Tom Schmidt Explains What You Need to Know about DeFi

I don't think you're the only one, to be fair, like, I think there seems to be a lot of interesting things happening in the space, but it's hard to wrap your head around a lot of them because frankly, they are so brand new, and in addition to that, as we've spoken about before, a lot of them seem to

be kind of wrapped around each other. It's like df I wrapped around DFI wrapped and DEFY sort of defy all the way down, and it's hard to figure out exactly what the application is to people outside of the space, right, And this is of course, like I think, like you know, there's a lot clearly a lot of like trading and speculation, and we'll talk about how those markets work because they

work differently than say the stock market. But then there's also like the question of like what is it for, because like it's very easy for me to like conceptualize sort of traditional equity or traditional lending, because I have an idea of like what these financial instruments are for. Where my impression of the Defy space and large part is like it's incredibly sophisticated and derivatives and all this kind of stuff, but like I still don't know what

it's like for per se. Yeah, I think that's right, And I mean to what I was saying earlier, who it's for. Right When I see a lot of before you Defy accomplishments, I think, like, Okay, that's great. You guys have built yourself a really interesting little defy eCos system. And I know that sounds patronizing, but like I don't know who's interested who's interested in an outside of that.

I feel like that's the missing part of Defy. The space hasn't been very good at delivering the message about what this means for people who are actually outside of the DeFi space right where where it actually sort of competes with traditional finance and so far anyway, we always ask these questions, But I'm very excited to say, um, I think our guest today is gonna be really good. Multiple people have suggested that he's a great person to talk to, very active in investing in the DeFi space.

So maybe we'll get maybe we'll get some answers today, I hope. So let's do it all right, I'm very excited we're going to be speaking with Tom Schmidt. He's a general partner at Dragonfly Capital. It's a venture firm that focuses on the crypto space. More broadly, Tom himself as a fairly long background long as these things go, in the DEFY space, a very active in it. So we're going to get all our questions answered. Tom, thank you so much for coming on odd Luck, thanks for

having me, Thanks being Tracy. So I'm let's start with your background. I mean, like I think the average person may be listening to this has been like sending the last like two months trying to understand Defy and the idea that like one could have a long lineage in this space is kind of weird. But you actually legitimately do what do you give us things sort of like a little bit of like your background in crypto and Defy, etcetera.

How you got here. Yeah, it's it's funny that defy is now sort of a thing that people talk about, but you know, it's it did sort of come from nowhere. I think in many respects, my sort of entrance into crypto sort of parallels defy in some ways. Not to get too poetic, I really got into you know, crypto

during college. Um, I was writing this sort of computer science ethics paper on on your interesting topic that anyone can choose, and I ended up doing this sort of big coin regulation back and back in twelve and I thought, this is this brand new asset, no one really knew what to do with it, sort of thinking through, hey, how many this thing be be viewed in the eyes of the law, and then sort of actually put it into bitcoin mining from from my dorm room along with

a couple of their friends. Um, and that was sort of when I got interested in in you know, the cryptocurrency space overall. If you look at you know, sort of those early days of bitcoin, you the things that people aren't doing are doing in defied. These days people were talking about back then, back on you know bitcoin talk, where they're trying to do where hey, there's this new asset, but it's sort of stuck. You know, it's not it's just it's this form of money, but you can only

just sort of send this money back and forth. And people want to do other things with it, right. People want financial services, People want to be able to exchange, but in order to do that with bitcoin, you have to go through a centralized party, UM like a coin based or like a f t X, and they have

to um, you know, because of your bitcoin. They might go down, they might lose funds that might exclude you, and so there's sort of those weird paradox where you have this great decentralized currency, but you don't have any financial services that are also that also those same properties. You know. One of those those main functions that I mentioned was exchange. Decentrized exchanges have been around for a long time. People have always been trying to build them.

I ended up getting back into the cryptocurrency space in seen when I joined zero x, which is one of the very first decentrized exchange protocols to run product for them. And zero x is it's sort of this pure to pure exchange where um, you and I can agree to a trade off chain, you can sort of find each other, and then this smart contract basically acts as uh, you know, sort of the counterparties that executor at the trade, so we don't have to trust each other. Um, no one's

actually taking custody. Um. This piece of code sort of runs it for us. So I ended up working at zo x for about two years, uh, and then joined Dragonfly about a year and a half ago to do investing for us and specifically focused on DeFi what was the transition like from bitcoin to more of the Defy experience, because we sort of take it for grounded now that there's a Bitcoin and now there's all this off being built on things like ethereum in the Defy space, but

years ago that split wasn't as a parent. So I'm just curious what the move was like or the transition a few years ago. There are a number of very early attempts to basically build defy these same sort of financial services on bitcoin. One of them is still around quite you know, well known. It's called root Stock, basically a sort of side chain that sits alongside Bitcoin where people can write smart contracts that they can on Ethereum that do the same sort of things that you know, Defy.

