PaperTrade Attracted $140M, Then Changed the Rules. Was It a Bait and Switch?

Transcript

You sell a bunch of people on a rule set beforehand, a bunch of money comes in and now you change everything after the fact. Like it's not exactly a rug in the sense that crypto Twitter is like very used to seeing, right? Like an actual rug where they just take all your money and run, but they are kind of baiting and switching you with the the rule set and the parameters around the protocol and and the token beforehand and after. [music] >> Hi everyone, welcome to Unchained, your no hype resource for all things crypto. I'm your host, Laura Jen. [music] Thanks for joining this live stream. Before we get into it, a quick ask. We're deciding right now what Unchained [music] looks like next year, whether we add a weekly recap show, what time we stream, what goes into premium, and I'd rather hear

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Find out more at nexo.com. Not listening to Bits and Bips yet? It's our weekly crypto and macro market show with Rahm Alawalia, Austin Campbell, and Chris Perkins. Search Bits and Bips and [music] subscribe. Today's guest is Jason Pagalotis, [music] head of markets at Deli Research. Welcome Jason. >> Hey, Laura. Thanks for having me. It's good to be back. Last week, crypto Twitter was a buzz with excitement about paper trade, and it even flipped NASDAQ's daily notional traded volume uh on one day. This week, it's a different story. Crypto Twitter

is very upset with paper trade. Before we dive into all the drama, explain what it is and why people were initially so excited about it. >> Uh yeah, I mean, that's a pretty good summary, right, of of the events of the of the last week and a half or so. But, uh, paper trade, I guess, like the easiest way to think about it, um, I'll I'll I'll use like their words to be to be as fair as possible, um, is, uh, it's like a fair launch. So, fully onchain exchange sort of, which I'll get into. Uh, launched on the Hyper EVM network, which is essentially like the hyperlquid onchain portion of their business, right? Uh, not the hyper core platform

where per. Um, and it essentially lets traders take these massive leverage trades, but mostly gambles, right? Uh, up to 1,000x leverage, right? Because if you're trading on a thousandx leverage, it's not really trading. It's mostly gambling. Um, and it was siloed to Bitcoin and ETH uh, positions. And when you take a trade on paper trade, you're not actually taking a trade against other traders. You're you're trade isn't going into to an order book. you're not selling into somebody else who's buying.

Like if you if you place a sell order, I might be on the other side of that on hyperlquid and I'm buying, right? Um but on paper trade, the positions are taken against the house, right? Uh against the house single pool, which I believe they called uh kind of funny funnily or LP, right? So essentially when you place trades, you're placing trades against the house, the house takes the other side of it. Um, and because of that, it essentially allows there to be uh no funding rates, no fees essentially, uh, no slippage and things like that. Um, that Martin Galer LP pool that you're betting against or trading against, I should say, started at $0 and it's funded when traders lose money. So,

their margin goes into that LP pool. Um, and then if if you lose money, you then mint paper as kind of like this rebate token on the back end. And so it's like at the beginning for every dollar of of USDC loss trading on the platform you would mint uh I think it was a 100 paper at the time. Um and then obviously if you win you don't mint any paper. So essentially it's if you go on this platform and you're trading and you lose money, you get some kind of rebate back in the form of these paper tokens which can then be staked on the platform for uh for USDC yield generated from the the uh the trading activity on that platform

as well. Um the easiest way to kind of think about it is if people who who are watching have have been around for a little bit like uh if you think back to rollit it's very similar to the the uh the roll bit model. Um there's obviously some different things there, but uh it it's probably the easiest way to think about it for for a lot of people. Um and it went live on October 10th, right? That that was like their whole thing. And I have like some issues with that, but like it was like that if you think back to last year, it was like that October 10th liquidation event where everybody got nuked, right? You had that Binance weird thing going on and then you had the ADL across the board.

