be just the fact that Compound and Aave have been around for a while and they are lower risk therefore, right? Um I think that smart contract risk is just an undeniable uh thing that anybody has to reckon with in DeFi. Uh and if you're launching a you know, a big ambitious new platform, you know, like Notional V2, uh you know, people need to think about smart contract risk, right? And and uh

I think that, you know, Compound and Aave have is that they've been around for a while and and this most recent thing with Compound notwithstanding, um they uh uh have have, you know, built a very strong track record of of security. So, I I would say that that's like you know, that's probably the uh most significant trade-off that I would that I would see, yeah. I just want to add add a couple of things here. So, one is that I think that one misconception that we we've seen a lot with Notional is that uh even if you're like lending or borrowing fixed on Notional two, you know, three or six months, you're not uh locked into that for the duration of the term,

right? So, one thing about Notional is that you can, you know, lend uh lend some money and if you need to withdraw that money, you can sell that fCash back into the markets and get your money out. And you'll be able to sell it at sort of the current market rate at that point in time. So, that's, you know, one thing that we've heard with Compound, oh, you know, like Compound, I can always get my money out. Well, that's kind of uh similar with Notional as well. Um and I also say one trade-off um on the downside here with Notional is that since you are going through a liquidity curve on both on lending and borrowing, you you know, the lending the gas fee on the lending side is going to be um similar to the borrowing side, right?

So, um on both sides the gas fees will be a little bit higher. I think on Compound since you're just wrapping C tokens, it's it's cheaper on the lending side. Um but, you know, for us that the action is is about similar on both sides. So, you'll pay a little bit higher gas fee. Um but, uh I think those are those are the main differences. Yeah. And what happens at the maturity date? Like, are you expected to have paid off your loan by the maturity date? And if you haven't, what what happens? You get liquidated or what happens then? Uh yeah, yeah. Okay. So, um basically, uh so and just for for your listeners' clarity here, so I'm I'm going to be talking about Notional V2, okay? So, so given that that we're launching this

pretty quick or pretty soon rather, um and we've changed a few things. So, in in Notional V2, if you're a lender and and you reach maturity and you haven't rolled your loan forward, um what's going to happen is that immediately upon maturity, you're going to switch from earning a fixed rate uh to earning the variable rate. Okay? So, so immediately upon maturity, you're no longer earning, say, 6% fixed. Now, you're just earning the uh variable Compound lending rate on your cash.

Okay? So, you there's no action necessary. That's what happens as a lender. Now, as a borrower, uh it's So, basically, the the way Notional works, it's it's very important uh in order for us to ensure that lenders can pull their money out when they're uh entitled to taking their money out, we have to make sure that borrowers uh essentially make good on their obligations, right? And pay their debts by the time that they say they're going to pay their debts. Um so, if you're a borrower, uh and you borrow until March 1st, 2021 or 2022, rather.

And you can you can roll your debt forward if you don't want to actually repay your debt. So, so, you know, let's say it's April 1st, you can decide, okay, so I'd really rather keep my debt open, so I'm going to roll my my March 1st debt into um, you know, March 1st, 2022. Or 2023, rather. Um, so you can roll your debt forward. Now, if maturity uh, does come and you haven't paid your debt, what's going to happen is that a a third party can roll your debt forward 3 months on your behalf.

So essentially uh you will be forcibly auto-rolled forward by 3 months at a penalty interest rate that's like, uh, uh, at the moment we've decided upon uh, a 250 basis points. That's 2 and 1/2% uh, penalty to the current market interest rate. So, you know, if the 3-month interest rate was 6%, your debt would be rolled forward at 8 and 1/2%. Um, so there's like a little bit of a penalty that you're paying for not paying on time, but you are not going to get liquidated, your collateral is not going to be seized. Um, your debt is just going to be rolled forward.

