What Brings Capital Back to DeFi? | Roundup

Transcript

Hey everyone, quick disclaimer before we get into today's episode. Nothing said on Bell Curve is a recommendation to buy or sell securities or tokens. This podcast is for informational purposes only and the views expressed by anyone on the show are solely our opinions, not financial advice. Our guests and I may hold positions in the companies, funds, or projects discussed. All right, gents. Welcome back to another episode of Bell Curve. You got me, Miles, and Zave. Dallas, what's up? Good to be back. Good to be back. Good to see you. Another fun week in DeFi.

It's been a month for DeFi. 500 million something 500 million mostly between Drift and Kelp, but Oof, it's not great. Not great. You know what this reminds me of is Do you guys remember it it just feels very reminiscent of the post FTX CeFi blow up and I mean that took down a bunch of like the CeFi lenders like BlockFi and Celsius, which that that never really got rebuilt, but I will say this is a bull bear case for DeFi episode, but to lead with my opinion here, I remember at that time everyone was like, I would never hold my assets in a CeFi account. Why would you ever do that? And DeFi was having its

moment. And now everyone is it's inverse and everyone's pulling their money off chain but for a bunch of reasons, there's a lot of stuff that needs to get improved in DeFi, but I do not view this as a permanent Yeah, it's like uh it's obviously like the losses are not even close and the reputation is damage is not to the industry is not even close as FTX. Um but during all those other like, you know, centralized exchange ruggings, like it's always like look at DeFi, humming along perfectly. Everything worked exactly as it should have. That was like always this weird victory lap that like DeFi people would take and unfortunately now it's really like it

technically is working, but it's also like very very very broken and that's so in some ways this is like kind of worse than FTX was for for the industry in terms of like what we actually want people to be using are these DeFi protocols and now we have a case where yeah, it's not like like the smart contracts are working, but nobody can get their money out. It's really bad. Let's just go through to kick things off a a quick overview of what actually happened over the last month. So, uh there've been two big exploits. One was for about 285 million on Drift and then roughly the same amount for Kelp DAO. Um although on the Kelp DAO side of things, this has

largely been focused around Aave because uh rsETH, which is the liquid restaked, you know, Kelp DAO instrument, that was listed as a collateral on um Aave Core. So, that's caused a whole bunch of knock-on effects, but you know, I think the the summary here is that North Korea is actually playing a really big part of this story. So, Lazarus Group obtained about $2 billion uh in hack proceeds last year from DeFi and crypto. That is a non-trivial amount and the exploits here are getting far far more sophisticated. So, a part of this story is we could be doing better in terms of multisigs. Like at least on the Kelp DAO

side of things, there was a LayerZero DVN, which was operated by them and it was one of one, which was a central point of failure. That's not great. Um and North Korea has gotten far more sophisticated. They've infiltrated the actual infrastructure layer and so I understand why there's this finger-pointing going on. Is this operator error on the part of Kelp DAO or is this LayerZero? Not for us to decide here. I think the TLDR is just that these attacks have gotten far more sophisticated and it's unclear what's going to stop them here. The other knock-on effect of this has been, you know, this is definitely slowing things down on the Clarity front, I would say as well. Not a good look that this is funding the North Korean weapons program, right? There are, you know, people that are making

the decision or key stakeholders on the Clarity side of things, which are getting briefings from, you know, various intel committees and they can see, you know, like what is this crazy DeFi thing and why are we supporting this if it's funding weapons programs. So, that's the high-level summary. I don't know Miles or Zave if you'd add anything and then we can get into feel like the meat of this has been around the Aave side of things, so we can talk about that. Yeah, I'd maybe just add one thing. I think someone resurfaced a tweet from Kyle Samani this week about him saying that, you know, security doesn't matter. Like all that all that matters is speed. Um I think for a while the last few years the industry has optimized for scalability and speed and

whereas in the early days of blockchain we really optimized for security. And I think that pendulum is swinging back. Now we know that we can have fast chains. I think we now need to work out how we have secure chains including smart contracts and that of course is under the same umbrella as DeFi. So, uh yeah, I I do think we're in a new era for security for both blockchains and smart contracts and I think there's going to be some interesting innovation. Another remark I'll I'll mention as you said before, Mike, around CeFi kind of was at a massive bottom post FTX and now is it's thriving again and actually doing quite well and I expect the same thing here with DeFi. I think it's reached probably a bottom and it's going to take maybe a year or two plus. Then

it'll come back in a massive way and I think there's going to be some great innovation learning from these problems and then yeah, new protocols and primitives being built that will take us into the sort of end state of what DeFi looks like. I don't have a ton to add. Um I mean the contagion effects are like very clear here. Um we're like going to spend most of the episode talking about Aave, but this is very much so like a LayerZero and Kelp DAO like configuration of LayerZero's set up problem. And yeah, I guess maybe like one speculative question. Don't know if you guys have any thoughts. Um Like there's a kind of a question of why these are accelerating. Is it because you know, AI has given Lazarus like way more you know, capabilities and like the

ability to find these things. Um Or there's another interesting theory of which um could be like they know Mythos is coming out in, you know, a month or two and they've just been sitting on all of these, know, hacks and just now finally like pushing them all out before Mythos will like actually see the vulnerabilities. So like yeah, I think it's a it's a very interesting time in general. Um Even outside of DeFi like Vercel had a massive hack over the week or the past week, which is which is pointing to something something weird going on, right? With like with with Mythos coming out around the corner, but um yeah.