Early defined protocoles can do. Now another sort of blockchain U called bit shares sort of that came around the same time that again had a lot of the same ideas that we see and defy now where you could you know, meant that you could borrow, um, you could exchange. It's it's hard to say why a lot of these

didn't take off. Certainly for some purposes. Uh, you know, the developer experience of building these things is pretty brutal um compared to the developer experience of building something on ethereum. And so you know, the argument that hey, you just don't have that sort of nexus of of developers you're going to make all these things that um, you know, interlink, it's just not probably not going to happen. You're not

going to sort of hit that that critical mass. You can also say maybe it's just too early, right, A lot of things that are happening in DeFi right now,

again we're being discussed you know, five years ago. But if you don't have the users, if you don't have the liquidity, if you don't sort of have you know, sort of this confluence of people in capital, you can't really get a true market farming and so some of the problems were obviously technological, where you know, Bitcoin is obviously very slow to upgrade, which is a plus in many respects, but a downside when you're trying to build something brand new and trying to um you know, tweak

the underlying platform to make it easier for developers to actually start building these things. So one of the what you know, within the defy realme, you know, one of the pitches I guess, or one of the reasons people get excited about it is like is the yield opportunity? Like they was like, oh, you're like enter into this trade or lock up your asset and you get two a p y or thousand percent a p y in

some cases. And we actually talked to someone several weeks ago it was like a yield farmer kind of more from the trader perspective, but like, you know, this kind of makes my head hurt because like, no one gives away free money, right, So how would you describe like where are these returns in DeFi come from? Like what

is the what is the activity? Who is paying you for the service of say locking up your ether or locking up your stable coin or whatever, Like how do you sort of like describe some of the basic mechanics at play. Yeah, this is I feel like what has sort of brought in part defined in the mainstream maybe over the past years. People see these, you know, I popping returns, and you know when you're kind of what's

going on because it sounds kind of insane. I think we sort of saw that with the whole mark cut in iron finance thing maybe a week or two ago. I think yield in sort of the DeFi space comes from a couple of places. The main source of yield that sort of drives again these huge meers that we talk about actually comes from these protocol tokens that are given away UM and very concrete example of this when the first project did do liquidity mining was compound finance UM.

Compound Finance it's a decentralized money market on Ethereum where people can deposit lenders and borrowers can deposit assets into the smart contract um and then borrow against it and if they wish, and so I don't have to call up a lending desk get a quote. I hope that

they're open, have them custom my assets. The smart contracts sort of take cares of all take cares of all that for us, and then they also set the rates problemmatically, so compound it's been around for about a year and a half or so, but m about a year ago, so it's March they announced this this program which has since been dubbed liquidity money, where in addition to the returns that you would get, the interest that you would get just for lending out assets to somebody who wanted

to borrow, so let's say maybe six percent on your young your stable coin, your USDC or ethery or whatever, they'll also give you some comp tokens. So comp is the native governance token of compound, where people who old comp can vote on how to upgrade the compound smart contracts over time. So if you want to add a new feature, if you want to add new types of collateral, if you want to adjust rate, comp holders get to vote on shain as to how that actually gets upgraded.

So there's no central party that actually controls this thing. So compounds started giving away about fifty of the total supply of comp two people who are using compounds, so people who are borrowing, people who are lending anyone sort of proportionately to how much you actually you're doing either those things, so how much capital you're actually borrowing or lending?

In addition to this six percent, you start to get this supply of of COMP tokens, and basically that yield comes from sort of the market price of where people think comps should be trading at. So you know, if I'm earning again six percent on that USDC, them earning a few COMP tokens, and let's say compass trading at a few hundred dollars, suddenly you sort of project out these sort of two combined as with them getting both the USDC the stable point interest plus the COMP and

so only my a R. It looks huge. And so people have basically been tweaking this over and over again, different ways of doing this liquidity binding where they're incentivizing growth of the of the protocol by giving away this native protocol token. And that's a large part of where you see. You know a lot of these numbers come from you call them governance tokens, but and you describe their value as being able to vote on upgrading the protocol.

But obviously just voting rights typically aren't worth that much. Are we really talking about de facto equity in a different name, and as part of the part of the upgrade that one can vote for is is directing trading revenue to the token holders. Yes, this is uh, maybe a little bit of a touchy subject and defied because people do not want you want to sort of scirt around this topic. But I think a lot of a lot of people, a lot of investors definitely see it

that way. Where you know, with compound, there's no company, right, there's no entity that I want to get take equity in um that is, you're going to take some some profit.

But the protocol itself obviously generates ton of revenue. And so there's sort of an idea that hey, these are sort of going into the company treasury, they're on this protocol balance sheet, and if I have control over that, you know, much in the same way that you know, maybe I, you know, have governance rights in a company that has a hundred million dollars on the balance sheet, Certainly those those governance rights should be worth something, even

if maybe I'm not entitled to to dividend rights at the moment, because I can vote in dividend writes down down down the road. I think one of the very earliest defect protocols. Make it out actually launched with this sort of baked in where make it out, it's a decentralized credit facility where anybody can come up. They can they can put down flateral and then they can borrow die, which is the natural stable coin, the native stable coin

against that. So you can put down you know, two worth of ether, you can borrow a hundred die against it, and now you have liquidity which you can use to you know, for operating expenses, to pay taxes, to pretend to your friend whatever. You have this die which is pegged to a dollar, and you can use it for a new purpose now Maker Obviously it's the lending facilities.

