Bankless - 36 - The DeFi Blockspace Cycle | Nic Carter

Starting point is 00:00:00 Welcome to bankless, where we explore the frontier of internet money and internet finance. This is how to get started, how to get better, and how to front run the opportunity. This is Ryan Sean Adams. I'm here with David Hoffman, and we're here to help you become more bankless. David, how you doing? Feeling a little bit more educated about block space and fee markets after this podcast with Nick Carter. Nick Carter recently put out this article called Public Blockchain Thirteen Thirteen Thirteen. fee cyclicality and negative feedback loops. And we kind of go into what the significance of what Nick discovered when he was researching for this piece. I thought it was a very interesting piece

Starting point is 00:00:54 to the point where I actually read it on the bankless YouTube. And so if you are the type of listener that likes to hear things as you would be since you are hearing this podcast, I've read this article on the bankless YouTube. And there's a lot of implications in there about what this means for DFI because DFI specifically has a lot of implications for what Nick is talking about in this feedback loop. So in addition to all of that, we get him on the bankless podcast to go through some of these concepts with him together. Yeah, I feel like we've never actually done a deep dive episode, David, on Ethereum block space and particularly gas fees, like gas prices. Why do they rise and why do they fall? I think a lot of folks who are going bankless experienced that this summer

Starting point is 00:01:39 and have over the past few months, like you wake up and sometimes gas prices, you know, 20 guay or 80 guay and other times it's 500 and you're wondering why. And you actually feel the downstream implications of that. Like, you know, what transactions are you willing to do at a way fee of 20 might be completely different than the transactions you're unwilling to do, I suppose, at a way fee of 500. And Nick provides some analysis, I would say, of the cycles of this gas fee demand primarily and the implications of that demand. So if you've never really understood gas fee markets, why price goes up, price goes down, and how that's even related to the price of Heath, this is the perfect episode to level up on. And I think we just had a very strong

Starting point is 00:02:33 example of what Nick is talking about in this article in Defi, where, you know, yield farming started with comp. Things started to get a little bit crazy. And then urine came around and it got even crazier. And then yams came around and it got super crazy. And then it kind of just spiraled out of control to one day we woke up and gas prices on Ethereum were three to 400 Gway. And the ether price was pushing up into $500. And at that same time, with the gas fees so high, people stopped transacting and the thing kind of all fell apart to where we are now with ether, you know, trying to hold its head above water above 300. And Nick, Nick contends that all of these things, the gas markets, the gas fees, the blockchain congestion and the ether price,

Starting point is 00:03:19 along with defy and how some of these protocols like Uniswap and Wiron depend on transactions in order to generate APY. And so that's kind of why we brought him on to the episode today to have some holistic conversation between the link between defy economic activity, block space demand, and block space fees. So if you're ever wondering why gas price goes up, if it will ever fall again, what these cycles mean for the innovation of Ethereum, will we have only a whale layer level one, or will normal folks be able to transact in a trustless way? This is a fantastic episode for all of that, and we can't wait to bring it to you. But before we do, we want to tell you about our fantastic bankless sponsors.

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Starting point is 00:07:17 I'm doing great. Thanks for having me back on. Thank you for making me your most frequent Bitcoiner guest. I don't know if that's actually true, but I'm just going to assume that. Well, last time we started with that power question of like, are you an Ethereum? And I think you kind of said yes-ish, right? So you belong in both camps. You made us define our terms first. I prevaricated heavily on that question. As long as you haven't gone back on it. All right. So on that podcast, speaking of that podcast in June that we did, you talked a little bit about this. And this was a title of a recent article, but you predicted that Ethereum's or Ethereum writ large would have to choose whether Ethereum is going to be a world computer or a financial network.

Starting point is 00:08:05 Were you right about that, do you think? Not to get all technical, but technically I didn't write that headline. So that's like the classic thing that happens when you have an editor. What would the headline have been had Nick Carter wrote it? You know, I can dig it up. I had like a great great headline somewhere. It might take me a second to find it. I don't know if we want to do it.

Starting point is 00:08:32 But yeah, I actually thought my draft headline was great. That was a good clickbait headline. Yeah, I mean, but that was like the source of some like discontent among, you know, a few Ethereums that Reddit. It's like, you know, like with the implication that you like have to choose, obviously, like, you know, Ethereum doesn't have to choose anything. It kind of just is. My draft headline, which I liked, was resurgent fees are a stark reminder of the monetary primacy of blockchains, which I can understand that they didn't think that would like popular appeal. Much more tempered, though. Well, exactly.