that's interesting. That's it's quite different from the experience say like on a, you know, typical uh, lending protocol where like you borrow the money and you just like pay the interest for as long as you're there and, you know, if you pay it back, whatever like you're you're paying the interest on the on the principal. So, when when this happens, who who are these third parties that get to kind of carry over your loan for the next 3 months? And are they is there some kind of incentive mechanism here for them to do this or doing this sort of rolling forward. And and the incentive is is, you know, so we

said that there's you're you're borrowing at this penalty interest rate, you're you know, at 2 and 1/2% over at sort of the market interest rate. Um that that's that settlement penalty uh is the liquidator's incentive. So, they essentially lend to you at a uh 2 and 1/2% premium to the market rate, uh and then the expectation is that they would lend to you and then immediately sell that F cash that they got from you on the on-chain market and just capture that spread.

Okay, I see. Um and you already um you already talked about the fact that everything is collateralized. So, can you talk about um the choice of collateral and um what the collateralization ratio is? Sure. So, so this is going to be something that that will uh that will change um and on on an ongoing basis, um but we are going to launch with uh so, we're launching with the same four currencies that we have uh live on our short V1. So, ETH, wrapped Bitcoin, USDC, and DAI.

Uh and all four of those currencies are going to be lendable and borrowable, and they're all going to be eligible as collateral to collateralize uh loan in any one of those currencies. Um and the initial collateralization ratio uh for like a a USDC debt collateralized by ether and for example, um we're going to start off conservative. So, we're starting off with a collateralization ratio that is that's roughly 150%. Um so, it's a you know, a slightly more conservative collateralization ratio, but that sort of reflects the fact that, you know, this is uh we're launching a brand new protocol, uh and we want to get comfortable before we sort of start making that ratio a little

bit more aggressive. Uh and then for at the actual collateral types, um so, you know, we're launching with those four, but uh the collateralization framework of Notional V2 is very flexible. So, we we will have the ability to uh uh uh deploy new collateral types, and we very much intend to do that. So, that that's going to be uh from a business standpoint uh we expect to launch a new batch of collateral types pretty pretty close following the launch of Notional V2. So, we will definitely like uh continue to add support for new collateral types that sort of fit fit within the risk framework of the protocol. So, yeah, so I mean, you know, this stuff will you know, we we

uh we do a lot of this kind of risk work in-house. Um, and uh uh uh you know, it's something that I think we we put a significant emphasis on as a company, and we want to put uh an emphasis on as a community. Um, sort of risk management of the protocol. And so, I think that these collateralization ratios and new collateral types, you know, these things are going to be fluid, and we definitely definitely intend to make Notional as capital efficient as can be without sacrificing the integrity of the protocol. Uh and we want to uh enable people to borrow against as wide a variety of collateral types as as we can safely onboard.

Okay. Um, maybe let's talk about the governance and how to add collateral types in a bit in the frame basically in in the context of the token also. Um, but uh just just uh for wrapping this up, so what happens if my loan is underwater? Uh yeah. So, so if your if your loan is underwater, basically um if you have become under collateralized, you are eligible for liquidation. So, what a liquid a liquidator can do is uh they can purchase uh a portion of your collateral, and uh you know, deposit the uh uh, currency that you owe, right? So, if you are taking out a USDC loan collateralized by Ether, your liquidator

can purchase some of your Ether and give you USDC in, you know, in exchange for that Ether. Um, so basically, you know, by doing that, they're going to reduce the risk of your account and and re-collateralize re-collateralize your account. And what's the penalty? Yeah, so so the uh, the initial penalty we're going with, um, for So, basically, the liquidation penalty is going to vary by currency. Uh, now, the liquidation penalty for Ether, um, the sort of the initial penalty we're uh, going for is 8%.