So if they figure out how to set rates, ray to get set by and care holders, so it's not being done programmatically and care holders basically to determine how much how much interest to charge people who want to borrow against and how people who want to make die. They also take on risk where let's say that they onboard bad collateral, they want to add you know, iron

token as clatteral into maker. People who meant a bunch of die suddenly dies, is suddenly you know the price of iron, you know drops by and now you have a bunch of unbacked die, so you really want die to trade out of dollar um. Suddenly there's not enough clatteral to back that up. So where you're going to get enough collateral to sort of reback this die And the answer is that the maker protocol will mint and

sell more in car in order to recollateralize itself. So in one sense, you're you're governing the protocol, but you're also taking on this risk because there's a chance you might be deluded if this this system accrues debt and so in response or you know, in compensation for that risk, and care holders also get reward and that they are entitled to all that interest that is being a crewed by the system. That interest is then used to buy back MKR off the market and you know, effectively give

that back to m care holders. So MKR you know right now, you can you can look online. There's a website maker burn dot com which will tell you, you know, how much cash flow is basically being given back to end care holders, uh, you know, every single year, and it's it's pretty insane. I think the last time I checked it was maybe a hundred million dollars or two and a million dollars that is bought off the market

and basically given back to end care holders. So they're a good example of one of the few protocols that it actually has those sort of cash flows turned on. But certainly to your point, there's a lot of speculation right now around m hey, when our fees going to be turned on, if they're gonna be turned down at all. I think there's a counter argument to which is, hey, these are all very nascent protocols, right you don't really don't want to be charging fees right now. You want

to be incentivizing growth. It's sort of like, uh, you know, if you're an early stage startup, you don't want to charge full fee. You don't want to you know, um sort of be maximizing revenue. You want to be maximizing growth and think about how to sort of turn on revenue down the road. So the equity question kind of reminds me of one of the bigger issues hovering over the entire space, which is I mean, defy in my mind is kind of like fintech on steroids. And I

used to cover fintech. I used to cover peer to peer lending, and a lot of the use case for that new industry was this idea of we're going to cut out the middleman and we're going to directly connect lenders with borrowers, and we have all this new, cool technology that's going to allow us to do it. I'm not saying it's a one for one analogy, but a lot of the conversation around DeFi reminds me of that. So my question is how much of defy is about the technology versus how much of it is about doing

something outside the existing financial system and existing regulation. I guess a shorter way of putting it is like, how much of this is regulatory arbitrage and giving people exposure to financial assets that would be more difficult or more expensive for them to get in a in the traditional financial system. Yeah, that's another great question, and I think it's frankly a large part of the appeal of defied.

I would say, you know, regulatory arbitrage. I think at face value, maybe sounds like a bad word, but when you look at something like Uber, or you're looking at something like Airbnb, where you know regulations were um, you know, probably overly arduous and probably you know, hampering the growth of this market. I think it's interesting about DEFY. There's a couple of main components, right, one being the permissionless access.

So anyone around the world can go and use these different protocols any time of day, um, any time at night, anytime anywhere, who you are, you can go and and trade, you can go and borrow. That's a pretty powerful, I think concept that you don't have to be living in a particular area. You don't have to be, you know, of a certain status or be able to post particular collateral order use any these things, and so you have

this truly sort of global market from day one. The other as is maybe you were sort of leading to is sort of permission list to build on top of. And that's where I think this whole thing gets really exciting. Where I don't think he incorporated. I don't have to live in a particular locale, I don't have to beat certain requirements. As long as I can write software, I can go and experiment. And I think that sort of permission list innovation is sort of what made the Internet

what it is. Where I don't have to go and you know, apply to the SEC for the license to you know, broadcast and you know, buy all this equipment to you know, sort of a television station. I can just go and take my camera and start posting it

to YouTube. And that's where you sort of get this this consumer surplus where you know, these entrepreneurs all around the world are constantly devising new, better financial services and they have a very low bar in order actually deploy them and make them accessible to anyone around the world. So you have not only sort of permission less access, but you also have permission's access for builders who can again just use this thing as long as they can

naturally write software. And the third thing that think makes

it interesting is sort of transparency around it. You know, people sort of against site sort of dozen eight, where you know, you had all this sort of crazy debt, all these you know, crazy derivatives that we're piling up, and you know, sort of after the crash, we started saw that many different parts of the US financial system were levered like three point five to one and that wasn't really revealed to us until after the crash because

there was not really a lot of transparency. It was just chechnically wasn't really possible to see all the different instruments in all different ways people were positioned with Defy, you know, as I was sort of alluding to early with Maker. You can go to any of these websites right now. You can look at the Ethereum blockchain itself and pull the data and can see exactly how much did his issue. You can see exactly, you know, the credit balance of every account Um. You can see the

revenues of Maker. You can see who's going to you know,

get paid, who's going to get liquidated, etcetera. And so this thing is a percent transparent and a hunder percent oudiable, and that just princess this huge sort of step function leap over what is possible today where you can have people that you know, maybe make an a t I that is up or available some of the time, and you sort of to trust that the data is available, but sort of that the core base layer is not auditable and it's not transparent the same way Um it

is with a lot of the product products that are being built in Ethereum are in the Ethereum Defy ecosystem. So those are sort of how I think about you know, a lot of value props of Defy. The fourth obviously being and sort of the you know, direct analogy to fintech is programmability. The difference you know, being with with defy is I don't have to rely on our particular company to grant me API access to you know, be be available when I'm available, to have particular up time

to do whatever is I needed to do. The API is sort of embedded into the into the contract, into the product itself. So as long as you know the Ethereum blockchain is running, which it almost always is, you can go and call into any of these contracts as as a as a as a programmer and actually go

and build new applications. And so you know, those are sort of a few of the core value props when we think about defy, and certainly there's a lot of overlap with with fintech, but there's a lot of things that are new and sort of expand the market beyond what you know, something like a stripe could do, for example. So pretty soon I want to get to the question of, like what are these tools being used for besides say speculation, because you know, you mentioned maker and I could post