Starting point is 00:09:14 And it's like, you know, it's kind of neutral. And that's like my objective. Like, you know, these are like the first couple articles I've probably ever written about Ethereum. And my objective is to be fair. You know, like that's, I want to be seen as a neutral operator. I don't really have a strong agenda here. I just want to describe things. Well, I for one, like both of us, have really enjoyed that you're writing more about Ethereum.

Starting point is 00:09:37 It's like, it's really great stuff. Like, thanks for adding to the writing pool here. But like, what if we take that Strawman that was the title, World Computer or Financial Network, do you think Ethereum really has to choose one or the other? Are there elements of truth in that Strawman headline? I would say so. Yeah, I never really knew what world computer meant, to be honest. So to me, it's like a kind of incoherent term. But like 100% I think blockchains optimize by their very nature to be, you know, financial networks and really to be like settlement style financial networks as

Starting point is 00:10:12 opposed to payment networks. So like a narrow breed of financial networks. But yeah, I am very strongly of the opinion that the financial use case is just by sheer force of gravity tend to win out with time. So I seem to remember this from reading the article. It was basically like kind of written partially to Ethereum's saying, hey guys, there are tradeoffs here and you can't have it both ways. Is that sort of the premise of the article that you can't have scarce block space and also have like non-financial low economic density, you know, transactions at the same time? Or what would you say the premise of that article was? Yeah, that's exactly right.

Starting point is 00:10:58 And I mean, it might be possible. I mean, it is possible to kind of like mercilize data and, you know, can use a timestamp method to compress lots of data and then commit to it and publish a small digest of that data. So you can still kind of commit to arbitrary amounts of. data. But if you want the really nice qualities, you know, the nice settlement and atomicity and kind of base layer qualities that you get with base layer transactions, you know, I think that's going to be challenging. So I'm, I generally tend to believe that to the extent that fee pressure exists and to the extent that block space is capped,

Starting point is 00:11:34 which I think is prudent, of course, to cap block space. Then you're going to just get this relentless optimization for the largest transactions, which are, happiest to be fee-bearing and are willing to outbid other transaction types. Me and Ryan, before we started recording, we were also talking about how the world computer metaphor or analogy is just somewhat like nonsensical. Maybe it fit the times in 2015 when we didn't really know what Ethereum was going to be. But comparing a world's computer versus a financial network doesn't really seem like a viable comparison in the first place. And I think you would agree with this statement, Nick, that like any and every blockchain that is successful must

Starting point is 00:12:18 become a monetary or financial-based blockchain. There's no such thing as a blockchain for like social media or something like that because because of the inherent scarcity of block space, because you can't have infinite block space because then you just turn into a database. Because there's block space scarcity, it therefore forces the convergence of all economic activity on that blockchain to be financial in nature. Would you agree with that take or would you amend it somehow? I mean, entirely. I mean, you're bidding against every other global user that wants access to the ledger.

Starting point is 00:12:56 And whomever is willing to pay the highest price, maybe they're super irrational and they really want to insert some arbitrary data. But most likely, if they're willing to pay a high fee for inclusion, that's because they're making a large transaction. So the fee is proportionally very small part of the transaction. Like I sent a wire today. Wire costs me $35 to send, which is preposterous. Of course, I hate legacy finance.

Starting point is 00:13:23 Let's go bankless guys. But, you know, I was happy to pay $35 for the wire because it was like a fair amount of money. And I needed, you know, instant settlement and all those guarantees. So in that same vein. you know, someone who's making a $100 million tether transaction is willing to pay, you know, probably 500 bucks plus for inclusion in the next block and final settlement and so on, they're going to outbid someone deploying, you know, an Aragon Dow on chain, right? That's just financial gravity.

Starting point is 00:14:02 When we were in 2015, 2016, talking about like a world computer or, you know, Ether's Gas, before we understood these things as we understood them today, what you're saying is that Ethereum was destined to be a financial network from day one, simply by nature of what it is. It was something that you probably could have predicted. Although in fairness, back in 2015, we didn't even really understand the nature of Bitcoin that well. A lot of Bitcoiners thought we would get these trustless side chains, and then we kind of figured out later on that you had to make all these

Starting point is 00:14:38 additional assumptions about proof of work and the side chain operator is not misbehaving. And we didn't really understand how lightning would play out and so on. So I guess to a certain degree, this whole thing is a process of experimentation. But, you know, I think a lot of Bitcoiners' early objection to Ethereum was, hey, like some of these promises are overcooked, especially in light of, you know, the effects of the emergent effects of scarce block space. Would you say the evolution from Bitcoin as like a payments rails or a payment vehicle to Bitcoin as a store of value reflects the same dynamic as well?