Nothing we can really do about that apart from uh you know, clean up our act as it relates to some of these things we've just kind of brushed under the rug like having one of one multisigs for, you know, securing nine figures. Um I think like 97% of LayerZero DVN setups were one of one or two of two. So like that's a problem. That should be addressed. Um yeah. >> Can I can I just add one small thing? You know, back in the day Chorus One we looked at a lot of these interop networks and we used to optimize as both investors and users sort of the most secure bridge. And back then you had like Wormhole, Axelar, LayerZero. And I remember seeing LayerZero back in the day and it was clearly the most

centralized and the most at risk of being hacked. And then I guess as an industry for many year or not hacked, but you know, compromised. And for many years as an industry we kind of swept that under the rug cuz it worked the best and it was the best product. I think right now in crypto we like the UX is so bad. We want great products, but I think a lot of the best products including things like hyperliquid, they're still they're still at massive risk of being compromised. So I think as an industry right now we have a huge conflict of like, do we want good products when we've had such bad UX or do we want good products with great security, which actually if you think about it, rarely exists in the entire crypto space. So that's a huge conflict for me right now. Yeah, I think

maybe to land the plane here too on, you know, when we talk about contagion risk, there's a funny dynamic, which is some it's almost the protocols that are the most successful and have big pools of liquidity that are most at risk here. So, you know, when Kelp DAO is probably not a name that many people were familiar with before this week, but it was kind of the fifth largest liquid restaking protocol and but it had a big, you know, relatively large war chest of ETH um and the you know, the instrument of Kelp DAO, you know, liquid restaked ETH was onboarded at some period of time in as a collateral into the Aave Core instance. So, the risk was not that Aave had a

you know, a bad multisig or oracle configuration or anything like that, but uh it another type of risk, which is the type of collateral that's been onboarded into one mixed pool, um it caused these knock-on effects and you're you're essentially looking at a bunch of people right now. Uh this is sort of without precedent. You know, I I I don't think in any of these maybe analogs that you could point to and try to find you've seen something like this, which is one everything is 100% transparent um and you have some folks who are locked a little bit or unable to um uh you know, unable to to move stuff on the wrapped ETH side of things. And so it's it's caused utilization rates to spike. It's actually creating revenue

for the Aave Core instance. There've been some immediate impacts here. There were uh deposits are down from about 45 billion to about 31 billion over the course of the last week. So, it it's a pretty unique situation here and I think something else that people are starting to think about including Aave as evidenced by the launch of V4 is what is the model of lending here? And you have like the Caminos and the Morphos of the world who maybe started with a more uh isolated markets or um modular approach to lending as opposed to um the more you know, structured product of Ave core. And there are trade-offs to both, right? But I think that's also something that people are thinking about

here too. Yeah, definitely. And Mike, I know you spent a bit of time in the space, but I also think it's worth pointing out, you know, Ave, you mentioned the asset itself is was the thing that created risk within Ave. It wasn't necessarily Ave as a protocol or their smart contracts. And I do think with Morpho, it's a similar story even though you can, you know, maybe make the claim that their design is more or better suited to the future of what DeFi will need in terms of security. At the same time, curators make decisions on Morpho, and they can also choose the wrong assets.

And so basically, you have to put the trust somewhere in in DeFi. I think in Ave, you put the trust in Ave, and in Morpho, you put the trust in the curator. But we've seen both Morpho and Ave, like curators have lost a bunch of money on Morpho as well. And Ave, this is the first time it's happening from a bad asset selection, but I I think ultimately the trust has to go somewhere. And then the question is I I have an overarching question I'm keen to hear from you guys in this episode, which is like I think the one of the big bull cases for DeFi is that it's more permission DeFi that we can trust. And there's a kind of counterparty and there's liability there if something goes wrong, you know, we can get our money back. In DeFi, permissionless DeFi right now, so much

is going wrong and it's very hard to get your money back in any circumstance. If you get hacked, okay, then you have to trust some third party is going to recover some of the money, which has happened a bit in this recent sort of hack that was related to Ave, but like do does everyone want to do that? Or does like the minuscule kind of like minimal amount of people want to do this within DeFi and crypto at large. So, I think again here it's a very tricky time for DeFi in terms of like even us three in this call, um you know, any of us incentivized to put money in DeFi right now? I'd pose that question. Cuz I feel personally I'm not incentivized. Uh no.

No, I don't think so. You get like very low rate, like lower than treasury rates, and you take on contagion risk. Like absolutely [ __ ] not. No. But this is the same question as would you put a bunch of money into a centralized exchange that wasn't Coinbase post-FTX? And it again, I don't want to immediately skip to the end here, but it those are some of the best businesses in all of crypto, those CFi exchanges that survived. So, I agree though, there's no it this is I'm not rushing to put a bunch of money into DeFi. No, I mean and the and the problem is it it's just um I think everybody assumed that DeFi like didn't have this 100% utilization rate can't get your money out risk. Um and that's

just, you know, it's obviously happening on like a a bunch more um when when any of these hacks happen, right? That's like a big domino effect. Um I was even this is like it's like a you can just like rug projects this way, right? Like if you like deposit a bunch of what was it? The Trump the Trump family coin, like the the World Liberty Fi into like a lending pool, and then you just max borrow USDC and just walk away. Like they can't come after your house. They can liquidate your, you know, shitcoins, but that's the problem in general with these like you know, large pooled models for for lending and and and DeFi when you don't have, you know, the ability to legally go

after these people. Something that I found interesting here is that if you were looking at this case within the context of TradFi, like a bankruptcy or something like that, there would be no decision to be made. There would be very clear rules about who gets what and how the losses are partitioned, and it would be based on seniority in the capital stack. Bank debt, mezzanine, preferred equity, that type of stuff. But I guess my question here would be like even if you let the courts decide here and it's North Korea stealing the money, what what happens then? Yeah, the North Korea is tricky. >> [laughter] >> I don't know. I don't know how to answer that one. That one's a tricky one.

