State of the Market - with Su Zhu and Hasu

Transcript

Welcome to Uncommon Core, where we explore the big ideas in crypto from first principles. Today, I'm sitting down with Su Zhu, my friend and co-host, to talk about the state of the crypto market and what he's seeing on the horizon. Su is the CEO, as well as Chief Investment Officer at Three Arrows Capital, one of the largest trading firms in crypto. Just one thing before we dive in. We make no money from this podcast, but we do want to grow our audience. So, please take the time to leave us a rating and review on Apple Podcasts.

It really helps a lot with discovery. Thank you, and please enjoy the episode. Su, welcome. I'm really excited to talk to you today. Yeah, should be a fun one. I I want to talk to you about the market. So much is going on right now. Um I have questions about things that have happened or that are currently playing out, but I also want to use these as a segue to dive deeper into the fundamentals and the theory behind some of the some of these things.

Um so, I hope we can tie them together in a way that's both interesting and informative for our listeners. Sure. To start out, so the the the big story right now is probably the the decline uh of DeFi across the board. Many many coins are down over 50%. Some of them even down 70%, such as YFI, Yearn Finance. Why do you think DeFi crashed, and um did you see it coming? I think the crash of DeFi is in any kind of big big explosion of interest and community, you'll have

quite steep pullbacks. So, I think that this is no different in that sense. Uh you can't really have prices go up 10 20x without having 50% 70% pullbacks. So, I think part of that is just the internal logic of markets um cannot be cannot be fought against. I think that um for for us for me personally, I think there were some warning signs a few weeks ago where you had a lot of sort of copycat stuff popping up. A lot of forks thought they could just, you know, copy and then get rich uh

from that. There was a lot of me too kind of uh behavior. So, I think that that's usually symptomatic of blow-off tops. Uh and there's a few reasons for that. I think one is that there's the the local tops are always defined by misallocation of resources. Uh whether that's in crypto or otherwise. So, during the you know, during the dot-com boom the during the absolute tops, there were a lot of normal companies that were adding uh you know, dot-com to their name and trying to refashion themselves as tech companies.

And similarly during the top of DeFi here, you had random projects starting to say that they're DeFi that they can add an AMM or add swaps. You know, I I had at least three or four uh discussions with top 200 coins where they wanted to figure out how to get into DeFi. Uh so, I think I think things like this are always um are always good signs because they signal that the market is trying to the the market is creating much more novelty than it is innovation.

And so, we definitely we definitely had a big sort of uh correction now where people are realizing wait the yields are not forever. Someone has to buy governance tokens for me to get that yield. Who's going to buy the governance token if there's no reason to own the governance token or because the fully diluted market cap is extremely high even at these levels. So I think that overall people are just starting to ask the hard questions now. And nothing has really changed even that strongly fundamentally, but I do think that for people who are overexposed to thinking that it's just the new paradigm that it never goes down. I think they're kind of also

having their own first taste of what markets are like, right? So I think it's a mix of all those things. Mhm. Yeah, and you and we touched on this in our episode on YAM, but you tweeted a few days before that picture of the the youth the nature roller coaster. This is This is sum up what you just described pretty much. Absolutely. Absolutely. The euthanasia I think euthanasia I I first came across this motif in 2018 on speaking with another prominent trader in the markets uh light crypto on Twitter. And and he was the discussing with me the idea of accumulation distribution. And what he means by that is that when you

have created a high in alt BTC pairs once that high has been created and then it nukes the next bounce up is always a percentage away from that top because people have seen that top and there will be X percent of people trying to sell to lock in some profits and they know they have to sell at a lower price than the high that was printed. Right? And the incremental buyer is suddenly gone because there's not an or the incremental buyer is still there possibly on the first bounce, but the sellers the the overwhelming size of the sellers is is too big for the buyers to absorb.

So so you have and as soon as you make a second lower high uh in something like this, then you will have this thing go again and again uh toward this kind of a vortex um as we're seeing now in some of these markets and and I think that that does that structure is very common in all BTC. It's very common in a lot of these hype cycles because fundamentally it's a money game in a lot of these coins, right? You're you're betting that more money will go in than will flow out, but if we're making lower highs then that's strong evidence to the contrary. So those who have unrealized profits, you know, they thought they were up 10x, 5x 8x, whatever it is they're now suddenly saying, "Okay, I

want to make sure that I book some profits so that I'm not one of the losers of of this game, right?" Cuz suddenly becomes very apparent that you need new money to come in and you cashing out uh strictly takes away some of that liquidity. So I think I think that that motif is is a very good way to understand crypto markets. I think it's it's helped me a lot and I and I strongly recommend at least when you see signs of of things happening that are very euphoric, you ask yourself, "Would it make sense for this to be the top of a euthanasia?" And that's a in general a good way to think

about it and it'll also help you not buy shallow dips, right? Like it's very scary. It's very dangerous to buy a shallow dip at the beginning of the break because f- like fundamentally for the value buyers, they may still not be bidding even if it goes down 50%, right? So, if you bid on a shallow dip, let's say 10%, it's kind of it's kind of you're betting that it's not euthanasia, that it's just another that it's just another dip to be bought. Uh so, you just have to be aware that if you're wrong, you can be very wrong uh in in that kind of a scenario. No, that's a great point.