Starting point is 00:15:18 Oh, yeah. I mean, that's a big issue with Bitcoin historically. It's that a lot of Bitcoiners kind of had misperceptions about what Bitcoin was suited for. And there are all these startups that got built with the assumption that P2P, basely our transactions could scale up to a global audience. And that's why we had the block size war. So we're really all talking about the same thing here. This is a kind of recurring theme, you know, just conflicting visions of what these networks can be. And it's afflicted Bitcoin and now Ethereum's having reckoning with it, although it doesn't seem to be, you know, dividing the community as starkly like we saw with Bitcoin. But it's all the same concept. It's, hey, what are the constraints here? Where realistically should we draw the line? What are we trying to optimize for? And what's our kind of time preference? Do we want to unlock, you know, do we want to unlock, you know, a marginal extra 50% of block space, or do we just kind of bite the bullet and keep block space

Starting point is 00:16:13 capped and then try and build a layered approach, which seems to me Ethereum's going for the ladder now instead of incrementally adding block space, which I think is probably a good call. So there was this reckoning for the Bitcoin community in 2017, as it realized Bitcoin would not be a payment network and like there were forks that thought maybe it would be. yet what's interesting about Ethereum is that I feel like there are still large numbers of the Ethereum community that will still tell you, no, Ethereum is also meant for non-financial transactions. What would someone like Vitalik say about your post? Yeah, I was interesting. Vitalik answered my post a series of tweets.

Starting point is 00:17:00 I don't think I interact with Vitalik much, so I was kind of taking. aback by that. But yeah, I mean, he told me that my interpretation of his words was kind of wrong and that he really did earnestly want to, you know, get the internet of money or whatever, down back to cents for transactions as opposed to dollars and fees for transactions. And he still wanted to create superabundant quantities of block space and that it was just a matter of waiting for ETH2 and then maybe with roll-ups being kind of intermediate solution. But Vatessen Alex seems to be defending his kind of original position on this, which is that there's like a teleology to blockchains. Like transactions should be cheap in absolute terms.

Starting point is 00:17:48 And so, yeah, in contradiction to what I wrote in the post, I don't think he's actually evolved his stance that much. It seems like he still really does want to produce, you know, really cheap transactions and lots and lots of block space through these kind of different, like, R&D initiatives. Why do you think he wants that? Well, it's a good question because, I mean, maybe it's like the unconstrained versus constrained vision kind of thing that, you know, Arjun wrote about in a blog post a while back, you know, he has this progressive streak to him, not in a political sense, but, you know, he has a vision about what blockchain should be for and they're the amount of inclusion that they can offer to people. And I guess, I guess I'm probably just, I would say more pragmatic maybe or more realistic. Not to, not to, you know, express a pejorative or anything, but I tend to believe in trying to optimize what we have and what we understand, what we kind of know, as opposed to, you know, putting all of our eggs in one basket of, you know, sharding, maybe.

Starting point is 00:19:01 or relying on, you know, significant computer science breakthroughs to kind of take us to the promised land kind of thing. So I do think it's just like fundamentally a conflict of visions. I would say that I think if you and Vitalik got in a room and fleshed out some terms and some parameters and some bounds as to what you guys are talking about, that you might come to more of an agreement than what we've, you know, what, you know, 280 characters on Twitter can express. I would say that Vitalik couldn't disagree with. And I think I remember him talking about his agreement with a thesis that, you know, heavy valuable transactions push out lighter or less valuable ones.

Starting point is 00:19:42 But what Vitalik sees is optionality with scaling and optionality with packaging of data into smaller and smaller packets where like even though you're still transacting on the main chain, you are doing that in kind of like you're on a highway, but you're on a bus with like 70 other people in it instead of you're on a car with just just you, right? And so you get bundled up or and because of that, you know, you come off with some tradeoffs where instead of being dropped off at your home, you get dropped off at the bus stop and you have to walk the rest of the way or something tradeoffs like that where Fatalik kind of counts it as an L1 transaction, but there are still some other other tradeoffs that as a result of the lack of density of said transaction that this transaction has to that. therefore go through. Yeah, and I think that is, that's a view that I share. I mean, my view of scaling blockchains involves removing data that's registered to the main chain as opposed to producing more data that the block, that the main chain can offer. And, you know, so to that end, I think that we're