You probably don't let them have it. Yeah, we've we've um we've had lots of projects that tried to do like um like even Uniswap V4 has these hooks, right? Where it's like it still is all smart contracts, but you can you get like increasingly more control, like real really granular control over like the what is actually allowed in an isolated lending market, and then you could add a bunch of like you know, hooks for KYC or AML checks um that actually block transactions from happening or circuit breakers that that can say like, "Okay, um you know, only 10% of TVL can actually like leave in one set in like an hour of blocks or something like

that, right?" Um and so we're going to loot we're going to sacrifice this like you know, perfect DeFi Lego atomic composability for, you know, trade-offs that like improve safety. And I think that's totally okay, right? Um it will just likely end up being with like two different types of DeFi. There's like one that's like, you know, and scale like with obviously some some things that look like trade-offs to people, but like a lot of people think like KYC and anti-AML and not perfect composability is fine, right?

Then you've got like the there will always be like a niche or, you know, World War III DeFi. Isn't it just fair to call these trade-offs? One thing that I feel like is happening is crypto is this fringe outsider movement and technology and industry, and it kind of won, and it moved into the fore, and the thing that's changed in the last year is that the US president, treasury secretary like, "Hey, we're going to do DeFi now." So, all of these theoretical debates are now the rubber's meeting the road on kind of all of them at the same time, and you know where nowhere is more indicative of this than how much the Overton window has shifted on asset freezes. I mean, do you remember it was

not that long ago where Tether was kind of hiding the freezes that they would do on USDT? And now Paolo's dunking on Jeremy for not doing it quickly enough and how much they're working with the US I mean, I'm just I'm not saying one is bad or one is good. I'm personally in favor of doing these freezes, but it's crazy how much the Overton window has shifted. And the last thing we haven't discussed yet is Arbitrum freezing about 70 men million dollars worth of the ETH. I mean, it is just funny. It intersected with this whole our are L2s Ethereum and all of this stuff, and we're getting our answers here. You know, there's no security council on Ethereum. So, in most meaningful ways it's not Ethereum.

Uh but it's also good because this is an advantage that you have that security council when you can do this kind of stuff. I I don't see how it could possibly be good that we're sending money to North Korea's missile program. >> [snorts] >> Like you just have to come on. So, I mean, I I pose this question to you, Mike, as someone again who's deeper in the space than probably I am. Right now, it seems from my sample size that a lot of active LPs in DeFi are taking money out uh of crypto and or DeFi right now. So, what do you think brings these people back deploying capital into, you know, vaults, etc.? That's my first question.

And then my I have a statement, which is like a sort of more thesis, I guess, but to me like DeFi makes a lot of sense when rates are low and like when economic times are good. Like I think the pendulum will mainly swing back when rates come down. Like for sure, like people won't care about the risks that the yields are going to go up, and people are going to take money out of banks, put it back in crypto. My overarching question is like without low rates, can DeFi actually or is it going to continue right now with higher rates to just get money in treasuries? Like I think this is a very serious question, which hasn't really been answered in the last two like in the even in the last cycle, really. DeFi didn't thrive as much as it did the cycle before that. So, yeah, I guess

what will bring it back? Is it just the you sort of, you know, macro climate? Or do you think there's other things that will bring it back? So, you know, I'm not I don't have a crystal ball here. I would just say that if you look at the composition of deposits and lending activity on these borrow lend protocols, people are interested in RWAs much more so than crypto native assets. I think it's pretty clear that the driver of the the next cycle, or at least a big part of the story, is going to be different types of actual real world assets and people using it like RWA looping, this broader trend.

I shout out 3F, small but proud bag holder there. But yeah, I think that that's a going to be a big part of the story. I know that that's most people have But I mean, you can even see that there's a big advantage. Like RWAs actually have the real representation of that off-chain, which I think is not the end state, but it's a big advantage at least for now in this current environment. >> [snorts] >> And in terms of the low rates, it's kind of a double-edged sword there, right? I mean, we started this off by saying why on earth would you ever keep your assets in DeFi when the rates are so low? So, you know, there's a little bit of a push-pull in terms of what the actual value proposition of DeFi is. Look, the only thing that I would say here is I'm

going through the process of getting a mortgage at the moment, and it yes, DeFi has all of these drawbacks. I will also say that the existing financial system is broken in a lot of ways, and it sucks. And I I want to be careful at this nadir of sentiment in what we're building in the on-chain capital markets assuming that everything works so well in TradFi because it really doesn't. And there's a bunch of ways that that system is broken, and it's hard to understand what will be the catalyst first and what is some entrepreneur going to figure out what's a gap in the current system?

But someone people will figure clever things out and it's not going to be a one shining moment. It's going to be a bunch of incremental changes that happen over time. Yep. So I guess Dave like the bull case for why you know assets come back and maybe even higher. Um so rates go down. Um let's say the market comes back and so like speculation comes back. So borrow demand comes back. Now USDC deposit rates go back up to like what they were in the last bull market or two which is you know roughly like five six percent. Um And then on top of that I guess you know whenever rates treasury rates are down people go hunting for like yield assets.

Um And we now have a lot more like yield bearing like RWAs that will be you know issued on chain that you could deposit into or borrow against and loop up etc. Um And yeah the folks that are like looping those that turns into a savings product for USDC or like stablecoin lenders. So you could end up just having like I don't know if this long I don't think this will go back to off A like um I think it's going to be you know the the protocols that are um probably offering like more control.