We talk so much about scarcity uh in the context of of cryptocurrency. And and each of these tokens is um seen basically on their own is scarce, has a limited supply of tokens. Um we saw that with with YFI, right? It had it had this kind of scarcity premium in the beginning. But then, what happens is um that we see a massive supply side expansion for these kind of projects because of all the different copycats.

So, first there was just YFI, right? Just just yearn. And now you have at least 20 different yield farming projects. And many of them, like some of some of the bigger ones like um harvest.finance or pickle.finance attract like over 200 million dollars of of AUM, right? So, would you say this this contributes to basically the the coaster? So, at first, you have like some projects that are like generally innovative and um and they they kind of lead on the way up. But then, with some delay, you have all these different copycats coming online. And basically, it's to such a large supply side

increase that there's there can't be enough buyers to keep it going for much longer. Sure. I I think that's definitely true. And what I what I would say is that it also depends on what part of the cycle we're in. In the beginning of the cycle, I think the forks or the uh copycats, the the first copycats, they actually help a lot. Like YAM you could say was kind of a copycat. The ultimate copycat, right? Because they copied Wi-Fi elements, ampleforth elements, compound elements. And that was hugely popular at that time, even with its issues. And I think it led to the DeFi coins that you could stake for it going up like tons for a couple days for for a few days. So, I think

copycats in the beginning of the cycle are are very good for the markets price-wise. But, I think that, like you said, as you get later in the cycle when people start asking questions about modes and what's the you know, what are the actual cash flows that are going to be achieved? You know, what's going to actually happen? I do think that at that stage you tend to have people saying, "Okay, if there's now harvest that's valued this price this market cap and you have YFI valued at this other price, you know, what what's going to long-term be the reason why people buy YFI and not this? Or how are they going to capture those cash flows, right? Um and I think that forks

are actually really good at pointing out these kind of things. Like same same with Sushi and Uni, right? Like people might want to say Uni is worth all this because it has the brand behind it and it has a behind it. But, at the end of the day, it's open source code and Sushi really does the same thing. They arguably have a better coin distribution in some sense because they don't have a pre-mine. Um so, there's no like I I think in DeFi the existence of those kinds of forks um does start to have people ask question, "Okay, can we actually put in a fee?

Can we actually make this uh like this token capture value?" And and so that I think is what's been really bearish for the markets. Like Curve putting in fees, right? Putting in an admin fee of two basis points and then having that go toward a buy and burn and then having the price absolutely nuke right afterward, I think it was kind of the market saying that okay, maybe you have some cash flows, but it's not a lot and your inflation is still much higher than your cash flows, right?

So there's ultimately not there's ultimately not like any easy way to say to new money that comes in and sees the space, why are these good investments if you can't articulate how this token has a moat, how this community has a moat, what what exactly is the value accrual. And so that's why I do think that you know, I'm I'm not as dovish as some people are on Twitter. I mean, I'm I'm a big long-term believer in DeFi. I'm not as dovish as some people are. I do think it's going to be a fairly long rebuilding period.

Especially as we're in a backdrop of what I think is going to be a high Bitcoin dominance regime in the next few months. Po- po- possibly a couple years even. I think that the big, you know, the builders in DeFi are ready to build and they're ready to truly innovate and create stuff. I do think that the speculators um need to be braced for more pain if they're especially if they're in the short term because I think that there's still a lot of froth in the markets. There's still a lot of stuff that's not that rational that's happening and I think the max pain point uh from my point of view, from what I can see, it's not really close yet.

I see. Um we touched on this earlier, but does this crash invalidate any fundamental assumptions that you and other people have had about D5 and maybe also even more interestingly, does it validate any assumptions as well? Maybe things that continue to work even though we've seen such a big drop. I think not a whole lot is invalidated per se aside from the idea of I think governance tokens people have been a little bit too bullish on as a concept.

Like you mentioned to me before, D5 should be governance minimalized, not maximalized. Well, I think this whole wave of D5, especially the newcomers, you've had this big push into governance maximization. Right? The idea that this token can literally change anything at any point and therefore it's really valuable because you don't know what they're going to pump and dump next. They may decide to vote in some crazy pool. And then those guys will want to pump that. Well, you know, this logic only really works in a bull market, right? As soon as you you turn into a bear market, like all of a sudden it doesn't matter what you do. It it's still going to uh still going to nuke. So, um you know, I I I I have this general heuristic that

a good sign that um things will take a next leg down are when projects try to vote in tokenomics that try to pump the coin and it doesn't even pump for like 4 hours. It just pumps like for half an hour and then it nukes, right? Or, you know, when when people will try to do things like make make the rewards vesting, right? It's ultra bearish because it doesn't actually accomplish anything. Uh and it's sort of like the last card that any of these can play. So, once you play that, you know, TVL goes lower from the smaller players, but the bigger players can hedge anyway and they don't care.