collateral and get die. But my impression is probably most people do that, just use that money to buy more coins as opposed to anything resembling business. But before we get to that, I like, here's another question I have. So we'll get there. But here's another question I have. Can you explain impermanent loss? Because I've like I had this after like people have done threads and explained like you know, the unit swap liquidity providers, and it's like, oh,

just can you explain what that's all about? Yeah? Yeah, So I permanent loss refers to this future of this byproduct of UM what are called automated market makers, and so automated market makers are smart contracts that perform the function of a normal market maker on a normal order book based exchange. So you know, normally, let's say you want to go and I don't know, trade Apple stock right on on the exchange of your choice. Maybe you want to buy a certain price, you want to sell

at a certain price. You have a market maker who's holding inventory that is quoting you on both sides right there, posting orders to buy, the posting orders to sell, to provide liquidity to this market so that if anyone wants to show up, they can buy or sell Apple stock at a reasonable price. UM. Now the same sort of market makers exist in crypto, where you go on coin base and you have market makers holding bitcoin inventory as dollar inventory, and they're sort of posting these orders to

make sure that there's sufficient liquidity in the markets. An m M basically replaces that function with a formula. Sort of. The most popular style to MM is what we call a constant product and M, meaning instead of asking a market maker, hey, you know what kind of quote can you give me if I want to buy or sell hundred shares of apple, the answer is whatever, the formula sort of spits out, and so that's the quote that

you're going to get. And the way this works again in a constant product sense is, let's go with another simple, really simple example. Let's say I want to a market aker for USDC market I can go, I can take some eth. I can take some USDC equal proportions and deposit it into a smart contract like unit swap, and

now anybody can buy or sell against me. Right, this smart contract is taking my assets, and now they're basically acting as the marketingker're acting as as the quote provider, and anybody can buy or sell any amount of asset through the smart contract any time they want, and the smart contract will give them a quote. So in this really simple example, um that. Again, the constant product formula

is um x times y equals k UM. So in this example, let's say I put in ten and ten USDC assuming E is one dollar, so ten times ten is a hundred. So no matter what sort of amount that you want to buy, at the end, there the amount of ether left in the smart contract times the amount of USDC left in the smart contract has to equal a hundred. So now the question is, you know, again, let's say I want to go and let's say I want to buy five Ether. I'm a new person. I

want to buy five ether from the smart con tracked. Well, so at the end of this transaction, there's gonna be five e F left, but five times something has to equal a hundred, so there's gonna be USDC left. So there's twenty U s dc. So let's say there's ten U s dc five, So my quote is basically two U s DC per. So this thing is basically able to offer you a quote for any amount of asset that you want to buy yoursell through a smart contract. Now the problem is, again, let's say you're that LP.

You're the person who put in ten and ten USDC. Well, now you've suddenly sold a bunch of eth, as eth has presumably gone up in market, and so you're worse off than if you had just held EATH and USDC. You have five, you have twenty U s DC. That's only thirty dollars. You would have had forty dollars if

you had just stayed in. Permanent loss refers to this concept that in a concept product market maker, as the market moves, you will have you know, less busy, less assets, less money than if you just held on those assets, um and not put them into this smart contract. They self permanent. Yes, so here here's the caveat right, this would normally be an absolute a terrible value proposition, right you would you lose money as soon as you start to put assets into this smart contract. The way am

ms make up for this is by charging fees. So Unit Swap for example, charges thirty bits on every trade. And the idea is that with enough volume that those fees will begin to make up for any of any of that permanent loss. And additionally, you know you sort of want uh what we call mean reverting assets, so you actually want a lot of volatility because that's gonna encourage people to trade, that's gonna allow you to your

crew fees. But ultimately, at the at the end of the day, UM, you want those assets to sort of return to the ratio that they were when you put them in initially, UM, And that's how you sort of avoid impermented loss. But to your point, UM, if those assets never returned to that initial ratio, So let's say you become a liquidity provider for ether beneath is ten dollars and he goes up to a thousand dollars, it is probably not going to go back to a hundred dollars.

You've you've you've probably would have been better off just just holding onto that ether instead of putting into a smart contract. But with enough volume, you can in theory make enough on fees or to common for that for that loss. So at a very high level, that's sort of how the whole m m impermitted lass sort of the thing works is you're sort of banking that's going to be enough volume, so you're gonna be able to crue enough fees in order to offset sort of the

drift and asset prices. Okay, I have a question, um, and it sort of feeds into where we want to go next, which is the real world applications and what people are actually doing in this space. But it feels like there is a huge obstacle to Defy going mainstream, just in the fact that it seems very, very complicated. So what you were just discussing about impermanent loss. Um, it feels like I am going to have to go back and really listen to that conversation a couple of

times in order to wrap my head around it. How difficult is it going to be for these types of concepts and this type of space to actually go mainstream and attract a lot of people if you're asking them to participate with a level of understand ending that like I would say, borders sort of on obsessive, like just listening to people who come on to all Blots before, like the yield Farming episode. These are people who are intensely into the space. How are you going to attract

people who are slightly outside of it? Yeah? I think right now, there's definitely a huge sort of pro sumer power user and element to defy where there are people who sort of live and breathe this stuff, and you know, they sort of biased towards being active with it, right, Like I like attending my yield farms, and I like