Um so that you could have a more accurate like analysis of what your risk profile actually is. Uh that's going to be required for like serious you know depositors to to come back. Um So yeah I think like there there are just higher quality like yield bearing assets that will be available to you know hold or borrow against lend etc. Uh on top of all the good speculative you know activity. Yeah. Uh I mean also to defend cuz everyone is uh you know picking on Ave right now. I will also say Morpho went through the equivalent on this on 1010.

Um and it would have been nice to see uh some of that TVL finding its way into Morpho if you're trying to make the Morpho bull case but TVL is actually down about a billion since all of this trouble with So to Zev's original point it does seem like everything is kind of down across the board. So to support the bear case. I feel like you know if you're a ETH depositor in Ave you have no [ __ ] idea is for thinking about Kelp DAO or like layer zero in a multi-sig configurations when you deposit in the Ave. You just said this is a protocol which you know is as safe as it gets for DeFi.

And now you can't get your money out. So I don't that that trust is really hard to to recover. >> Yeah. And look I did like a master's thesis on risks in DeFi back in 2019 when the space was exploding. And back then I did that thesis because DeFi was so appealing and so much capital was going into it so fast. Growth was like out of control. There was all this experimentation innovation you know yields that were material yields that were obviously all fluff that eventually compressed from just you know uh releasing new tokens. But now it's like we know the risks already but the risks are actually getting worse over time.

And actually the return is getting worse as well. So like these things are also conflicting of like what like this is the question I keep coming back to of which I find it very hard. Like I feel for DeFi builders right now cuz I think it's quite tough. Um crypto native LPs I think aren't getting money into DeFi right now. I think they're very happy diversifying into other assets even outside of crypto like full stop not even just treasuries. So then who's the next LP? Like all these distributors of RWAs as well they need crypto native LPs coming in but I I just don't think that like they're really there right now.

Look I think they could come back and I also do think within 12 to 24 months you're going to have more kind of like hedge funds etc. start providing liquidity into some of these yield opportunities. But I think these next 12 months are going to be very challenging for for the entire DeFi space and I I think even for blue chips even blue chips like Morpho which I like and I think they have a very strong moat in the space that they're in even with a strong moat it's got nothing to do with that. It's actually just got to do with the demand and the growth side. And the growth story for Morpho right now long term I think it can grow.

Like don't get me wrong. I wonder in the next 12 months like how much it will grow especially as we keep watching AI capabilities uh improve you sort of every month or two now which is kind of crazy. And we talked about Mythos earlier in this call. Uh I think Mythos is a massive overhang on the entire crypto space not even just DeFi. I I think DeFi is the first to feel it cuz that's where the most capital is and that's the most at risk. Yeah it's kind of like a quantum overhang. Um so maybe just one point to touch on like um what I worry about uh is uh I guess like an example that I was actually very excited about. So [ __ ] is like a emerging competitor to Stripe. 2 million businesses and like 20 million creators

hold assets on [ __ ] They had a partnership with Ave and Plasma and Tether right? To just if you're holding money on their platform hey you want to earn some yield they're going to deposit that into Ave on Plasma in the background. So So these DeFi mullet cases which I think could have gotten big big chunks of depositors just because you know it's all abstracted away. Now that's going to be kind of hard right? Because those risks and you know if I was just talking about an ETH depositor that didn't know about Kelp Kelp DAO. How about like a [ __ ] creator who just has like you know clicked a button to like convert >> creator is like what is Kelp? Why have I lost money on Kelp? I hate crypto. Yeah it's like that that I could totally see

happening. Um And so you know there is a you know a path here as well where like if you have a ton of capital like Tether you could probably you know improve your positioning in DeFi right now just by like offering striking deals with these protocols. And I think they're doing this with Drift already just to backstop them right? Like we've got a massive balance sheet we'll take like a larger cut of the yield that would go to like Wop's creators just to you know ensure basically everything. Um Cuz without that I mean that's that's there's like on chain insurance is not happening cuz that takes it even more you know that lowers the yield even more so. Yeah. But I I think that's

a good topic on chain insurance cuz I feel like it's being discussed and talked about a lot and we spoke about it in preparation for this call. Uh I'm curious to hear your thoughts on on chain insurance here but I think on chain insurance as well I question what this actually looks like and who would pay for and if you can even trust that insurance itself. You can't trust it. Like can you trust insurance? It's I don't even know if it's that. I mean how do you even underwrite to this? It's like having a house in Florida in Boca [laughter] Grande. Sorry Miles.

Uh but yeah my Miles Miles and I are meeting down in Florida. We got a bachelor party in a couple weeks. An uninsurable house [clears throat] though. Uh but I I think it's that right? I mean we're we're far away from being able to underwrite this because I think in order for anyone to get comfortable really what you're underwriting is the smart contract layer and as as we're talking about the risks are so manifold. I don't see traditional providers stepping into the market at all anytime soon. One thing though that I did want to discuss just on the the bull side of this cuz you're you're convincing me live Zev. I think at least in the next 12 months this is going to be very challenging. Um but

I also the the two points that give me a lot of confidence in this working long term is one the you know you you should never buy anything because of what's happening on the regulatory side but genius and clarity are both aimed at this. And when you have first of all real legislation but also the heads of the SEC and CFTC saying we are encouraging actively encouraging finance get rebuilt on these rails. There are some thorny problems that seem intractable right now. But nothing is nothing here can't be solved. This isn't rocket science. It's it's creating more rules and figuring out making these incremental improvements that will eventually stack.