Um, so yeah, so that that that is the liquidation penalty. Um, one thing I know that we're talking about collateral here, and so one thing I wanted to mention, I think Teddy can describe this uh, better than I can, but one thing about Notional which is different from Compound and Aave is that um in Notional, your collateral can also be liquidity provided into uh, Notional fCash markets, right? So, uh, like Teddy mentioned, uh, ETH is both uh, tradeable uh, on in these fCash markets. So, you know, you could deposit ETH that'll be wrapped into cETH uh, as your collateral, but you can also uh, deposit ETH and have it turned into liquidity, which has been

provided on those ETH markets. So, you'll be uh, earning additional sort of yield on your ETH uh, while it's being provided as collateral. So, um, one thing about Notional which uh, you know, I I know we're talking about a very high level here, but there's a lot of depth in terms of the collateralization framework, which allows people to uh, sort of collateralize uh, not only liquidity, but also uh, lending, right? So, you can be lending ETH out at 6 months and be borrowing against it. So, there's just a lot of ways to There's actually like beyond just the currency types, there's also like different sub sort of subcategories of each currency of how it can be represented as collateral. I don't know,

Teddy can probably explain this a lot Um yeah, yeah. So, I'll I'll just kind of like follow on that a little bit. Thanks. Thanks, Jeff, for sort of bringing that up. But like But yeah, so so if you want to take out a USDC loan and you've got ether as collateral, you can just deposit the ether into Notional and borrow against it or like Jeff said, you can earn yield on your collateral while you're using it to borrow against, right? So, so if I've got my ether, I can actually lend it at a fixed rate on Notional and then use that loan to borrow against, right? So, I can I can lend it. I can also provide liquidity on Notional. So, we haven't talked about this yet, but in Notional

V2, we have this thing called N tokens, which is sort of our version of Notional liquidity tokens. So, you can mint N tokens from your ether. So, you can provide liquidity to Notional and then borrow against that liquidity you've provided. So, you can earn liquidity fees, you can earn note incentives, and then borrow against it. Right? So, we think that this is like you know, it took a lot of work and I add like a lot of code to to make sure that this works, but we think that this is like a pretty killer feature because essentially what it means is that you are giving up nothing as you use it, right? So, there is no dead weight from your capital, right? So, like your

collateral can always be earning an attractive rate of interest. So, you never have to like just put up capital and not earn anything on it. And we think that that is pretty critical and it's like it's something where it's It's you know, if you look at the decentralized like OTC lending businesses in crypto, uh they don't give you any So, when you borrow USDC and you you know, collateralize that with ether or wrapped Bitcoin, they just take your ether. They don't give you any interest on it. Right? And whereas like So, so on Notional, this is an objectively better thing because you are earning all the all the possible sort of interest and returns that comes from your collateral

at the same time as you're using it to collateralize your loan. So, we think that's pretty cool. That is cool and uh capital efficiency is something that is notoriously important to DeFi users. But, um this kind of brings me to a question for Jeff. Um So, Jeff Jeff, in terms of security, I mean, so basically, this is this is often a criticism that's levied against DeFi, right? Basically, that it's a house of cards and as soon as uh one card falls, the entire house collapses. And I mean, we've seen that even Trident has the protocols such as Compound and Compound had a huge bug last week and uh pay I mean, it it it it wasn't catastrophic and it paid out too much in fees and so on. But, basically,

it wasn't um it wasn't a catastrophic failure, but it was pretty severe bug. Um So, how how do you go about mitigating this risk um for your protocol and your users? Yeah, so um So, I I would say just like broadly, the way kind of the way we think about Notional the product and and like everything we do, you know, uh our priority is like number one is security. Uh number two is capital efficiency and number three is like user experience. And we kind of evaluate everything we do sort of in that framework. And so, in I think security uh especially in DeFi, like it's sort of

it's just software quality, right? At the end of the day. And and software quality at that's sort of like the highest level that you can like achieve. And that comes like kind of critical components of like good software quality are I think are well known. You know, it's it's good documentation. It's naming your variables cleanly. You know, it's it's like being a really good like conscientious programmer like first and foremost. And then it's testing, right? It's just like exhaustive testing in like different scenarios. And then even beyond that, you know, and like a lot of kind of issues you know, that are ongoing. But at the same time, it's one place where users and