Starting point is 00:20:51 pretty firmly in agreement there. You know, like, that's why I advocated for for batching, which is a simple thing, but it has kind of the same effect. You know, putting lots of payments together in a single transaction. Bitcoin saves you a lot of that overhead. And that's why I'm still optimistic about side chains. I mean, TBD. If I look at roll-ups, roll-ups kind of resemble side chains in some respects. But yeah, I think that's fundamentally how blockchain scale. They don't really scale arbitrarily by, you know, forcing more data through the network that obviously has really significant externalities. What's kind of interesting to me is I feel like at some level, the Ethereum 2 roadmap has sort of evolved a bit more with like that notion in mind, Nick, and you might call it a Bitcoin

Starting point is 00:21:40 or notion that there is kind of one main chain for settlement. Even a, um, an ETH research post that Vitalik put out two weeks ago, a week and a half ago maybe. It depends when listeners are listening to this, about the ETH-2 roadmap, like almost an alternative, kind of an ETH-1.5, one and done. And basically, for folks that aren't familiar with ETH roadmap, what that kind of means is less urgency on a full sharded ETH2 with like EVM capabilities and state execution. and maybe you just get basically proof of work, a proof of stake, a data availability layer, and you kind of scale in these roll-ups instead.

Starting point is 00:22:27 And you keep almost like something similar to the eth-1. Chain as a settlement chain, which has been an interesting evolution. It feels a lot more like the kind of the Bick-Corner feel on this. Have you read that post or like, are you familiar with kind of the evolution? of the ETH2 roadmap? I have, yeah. And I can't say I'm as familiar with it as you guys are. I kind of dip my toes into the ETH2 roadmap every six months or so to see what's going on.

Starting point is 00:23:00 This time I finally wrote about Ethereum, so I figured that I had to actually learn about it a little bit better. So people wouldn't just immediately dismiss what I wrote by saying that I was non-educated Bitcoiner, which like totally pisses me off so much. So I did my homework, you know. And I honestly, learning about roll-ups was very challenging. It was, it was, there's a lot in there. There's kind of a lot to it. But it is very interesting to see this.

Starting point is 00:23:31 And I often say this. I think kind of Ethereum ideology is sort of Bitcoin ideology with a 24-month delay. Not to be trite or kind of uncharitable, but you do notice these. You notice certain ideas which are popular in the Bitcoin community, which then are manifested with Ethereum. So I would say, you know, acknowledging that governance is extremely challenging and maybe on-chain governance isn't the best idea. That's something which Ethereum's in the last couple of years have adopted, you know, believing in the quality of fees as a really important stabilizer and a way to retain scarcity. in kind of the units of the network, you know, believing in this layered model, you know, avoiding protocol funded slush funds to pay, you know, finance developers, stuff like that.

Starting point is 00:24:31 All these things are features, which I've sort of, you know, Bitcoiners were sort of preaching for a while, and then, you know, later on you see them manifest in Ethereum, which is either encouraging or perturbing. I don't know what the interpretation is, but I see Ethereum culture as like slightly downstream of Bitcoin culture, not to be like unfair about it. It's just like an observation. I feel like there's maybe two points of pushback on that, which is I largely agree with what you're saying with many of the points that that you raised on sort of the convergence there. But one area of non-convergence has been, Ethereum has always been steadfast on having some programmability and smart contracts on the

Starting point is 00:25:13 base layer, which, you know, does not seem to be a, a, a, a, a, a, a, a, a, coiner kind of notion. Like, that's, that's, that's always been rejected on, on, on, from bitcoins. And another thing I think, uh, Ethereum's would say is they, they, they, they might say, like, it feels like Bitcoin is kind of given up on the vision of a peer to peer money at all. They're kind of scaling with, with crypto banks. That would be almost like the, the bankless editorial criticism of Bitcoin. even though a bankless, we love Bitcoin as well. But it's basically like Ethereum has not given up on that scalability vision, hence pursuing

Starting point is 00:25:53 technology like roll-ups and plasma and all of the various ways it has evolved. Whereas Bitcoin just kind of feels like anyway, only one bullet in the chamber, which is lightning. And that hasn't quite taken off yet. Any reaction to that? Yeah, I think that's fair. I mean, Ethereum has always been less encumbered when it comes to vision. And Bitcoiners are very adamant about, you know, not including tokens on the network. You know, that's definitely Bitcoin, I say Bitcoin's interested in cultivating its own UTXO set and very little else.