But I think the choice has already been made here that these are going to be the rails is what I would say. And then the other thing is I mean this is more of a prediction for how this space might evolve but you know someone told me a while ago when you're building a startup make sure you pick a hard problem. And this is a hard problem. This is not easy to replicate. I think the big challenge at the highest level of building these protocols is financial acumen smart contract security expertise. I mean how big is the Venn diagram there?

It's tiny. If you are looking purely from the perspective of how do I staff a company here and build reputation especially within the context of one hack and you're done it's really hard. So a lot of these spaces will fail or sorry a lot of these companies probably will fail but there'll be consolidation I would I would imagine over time. And I also think when you think about price discovery and how that's going to work in the next cycle maybe retail comes back um in some way shape or form but the space is institutionalizing. And I think more traditional distribution channels and more what this space calls like boomer money that's going to drive price discovery.

So I think an interesting thought experiment for everyone listening is what are these what's going to make sense first right? I think part of the reason why everyone you know got so interested in out things outside of Bitcoin was DeFi because even with all its problems you don't even have to squint at it. You can see it working in real time. So, I can see more of that money finding its way into DeFi than really any other category of crypto at the moment. But, anyway, that's more than >> I just my my question there, Mike, on the institutional side would be even if they start coming on chain in the next 6 to 12 months, etc., and they have the option of

first of all, where do they get the stable coins from, I guess? Like, does it does it just land in their wallet or do they have to like buy it from somewhere? Or like, where does that sort of come from? And B, if they have the stable coins, that's the first step, but then the second step is like, okay, then they might want to get yield on the stable coins. But, if you're an institution with like a billion plus to put to work, are these protocols actually battle-tested and secure enough to put a billion to work? Like, that's actually my biggest question right now. The financial industry outside of DeFi is so huge. Yeah, in DeFi, it's been around now for 5, 6 years, and like with that massive growth in 2021, I think it can get there at some stage, but for me it's

a it's a timing question. Is this going to happen in like 5, 10 years or like 1 or 2 years? I'd be pretty firmly in the not 5 or 10 years, probably 1 year time. I mean, here's the in terms of at least on the stable coin side of things, where is that going to come from? To me, that's the easiest answer, which is we passed genius last year. And but we still haven't actually aligned on um the implementation and like actual nitty-gritty rules, that's not happening until November of this year. That's the first rough timeline when you can actually launch a genius compliant stable coin, which is why there hasn't been some crazy hockey stick. This was a headline that went under the radar a couple of months ago, but Meta is talking about reviving their stable coin efforts. Stripe is doing

this, and the driver for them is yield. This is Yeah, I can see why the banks are pushing back on this so hard. This is directly competitive with their model. And the the ability to collect some of that yield if you are the issuer of if you're just a platform that a bunch of payments and commerce runs through, you're not only are you not seeing any of the yield of the underlying currency, you're paying a ton of fees. So, I mean, this is the bull case of Tempo, right? I feel like I'm describing this is exactly why Stripe is doing all of this, but I think there's a ton of incentive for Well, I was actually going to say that.

I totally agree. I was going to say the only thing I think which would make this thesis wrong is if Tempo comes out and actually all these merchants, they kind of, you know, put their stables to work either for the merchants or maybe even for themselves, or they take all the yield that these merchants would be normally getting for themselves, and that's part of the business model. I don't know if that's actually announced or not how they're doing that, but I definitely think that that would be the bull case of like I I even this week, the more I think about it, I'm still a massive bull on adoption of crypto via Tempo. And so, I think something that the whole space is discounting right now is if Tempo gets a bunch of stable like businesses with stable coins, and then also it's like one click, bang, you put

it into some DeFi vault or DeFi primitive. Like, that for me, that that kind of distribution and UX and onboarding flow, I think they're the only company in the world that can do this and really turn it around for DeFi. Sure. And you know, because it's doesn't have like the crazy sort of velocity that that Ethereum does, they're not like like in terms of how permissionless it is, something goes wrong, like you just get a bunch of, you know, the validators on the phone and the tokens back, right? But then my my question, I don't know, this could have been announced as well, but if these merchants have stables and the they get put to work, where are they getting put to work? Like, are they working with Aave or like, where is that

actually happening? So, I mean, the warp example is like, you know, Aave on on plasma. I don't think anything has been announced equivalent for for Tempo, but I would guess it's uh you know, a lending protocol that they decide to work with Is this a native lending protocol on Tempo that isn't Tempo or Stripe itself? That could potentially come out of nowhere and get more TVL than legacy players. Like, I don't know. True. True. Depends on depends on kind of like philosophy they have to ecosystem building, right? Like, are they going to do it themselves or are they going to But, it's also a focus question, right?

Like, this is going back to that old episode that we did on The companies that have distribution in theory could do everything, but any company that's a good company doesn't do everything. So, they're going to pass on some opportunities here. So, but I do think a good part of this comes down to clarity and the yield compromise that's found in between. Seems like Coinbase is leading the correlation on the like stable coin issuers, you know, pass yield back, and the banks are on the other side. I think a lot of this depends on that and what the loopholes may or may not exist on the other side of that bill, cuz you know, if the if the stable coin issuers themselves can't pass the yield back directly, people are still going to want yield on

those assets, and I would imagine that drives more incremental deposits into these borrow/lend protocols. Unless there's a chance that all your money goes away. >> [laughter] >> You know, like then it absolutely won't. You know, also to return to the original I can't remember, sorry, I think Zev, this was the point that you brought up at the top of this episode, where does the counterparty risk exist? And I don't think people had asked that question that directly, especially in the Aave side cuz just use Aave, and it had the best security track record.