Um you know, they're they're very mercenary about it. So, you'll end up just having even less of a community if you do vesting. you'll you'll just have whales basically farm the entire thing because they can handle the vesting and they can hedge it. So, that's also like a good sign that it's it's not it's not going to go great. Um so so I think that there are these these are some of the things that you'll tend to see uh where I think tokenomics people are putting a little bit too much focus on tokenomics. Um the ability of tokenomics ultimately fix adoption um I think is a bit overstated. I do think that that's a good thing because that means that in this bear market people will go back and think about what

innovation they're really bringing as opposed to trying to like take you know, something that's already worth a lot and then say I've created something else that is a subset of this with one thing changed, can I be worth that? Right? So, I think that that's um that's going to be the direction that it goes toward. I think in terms of validation, I I do think that AMMs have been quite validated overall um as a concept. I think that, you know, you've seen bunch of token sales happen on AMMs. You've seen a bunch of um projects really bootstrap their liquidity through AMMs. Uh Uniswap as

well as Balancer as well as others. So, I think that is very healthy to see and that's even happening now, you know, Uniswap volumes are still decent. Um Balancer volumes are still okay. So, I think it kind of does show that um even if people are losing money, they still find it convenient to trade on a DEX you know, on a web wallet. So, I think those are good signs and those do validate the idea that something has been created here of lasting value and people can build on that.

Yeah, so since you brought up AMMs one project that basically marked the basically the top of the DeFi hype cycle is Uniswap with the launch of its UNI token. You can farm UNI by being an LP in one of four Uniswap trading pairs and then stake these LP shares in the Uniswap DAO and by doing that you earn UNI rewards. Um So I I am farming um this and so it's very interesting to me.

Um and I I I would like to use this as a segue basically to talk about market making in general. Last week you you wrote an article that was very well received for Deribit called toxic flow, its sources and counter strategies. Um maybe let's start with that. What are the main insights from that article? So I think AMMs are revolutionary in the sense that anyone can now be a market maker 24/7, right? Their liquidity is posted um on the internet and anyone can buy or sell from it. So I think that's important to understand first and

foremost. Now with that you have takers as well who are trading a lot of volume. So when you see very high Uniswap volumes the the questions might be, "Okay, well, those volumes are so high, but what are they doing? Right? Like are are all those people clicking on web wallets? Are all those people just fascinated by, you know, trading from MetaMask?" I think the answer if you look on chain it is definitely not, right? What what's actually happening is people are arbitraging between the price on the AMM and the price on a centralized exchange.

So for for pairs like like tokens, like smaller tokens, you may actually find that the price discovery is mainly occurring on Uniswap, but for a lot of other tokens, say Ether itself, that's definitely not occurring mainly on Uniswap, but it's occurring it's occurring on centralized exchanges, right? Like Coinbase, um Bitfinex, and others. So, what that means is that every time the ETH price moves, people are competing to do the trade on Uniswap and then hedge it with a centralized exchange. So, that that whole process of arbing the

DEXs, as you can call it, is what's really generating a ton of this volume. Um and so, you might ask the question, okay, so so these guys are obviously all making money cuz they all obviously will only trade if they make money. Um so, but the AMMs all seem to be happy. They all have their money in there. So, so they seem to be making money. So, so who's losing money, right? Like or have we just created like an infinite money machine? And the answer is no, you have not created an infinite money machine. What what you have created is two things. One is a belief that the assets in this pool are correlated enough that the up and down movements are relatively safe uh

to be indifferent between. So, what that means is, you know, that one of the two assets in your Uniswap pool is not going to go to zero, right? If that goes to if that goes to zero, that's that's what the kids call like a rug pull, right? So, it's when it's it's when you have a token in a pool and Ether in the pool and then one day you wake up and the token's worth zero. So, you ended up by being in the pool, you ended up now owning uh zero Ether and a lot of token. Um so, that that's impermanence loss in a nutshell where you get you basically get stuffed with the one that's worse.

And you don't have the one that's better. So, I think that that price right now, people don't really I mean, it's already very mathematical, I think. And I I I mean, I think what essentially being a MMOP is is you're you're actually buying a uh unlicensed structured product is what you're doing. You're buying a what? Uh, an unlicensed structured product. So, you know, in in Korea, a a very common structured product is called a worst of put. And a worst of put So, a normal put is when you sell a put and that means that uh you agree to buy uh something at a lower at a lower price if it's out of the money. You agree to

buy it if it gets there, right? So, if the price blows through there, then you you know, you're losing money because you sold that put. And you get assigned. The The person who bought the put from you, they say, "Okay, I'm going to sell it to you now at the put strike." Um, here you go. So, a worst of put was invented by investment bank sales, devious as they are, and they said, "Okay, well, why don't we put three assets uh into a basket and we say to the guy we say to the client, "How about you're selling a put not on one stock, but on the worst of three stocks?"