Starting point is 00:26:31 You know, so it's kind of discouraged the insertion of third-party tokens on the network. And then, of course, discouraged excessive complexity or expressivity. the base layer for kind of safety reasons. So yeah, Bitcoin optimizes for one thing. And Ethereum is much more aggressive in pursuing different value propositions. I think that's very fair. And that's the chief distinction between the two. On the lightning front, I think this isn't acknowledged that much among Bitcoiners. Lightning was like a very convenient kind of, sorry, this traffic outside. It was a very convenient sort of rhetorical stick to bash big blockers with as, you know, the token layered scaling system. I was never convinced that lightning would be

Starting point is 00:27:18 a panacea or salvation for Bitcoin or that even it would be the predominant popular scaling method employed in the future for Bitcoin. And there's going to be some disillusionment, I would predict, you know, that if lightning continues to not really take off in the coming years, people will say, well, you know, is a red herring. You know, you guys falsely advertised lightning is the panacea here. And to a certain degree, I think it was wrong to overindex on lightning rhetorically as a way to ward off the big blockers. The correct approach should have just been to say, look, we don't know exactly what, you know, layered scaling solution is, but we do know the constraints of the mother of all creativity and eventually will develop some, you know,

Starting point is 00:28:08 good layered systems and lightning will be one of them, but it's probably not suited for all second layer models. Unfortunately, I think there's going to be some, you know, like a slight realization that, you know, clearly lightning is not going to take Bitcoin of the promised land. Again, I mean, I could be wrong on that, but it's always the issue of managing expectations when it comes to blockchains. You never want to oversaw a feature.

Starting point is 00:28:38 All right, guys, we're going to get into the details of Nick's article, as well as how it creates a cyclical market cycle in the Defy ecosystem. But first, we're going to talk about some of the sponsors that make this show possible. Y-Earn is Defi's first self-building project on Ethereum, focused on producing products for those who are interested in earning yield in D-Fi. Yarn's various products are all built to suit each individual investor's preferred level of risk from various vault-stress. strategies that leverage defy tokens to the safer urn system which relies on stable coins. Vaults are aggressive yield farming robots, each with a unique strategy that is designed to maximize the yield of the deposited asset. Y-Earn employs from the most informed developers in D-Fi to keep the vault strategies updated

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Starting point is 00:31:40 Unstoppable Domains.com. We talked a bit about the CoinDest article, World Computer or Financial Network, and I felt like the article that you more recently released on fee cyclicality was almost a follow-up to that in a way. At least it was certainly a continuation or related to that original article because you got into explaining actual data and what we're seeing in the fee markets today. And you started with this really cool metaphor, like a governor and throttle metaphor. Can you talk about that metaphor and get into the article a bit? Yeah, so basically I wanted to explain visually what a negative feedback loop was.

Starting point is 00:32:25 People talk about positive feedback loops all the time and talk about reflexivity. And I wanted to instill the visual of a negative feedback loop. So basically, this was a widget, a type. to steam engines that basically made them work. It made them, it gave them moderation, made them more stable. And effectively, it was a spinning valve that would take rotation from a steam engine, like a rotational input. And as it rotated, these ball bearings through centrifugal force were pushed upwards, which itself was connected to a valve, which would, choke off the flow of steam to the engine. So basically, the faster they spun, the more they would

Starting point is 00:33:13 regulate the flow. So it's a negative feedback loop. And this basically allowed steam engines not to overheat and explode. And it made things like the textile industry, you know, basically function. So that was the baseline metaphor. And the point I'm making the articles that fees are similar to that. fees regulate the usage of blockchains. But maybe unlike the governor on a steam engine, they do it in kind of a less predictable way, maybe a slightly more chaotic way. So the through line that I'm seeing in this article, your first article in CoinDesk, and what we've been talking about so far on this podcast is you are on this quest to find

Starting point is 00:33:57 evidence of economic density or transaction density, where we started talking about how all blockchains that would work would ultimately become financial blockchains because of the inherent scarcity of block space. And in this particular article, you go on a little bit of a quest to actually find evidence for the thesis behind economic density of a transaction. So when you were looking for that evidence, what did you find? More generally, I was looking for evidence that capped block space causes interesting emergent phenomena to result. And one of those is economic density.

Starting point is 00:34:40 But the other ones is the other features are, you know, strange oscillations and transaction count. But yeah, I mean, I found a number of things. I mean, my most startling discovery probably was the fact that as fees rose dramatically in kind of late August and early September, the number of smaller transactions on both Tether, on EURC-20 Tether and Ether itself dropped off a cliff. So smaller transactors just stopped transacting.