like developers all value security like very highly, right? And you kind of don't see that in sort of like the more traditional software space. Like security tends to be something on the back burner. And so I think it's nice that users actually value this and and pay attention to like, you know, the audits and you know, and care about those things. So, you know, you know, along those lines, you know, it's also not just testing, but it's audits. And it's also like adopting new technology, right? So, we're working with Certora on formal verification and like kind of some of the newer kind of like fuzzing tools coming out which sort of expand the capability of testing beyond just like just what we're kind of writing

you know, right off the bat. So, I think we're always looking for ways to just get more confidence around the code and and just kind of ensure that that it is doing what what we intend it to do. Yeah. Okay. So, basically, if I step back one step, if you look at each individual module, it each DeFi LEGO brick, even if each individual LEGO brick is structurally sound and well-engineered and has clear APIs and inputs and outputs and no intrinsic bugs. I mean, if you combine enough LEGO bricks together, you can still get a structurally unsound system, right? So, basically and to me that's also a

systemic risk that kind of we as an ecosystem kind of need to think about how to go about this and how to protect the users who even despite the fact that maybe each individual brick is fine, but if you if you actually stack them in a certain way, it ends up being very much not fine. So, do you have any measures in place or any thoughts on how how we as an ecosystem should address that? Yeah, I Yeah, I think that's I think that's a great question. I would say what happened with Compound, you know, was I think for me was a eye-opener, right?

Because we you know, we were integrating with Compound. It's It's a It's a dependency here. And you know, unlike some software dependencies where you can sort of hard fixed version, right? Like Compound's going to change. It's a dynamic sort of dependency. And so, I I think it's something that you know, we at least for me the my takeaway was that, you know, I need to be we you know, I need to be paying more attention to what's happening there and sort of what they're doing on on their side in governance, right?

And I think that I think that's true of a lot of protocols which depend on Compound. And you know, I you know, and and I think that's you know, I think at the end of the day, right? As we sort of become more interconnected, you know, I think it's sort of it's in our best interest to make sure that Compound is working well and and working healthy. You know, we depend on Uniswap for people to be able to kind of trade out of positions during liquidation. So, that's you know, another thing that you know, we we're going to do we're going to monitor the liquidity pools on Uniswap and Curve and make sure that they're deep enough for our liquidations.

Um and yeah, I think we we just kind of need to be vigilant as sort of as as a community and a system, right? Because yeah, I I totally agree. We're all dependent on each other. I'd like to ask you about the the F token and or F cash token. I I read that there's a you guys have built a token standard or you're leveraging an existing token standard called the ERC 1155. I I had I never heard of this token standard. What does it do exactly and how's it different from other tokens you may be familiar with?

So, I think most people are familiar with the ERC-20 token standard which So, something about the ERC-20 token standard which is nice and makes it easy to develop against and understand is that something like USDC is always going to be USDC. It's never really going to change. We can pass it around to all of us and it'll sort of it's going to remain USDC. Um one unique characteristic of F cash is that it matures. So, on a particular day, December 1st, you know, 2020, 2021, it's going to convert from a promise to like actual like redeemable USDC, right?

And so, it sort of doesn't adhere to the expectations that you would have of an ERC-20 token because it changes at a very like distinct point in the future. In addition, like one thing that we want to do with Notional and and one like important piece of Notional is the ability to trade and create F cash at different maturities, right? So, we have the three and the six-month and the one-year. And one thing we haven't talked about and is available in Notional is the ability to actually lend and borrow at dates that are in between those different points in time, right? So, you can actually lend in OTC markets at nine months or 8 months. uh uh If if that's something if that's a product that people want, right? And and

a really cool part about Notional is that we can actually value that and value those fCash assets and let you borrow against them. But, you know, sort of the scalability issue of creating ERC-20 tokens for each one of those dates and like, you know, having different token contracts from like a technical perspective, it kind of becomes really cumbersome. And so, that's why we chose the ERC-1155 standard, which we think fits the fits the nature of the token much better. So, the key thing about an ERC-1155 token is that it's sort of it's identified by an ID.