Right? Yeah. And the guy's an idiot, so he doesn't really care. So, so, so, he'll go and say "Okay well, what's the yield, right?" Cuz you're getting a premium when you sell a put. And obviously, the yield is much higher the more stocks you put into the basket, right? Because, you know, given sufficiently many stocks in a basket, the certainty that one will go to zero is like 100%, right? So, even if it's large caps. So, that that whole process became a very fun game for investment banks for a few years and then regulators started saying like what's going on here? Like how do you do this? And so now it's generally capped like they only put free stocks in and they're very blue chip ones usually.

But yeah, it it's it's something where it's similar to that, right? Like you're going to get the asset that is the worst and the question is are you paid enough in the meantime that it was all worth it? Right? So no one is really doing that math that closely aside from the big sort of industrial scale farmers of Uni that are out there. And you know, Sushi as well. You know, we all know that there are quite few industrial scale farmers of Sushi as well. And for those guys, you know, what what they'll be thinking about is how do I hedge my risk, right? How do I use options on Deribit to because those are the only place where that's liquid enough to buy huge

size. You you have to go there and basically buy buy out of the money calls, out of the money puts and hedge your risk that indeed one of the assets you wake up one day and one of the assets goes down to 50%. Or goes up 50%, right? And if you just back, you know, if you if you if you back test crypto, that happens all the time. So I think right now it's quite fascinating to me that DeFi has generally gone up in a period of Bitcoin going very flat, right? It's basically been very range bound in 10K to 12K range. Um past few weeks.

And ETH itself has also been relatively range bound between 310, 320, and 480. So I think that the DeFi markets all a lot of these primitives have been generally um in that kind of environment where it hasn't really been tested how how people will behave if you start to get some serious impermanent loss. Um so I think that, you know, if you're not hedging um it's probably it's probably going to go bad at some point, right? As a guarantee, cuz you're basically selling uh volatility.

Mhm. And that's that's inescapable because you know that your hedge is to buy strangles, right? It's to buy straddles, to buy strangles. So, if you don't buy them, then you're not flat. You're actually short. That's what's paying for everything, right? It's the fact that if if one day, you know, people wake up and uh you know, Donald Trump says he's buying all all the Bitcoin he can and Bitcoin doubles, that, you know, if you're in the ETH WBTC pool, you wake up and you see that you actually don't have much WBTC. You have all ETH.

And then you think to yourself, but that's that's unfortunate, right? So that that hasn't happened yet because of the relatively low volatility environment that we're in, historically low volatility environment, but I think it's a huge mistake to think that it'll last forever. So, um you mentioned um buying strangles and straddles. Um so, are those um like what does it take to to buy those? Are those individual products on on Deribit, for example? Yeah, you just buy you just buy an out-of-the-money call, out-of-the-money put, and then at least if the prices go up, you're covered for that. And the UNI rewards you're getting and the fees you're getting, it

pays for the premium on your options, right? So, all the all the big industrial-scale players are doing this because they're very because one is their size is big, right? So, so, you know, if people playing around with a few hundred K or like tens of thousands, like you're hedging, you know, you're you're ultimately trying to save yourself from losing tens of thousands, which is not a lot of money, right? But but if you're farming with like 50 mil, 100 mil, then you you start to say, "Okay, I don't I don't want to do it as a game, right? Like I want to do it as a like like ASIC farming itself, ASIC mining itself, right?

So, there've been a lot of these products that have been launched in some in in both China as well as in the US. I think CoinList has one and there's a few in China I can't name that that that have them as well, but but many of those will be hedging in some intervals um with different strategies. I I've helped devise some. I think that ultimately those guys will be fine because they understand the math very well and they'll even pull out if the math goes bad. But I do think that the math's capable of going very bad for for people that don't hedge because they won't have the gains on their hedge legs to offset when the market start moving

again. Right. So, so you you hedge your AP shares with with options. And you mentioned you also hedge your reward tokens, I I suspect. Hedging reward tokens is an interesting question. I mean, I can't comment on what we do, but I will say that a lot of people do hedge rewards similar as they might hedge Bitcoin mining rewards, right? If they think that they're going to farm this amount of Bitcoin, they'll definitely over hedge it in a neutral environment because they want to lock in their profits. So, you definitely see some of that going on um in the farmable coins.

And I think that's that's just prudent, right? Because if you if price goes up, you just become richer and if the price goes down, well, you're you're glad to have have been hedged. So, I think that like in a way that kind of shows the ultimate uh the ultimate irony of yield farming, right? Because the yield farming or like generalized, you know, liquidity mining, the initial idea was that you were going to you were going to distribute the coins of your protocol to people that are using it the most, right?

And that this you know, by this process it would be the fairest distribution. And it also achieve sort of the most uh motivated participants like in it, right? But but in practice what has happened is that the largest players in crypto itself just use it as a money market, right? They they put capital in, they farm it, they hedge everything out, it's pure arbitrage, and they walk away with lots of money, right? And and in a way it's similar to mining, right? Where with GPU mining, let's say the GPU miner, he doesn't need to care

about like any specific coin. He just wants to mine the stuff that people want to buy. So if if there are people buying some random GPU coin, then he'll absolutely mine it and jump on them, right? And hedge it out. And when the coin dies, he'll he'll move on to another coin. So money is sort of the the ultimate GPU or CPU, right? Because you can use money in anything. Uh there there's no like other machine needed. The there's no other proof of work needed. Hence why you see a lot of um heavy dumping because the participants who have the money uh you've you've created a dollar auction whenever you create a a yield farming uh scheme, right? You've created a dollar

auction for people to come into your come into your network and use liquidity to bid for that dollar. And there's no promise that they will stay around and and play house after they they the ROI is not high enough, right? There's no such there's no such social contract and there's no such uh promise either. So, I I think that in the beginning these projects probably got some hype out of it because the total value locks went up so much, right?