Everybody lost all their money. Everybody called it like that, you know, that liquidation day and then this paper trade protocol is like, oh, you kind of have that narrative of like everybody got liquidated and now we're launching this thing where if you get liquidated, you at least get, you know, some kind of rebate uh back as well. So that's kind of like how it all started when it initially launched uh maybe like two weeks ago at this point, two and a half weeks ago. >> Yeah. And um to to my mind, you know, when you said it's sort of like gambling, like even the fact that when you trade on it, you're trading against the house like that's, you know, it is from >> so in their docks or like uh in in like posts that they've had like they've they've like likened their model like

this isn't my words, they've likened their model to like those early bucket shop models back in the you know late 1800s and early 1900s where people would essentially be able to go to these like storefronts or whatever and place bets uh about an asset but not necessarily trading the underlying asset and the bucket shop would take the other side of that trade. It's a very very similar model. It's been around for hundreds of years. Uh just now we could do it on a computer. >> Okay. And so explain also this bit about so um there's no slippage or fees as far as I understand. Correct. So explain like what happens when you lose, what happens when you win, like how does it

all work on the back end? >> Okay, so um going back to the roll bit example, when you win paper trade copies, the roll bits uh like asymmetric fee on winning trades, right? So essentially if you win, you don't get the full 100% of the win. You get like 88 or 90 or 90 something% of of the win from there. Um, and if you lose, you obviously lose your money, your margin. But, uh, when you lose, the amount of money you lose goes to minting paper, which you then get back as like that rebate token, right? And then theoretically, people would go on this platform. they'd be like, "Oh, well, like if I, you know, lose a bunch of

money early on, because based on the way that the, you know, the the curve of of of minting worked at the start up until there was like about $2 million of losses, the amount that you got, the amount of paper you got for per dollar lost was higher, right? So like the incentive was to be earlier to lose your money. So you would get a higher amount of paper. Um, and so when you lose, right, obviously that's that's what funds the the Martin Galer LP, which pays out to the profitable traders, right? Um, and if the LP is out of money, you it enters into this queue where like you can't actually get your profits until other people lose enough money to then start paying out the queue again. Um, and so that's kind of like

how it works. It's like a Yeah, it's just like one hand pays the other back and forth, back and forth, back and forth, and then there's like a haircut in the middle on fees. Um, and because you're trading against the house, that's why you can have no slippage, no fees, right? Because a perpetual future, you actually have a funding rate, which is what kind of keep it's the mechanism that keeps a perpetual future in line with the underlying market. That doesn't exist here. Um, and so that's why you can have these no fees, no slippage, 1000x leverage because none of these orders are actually hitting the market.

When you place an order on on paper trade, you're not actually moving. Like if you go buy $10 million of Bitcoin, you might move the market a couple basis points or whatever, right? Depending on how how liquid it is at the time. If you go buy $10 million of Bitcoin on on paper trade, that that market or that order never hits the actual market. So, it doesn't actually have any market impact, which is why you have all these features, you could say, that are enticing for traders. >> Yeah. I mean, again, it like I I'm not trying to disparage it, but again, it gives me the casino vibes because it's like you have these poker chips. Yeah, >> it is a casino.

>> So, it's it's like play money. [laughter] >> Yeah. I don't think it's disparaging to to it's it's it's what it is. I think anybody who's being honest would be like 500x trading isn't trading, it's gambling, right? Like Bitcoin can move 10 basis points for any reason, no matter what. Like you're not forecasting 10 basis point moves. And if you you use a 1000x leverage, that's how much Bitcoin needs to move for for you to get liquidated. So yeah. >> Yeah. And another part of the billing was that because you when you lose, you get paper. It's like you own a a part of the house or something. Correct.

>> So, it's sort of um kind of like this decentralized like Dow model being applies to a casino. >> Yeah. Or >> Yeah. It's a way to Yeah. It's it's a way to think about it. Yeah. That's it's what it's it's what it was uh you know branded as at least initially. But then maybe we get into this right like last week they had a different announcement where they kind of changed a lot of things retroactively. Well, okay. So, but let's set it up just just so let's describe what paper was initially supposed to represent and like how it worked and and you know those Yeah.