But, you were trusting a team to manage that risk, and it's not like on the modular side you're not trusting anyone, you are trusting the curators. And that also means counterparty risk for those curators. So, That's better though. Like, you can you got somebody like, okay, that's not >> I think one point worth noting here is the stage we're at right now in the vault curation space. So, you know, without naming names, some of the bigger curators which are well-known in crypto with nice brands, uh unfortunately, they've lost a bit of trust from making some bad choices and people losing money.

Um the tough part there is they're not, you know, RIAs or whatever else. They don't have that extra level of accreditation, you know, that you maybe might want as a user in future. Like, when you have companies like Bitwise coming into the vault curation space, and I think Miles and I in a fidelity, like we spoke about I think maybe in some other episodes, these kinds of curators coming in, uh you know, where you can hold them liable and like there's more at stake, like maybe that's actually what the space is missing. And so, maybe there's a bit of an even though I have a lot of respect for the curators right now that aren't necessarily RIAs or whatever else, and I think they're doing a good job, but there is still risk there.

Like, they can still lose your money, and if they're generating you 5, 6%, I I might not even know who's on the other side of this curation strategy, and I'm like, "Oh, here you go, here's like a mill, like put this to work and earn me 4%." Or I can just go to the bank and say, "Give me 5%." And and the bank's like, "No worries, you're never losing your money ever again." So, I think maybe if the yield is on par with treasuries and it's like an RIA or something like that behind it where there's like further credibility to where the money's actually going, that might actually be what the space needs, and that could be again another sort of antithesis to what I'm saying around the next level of growth and scale for DeFi. If this if this comes soon, this could actually I think grow CVL quite

fast. Yeah I on the curator side of things, I have less of a strong opinion. I think I have a high opinion of some of the curators. I also think that that business got models going to be I mean, the the most interesting thing happening in that space is other entities who might have been customers of the curators becoming curators themselves. Like, Bitwise is a great example. I don't really know how that shakes out. Um But, >> Yeah. I tend I I also do tend to think that companies that are are competent can either move up or down the the value stack as they see the industry changing. But, anyway, not to, you know, get No, I I I think there's a big opportunity for like, in general, companies that come in and just are willing to take on

liability and like own this. There's tons of like actors in this episode that are just kicking liability, you know, to other people, right? Like, even Circle, like, the fact that they purposefully don't freeze assets because that makes them that makes them on the hook if they ever miss something, right? Like, that's shitty. Fact that, you know, you've got like Aave had two different risk curators that always had to like that weren't the Aave team, they were separate, and they all had to like, you know, do this crazy dance, and then they let in Kelp DAO without actually caring, and then, you know, Layer Zero is kicking liability to everybody except for themselves, even though like

they were running the chain or running like the the bridge. So, I don't know. In general, I think there's a there's an opportunity for that. You do need a lot of capital, but Two two questions for you guys here. One, does Who are the beneficiaries of some of this activity happening? So, and specifically, I'm actually curious on the money legos thesis. Over time, I mean, this was the original kind of if I had to back into the two primary mental models of crypto is in the beginning is fat protocols and money legos.

And I mean, we've been talking about this on this podcast for years. And now, remember, Miles, we did that whole season on the smiling curve and aggregation theory, which I've seen now picking up a bunch of steam. But, I also I'm I'm curious if the vertical integration part of that is going to come into the fore as well. And whether we see consolidation, and I think vertical integration here makes sense because if you are one layer in the stack, you there are a lot of dependencies which are outside of your control. So, I do wonder if we see fewer and just an analog for you, remember there was a period of time where there were a bunch of viruses that were on your computer and they could crash your computer and a huge part of

why Apple solved it first is because they had more control over their ecosystem. And so, I wonder if we start to see a swing in the opposite direction, which leads me more to a maybe Solana-centric view of the world. But, yeah, I'm curious what you all think of the money Lego pieces. You know, how's that going to hold up? I mean, it will just I I I I I think the totally trustless money Legos, you know, sort of activity will just get smaller and smaller. Um, >> [sighs] >> I think that, you know, offering like more control and liability or like having a more central you know, person to point to for liability is kind of at odds with with DeFi, but you could we could thread this needle like where

we harden the protocols, we add in a bunch of these circuit breakers and like you end up with this trans you know, a spectrum of of of like DeFi opportunities. Um, and you choose where you want to deposit your money based off of like, you know, your level of risk appetite, but also your, you know, how like easy it is for you to KYC and onboard, right? Um, I don't know. What do you guys think? Yeah I have a small take, which is maybe more to do with >> [laughter] >> more to do with the the distribution angle. So, like money Legos fat protocol thesis,

I think now the fat protocol thesis is still TBD. Like, I guess that's somewhat correct. And now we also know that, you know, the application layer also captures value, so that's evolved. I think the money Lego thesis has also evolved. I I consider DeFi like a back end. This is my problem with DeFi right now and the security of it. Like, it's like having an AWS server that is non-secure or unsecure and you you have to trust all your data, all your information, all your workflows are on the server and then all of a sudden someone hacks the AWS server and it's like, oh oh god, like how do I actually how do I maintain my workflows and continue processing and executing on my my goals and to get the outcomes that I want. And right now on DeFi, let you

know, let's just zoom out a little bit. Let's say, you know, agents continue becoming one of the more primary users of DeFi and these DeFi protocols and smart contracts are just the back end for like how we use DeFi. How are we possibly going to have or execute on our sort of financial goals on chain if we can't even trust the back end code itself. So, I guess my point that I'm making here is this. Like, I think right now one of the most There's two layers here. One distribution layer is the human layer and this is where brands are really important. You have like Morpho and like Aave is still a brand. Like, even with all this and you know, all these things happening, like again their moat is this. Like, we could try and vibe code Aave Aave today, uh but we still would find it hard to