Um on compound, you know, the the TVL first it was the the strategy was USDT versus USDT, then it was BAT versus BAT, and now it's DAI versus DAI, and then they realized that okay, well, DAI versus DAI industrial farming is the least is the least bad option because at least it makes DAI supply pump which then helps Maker. And so, there's that kind of uh logic to it where they decided that that's the most allowable form of yield farming. Uh But yeah, it it it's ultimately it's ultimately tied to that idea that you are distributing the token to people that are just going to sell it

for dollars. But how do you do it in a way that people buying it actually make money in the end. You have to let the people that are buying it make money. If you don't, then there's no real chance, right? And so for UNI, that would be the test, right? When if people are actually farming and holding UNI, the question is what do they expect to achieve? What do they expect that they'll be able to get for their UNI? Um because they are very much paying for the people that are just farming pure profit. So, given that all these large firms basically mine fully hedged, would you say that other market participants just underestimate or basically misvalue the

the combination of having like a low return but with a very high sharp ratio? Because you can always use leverage, right? To to increase the returns. You can't really increase leverage, at least not yet. There's a project coming out that that we recently invested in called Alpha Finance. They They actually do allow you to leverage farm on Uniswap. That's interesting, but you can't really use leverage in the traditional markets. I mean, in the in the foreign markets because you need actual capital, right?

Um whether it's your capital or you're risking someone else's capital, it still ultimately one unit of risk. Uh it's it's it's atomic risk, basically. Um it's not like a derivative where you can go 5x or 10x or 25x, right? So, I think that that generally gives a huge advantage to big players because they have the money, right? And as I alluded to in a tweet, the main money in the space is not even from stablecoin whales or altcoin whales, it's it's from Bitcoiners, right? Bitcoiners have all the money because their coins are worth the most.

Uh so, with that So, what that So, what that means is that from what I know, I mean, Bitcoiners make the most money in DeFi yield farming because they have the most money to begin with. And and so and so that that kind of has become a basic yield. Uh it's ultimately a BTC-denominated yield uh for for a for a lot of folks. And and so that that I think is the ultimate irony of DeFi where the populist narrative on Twitter is that Bitcoiners don't understand DeFi or they you know, like Tone Vays, he doesn't even get uh that Uniswap can't be stopped, but in reality there's a lot of quiet Bitcoiners with you know, 100,000

uh you know, 50 to 100,000 Bitcoin, like large-scale, and they if they deploy even 10% of this into DeFi, like that's what happens, right? Like because because ultimately the base reserve of crypto is BTC, right? It's got the market cap and it's got the liquidity. Um so, I think that that reality means that all yield farming ends up being done by people who view it as a money market. And that's not to say that they're naive, either, right? I mean, these guys These guys read the code.

They read the Solidity code. You know, they hate Solidity. They hate They hate Ethereum. But But they read it. So, it's this funny thing where, you know, they view it just like mining, right? Like they may mine Litecoin, that they may mine Zcash, they may mine other coins, but ultimately they view it as a business. So, I think that that's ultimately the reality in the space. Um So, all all yield farming projects today are being farmed in that way uh for a very large percentage of their of their supply.

So, yeah, I mean, it's easy to forget that Bitcoin is still 20x larger than USDT, even, right? Which would be the same really reserve currency of the space. So um given that BTC denominated farmers capture most of the rewards of all of these tokens, is that part of why you think um Bitcoin dominance is going to increase over time, especially these yields flow back into their base currency? I think yeah, that's one reason I see.

Uh the other reason I see is that WBTC ultimately is is very bearish for Ether. I think, you know, there there are some arguments that because it uh hurts the the ability of the Bitcoin blockchain to receive fees for transactions, that it'll therefore be more bullish for Ether. But I think in the near to medium term, what it will mean is that if people come in and buy Bitcoin up to 15 16k, now you can FOMO Bitcoin from the ease of your decks, right? You can go from your ETH straight to your WBTC. You can go from your stable coin straight to WBTC. So, I think that that effects in the near term will be

much more pronounced than the theoretical effects, which is that you know, Bitcoin is on the Ethereum chain. I think that that is something that um that is very very bearish for ETH because it also, you know, if you think about the Uniswap pool, if WBTC is one of the four pools, that means that anyone can go from a lot of ETH to a lot of BTC very quickly. And because of the way that that market works is that you probably don't have people sitting on a lot of WBTC to begin with um as a natural user. The like the natural users are all Ethereum ETH holders on the Ethereum chain. So, like WBTC is not really held in that