>> So, yeah, like like I said, when it launched, you just predeposit money, crypto, Twitter, I think deposited or pre-deposited 140 million USDC uh so not a small amount of money into the platform uh to start trading as soon as it went live. It went live on October 10th. Um and then it had like a a really good week, right? Like uh a lot of people were using the platform, lots of paper was being minted. Um trader losses uh you know mounted uh I think I have the number here uh somewhere, but I think it was uh at this point um $57 million have been paid to paper holders via, you know, staking your paper after you've

lost your money. Um, and so for the first like week or so it was kind of functioning as fully intended, right? Like it launched. Everybody's placing these massive trades. Everybody's trying to get into that like I mentioned that first that first trunch of losses where the rewards for your liquidations uh were higher. Um, and everything kind of was working as intended. Uh obviously there's a there's a whole like infra aspect with launching on Hyper EVM which uh kind of made the launch a little bit tricky up front. You had these cues to close positions because Hyper EVM isn't exactly a super high throughput chain.

it doesn't have enough um you know capacity to to to kind of support all of this speculative HF not not high frequency in the sense that you would think about it in terms of market making but higher frequency type of trading activities right if you're trading a 1 uh x leverage position like you might want to close that trade 30 seconds later but if you try to close your trade and there's a bunch of other people ahead of you in the queue to close trades because the actual underlying infrastructure can't support all of these things happening at the same time, you're going to have a bad time, right?

Like, but by the time you're the queue gets to your order, you could have already been liquidated and you're like, "Oh, well, damn." Like, it's no way to trade. So, like, you had that little hitch go off and then you had another thing going off on the first day, which is probably a bit of a bigger issue. And the main reason for the announcement that we'll talk about is that when you have something like this, there's always going to be an incentive for somebody to try to game the market or use the rules that you put in place to profit, right? That's we see it all the time in in anything, right? Uh and so when you have these really big positions uh allowed on, for example, paper trade, you can then go onto an actual exchange, right?

So, Paper Trade derives its prices or takes the midpoint from Hyperlquid's actual price feed. So, its market prices are based off of what Hyperliquid's trading prices are. And Hyperlid is an actual open order book. So, if you have enough size where you can go into the hyperlquid market and push around Bitcoin or ETH even on small amounts like sub 1% even for short periods of time, you can theoretically push paper trades price feed and then because everybody's trading on these massive amounts of leverage, it doesn't take much to, you know, kind of wipe out traders in one direction or the other.

And so you actually saw that happening on the ETH per pair on uh paper trade and hyperlquid the day of launch. You had somebody putting in these, you know, five or 10520 million market orders pushing the price around. And the team realized this. It's also it's it's a risk they actually, you know, highlighted in their docs ahead of time. Unfortunately, most people don't read anything anymore. And so, uh, the team actually had to kind of go in and manually like lock the positions on paper trade. So, he couldn't kind of, you know, I don't want to use the word exploit because it's not really an exploit. It's somebody just using the mechanics of the market in the way that it is. Other people might disagree, but uh, they realized this was happening and kind of went in and kind of locked his

paper trade position so they couldn't close them and then kind of got in contact with them and came to some kind of agreement. But it does show there's an open attack vector here and um that's something that people should be aware about or aware of for sure. >> Yeah. So, in a moment we'll talk a little bit more about what happened next, but first we'll take a quick word from the sponsors who make this show [music] possible. What if your crypto could do more than just sit in your wallet? Nexo is a digital assets wealth platform where you can generate daily interest on your crypto or borrow funds against your assets. Today, Nexo serves more than 10 million clients. Find out more at nexo.com.