Starting point is 00:35:18 And then the other thing that was really interesting that I found was a really tight correlation between fees and Ethereum terms and then the median transaction size of Ethereum and other tokens like Tether. as well. So clearly there's some interesting threshold in people's minds where they're willing to pay X percent of the value of a transaction in fees. And as fees climb, the transactions they're willing to pay necessarily get larger. And maybe they defer those smaller transactions or they just choose to only make larger transactions. And I don't know what the percentage is, and I'm sure it differs for lots of people. But I don't know. If you were up to me, I would probably

Starting point is 00:36:01 mentally peg it at 2% or something. But the point is, as fees rise, as the stakes rise of transacting on-chain, people become less willing to make small transactions than the opt for bigger ones. Or alternatively, again, I need to collect more data on this. It could just be the composition of transactorist changes, you know, that certain people that are predisposed to making smaller transactions just cease their activity altogether, and it's only the larger transactors that are left. And this isn't the only time that you had seen this behavior. This is the first time that you had seen this behavior on Ethereum. Talk about what you saw back when you looked at the data back in 2017 for Bitcoin. Well, I didn't look at it with this much specificity on Bitcoin.

Starting point is 00:36:44 Those are things that I specifically sought out those data points in the Ethereum context. What I did see in 2017 was this relationship between transaction count fees and Bitcoin. We saw this cycle repeat six times in 2017, you're probably going to want to look at the article to visualize it here. But basically, as transactions rise, they drag up fees once you hit that capped block space ceiling. And then the fees themselves actually moderate the transactional intensity. So the fees are then a disincentive to transact. And so then you have this kind of attenuation or you have a decline in the transactional intensity. And then as the blocks empty out again, people realize, hey, there's lots of interesting opportunities to transact cheaply on chain.

Starting point is 00:37:33 They start transacting again. And then the fees rise again. And so you have this cycle that, you know, from peak to peak, the cycle lasts about 60 days on average, or at least it did for Bitcoin. And there's always a latency between the peak for transactions and the peak for fees. The fees always follow the transactional peak. So it's just a fascinating relationship, which I didn't see pointed out much in 2017. I pointed out at the time as just a curiosity. And then when fees started to really take off on Ethereum, I thought to myself,

Starting point is 00:38:08 hey, maybe this is going to happen again. And maybe there'll be some interesting effects on Ethereum because Ethereum's liquidity is much more kind of on-chain than Bitcoin's liquidity was in 2017. Yeah, that's kind of why we wanted to get you onto the podcast, because, you know, the integration of smart contracts and native financial activity changes up this cycle. And so just to reiterate the cycle super clearly, the cycle begins at one part in the loop. You know, we'll just start with there's some amount of blocks-based demand. And as demand increases, the overall transaction count increases or transactions increase, therefore there's more demand.

Starting point is 00:38:50 And when this happens, the fees go up, right? And when the fees go up, the smaller players are incentivized to transact less. And in your article, you call this, you know, it turns out that transactors on Ethereum are very sensitive to fees. And so people that are sending some amount of value don't want to pay above a certain ratio of that value in fees. And transactors are very sensitive to that. Therefore, when fees go up, these people who are sensitive to this stop transacting.

Starting point is 00:39:22 and then the transactions decline, and then the block space starts to empty out and the fees decline. And then once the fees decline, there's incentive to purchase that block space again because the block space is therefore cheap. But what you alluded to in your article is that when Defi, there is so much native economic activity that is possible that it changes the game.

Starting point is 00:39:48 And you specifically talked about how Ethereum has so much Ether liquidity on chain, whereas in Bitcoin in 2017, Bitcoin price discovery is founded on centralized exchanges, where there isn't actual transactions on the main blockchain. So in your view, how does the fact that liquidity for ether, the native token and other tokens, because it exists on chain in defy, how does that change up the cycle? Yeah, so this is really the key, I don't know if I want to see finding, but this is probably the most important. takeaway, I think, is that in a network like Ethereum, which itself is like an enormous decks, you know, you could probably describe Ethereum as a big clearinghouse for value between

Starting point is 00:40:32 various tokens and ether itself. You know, with ether acting as that liability-free kind of reserve collateral, you know, it's the base pair for everything else. And since so much liquidity is on chain, I mean, we have uniswap flipping in Coinbase in terms of volumes. So much liquidity is on chain, all of these transactions require on-chain settlements. That effectively means that the fee break is more of an effect, it has a more pronounced effect on liquidity and volume than the fee break did for Bitcoin at exchanges in 2017. The reason for that is to buy Bitcoin on an exchange, you have to send them a wire or an ACH deposit. You can buy Bitcoin. You can sell Bitcoin. You can sell Bitcoin on the exchange.