sort of playing around with new stuff. And for the majority of people when they think about you know, financial services, that's not what they want, right They want to you know, by by S and P and put it in there for O, n K and and not really really think about it. And so I think the answers comes from from, you know, a couple different advantage points. One is just

from a sort of offerings perspective. I think they are could be more and more abstractions built on many of these protocols such that the end user doesn't really end up thinking this kind of thing. And the impermanent loss example, you can sell off some of that yield to to pay for, you know, any impermanent loss that you might you might experience, or you might buy put some calls so that you know, you can sort of hedge out

some of that volatility that you're exposed to. Ultimately that can be you know, bundled inside of a structured product and sort of give into an end user. And so I'm not thinking about you know, sort of what's in this basket of goods that then I'm buying. I just know, hey, I want to know, earn some yield on asset x y z, and then maybe this is a good way

to do it. I think actually the stable coin market is a great example where you know, cryptocurrency users are willing to pay you a large amount of interest in order to get leverage on some of these assets. Right like you know, um to the futures markets often hit three annualized or even lending markets hit hr in order to borrow stable coins to to get leverage on some

of these assets. But you know, if you're not a tryptop person, if you just want to you know, uh, sort of earn some interest on some cash that you're he laying around, you can go to you know, services like coin base or block by, and you know, they will take your USDC and they will lend it out for you and you don't have to think about, you know,

anything that's sort of going on under the hood. I think actually a great example of this is in China there's a company called Matrix Suport which actually want to portfolio companies and they've sort of pioneered this swortter we called c D five. So it's half centralized, half decentralized, where it's a custodial service. You know, they own your bitcoin, they own your USDC, they sort of take care of

it for you. You can't lose it. But under the hood they'll go out and they'll yield form for you. So they'll go put your USDC into compound, they'll take that comp they'll sell it for more u SCC, and then they'll go get to give it back to you at the end of the day. So from an end user perspective, you don't sort of see what's actually you know, happening. You sort of think about, you know, the yield that

that's that you're getting. And so for a lot of users, I suspect that's going to be the way they're going to use defied much in the same way. You know, most people they don't think about trading bonds or you know, selling your complicated drivetives. They just think about putting money in the bank account, and you know, the bank sort of handles how to get actually interest on it. So I would say there's still a good amount of abstraction that for meaning to to make this stuff really palable.

To to end users, not even talking about a lot of the transaction costs and all of the scalability issues. But I just like that's going to be a large part of the way people actually get exposure to this thing. Just on that note, we sort of touched on this before,

um with the fintech angle. But if it's going to be similar to putting your money in a bank and just sort of trusting the process, isn't that where you kind of need regulation or at least you need to have some sort of faith in the middleman or the process that's doing this for you. So I guess I'm just curious, like how you swear like people not necessarily understanding all the details of the process, but also having faith in a decentralized process or method of doing this.

I think it's about having exposure and having the ability to sort of go down to the middle and get access to it or audit it or do whatever you want. But there's always going to be people who are not gonna want to be their own bank. I always hated that that slogan that I think a lot of crypto people push because it's just not something that is appealing or feasible for a lot of people. I think of it a little bit sort of like email, where most

people don't run their own email server. Most people don't have their own email client. They use a hosted service like Gmail, and Gmail sort of runs the email server for them. But email itself is still an open protocol. Anyone can go and run their own email server and I can go send you an email, You can go send me an email. That open protocol is always available

to us if you want to use it. But of course, for convenience sake, a lot of people are gonna end up using, you know, a lot of these sort of hosted services at the end of the day. So the beauty is you have this sort of global permission list seven auditable um um settlement layer that anybody can tap into, and again that allows sort of permission permission list innovation.

But you can still have these really nice financial services that sit on top of it that you know, give people a really simple yield that's when they get access to or you know, really let them let them really easily, you know, borrow money if that's what they want. Um. The two don't ness searily have to stay in conflict. So you brought up something, and actually it's come up a couple of times that have been maybe very curious about.

So it's like, if I look on coin get go the top volume pair pairs traded on unit spop right now, it looks like fifty over is the U s DC pair, another five percent is the tether pair, another four percent is actually the U s DC tether pair. A lot of this so called defy is built on centralized um stable coins. So this is literally like a token that in theory we were told is represented by a dollar's worth of dollar denominated assets held at a bank somewhere.

And then there is a decentralized able coin called die which is backed by crypto assets, except from my understanding even that is significantly as one of the backing assets us DC. So how much is this whole thing still like sort of like built on a highly centralized regulated

asset that also could be significantly regulated further. Yeah, the stable coin risk is a real one, you know, maybe for for listeners who aren't to wear a stable coin such as USCC, which I realize I've been referencing quite frequently. It's a token that lives on ethereums as well as a few other blockchains that is backed one to one by dollars that are in a you know, audited US

bank account. So one dollar comes in, one USDC is minted, and simultaneously you can then go and redeem that USDC so you can, um, you know, give centers, need the name of the company given the USDC and they'll redeem it. And and why are you you know, US dollars to the bank account that you want. So really really simple,

you know, one to one back. Now, the problem is this is sort of you know a little bit of a golden age of of this is sort of pure regulatory arbitrage right where um, if I want to go and you know, send a million dollars to you Joe, you know, throw a wire or to paypaler or whatever, yeah, we'll lose that up. You know, I have to go through m K, I C A, m L. We have to be using you know, um, everyone who's who's in