If you like this show, there's another one from our network you should be listening [music] to. Bits and Bips is our weekly market show. On Mondays, Ram Alawwalia, Austin Campbell, and Chris Perkins chat about where crypto and macro collide. It's sharp, [music] it's fast, and it has its own channel. Search Bits plus sign BIPS and [music] subscribe. back to my conversation with Jason. So, [music] if they had identified in the documents that this was a possibility, why do you think they allowed paper to be or or said that it was on the road map for paper to be transferable? What happened to that

trader? I saw people speculating that like this person was going to be blocked from cashing out. >> That's what happened. the team the team did lock and lock those positions uh once they realized what was happening and I believe they probably got in contact I don't exactly know what the resolution was pretty sure the team handled it with the person and like on the side um but yeah they they went in and and manually blocked those positions from from being closed on paper trade which then forces the guy because if you can't close on paper trade then clearly it's not profitable which forces him to go you know stop doing it on on the hyperlquid side of things. So yeah, they they manually block the position. So

like when you say something's like fully onchain, it doesn't actually it's not like fully decentralized, right? Like it's still a multi-IG. They still have full control over whatever goes on. So I'm not sure that was ever, you know, anything anybody really cared about with respect to this specific protocol, but like it's it's something worth, you know highlighting too. >> Yeah. Yeah. I think I saw um the Defiance said it's a 203 multi-IG um and and you know like it was um yeah like a two-part operation as you said he was pushing down the price of ETH on Hyperlid and then because that's the oracle and paper trade then he was profiting from >> correct >> from a short there. So >> all right so now let's get into the meat of the controversy.

>> Yeah. Um because on Monday, I guess, so this was actually like roughly a week after those events. So maybe it took them a while to figure out how to resolve this, but they stirred up controversy when they announced that they no longer had plans to make the paper token transferable, at least for now. uh after as we mentioned the road map explicitly outlining that as one of the later phases they explained quote if we were to make the token transferable at this point we are confident we would quickly enter a state too dangerous to allow any material exposure to be taken on paper trade and as an example they said if our bankroll is 10 million an attack costing 15 mil 15 million

manipulating the price of bitcoin or ether is not viable you simply lose money if however you are able to put on 10 million of paper shorts short short side exposure. Suddenly an attack costing 50 million is very viable indeed. So do you feel like what they did here was justified? There there were a lot of reactions to this. >> Um I've gone back and forth on this personally. Um number one, they're right. That is what will happen. It's not a matter of if that that will 100% happen if the token is made transferable because anybody can whip up a per market and then boom, you have all the

ingredients you need for this to come true and we've already seen the first part of it happen the day of launch. So to think that this wouldn't happen if given the opportunity is just naive. Um so they're right in their analysis of the situation. The question is did they know this ahead of time? And if they did know it ahead of time, why would why were they talking about making the token transferable after some time when clearly by doing so it either opens up the protocol to existential attack vector risk or because there are solutions, right? Like you can um you can cap the pool size, right? You can um maybe add caps on leverage. you can maybe do like

certain things to to to really like mitigate a a lot of the math here, but in doing so, you kind of take away all the reasons in which somebody would use paper trade to begin with, right? Like you're going on paper trade to use a thousandx leverage. You're not going on paper trade to trade Bitcoin with 3x leverage the way you would on Hyperlid, right? Like that's it's it's it's clearly there to solve like that DGEN roll bit casino gambling quick hitter type type activity. And by adding in those caps, adding in those restrictions, adding in those parameters and safety things, it kind of takes away from the

whole point in my opinion. And so you're in this really weird spot, right? You you you kind of made a promise in a sense or you at least like sold it like everybody was under the impression when they predeposited their money into this protocol that these paper tokens would be transferable at some time. And now it seems pretty clear that they're not going to be transferable for a while if not ever. Um because I don't know how you can actually like how you actually solve this risk. Maybe it's obviously somebody smarter than me on, you know, per stuff might have a solution here, but at the

end of the day, they can't control per markets and um and if the pool is at risk and you don't really like at the end of the 10 a $15 million Bitcoin trade isn't that big, right? At like it's it's not something that like only one or two people could pull off. It's something that lots and lots and lots of people can do and the incentive is there if the pool gets big enough which it probably will and then it's just like a really weird thing and it's just like a people are saying it's like oh good communication. I'm like I disagree because like they were they were clearly aware of the attack vector.