way. So, in a sense, the most likely flow is that ETH people sell that pool consistently for WBTC to diversify right? Mhm. So, I think that I think that that concept is something that people just need to be aware of as well. I think separate from that, I think there are going to be some headwinds for Ethereum over the next few months. I think as Vitalik uh has pushed toward a more roll-up focused roadmap, I think ultimately it's more fundamentally sound, but I also think that it's going to be a a wake-up call for

the community, too, because it does mean that a lot of the a lot of the ETH 2 research was probably wasted. It also means that the TPS may not get to anywhere that allows mass scaling or anything resembling mass adoption anytime soon. So, I think that that will be the challenge. I do think that all applications will still continue to use Ethereum um and probably with other chains if they make sense. They'll be very chain agnostic, but they'll use Ethereum given that's where the users are now.

But, I think for ETH the asset, uh it'll be challenging environment for sure because ultimately that that headwind of the long-term road map being so so um ultimately not very very scalable and also not very clear even at this stage. Several years later, we're still at the same TPS and optimistic will only really get you to 200 TPS. Um and it will it it will force a lot of social um coordination up the stack, right? It It just forces it into layer two. Uh it You don't really solve that many issues and it creates socialization

in terms of community uh in some sense, too. So, those I think those are all things to be aware of. Right, and it's not just WBTC. Um now, we also saw the the recent launch of TBTC. And um at least in my little Bitcoin bubble, I I'm seeing some people who would use TBTC, but not WBTC because TBTC is trustless bridge, the first trustless bridge for any um cryptocurrency. So, that's interesting as well.

I get that. I get that. I think the difference between TBTC and WBTC is very similar to the difference between DAI and USDT, right? Where it's I think keep academically quite interesting that that it can be done but the thing that academics need to remember is that not everything that can be done should be done or not everything that can be done is more than an academic experiment right because you know for players like us or for Alameda or for grapefruit or any of the other big houses like you want to get in and out fast right like you want to get in and out of 5k BTC 3k BTC to be able to do that you ultimately need

that one to one peg somewhere and I think that that also has to be capital efficient so that's very hard to do with a lot of the other more decentralized constructions and then the question will be does the market care or not or do they trust BitGo or do they trust the BitGo DAO I think the answer is they trust the BitGo DAO more than they trust the holders of whatever token is come up with to bootstrap whatever new so-called decentralized Bitcoin is made up BitGo DAO So WBTC is governed by a DAO actually this DAO is is quite powerful it can even it can even vote it can even vote to so if you send WBTC

to the contract address they can actually vote to retrieve it so they they have some interesting powers Oh yeah okay that's something that that happens sometimes to people when they accidentally copy paste like one time I've seen this happen is when people try to add a token to a wallet at a custom token or to an exchange and they accidentally copy paste the address into the into the the contract as entity address field on the sender yeah so well I was not aware that WBTC is governed by a DAO so interesting I I actually want to jump back

um to to Uniswap for a moment because there's one thing that has been on my mind for months, actually. Um And it's the question if So, in in a central limit order book exchange, market makers tend to increase their spreads when volatility is high. Basically to to spread the inventory over larger level of of of prices. Um but AMM market makers don't do this, at least yet.

But you you you can do this, right? So, my question is like even in Uniswap you can do this. So, my question would be like do you actively manage inventory uh in LPs based on expected volatility? Is that Is my logic here even sound that you should be doing this? Yeah, if you're if you're a market maker who needs to make money on trades, then yes, you should be doing this. If you don't need to make money on trades. So, people who LP in Uniswap, they don't need to make money, right? They may prefer making money, but they don't need to.

That's a key difference. Uh I think um Tiantian at Amber in the article he wrote with me, he made this very good point where he said that for a holder of an AMM LP token, he simply needs to personally be indifferent between these two coins somewhat, and he needs to believe that roughly over the long run that these will outperform buy and holding the two of them. So, as long as he believes this, then everything's fine. And even if he loses money, it's the same as the Korean retail that buys social product because he also thinks he's okay because most of the time he gets the coupon. But then once every four years you have a big crash, and then And ends up being long the worst of five stocks.

So, you know, I I think that there's a lot of things that in theory shouldn't work because of efficient markets and because people are not dumb, but in practice they are working in DeFi because of the fact that um you know, even if it's dumb, it's still less dumb than than other things they may do, right? And it still is a is some liquidity like for instance that like that guy who puts it in the AMM pool, he may have been doing something even dumber with his money. He may have been trying to buy and sell levels. He may have been trying to get liquidated on BitMEX, right? You have no idea what he was doing. So, Mhm. Yeah. It's it's it's not a it's not a perfect There's no perfect solution. Not everyone can arb everything all all the time. Some people

have to just own things. Some people have to just try to compete. Um not really with the market, but with just with themselves. Just try to make a little bit more money every year, right? So, I think in in that framework, then you quickly see why, you know, spreads probably don't aren't going to widen, you know, for for for announcements. Um probably the simplest solutions will do okay, better than people think. But yeah, there's definitely a lot of room for AMM innovation, too. We We backed a number of AMM competitors recently that have what we think are slightly smarter AMMs, but yeah, the the market will decide. Because Yeah. like if there's an announcement and then price goes way up and then way down, Uniswap LPs are

happy. And if you were an LP in a smart pool where where you widen, you wouldn't get that volume, right? So, then maybe your LPs will be results-oriented and then say, "Okay, I wish I was in the other pool." You never really know how people will think about it. Um if you try to always make money, you won't do any trades. That's also a good way to think about it, right? Like if you're if you always want to make money, then you should never be a maker, actually, because makers can buy by philosophy never guarantee that they make money.