the sort of the middle party is being MSB. There's a lot of regulation in between to make sure maybe bad actors can't use this with USDC. Once it's minted, I can go and send it to you, you know, on chain it's pseudonymous um, you're just one address. I'm one address, and really the only the k I c aml apart takes place off chain. Sou if you want to go take that million dollars and you want to then want to go but redeem it, then you have to do ky C. But in the interim, you know,

it's all sort of being transferred on chain. There's always this risk that and we see this occasionally where you know, USDC and and TELL both have the ability to to blacklist and freeze as so if they determine that you know, these funds were sees as part of a hack, or maybe they're being used for money laundering or funding terrorism. Granted this is a very very very small percentage of all the sort of activity that's happening, they can say, hey,

actually these tokens are frozen, they're not redeemable anymore. We're going to you know, it would be like you know, you your bank account is pros and sort of functioning the same thing. And so there's always this risk that hey, that might happen into Maker or compound or unit spop or any of these services where they're sort of reliant on a stable coin right now. Over time I think

sensible regulation will come around. Hey, how are these thing is actually going to interact with the traditional and financial system. I certainly don't think it's going to be, you know, everyone needing constant, unchain financial surveillance all the time. But in the interim it is sort of this this weird place where there's always a little bit of risk that

that something like that might happen. I think to your point that sort of speaks the need for something like Die, which right now is has a percentage of it's of its backing in USDC for the purpose of of stabilizing it um. So certainly they could get rid of USDC tomorrow, but basically die with trade above a peg because people like to take that USDC and quickly arbitrazed Die by minting it when it's above the peg and selling it and sort of capturing that spread. So it's sort of

at this trade off for it. You can have that that stability, you can have that, or you can have that decentralized stable coin. But if you want to be perfectly stable, if you want to be really not volatile, there's a little bit of a crut right now. We're sort of depending on USDC. I think most of these teams have plans to gradually wean off of these these centralized stable coins. Is they see these same sort of risks, But you're right that right now it is a risk

in the in the in the ecosystem. So this reminds me of something else I've been wondering. But to what extent is Bitcoin collateralizing a lot of these defy um operations or trades or industries through the stable coin channel, And like, if that's actually happening, does that mean that crypto because defy seems to be such a dynamic space, does that mean that defy like is eventually going to

have to outgrow Bitcoin? Or I guess another way of saying it is like, by definition, you can't have a finite pool of collateral in the form of bitcoin um that's being used in a system that's growing exponentially. Does that make sense? That does make sense? I mean, I think the way I sort of think about purposes or sort of don't. I've been discussing what for sort of three main buckets, one of them just being financial services

for crypto assets. So by and large, a lot of the services that you see and defy today are for ether so people hold they need liquidity against it, they want to trade it, they want to borrow it, whatever. All these sorts of different services allow you to do that. And there's even more sophisticated derivatives now where I can buy and sell decentrilized options against my ether um and and I can really do anything I would do on

a normal exchange, but do it and defy. And increasingly this has happened with bitcoin as well as mean maybe you alluded to where there are tokens such as wrapped bitcoin, which is sort of like USDC for bitcoin, where custodian holds onto your bitcoin and midst w BTC on ethereum. And now you know, sort of going back to that initial Bitcoin defied dream, I can put my bitcoin as collateral and I can borrow against it, or I can trade my bitcoin for ether, or trade my bitcoin for

USDC or vice versa. I would say that's actually a small percentage of what's happening in defied today. Most of it is sort of around ether and other sort of definative assets, but certainly for people who want Bitcoin exposure, it's a great way to sort of get access to these again sort of permission lists financial services that in many ways are superior just not accessible to you know, many of the people who are using them. I think, you know a great example of sort of this permission

lists innovation. Um, there's this service that that we recently back called ribbon Ribbon. You know, one popular way people get yielled is they sell covered calls. Right, so I have some bitcoin, I ask some either I want to stack more bitcoin, I want to stack more ether. I sort of care about accumulating when you sell these like out of the money covered calls. In theory, they're not gonna expire in the money, and so you've got to collect the premium and and just sort of kept keep

collecting more you collecting more bitcoin. Ribbon. You know, this is this is a service that isn't really accessible to many people in the US. It's if you do want to do it, you need to sort of post ten dollars in collateral. Um you go through all these different types of you know, hoops and actually get access to this thing Ribbon. You can go. It's it's all on chain,

it's all trustless, it's all decentralized. Anyway, who go and and get access to this sort of sophisticated structured product without having to go through middleman and without having to uh, you know, sort of sort of subject themselves to financial surveillance, which I think is actually a huge plus. I think, going back to initial question, these are all sort of

just different types of financial services for crypto assets. The big sort of question is how do you sort of break out of this realm, right like, how do you get out of just lending to Ether, just letting the bitcoin? And I would say that there's a couple of different different ways I personally want to think about it. One is is sort of through this realm of synthetic assets, where you know, there's I would say Die is a great example. Die is a synthetic version of US dollar.