compete even with all this sort of trouble going on with Aave because they've been around for years and then were the blue chip. You can argue maybe Morpho has a better or similar brand. I agree and they're two different products. But, I think the more interesting thing here is like, all right, well as agents start deploying more capital on chain, which I think they will in the next few years, how can you get in front of these agents? And like, potentially there's a lot of value to be captured there in terms of owning that distribution channel. And so, they're not really like money Legos anymore. It's just more like a back end as opposed to like composable primitives that developers use in their own smart contracts. So, I think the Lego sort of conversation is changing more to like a direct to smart contract back end kind of conversation. Like, do

you need to compose anymore? Yeah, maybe maybe you do. And maybe the money Legos are actually like new kinds of APIs. And then maybe the agents use the most reliable ones that can aggregate in the safest and most secure way. Like, I think the entire DeFi back end almost needs to be ripped out and replaced with like more security, uh more agent-friendly ways of using the the tech and also more liability like Miles was mentioning before for these agents if something goes wrong, you know, either the DeFi protocol or the curator or the counterparty, it you know, has to pay up basically if something goes wrong. So, I think this where we're at right now in terms of timing for DeFi is a critical time.

And I think the, you know, alarm bells should be going off for every DeFi protocol in the world and every DeFi protocol now should be thinking about not only making their smart contracts more secure, but also thinking about like what does it mean when it's not just humans accessing a DeFi protocol because of the brand, cuz that's one thing. The new market is agents accessing something because it's reliable and it works and it's secure. And I think that market is just getting started and I think that's a massive opportunity right now for both Morpho and Aave and human trust brands as well as new entrants that are popping up. Yeah. Cuz funds will move just a lot faster, right? It's just like a human having to like it's miserable depositing and withdrawing from DeFi protocols and moving them to another one. So,

that all goes away, right? I do I do think one one extra thing to mention like Morpho itself, which we haven't mentioned in this episode, but they've actually been working on their own agents in the last like two or three weeks as well. So, now it's getting a lot easier for agents to execute directly via Morpho back end. So, Aave I don't believe is working on this right now. And so, again the Morpho bull case and the DeFi bull case is if more of these DeFi protocols actually start targeting agentic workflows. Cuz then it gets very interesting very fast, especially if they're secure. And if you can own that distribution and that workflow on top of the human distribution you already own like Morpho's targeting right now, this might go hand in hand with Mike's bull case for >> [laughter] >> for a sponsored protocol. But, I think

yeah, Morpho itself like it could potentially be in a good position if it owns human >> Not a sponsor. >> [laughter] >> Not a sponsor. Actually, just a just a fan of the demon that the architecture. But, I will say, I mean, it's interesting to save just a poke at you here. It's I I like I'm curious because you're so uh bullish on Aave's uh agents deploying into this market, but also bearish on what to me is like the much lower hanging fruit rail of just, you know, big FinTechs using this as the the back end. So, like I I would have I would have inverted the the demand drivers there. But, can But, yeah, maybe respond to that. And I actually I had some data that I wanted to show you guys cuz honestly, this is not necessarily how I would have predicted the market responds to this. And it

actually does support your thesis, Z that uh money's moving out I want to say just quickly to respond there, Mike. I guess as a FinTech, you want to you just care about the user and the customer. And like, in your product interviews, if you say, would you like 5 and 1/2% Treasuries or like 3 and 1/2% on Aave and you might lose your money, well I think the users are going to say, just give me the Treasuries and 5.5% is fine. So, I think if FinTechs are the driver to come into DeFi and they care about their user, I don't think the best user experience right now is moving them into DeFi. So, it has to come from elsewhere. But, at the same time on the agent side, we are very far off. That's not like I actually wrote a bit about this this week, but like I think DeFi hurting is

hurting DeFi like agentic DeFi even more. Like, I think agentic DeFi is in a really bad place right now. Which again is a sort of double bear case here of like if FinTechs aren't moving in and agents aren't moving in, but it's clear that's where the space is going, something needs to be fixed. And I again, I don't know if it's economic conditions or like better security, but like there's definitely a big gap there in the market. Okay, let me see if I can share my screen here. Um, so this again, it's just really fascinating to watch uh in real time. Can you guys see my screen? Should be a bunch of all Yeah. Okay, so one of the things that I feel like is forward-looking as an indicator when you're looking at these markets is deposits.

So, you can see Aave obviously still is um, you know, the juggernaut in the space, but deposits are down from about 45 billion to uh at least as of yesterday uh about 29 or just under 30. And so, you know, the this is the question, right? Is are other protocols picking this up or is it just leaving the market? Uh if you look at Morpho here, Before you pull up the chart, I'm going to go ahead with relative confidence and say that the other protocols are picking up a little bit, but I think the majority of it is moving off chain. Yeah, you're right. Yeah, so on the deposit side of things, Morpho took a little bit of a hit, but seems to be recovering. Um, you know who actually was a big beneficiary on the Ethereum side actually was Spark. So, they

actually almost doubled deposits, which might explain Now, I think Spark actually moved some of their own um assets away from Aave as well. Uh this is also Spark Lend, uh which is different from Spark, the actual protocol, but uh they seem to be a big beneficiary on the ETH side of things. I mean, Camino has been basically untouched. Um, I it's interesting to me still that there is so uh it's it's very interesting to me that um you know, there's like no flow in between ETH and SOL DeFi, which you you you would think there'd be at least some. I mean, it's it's surprising to me that it's completely uncorrelated or it seems to