And so, each identifier will be like the currency and the date that sort of identifies the fCash asset. And basically, you can call that contract saying, you know, I would like to transfer, you know, December 1st USDC fCash, and it'll sort of be able to locate it properly and transfer it. And what that does is it gives the developer a single contract, a single point of entry for transferring all different types of fCash assets. And that's kind of it makes programming and kind of like understanding system like a lot better. And one analogy I think for this that kind of helps make it more clear is that you know, in traditional finance, you know, if you're going to trade something

like an equity, you go to the stock market, right? But if you're going to trade something like a bond, something with a fixed term, fixed interest, like you go to different markets, right? You go to OTC desks or you go to like you just go to different markets, and they're not like they're not sort of intermixable in the same standards, right? And I think that's something very similar here, right? This is a different type of asset, and so I think it requires a slightly different standard to to make a make a good experience for the developer. Yeah. So, so it's it's it creates a token which has properties that were where you have a common properties but there's like a non-fungibility between different characteristics of the same token. So, it's like a one contract to manage different uh

fungible tokens that are not fungible amongst each other. Is that like a good way to describe it? that's that's great. So, great way to describe. So, USDC on December 1st is fungible with all other USDC on December 1st. But, USDC on you know, January 1st is not fungible with USDC on December 1st, right? So, so that way, you know, you kind of have these kind of stacked maturities that are going out. They're fungible within themselves but not between. Talking about maturity, uh who who defines these maturity uh periods? And I I I suspect it's governance. Uh so, maybe we could uh talk about that a little bit and uh how all these uh maturity dates get um get defined.

Yep. So, uh again, this is in Notional V2. In Notional V2, um so, one thing about Notional is that when when you provide liquidity, uh it it gets distributed across the different fCash markets. And so, that that has the effect of uh fragmenting liquidity across these different pools. So, one thing that we didn't want to have happen is uh get have it get fragmented across too many pools. So, what we've done with Notional V2 is we sort of um hardcoded uh like a fCash market cadence that will go from three month to six month to one year to two year to five year to 10 year uh and then to uh 20 year. So,

that's sort of like the defined cadence of the fCash markets going out in the future. And governance will sort of enable uh like turn them on as as we go forward. So, we're going to start with the first three, uh three month, six month, and one year. Um so, that's what users will be able to lend and borrow on the liquidity pools. Um, but, like as I mentioned with the actual like uh token standard underneath there, um, there is the ability for uh like OTC trading, like direct trading between two parties at uh sort of dates in between uh kind of those liquidity pools. Um, I don't know if Teddy if you want to add anything to that.

Um, no, I think that's that's uh that's pretty good. Yeah, so so there's like we have this sort of predefined maturity cadence, um, which references a uh a reference time uh that rolls forward every 3 months. Um, so basically, you know, you might have uh January 1st, let's see, what would it be? It would be I suppose it'd be December 1st, March 1st, uh and December 1st, 2022. Those might be your liquidity pools. Uh and then once you uh get to December 1st, those dates would roll forward. They would all roll forward. So, then you'd have March 1st, June 1st, and June 1st, 2022.

So, every 3 months, the active maturities for the liquidity pools are going to roll forward 3 months. When do you plan to introduce um the longer cadence ones? Because I mean, these would be also super interesting um to see how people engage the future of the ecosystem, right? So, basically, if you if you're going to buy 20-year fixed loan on a DeFi product, uh this this has so many externalities that go into this beside what you think money's going to cost for the next 20 years, right?