But there's many protocols that use that same mechanism of posting collateral and then minting debt and and you sort of using what we call an oracle in order to keep it in pegg with some target price feed. But for other types of assets. So you can go on on defied today and you can go and buy synthetic Tesla, you know, synthetic apple Um, synthetic you know game stop stock, anything really um and it doesn't even have to be

a real world asset. It can be the synthetic price of the median you know, housing sale in the San Francisco Bay area, or it can be you know, a synthetic a number of barrels of oils that are going to be you know, shipped across the specific this week or whatever it is. You can go and create these really novel financial products again without having to apply it, without having to jump through a lot of the arduous

hoops that are normally required. That I think is a really burgeoning area of innovation within defied where I can go and you know, sort of get access to these products wherever I'm around the world. And and we already see companies that are you know, trying to do this, and and we see see a lot of limitations with you know, traditional brokerages for example, around you know, geographical

restrictions or you know trading restrictions. As we sort of stat with the whole again, you know, Robin Hood, um

gmy thing, these services you can't be stopped. As soon as this sort of synthetic gimme gets minted, anyone around the world can go buy and sell it seven wherever they are so there's there's actually room, I think, to sort of grow a lot of the financial services that are becoming very popular, you know in the U S and Europe, but have this sort of truly global seven version of them that is, you know, in many ways superior.

I think synthetic assets. Obviously, you know you're still sort of looking at ways to sort of expand the existing financial system. Right these are just sort of extensions of the equities markets. I think the really cool thing is, you know, sort of what we call real world assets. So how do I go and get a mortgage from my house from Maker? How do I go and you know, trade early equity for my company on unit swap? How do how do I go? And it actually like bridge

these things to the real world. And I would say that is probably the most nascent area within Defied. This last month, Maker I think sort of broke new ground where they are taking shipping invoices and using those as collateral and Maker and so Maker basically becomes this this invoice factoring facility where if I'm trying to get liquidity for you know, assetding debt from this invoice, I can go, I can work with a partner, I can create a token for this for this asset again in a very regulated,

legally compliant way, I can put that token inside of Maker, and now I can die, and I can convert that die against Pegg one to one with dollars. I can go convert that die to USD, send it to my bank account, and suddenly a Maker is undercutting you know, all these other existing invoice factoring services by let's say three or four x. And so because there's no middlemen, because there's no employees, because there's not a lot of

this operational overhead, it's just a smart contract. You don't need sort of these these huge bodies employees that you know, someone like a neo bank, my employee, I just need to go and tokenize this asset, putting the DeFi and start barring against it. So this is starting to happen, but I expect we accelerating the next year or two.

Someone in that example whether and I'm aware of like a few different entities that are trying to but someone in this examples sort of like needs to be like I don't know, I guess I occupy the meat space like if the if the ship or the you know, the shipping invoys. There's like someone has to like okay, you're like have you have to deliver the goods or something like someone sort of has to be the real world proxy like take the ship or to court if

they would show up with the goods or something like that. Right, Like, there's sort of like there's a lot of like the connective tissue between the chain or between just the protocol and the sort of real world assets. Like there's no real way to like avoid the fact that like some sort of like human at leasta now some sort of like human has to be there to like sue a delinquent, you know, someone who doesn't show up with the goods

or whatever it is. Yeah, that that is true. Um, They're they're that whole sort of you know tokenization process that I mentioned, you know, is somewhat human intensive, but I think over time that will come down and become more automated. You know. Another interesting thing that we see happening in Defy is is sort of like capital formation Defy the Princess. You're it's really low barried entry where um, if I want to go and raise funds to um, you know, donate money to a cause or purchase an

asset or start a company or whatever. I can go and you know, potentially pool funds with other people inside of Defied, give them sort of a pro rade of share in it, and then we can go and I'll take our money and go to you know, whatever it is that we actually want to do. And so you know, we sort of saw this this deliberate of an idea I think in the initial sort of i O wave in seventeen and obviously I think that was very you know,

sort of poorly executed. But the idea that you don't have to go through trational fundraising means, especially if you don't have access to those, in order to get access to capital um and then be able to have sort of this you know, pseudocap table um. I think it is really powerful and it is starting to come back

through the rise of a lot of these taws. So if you were going to describe Defy to someone who had absolutely no knowledge of the space, but your ambition was to get them very very excited about out it and about how, you know, how much this could improve or change the world, what would be the project or the function that you would point to. I mean, I think I tend to fall back on these sort of

old reliables. I think Maker is really just incredible system, not only because it's it's sort of demonstrates the power of decentralized lending, where again, anybody can show up with collateral, borrow you know, any time of day, they can repay any time they want, etcetera. And the whole thing is sort of self sustaining, there's no company. But also to use it produces this very useful asset at the end

of the day, which is die people. I think you inherently sort of get the value of a dollar, the ability to send these dollars back and forth on on a blockchain. We often use stable coins for for funding, where you know, a team maybe isn't incorporated yet, or maybe they don't have a bank account yet. We can just send them stable coins ditrectly to their theory and wallet, and then they can go and pay their employees who are sort of distributed across the world to do a

little test transaction first. Like when you do that, you never you never grow out of that. Unfortunately, always get a little ish, but yes, you know, just superior to trying to send international wire uh, you know, waiting five business days you know, praying that you typed in the correspondent bank you number correctly. A stable coin such as die is able to do that just instantly, and I

think that's really powerful. I think really the answer, you know, and sort of the most distinct, you know, maybe a little glib answer, is that it's going to do for finance with the Internet for information, where instead of being siloed, instead of being opaque, instead of being limited access, it's permissionless,

transparent access to anyone around the world wants it. And I think what we've seen is entrepreneurs will take that and they will develop novel products that we couldn't even imagine right now and probably won't can't imagine right now, that will create this this massive sort of consumer surplus. So so my last question is, I mean I go to like Una Swab, it looks like an unregistered stock market. I could see like mirrored Apple and mirror Tesla. Those