be completely uncorrelated or maybe there's going to be a lag in in a couple weeks we'll see that those deposits show up but again on the not that this is at all the point of the episode, but it does I think if you look at the L1 layer and what the implications are, I don't know. I think that these use cases are far stickier to core ecosystems than you might believe. And and in theory you'd think it'd be much more fluid, but they really aren't. They really aren't. I mean, just to riff off that, I I think Solana, talking about security and I'm a massive Solana bull, but Solana has been around less longer less time than Ethereum. And I think Solana's this fast chain, which

has been known to go down. I mean, obviously it's up most of the time, but it has gone down a few times, and Ethereum, from what I understand, hasn't really been down at all whatsoever in the entire lifetime of the chain. And so, if you have billions of dollars, probably these billions of dollars you'd prefer to have on Ethereum because it hasn't gone down, and theoretically the security's better, obviously TBD long-term, but like on Solana, it's a fast chain, the UX is good, it's like not buggy, but it sort of like feels fast, and it's like, "Shit, I'm putting a billion dollars on this chain right now, and like, is this really massively secure versus something like Ethereum, which is even the EVM developer ecosystem is slightly bigger as well?"

So, I think it checks out that more DeFi is on Ethereum. The second point I want to make is it's also where funds receive capital. It's not even just about like choosing an ecosystem like Solana or Ethereum. Like, I'm someone who doesn't actually care for Solana or Ethereum, but like, where do we receive funds? We receive funds on Ethereum, right? It's just sort of like practice. And I imagine most funds receive USDC on Ethereum, not necessarily on Solana, which maybe is alpha for Solana if they somehow get a bunch of funds receiving USDC on Solana, and then getting that put to work on Solana DeFi cuz I know right now any Solana funds we have we put to work in Solana DeFi, but then everything else is is mainly Ethereum.

So, I feel like that's probably a few funds that are the same, where they're agnostic, it just depends where they get the capital. That's interesting. I mean, have you guys actually like pulled out of Solana DeFi at all? Um or out of Ethereum DeFi? Yes. Yeah. [laughter] Yeah. Yeah. Okay. Absolutely. That's interesting. Anyway, it's just it's interesting that these use cases have been far stickier. And honestly, Kamino is doing really The the one caveat that I'll say here is it's not clear who has won the RWA game, and that's the big question mark here.

Um I think that Ethereum still has it's their game to lose with uh with I think Morpho especially, people building, you know, on the you know, people building on top of Morpho as a platform. But Kamino is, you know, doing great work here as well. The on the RWA side of things, they've been very successful, and I know the Solana ecosystem is very focused on that. But it's just a remark, right? Like you Yeah, yeah, I can't really think of any instance in crypto which a use case was won on a general-purpose chain, and then it migrated to another chain. So, I don't have a great answer for why that is other than just And Rob still sucks in general customer inertia, but

just an observation. It's even really difficult for protocols to migrate users from one instance to another. Like, if you were to break down where the revenue comes from in Aave V2 versus V3 and Uni V2 versus V3, It all feels scary. >> And V and V4 on on each, yeah. Well, it's also just a question of usability. Like, some of these DeFi protocols, for example, there's V1, V2, V3, V4, and you can click on different versions, and it's like, "What the hell am I even using in the first place?" Like, it's not even that simple to work with, to be honest. I don't think that I mean, this is I feel like it all makes sense if you zoom through the individual problems.

DeFi is not really meant for individual user use cases. It Yeah, even from the very first time that I used DeFi, I was like, "This isn't built for me." really. Like, And maybe that's fine cuz the DeFi mullet the DeFi mullet to me is the thing that I think makes the most sense. Although, I do think there was an article saw the headline that these DeFi hacks are causing some institutions to rethink things. So, we'll see how much of that materializes. >> Which makes sense, I think. And then on the North Korea side of this, obviously, that's a purely bad thing, uh but I do think it's at least something for the industry to rally around a little bit at the moment. I mean, th- this is a Sorry, this is not like a

numbers-based analysis, it's a little highfalutin, but crypto kind of won, and there is a weird transition where you have to go where you don't have anyone to blame anymore. W- which I think is healthy in some respects because you can't just blame the regulators for token prices going down, which is totally what happened last cycle, and it had obviously nothing to do with them. Maybe something to do with them, but that was clearly not the driving factor, right? There's kind of no one to blame but ourselves, but now we kind of have this little enemy to rally around and cause the the type of pragmatic change that we need to in DeFi for it to get adopted. And I would also say our modern financial system wasn't built overnight. It was a ton of incremental over time that initially worked, and then opened up areas where

it wasn't working right for disruption, which is what DeFi is. So, anyway that's I don't know. I'm ending I'm ending on the bull case here cuz I less less I mean, not financial advice, do your own research. Certainly don't put money at risk because of anything that you're hearing on this podcast, but I think that they'll figure this stuff out over time. And every everywhere that I look, I honestly just see consolidation. That's the defining trend of the next couple years, I think.

The good teams will make it, and they'll slog through the crap, and those will be household names in 10 years. The bull case is that people have short memories, uh typically. Yes. So, you know, As soon as the market comes back, I think I don't know if people will be stopping from putting money into DeFi because of what happened, you know, this week. Yeah. Yeah, like also we're in a bear market, so of course DeFi is like this regardless of security, so >> [laughter] >> you know, even in a bull market, when something like this happens with security, no one would probably care.

So, that's also something to consider. Yeah. All right, fellas, this was a fun one. Um This was great, and we'll see you guys back here next week. Study, lads. More capital coming. >> [laughter] >> Cheers, guys. All right, guys.