Yeah. Yeah. Yeah. Um, so I I think that uh you know, I think it'll be a little while before we get to 20 years, if I'm being completely honest. Uh I I think um you know, basically, our our intention here is is you know, there's there's a lot of things to consider when we activate one of these sort of longer dated maturities. So so as Jeff said, we're launching with a three-month, a six-month, and a one-year. So the next thing to turn on would be the two-year, right? And and when you turn that on, it's very very difficult to and and I think technically it might be impossible to turn it off.

Um but uh but you know, basically it's it's hard to go back on it, right? And so once you once you turn it on, uh you need to sort of support it in perpetuity pretty much. Um now, because of that, uh you know, it's not a decision that we take lightly. Uh and kind of the downside well, one of the downsides of turning turning on one of these longer dated maturities is that you distribute the total liquidity amongst a greater number of liquidity pools. So you're sort of fracturing liquidity. So there's like a very tangible downside to opening up one of these one of these longer dated maturities. Um but so basically we want to be sure that uh you know, people really want it

um prior to prior to turning it on. And the and the way we like are going to sort of figure that out uh is by you know, so in Notional V1, we had a three-month and a six-month maturity, and we saw that, you know, the the vast majority of the activity was in the six-month. All right, so this sort of made us believe that, you know, what people really want with fixed rates, they want long durations. Um and so that's why we're launching the one-year at launch with Notional V2. Uh and so we're going to go see and and see what happens, you know, like is the majority of the activity going to be in the one-year? And and are you are users going to tell us that they want uh long even longer dated maturities? Um so, you know, I think that a lot of it is just

sort of like, you know, um we're we're extending the maturity horizon with Notional V2. We're going to see what people think, see, you know, like listen to what they tell us, and if they do want a two-year and we're satisfied that that there's going to be a decent enough amount of activity to justify putting liquidity in that two-year, uh then uh you know, we should be able to turn it on. That makes complete sense, but it kind of leads me to my next question. Who is we? So, who decides? What's the governance look like? Good question. Um okay. Uh yeah, so uh so we have uh uh in Notional V2, as as I alluded to earlier in this in this podcast,

uh we are issuing a you know, the the protocol's governance token, the note. Um and uh you know, like our the governance decision-making so protocol upgrades and and risk parameter changes, um that's all going to be subject to on-chain voting by note holders, right? Um and so uh uh you know, we we've pretty much um we've pretty much forked Compound Governance uh and and maybe Jeff can say a little bit about exactly um any any kind of differences between the way our governance module works and the Compound Governance module works.

But before we get there, I'll just say a little bit about uh you know, the sort of the token distribution. So, you know, note holders are going to be making these decisions um uh and and we are really uh you know, we really believe that uh ultimately you know, we want Notional to be foundational infrastructure for this new financial system, and so we want to dis uh distribute and uh governance of the protocol and to decentralize control. Um and so to that end, uh we have earmarked about 55 to 60% of the total token supply uh for the community to be distributed uh mainly through liquidity incentives, um but

also through a foundation that will support the community with ecosystem grants and sort of you know development grants. But basically you know over the next few years we plan to distribute that you know majority of the tokens to people that aren't us basically. And so you know we we plan to progressively decentralize the effective control of the protocol. Yeah and then and Jeff I don't know if you want to say a little bit about you know our governance system from a technical standpoint.

I mean the governance system will work very similar to compound you know in terms of voting and and the way it can make changes to the protocol. I think you know this is an area I would say is uh you know there's a potential for us to you know as a protocol as as a kind of community to decide to upgrade and change that. To I guess there's you know tons of different governance models out there. So you know I would just say like you know where we're starting is kind of like starting point and we'll kind of see what what the protocol needs uh to to do from a governance standpoint to kind of change that.

One thing that the way we're parameterizing it I think this is kind of like uh maybe interesting is like so compound currently has like a 7-day cadence. I think everyone's kind of aware of this now of actually getting changes through. So one thing you know we're keenly aware of is that this is a new protocol you know as we go out and and so we want to be able to make some changes quicker. So we're going to shorten that time cadence for us to be able to about 2 and 1/2 days in the beginning. And as the protocol matures as we feel more comfortable with that we'll kind of elongate that time cadence.