A lot of these AMM models get constructed on paper, right? In an academic context where you assume strong rationality. Then they meet the real world where the market acts with bounded rationality. Um and suddenly some model becomes dominant that kind of relies on people not being rational, right? Well, like people bound uh have bounded rationality such as Uniswap and it becomes a new selling point for liquidity. So, so it's important to keep in mind.

Um one story that um bubbled up yesterday was um so uh on-chain um analysts found that someone borrowed a lot of YFI on I don't know if it was Cream or Aave actually and uh then sent it to uh Binance uh which which makes it pretty likely that they were short seller, right? Because for what other trade are you you would do that? May maybe market make the coin on Binance but um the address was I guess associated with Alameda um which which mostly probably makes on their own exchange and not on I don't know on Binance. So,

there was a a bit of a shitstorm against them in response on on social media and some Telegram groups that I mean so uh what do you think about that event? I think it showed how early this whole space is where people don't really understand trading and they also don't really understand what the goal of DeFi should be, right? So, I think first of all, whether Alameda was short or not or they were short for a client or they were short for an inflow or they were hedging, it's completely irrelevant because for every trade that occurs in the market, there needs to be a buyer and a seller. We can't all be bulltards and just like no one that does any trades

and it goes to infinity. It has to trade at every price up. Someone has to sell for every buy, even if it's going up. Right? So, to say that because he's short selling, it kind of just tells you the mood of the market, right? Where it's kind of getting into an anger phase of the market. And they're looking for real excuses or scapegoats. Um I think that what's what's very likely that they were doing and also what people do is that they're just arbing the centralized exchange against the DEX, right? If you have most of YFI sitting in in terms of liquidity, you if you have it sitting sitting in the Uniswap pool in the YFI ETH pool,

well, if there's huge sellers on centralized exchanges, then you want to buy from those guys and then sell to sell to the Uniswap pool, right? But they need to wait for your withdrawal from Binance or wherever and that might take quite some time. Might take half an hour. So, you might want to borrow some YFI and that way you have it, you know, in your account and as soon as the market nukes, you can hit the Uniswap pool. You can you can be the first to arb it, basically. Um obviously, you can't do a flash loan because you can't close the loop, right? You can't buy YFI uh USDT on Binance using uh and and then use that YFI immediately to deliver

uh to Uniswap. Centralized exchanges kind of have to be part of my flash loan, yeah. Exactly, exactly, exactly. So, you always need uh market makers to be borrowing lots of coins to be able to arbitrage uh centralized exchange versus DEXes. That's actually what fuels a lot of the borrow and lending activity in the markets. It's not people short selling. It's not people doing um you know, crazy spoofs or but it's really just market making. But, I will say that even if they were short selling, that there's absolutely nothing wrong with that and like we saw with the link uh with the link short sell attempt on Ave, those guys got liquidated because the market was bullish and they realized

they could push the price much higher than the liquidation price. So, there's no risk-free money in short selling, right? The the It It actually takes quite a lot of It takes quite a lot of uh conviction to short an asset because a short can you can you can have an infinite loss on a short, right? You can lose your whole account on a short. So, from that point of view, I think that the the the DeFi space in particular risk making themselves look a little bit silly if they go around trying to vilify short sellers because that's also the main point of Ave and Compound and Cream, right? Which is that you have two-sided liquidity. You have suppliers and borrowers. If you now are like mad because borrowers are selling

your asset, well, you're probably not cut out for DeFi, right? So, I think that that that's kind of now become I think in the last few hours on Twitter I I do see people just saying, "Okay, yeah, he should be able to do whatever he wants." Um but yeah, you definitely have a few people that obviously are sitting on a lot of losses now and kind of trying to find things to blame. Yeah, and I mean also the the borrower pays interest to the suppliers, right? So, the supplier gets They get compensated for Exactly. for whatever the the the borrower does with the money. And I mean you have you have some people saying, "I mean, so you you can earn more uh interest by uh staking your YFI in

the in the vault, you know, in the governance vault, for example." But if everyone did that and nobody supplied Cream and Aave, then of course also the um basically whatever uh revenue people in the in the governance world get would also be way lower. So, um I think basically it it it all balances out in the end. But this this story was interesting to me, not just because it shows like the kind of the irrationality that you described, but also because it it kind of showcases a fundamental problem, something that really bothers me actually with Ethereum and DeFi

definitely, which is that it's getting easier and easier to track um large accounts with software like Nansen, but um I mean, I reckon that funds have even better proprietary data and tracking software. So, in that sense, I mean, there's especially no on-chain on-chain privacy. And it's so much more so much more deadly in DeFi chains um and basically any kind of stateful chains than it would be in Bitcoin, where basically transactions can't be front-run or otherwise manipulated or against you in any way, right? So, if if I hold money in a Bitcoin account or send it to an exchange or send it to my you know,

whenever you just any kind of things you just hold it, there's nothing really really malicious parties or like other yeah, you know, other kind of market participants can do with your transaction, but but when your transaction kind of interacts with the global state, then you know, when they know what you're doing, they can mess up your whole transaction and future transactions as well. So, like how do you, as one of the largest firms in DeFi, who's doing plenty of on-chain trades, how how does this lack of privacy affect you?