It's in their docs, right? The the oracle price risk. And if they were aware of that and these guys are really smart like Blur and Jez, they're not dumb guys. are really really smart dudes. Um, and so like if they made if they were aware of that, they were probably also aware of the second order implication of that, i.e. the per aspect. If you if you have a a native token that has a per market on it and what that means and so it it seems just like a it's what they have to do if they want the protocol to survive. But it's also a bad like and like I don't there's no sugar coat. It's a bad look, right? like you you you sell a bunch of people on a rule set beforehand, a bunch of money

comes in, and now you change everything after the fact. Like it's not exactly a rug in the sense that crypto Twitter is like very used to seeing, right? Like an actual rug where they just take all your money and run, but they are kind of baiting and switching you with the um with the you know the rule set and the parameters around the protocol and and the token beforehand and after. Um, >> yeah. I think also what makes it so much worse is the fact that in order to earn paper, you had to lose money. So people were >> Well, I never went on because like I'm not going to try to lose money. That never made sense to me. I was like, why would I go golf instead? Like I don't >> A lot of people Yeah, a lot of people were on there trying to lose money to to

earn this token. >> I had a bunch of group chats where friends were like, "What's the optimal strategy to lose money fast?" So I'm like, what are you talking about? >> Yeah. Yeah. And that money literally went into the bankroll, so it's like >> their money now. >> Yeah. It's It is what it is. >> So I think that's why like like I feel like Yeah. I mean, I think people would have been mad no matter what, but the fact that people were on there literally trying to lose money to earn this other token that they thought was going to, you know, >> that they could then sell to make back their money. Yeah. Like it's Yeah. You got >> you got uh

>> Yeah. It's not a I wouldn't I would hate to be in this position right now, but uh fortunately I'm not. >> Yes. Yes. Well, so people are tweeting today that like paper trade is over basically. Ryan Ryan D crypto or Ryan crypto I don't know how to say this person's name tweeted paper trade staking revenue today 84.5K with two hours left yesterday was 1.28 28 million Sunday with 2.1 million 93% drop in a day. And then Alex um.HL uh the hyperlquid account tweeted, "Yeah, I think it's completely over.

Volume was purely from speculators farming paper hoping it becomes transferable instead of 1000x leverage finding PMF." And yeah, I I just saw a whole bunch of tweets saying it was over. Do you do you agree? Like do you think there's anything they could do to revive it? >> They're funny takes. They're not they're not horribly wrong, I don't think. Um, it's tough. It's really tough, right? Because this like what you now see is what the organic usage of people who want this type of thing is versus the activity that was there to potentially farm a token to then sell.

Because if you can no longer sell this token, there's no reason to go farm the protocol anymore. So what you're left with is that that that big gap is like the farmers are now mostly moving their money away because they're like, "Oh, I'm not going to lose my money and stake my paper and get some some yield on that maybe, right?" Like it might take I don't know what the payback rate is at this point to, you know, make up your losses if you were to lose like $10,000 today on it or whatever, but it's not great. Um, and so yeah, like it's tough. It's going to be very, very, very tough.

I I'm not going to say it's over, but um it's going to be extremely tough. And on top of that, right, like they changed the mint curve, too. So, like each dollar lost now mints a fixed share of supply at that moment in time. So, you don't have ever actually know what you're what you're getting until that moment in time. Um, [snorts] and so I think like the math is essentially like 0.1 supply per like $1 million lost is like the math or whatever. Um, and I could be off on that, so don't, you know, nobody take that and make a decision based off that. But, uh, yeah, it's just like a

lot of things have changed from pre-launch to today, and that changes the whole decision-making matrix of everybody involved. Everything has changed. So like yeah like you you you could make the the protocol today is different than it was when it launched. Everything is different about it besides like the 1000x aspect, but like the tokconomics, the the the payback, the yield, the the pool, everything, right? It's the the promises about transferability. It's all different and it all makes everybody need to kind of redo their calculus a bit on if this is a place where they think, you know, the capital is well placed and being used efficiently or if the opportunity cost

of keeping your capital here is way too high. Um, which is kind of where I've landed. I mean, I was never going to, but I'm definitely not going to. Um, now, and it's not like I'm not like trying to be mean or, you know, trying to on them or anything like it's a it's an experiment. Clearly some things that were wrong. I think maybe communication probably could have been better up front. To be fair, they literally put the risk in the dock ahead of time. You can't be more transparent than that. It's also not really their fault nobody reads. At the end of the day, they did change things too. So, there is some blame to go around for everybody.