So you know just as a way to to kind of represent the maturity of the system. Yeah so but otherwise I think it works pretty similar to Compound. One thing that I thought would be really cool here is if you know cuz like lots of people let's say have positions in Aave and they may want to move those positions into something like Notional to benefit like basically from a better interest rate or like at least a fixed interest rate. Is is there a way or are there like products that you know of or like you know without having to code your own flash loan contract where basically you could say okay here's my position on Aave I want to move it over to Compound. This is how

much gas it's going to cost but it's going to happen and I'm going to be able to move all those positions there in kind of one transaction? Cuz that's something that I I think like I would use. Yeah, absolutely. So So I I think Instadapp does this between Compound and Aave although I'm not really entirely certain. But we actually as part of like the code that we've open sourced for Notional V2 there's there's a flash loan contract that will move your Compound you know variable borrow into Notional and then essentially like flip you from a like a variable rate into a fixed rate borrow in a single transaction. And then also on the flip side actually if you're holding C tokens and you actually just

want to lend at a fixed rate you can actually just deposit those into Notional and receive f cash in return. And so that you can actually flip your variable rate loan into a fixed rate loan directly. With the Aave integration since we're not using Aave as the underlying money market in Notional V2 you know swapping from Aave is something that is possible and we'll definitely look into it's something that you know as steady alluded to part of like building the community.

Those are the types of things that I think the foundation would look to um uh supporting through like development grants and and things of that nature. So, maybe um let's zoom out to the ecosystem a bit. Um in your view, um what are the next um milestones um that will hit in the DeFi um system. So, I mean, we we we this this week we we saw that uh Sebastian, help me out here. Uh French bank Societe Generale Forge, yeah.

Yeah, here we go. Uh made a maker proposal. So, I mean, what what what what do you I mean, so basically, Teddy, as as someone um coming from uh traditional finance, uh what do you think um the next year's going to look like? Okay, yeah, so that that's a really interesting question. I I I think, you know, first first of all, let me just um uh say that, you know, I obviously I'm biased, but I do think that that Notional V2 is going to unlock like uh some really cool stuff in DeFi that you haven't been able to do. So, I'm just going to say that real quick first, uh because basically, uh so these fCash tokens that we've been talking about, um they, you know, allow you to define and manipulate cash flows at specific future

dates where you have guaranteed liquidity via the Notional infrastructure, um and that's something that you do not that you've never had before in DeFi, and so you're going to be able to like create, you know, really cool sort of fixed income security. Well, sorry. Fixed income products. Like, for example, uh coupon bonds, right? So, so you could like you could essentially bundle uh a number of these fCash tokens together, such that you could buy uh a bond that would give you fixed payments on a periodic cadence. So, you could have like you could, you know, uh lend $100 for 2 years, and you'd get fixed payments every quarter, right? Um as opposed to like taking the entire payment at the

end, right? And I think that that's that's something that's really cool. It's a obviously a super popular product in traditional finance. You can't do it in DeFi today. And and something like fCash allows you to do that. So that's just Okay, so that's just my little thing on natural. I had to say it. Now I think like from a more sort of macro perspective, yeah, I think this is going to be a really really interesting year to come for DeFi cuz I you know, I I still talk to a lot of my sort of friends in traditional finance. And you know, like even some of the more conservative ones, like they're coming around to DeFi. They really are. And I think like it's past the point now where you know, we've we've hit the big

numbers and so we've gotten people to pay attention and we sort of like I think proven out like some real product market fit here. And the longer we stick around and like these things can continue to work, like just the more undeniably useful like this space starts to look to outsiders, right? So I think that the number absolute number one thing that people that has made sort of more mainstream users wary about DeFi is is the security risk, right? So the the idea of like cuz you just think about how weird it is, right?