Starting point is 00:41:22 None of that actually requires cashing out to the chain itself. You could just perform that whole process with kind of traditional banking infrastructure. And that was just the nature of the liquidity environment in Bitcoin in 2017. Now, to participate in defy, which was, you know, really the big attraction this year, you know, a lot of that was, you know, defy native. You couldn't really, you know, yield farm through an exchange. you'd have to actually instrumentalize that on-chain. And my hypothesis or kind of presumption here is that as fees rise,

Starting point is 00:41:58 you're massively raising the barrier to entry for these putative defy users. And they're willing to tolerate some amount of fees because the opportunities were good, of course. And there was literally free money floating around at some points with some of these airdrops and it's kind of similar opportunities. but at a certain threshold and fees, those smaller kind of defy transactors got priced out. And their bankroll just didn't justify paying, you know, a $10, $20, $50 fee to, you know, make a trade on Uniswap or something. And it priced out everyone with a bankroll maybe, you know, below $10,000 or $50,000.

Starting point is 00:42:40 I don't have exact numbers and it obviously depends on where the fees are. But certainly there are some smaller users that got priced. out. And the point isn't to say, you know, this is unfair or anything. I'm not taking like the Roger Vair perspective where fees are like this hideous evil thing. I think fees are great. Yeah, no, I'm 100% in favor of, you know, fee intensity. I think it gives you tons of discretion and choice as a protocol architect, right? The fees are an asset. You know, that's the chain's own revenue. And you can sort of instrumentalize that in a variety of ways. And that's exactly what Ethereum's are planning on doing. So the fees are great, but they also have some potentially

Starting point is 00:43:22 adverse consequences in terms of pricing out some of those users of those kind of native on-chain defy platforms. And the conclusions you draw from that are up to you. You could say, well, this is why we need these super scalable eth killers. Or you could say, well, that's just going to be the nature of Ethereum for now. I mean, the conclusions are kind of up to you to draw, but I really just wanted to point out this phenomenon and also encourage people to do more research on it. I think the phenomenon that you mentioned, like bankless listeners and people who are using DFI systems and going on the bankless journey, as we call it, like we feel that, right? David and I probably have, you know, 100 or more examples of this. Just a few that come to mind.

Starting point is 00:44:10 had a had a someone in the bankless community going bankless with a small amount of money so depositing some funds into an argent wallet not a lot you know maybe three hundred dollars something in that range but then when gas fees go up it makes absolutely no sense to withdraw those funds right because maybe you're paying a 50 dollar fee or to do anything in defy like take out a loan starts to require a lot of money for a, you know, a small transaction, a small capital transaction. You know, David, I remember you have an example of doing some defy farming at one point and just realizing, oh my God, that my farming proceeds aren't actually paying for my gas fees. So this whole thing doesn't make sense.

Starting point is 00:44:58 I should just stop farming. Curve, man. Yeah, very too expensive. Right. So it's like the defy equivalent of the Minsky moment. Yeah, exactly. And so, like, we have tons of examples of this. And it's particularly interesting.

Starting point is 00:45:12 And I think it's unexpected for some defy users who haven't seen one of these cycles play out when they have some small amount of funds and on chain and in liquidity pools and that sort of thing. And they're not expecting a sudden rise in fees, right? So they almost get a little bit trapped on chain, I might say, because then it doesn't. make sense to pull those, pull those fees out. This happens to a lesser extent on Bitcoin, because on Bitcoin, you might have like wallets, let's say, with trace amounts of Bitcoin that, you know, the fees to move the Bitcoin from one wallet to another, it's not worth it. It costs more than the value that's inside the wallet. So you get this trace, this trace Bitcoin and all of these wallets. But on Ethereum, because it's a much more, I guess, robust and

Starting point is 00:46:06 interactive financial system, a mini-dex, a mini-financial system, a mini, you know, stock market in a way, it does have some downstream effects that, that users see and aren't necessarily ready for it. And it also has effects on applications. So applications that plan to develop on Ethereum with a certain, you know, gas fee, I guess parameter or assumption, they have to re-architect to plan for. a higher gas fee world. So that's kind of what you're talking about, right, Nick? Yeah. And I'm not, you know, trying to inject much normativity or kind of prescriptive findings into the discussion. I just wanted to point out that, you know, this thing that you feel intuitively as heavy users of

Starting point is 00:46:53 the defy system, first of all, I wanted to kind of quantify that and try and find evidence for it. And then second of all, say, yeah, there might have to be rethinking around which applications, and kind of usage modes are possible, at least in the near term, you know, barring any dramatic changes in terms of sharding or, you know, new superabundant forms of black space, there might have to be a bit of a reckoning in terms of what is considered economically viable in terms of a transaction type on Ethereum. Now, of course, fees have declined since then, and, you know, a lot more things are possible once again. But my guess is that we do have another cycle like this.