look like synthetic derivatives. I mean, they're basically described this such anyone can buy them without any sort of like obvious like registration. There's no account or anything like that. Capital formation. The I c O s sort of like we're basically just I p O S. But without all of the regulation, why is this not just all you know, even if in theory it's more transparent stable like sort of a flagrant violation of existing securities laws. And do you think about like that risk frankly as a as

you're investing, It's definitely something that we think about. I think one interesting thing about about Dragonfly is that our team is sort of split between Asian and the US, and so I think we talked about things you're very

freely this very much US focused view. But you know, increasingly a large part of exchange volumes up until very recently, large part of mining volumes, and increasingly large number of defight users are coming from Asia, They're coming from Japan, or they're they're they're coming from China, they're coming from Japan, coming from Asian more broadly, and so what we see is sort of a lot of global talent around the world that might not live in the US, might not

be American, and UM might not sort of be UM I think, relying on a lot of the same issues that that you see in in U S jurisdictions. I think to your earlier point, what we see with with defile lot and why we sort of emphasize this decentrized element is most of what we've seen today is is really covered under under free speech where users you know, for example, the developers of unit swap, they've written this software, they've deployed it, but they're not taking fees, they don't

have you know, customer rights, they're not executing trades. Certainly they'reun this front end, but it's just a website, right, it's not actually doing anything. You can go on the ethery and blockchain and make the same sort of trades or you know, become a liquid in provider or whatever. Because the software is permissionless, because it sort of runs

without you know, a middleman requiring to run it. It's it's sort of like like BitTorrent, where BitTorrent can be used for legitimate purposes, but obviously people can use it for relicious purposes as well, but that doesn't make the

creators a bit torrent liable for those malicious purposes. So Defy I think has created a lot of again sort of consumer syrplus it's made a lot of that's in my life easier, just you know, going over the wiring stable point thing that I mentioned just a few minutes ago, but that doesn't mean that, and certainly everything not within it is not super palatable, but then doesn't mean, you know, you just have to sort of throw the baby out

with the bath water. I think the other elements sort of that you mentioned around securities laws is certainly something that we consider, but I think that really relates more to sort of token issuements and not every protocol, not everything that comes out is going to issue a token. You can just create software and have people use it. UM and that you know it is is perfectly fine. That's sort of sort of covered under the existing understanding of the law. Tom, So great to have you on

odd lots UM. I feel like that lived up to the hype that you are going to be able to explain these things in a very clear way, and I feel a lot smarter. Well, I really appreciate it. Thanks for having me, Thanks Tom, That was great. Thanks Tom, Tracy. I have an idea for a DeFi project that we

should do. Okay, I kind of I like the idea of tending my own yield farm, but I have a feeling it's probably very different to uh, the you call it UM vision that I have of that, but go on so you definitely, like Tomas said, you could like create any sort of like synthetic sort of like asset that's tied to something in the real world or sort

of like you know, tied to some price. We should um create token ized onion futures because that's like the one thing that you know, there's a law like there can't be onion futures, but in defy, I don't see anything stopping us from like creating a decentralized onion futures market that just like goes based on like you know, supermarket onion prices. I'm sorry why onions specifically, there's a law that says there's no onion futures in America. You

didn't know that, No, I didn't. I'm over here in a Onions are a pretty big part of the economy. I think they've been fairly financialized. But maybe there was some law like a hundred years ago that said onions there could never be an onion futures market in the United States. Okay, let's let's do it, the Great onion Futures. I'm surprised you didn't know that then. See, I thought that would be like a little. I thought that would be like a tracy trivia that you would know about.

I had no idea, but I have a feeling I'm about to go down like a massive research hole and learn about it. Let's do it, Yeah, let's do it. But it's seriously. I did think Tom was great, and I do think that he lived up to the hype in certain terms of like the clarity of explaining how

all these things work. Um, I agree. I was also, you know, on the regulatory arbitrage issue, there is a tendency to think that regulatory arbitrage is a bad thing, particularly in finance, where rules tend to exist so that you know, there isn't money laundering or people aren't losing

all their money. His vision or his summation of regulatory arbitrage as a way of generating more change in the financial system, similar to you know what happened with the internet and the idea that everyone can broadcast things like that. It's very alluring. I think there are still questions around it, but I can see like what he's getting at, and I can see why a lot of defied people are very excited about using this process regulatory arbitrage to affect

change in the traditional financial system. Yeah, well, you know what I was thinking, like, and I get that. I think it's interesting. And he made a comparison to Uber

and Airbnb, who is sort of like changed regulations. Like Uber was going up against taxi companies, and frankly, I don't think the taxi drivers have ever had, you know, in most places, all that much political power is sort of like going up against like highly regulated entities that in some sense like make regulation and lobbying like a

huge part of their core business model. I don't think is going to be as easy as sort of like Uber basically rolled rolling the taxi industry and all these cities no ins so much more sensitive industry, given that you're dealing with money. But I think it's gonna be really hard. Well, yeah, I definitely wanted to watch them. Absolutely. Shall we leave it there. I'm keen to go start reading about onion futures, So yeah, go read about that. Okay.

This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't All. You can follow me on Twitter at the Stalwart Follow our guest on Twitter. Tom Schmidt is at Tom H Schmidt. Follow our producer Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesco Levy at Francesco Today, and check out all of our podcast at Bloomberg under the handle at podcasts. Thanks for listening year to