That's a very tough question because there's no solution right now in Ethereum, right? So, most big players don't even bother trying to be private because they know that it's not worth the hassle of trying. So, especially if you own a large amount of supply, even if you try to deposit it to a centralized exchange and then withdraw it back, people are going to easily see it's you because who else would have done that, right? So, there's absolutely no there's absolutely no way to get privacy. And I think that that is a huge barrier to adoption as well because I don't think that companies want like imagine if everyone's bank account was just an Etherscan like you can go on Etherscan and I could just see how much money you have in the bank.

You probably wouldn't like that too much, right? So, I kind of think that that that is a very understated uh problem in Ethereum. It mainly impacts whales, which is why I think it's not as talked about, but I think that it's a huge impediment for institutions to come in, huge impediment for privacy-minded people to use DeFi. Um it's it's not it's not unsolvable. I think people are working on it, but yeah, it's it's a it's a huge issue, right? Because one is what you mentioned, which is the minor front-running, right? Where you can actually have censorship very easily on chain through that.

Uh but then two is that you could have all your trades you could have all your trades uh be seen. So, you have to basically you have to justify that you're buying or you're selling, right? Whereas in practice in the stock market like when when Bill Ackman buys stocks or he sells stocks, doesn't have to tell the world why he's doing it, right? He doesn't have to tell people, "Yeah, I'm bullish now, that's why I'm buying or I'm bearish now, that's why I'm You don't have to give a speech about it. He just he can just do it, right? But in Ethereum DeFi, there's there's this big uh there's this big meme around like oh you never sell or oh you never do this or you never do that.

Um and so like Blue Kirby had that issue, right? Where he said, you know, I'm selling from my from my ENS address and I'm going to buy back somewhere else cuz I don't want everyone to follow my 30 Wi-Fi all day long, right? So, I think that you know, that that kind of a uh that kind of a community feel or that kind of a that kind of a mantra is definitely not healthy. It's definitely not the underpinnings of actual global finance, right?

And it's a very provincial uh kind of a mentality. So, I do hope that people do build the needful tools there and and get it to a level where it's actually uh usable by by by real firms, by real people that just want to do finance. They they don't want to be in a community. They don't want to be on Twitter, you know, talking about coins all day. They just want to use finance. Cuz that's real people, right? And I think that uh Ethereum does run the risk of being a circle jerk in that respect where it's it's mainly an elitist or a kind of a a very niche kind of a

subculture in the end. Yeah, totally agree. And um I think the um the Wi-Fi borrow story also shows that the the game theory just changes completely between a paradigm with hidden information and one with open information. I mean, it's not necessarily unwinnable when basically you um basically all your information is private and maybe that all of the the small the smaller players is hidden. But it requires some changes in strategy, right? As if you're a whale.

If if if if the market is so fickle and people are paying so much attention that borrowing Wi-Fi on Ave can and that alone can basically make people dump then you basically uh firms should start doing that as a bluff right? Yeah, and then eventually it won't work. And so it'll all be equilibrium, but the bigger danger is that these kinds of things as it become very very normalized that people just track whales all day and they and they enjoy the game, right? Because if you're going to build a global financial system you have to move beyond that.

And if you're not able to move beyond that, then the big money won't come and play, right? They they won't want to join these games. So yeah, it it has created some very interesting money games. And there are definitely ways to exploit those games and exploit psychology. But it's uh it's a little bit sad for me to see, too, because I think that, you know, if Ethereum had better on-chain privacy or had some ways to to get at that then like I could see it being much more usable, right? I mean everyone knows the top 20 addresses uh pretty much who they are in terms of farming, in terms of trading.

And I will I I will say people are generally pretty good about not doxing, but at the end of the day, it's it's a very very it's a very very small community and I don't see how newcomers will be that comfortable with having all their financial transactions seen globally, right? I just don't think that that's like that that to a newcomer seems strictly worse than how a finance already works. Like way worse. So cuz you're telling the because you're telling the guy he can he can both lose all of his money from a hack.

And by the way, most custodians don't support these smart contracts yet. But also, everyone can see your transactions. So, they can see when you capitulate, they can see when you buy, they can see all these things. I just think it's not going to fly. I think it's a bit of a sober way to end this episode, but um thank you very much for the discussion. Most fascinating. I don't say this enough but I think you leaked some uh some real alpha. All right. Take care. Take care.