>> Yeah. I mean, I know at Deli you guys work a lot on tokconomics. So, I was wondering if and I know like the this whole thing about like mercenaries versus missionaries in in crypto has been just a problem for forever. I don't know like do you feel like there's some way to resolve this or do you feel like this will always exist? It's like, you know, I just remember back in the day after kind of like Bitcoin and Ethereum, people were like, oh, like you can use the token to bootstrap and blah blah blah, but now it's like it just doesn't work. Am I like what what is your kind of philosophical take?

>> So I guess it depends. Um I'm I'm not a super big token expert compared to some of the guys at Deli who like that is their you know expertise. Um like I actually had this question on on our Hivemind show yesterday with Yan and Jose who are a lot more in like the tokcon who a lot better at tokconomics than myself and I was like I I asked them about paper trade. I'm like can they like fix this? like is there anything that you see? And uh they weren't sure, but it was, you know, definitely something worth looking into because if you can fix it, it's probably, you know, something cool to do there. Um but like yeah, like it's it's tough and tokconomics are not easy. Um there's a lot of stakeholders. There's um a lot of times people mistake the

token for the product. That has been the case in crypto for since I've been here for the most part. Maybe it's not mistaken. Maybe everybody's just pretending that, you know, or lying to themselves or whatever. But like, yeah, like if your token is the product a lot of times it can't work. Um, but there are cases of tokens like working like Hyperlid is a great example of it, right? Like it's it's a recent one. Um, but like Hyperlid be would be successful without a token. It was successful before the token launched.

And so what it comes down to is you just need to have a good business. Like just think like think of it like as as like just like remove the word token and just pretend it's equity, right? Like you just like for equity to be worth something, it needs to be tied to a business that produces value in some way. And so companies use equity all the time in the same way that crypto teams use tokens. When you go join a company like oftentimes they'll give you like you know RSOs like restricted stock options that you can then you know exercise invest at a later date at maybe a discount or something right like it's the same thing here in tokens. It's just

that those things are tied to actual businesses that make money and have PMF and have customers and retention and durability. And a lot of times the tokens that we attach to things, it's just like a speculative Ponzi or like uh uh something that hasn't demonstrated demand and it's mostly just a narrative or whatever, right? Like a lot of that has been what crypto is. And I think thankfully we're making a lot of really good steps in the right direction. Like Metadow has, you know, it's it's its launchpad um where they kind of like vet things a little bit more. uh you have like real businesses and you had cases on metadal where it didn't work out but they returned money to the people who

who who they raised from which is I would consider a successful thing right like no not every business venture will succeed most fail but just be honest about it and if you're realize you're going to fail don't go milking the treasury for five six years and taking a salary return the money to investors like a like an ethical person would I don't know like I think like it's not rocket science. It's just make a business that's profitable that that's valuable and produces value and a token will be valuable in that case assuming you're not rugging the token from all value. But yeah.

>> Yeah, it's not rocket science and yet it is somewhat challenging. Anyway, Jason, this has been a great explainer on a whole debacle. Thank you so much for coming on Unchained. >> Thanks for having me again. It's uh it's always a lot of fun. And thanks to everyone who joined this liveream. We will catch you next week. Bye now. [music] Nothing you hear on Unchained is investment advice. This show is forformational and entertainment purposes only. And my guest and I may hold assets [music] discussed on the show. For more disclosures, visit unchainedcrypto.com. [music] >> [music]

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