So it's like I'm going to take my money and I'm just going to like put it in a computer program, right? And there's nobody I can call if like things don't work as as as they're supposed to, right? It's like a really weird thing and it's like a psychological barrier that you that you need to get over. And then really the only way to make people comfortable with doing that is is time, right? And it's time that these things are operating and they're operating correctly and people are getting their money back when they're supposed to. Right? And you know, we've had time now where these systems have been operating safely and securely, right? And I think that you know over the next year that will just continue like that will continue and and people will become sort of more confident and less

worried about sort of smart contract risks. I think that you know we're also seeing innovations in sort of like the the DeFi insurance space that are going to get people more comfortable which I think is like super interesting and you know basically the the thing that's that's the barrier to entry is is risk, right? So it's smart contract risk, it's regulatory risk. And I think over the next year you're going to see like a significant diminishment in both of those risks, right? So like one just with additional time and and sort of new insurance solutions coming to market for DeFi that's going to reduce the smart contract risk and then kind of the other

thing is um you know like a lessening in the regulatory risk because I think that you know like I saw like a headline that the FDIC is looking to potentially insure stablecoin issuers, right? Or like offer insurance to stablecoin issuers or to like approved stablecoin issuers. And I think that like you know there is a a recognition that that DeFi is important and I think regulators in the US are you know going to be offering some actual clarity within the next year in the space and that's going to I think make a lot of people sort of

more mainstream users much more comfortable. So I think that you know in the next year you're going to see like a lot of the risks and barriers to entry significantly reduced and that's not even talking about like and I hadn't mentioned but like the you know layer two solutions coming online. So I think like a year from now you can see like a lot less smart contract risk, a lot less regulatory risk, and lower gas fees because of layer two. And I think if you put all those things like those things together, then it's like DeFi is just like a no-brainer, and it's objectively superior to traditional finance. And I think it's like a super exciting time.

I I totally agree on many parts of what you just said. The one issue where I feel like my personal feeling is um more or less diametrically opposed to what you just said is regulatory, right? So basically it basically to me the feeling is that regulators, especially in the US, uh um not moving in the right direction. I I I I think that I I think it's up for debate, I would say. I mean, I think that, you know, people are obviously like some of the stuff from some certain officials has like caused concern crypto space, but I think that in the US what you've actually seen is

like significant pushback from people who are very, you know, like like pro crypto and pro innovation in the US. I think that there's like a non-negligible you know, number of politicians that are really on our side. And I that I find very encouraging. And I think that there's a growing recognition from sort of what what we've seen. You know, yes, there are people who are against crypto, but I think that there is a growing recognition that this this space is going to be, you know, extremely important and like just like this thing is growing extremely rapidly. This thing is going to be big, right? And I think that there's a growing recognition of that, and there are a lot of people who want

to make sure that that the US has like places a stake, places a flag there. So I think that, you You I'm I'm really actually pretty optimistic from that standpoint. Okay, that's good to hear. It's always It's always nice to hear people be optimistic about the the regulatory environment. Um, so Teddy Jeff, uh, when is Notional version two coming out? Uh, yes, so we're targeting first week in November. Um, yeah, so that's that's what we're targeting. I I think we'll I think we'll do it. Uh, so I'm I'm again, I'm I'm optimistic.

Uh, I I see Jeff chuckling in the background, so uh, we'll look out uh, first week of November. Um, and where can uh, people find out more about you? Where where can they um, go and uh, partake in governance and uh, in liquidity mining and so on? Uh, yep, so you can visit our website, notional.finance. Uh, you can follow us on Twitter to hear all of the updates on on what we're doing. Uh, that's @notionalfinance. And uh, you can also just jump in our Discord and and ask us questions. We're all there. Um, we're very responsive.

Uh discord.notional.finance is the link there. Um, and yeah, and uh, you know, keep in touch and and let us know if you have any questions or uh, you know, any stuff that you that you want to see us build. Cool. Thank you guys. That was uh, super interesting.