Starting point is 00:47:40 And so people will be better prepared for it now. You know, they've been through it once. But, you know, what does it theorem look like if it is characterized by these cycles? You know, does that challenge your assumptions about the system? Nick, in your article, you talk about the link between the brakes on the system because fees are too high and the price of ether. And I actually didn't totally understand that connection. So I'm hoping you can reiterate it here. Yeah. So this is like maybe the most speculative part of the article. But if you look at the fees on Ethereum and then the actual local top for both ether

Starting point is 00:48:23 and a bunch of kind of defy assets, obviously the value of a of a defy pseudo equity token is a function of the kind of summed discounted cash flows that end users expect to accrue to, you know, the decks or the marketplace. And so effectively, the value of that token is a function of the volume and the liquidity that, you know, end users expect to flow through the exchange or the, you know, interest rate swap product and so on. But with Ether, the valley of Ether is to a significant. significant extent, a function of the usage of ether as this collateral asset for defy and

Starting point is 00:49:05 the reservation demand for ether and kind of the induced scarcity that defy brings to ether itself. That's all pretty long-winded, but my mental model has ether's value being at least partially indexed to defy. That's why we saw it eventually being dragged upwards by defy this year. And so basically the hypothesis here is that the fees act as a break on usage of some of these dexes. It kind of collapses volumes, not by a catastrophic amount. I mean, volumes are still pretty high across the board. They've definitely declined since kind of early September. But they're still higher than they were in, you know, early August, for instance.

Starting point is 00:49:52 If you look at the dex volumes. And Nick, when you were talking about volumes, were you talking nominal dollar values, volumes or are we talking transaction volumes? Oh, yeah, volumes and dollar terms. They've come down since that fee peak. That was also the peak for early September was the peak in the ether unit price and for a lot of those defy assets, which is less surprising. But I do think that in this case, there might be a connection between the fee intensity

Starting point is 00:50:24 and the price of ether. I know that's maybe a bit more tenuous. But I see, I'd have to kind of do a little bit more work on this, but my intuition is that some of the ether backstopping these systems in the same way that it was kind of scooped up when Defi really exploded. To a certain extent, it was disgorged when interest in these systems waned a little bit. as the fees kind of took away some of the enthusiasm.

Starting point is 00:50:58 So it's kind of like, if you guys remember, the ICO kind of induced scarcity effect in 2017, where you needed ETH to participate in ICOs, and that was really accretive to the price of ETH on the way up and then catastrophic on the way down as a lot of these ICOs paid salaries and divested that ETH subsequently. You see a similar kind of related version of that same phenomenon where ETH is, you know, a lot of ETH supply is taken off the market to be employed as collateral

Starting point is 00:51:29 or to be the base pair in DFI. And then maybe as some of the interest in DFI wins a little bit, the ETH appears back on the market. You have this fresh supply and that puts pressure on the price of ETH. So that's basically the hypothesis. But again, it's, you know, it's always very hard to kind of evaluate, you know, the drivers of price. I definitely agree that that hypothesis is, there. However, if I were to add something to your article that I think you missed is that a lot of these defy protocols and these defy tokens that have valuations themselves are valuable because a transaction in their respective system is revenue for that respective system's protocol and therefore the token, right? And this is specifically true for uniswap, but also for WIRE and

Starting point is 00:52:22 you know, a few other other farms and yams and themselves, even though a transaction with a yam doesn't add much to the market cap of yams, economic activity around yams adds money into the yam treasury, right? And so what we kind of saw with this defy yield farming mania is that a lot of these protocols learned to produce a treasury, which is what the excitement came about from. And especially with the uniswap and wiren, a transaction through these systems added a fee or took fees and added it to the protocols treasury, right? And so you slap on this cyclicality nature due to this kind of like two market, two month long business cycle in Ethereum and DeFi. And you slap on these protocols that are also generating revenue from transactions themselves in addition to the

Starting point is 00:53:12 fees being paid to the L1 blockchain. And you have this secondary secondary secondary secondary. system that is kind of replicative of the primary system. And so we've seen APY from YERN, or APY from providing liquidity to UNISWAP, track the returns, or those returns track economic activity on Ethereum. And so when fees get too high and the smaller transactors get washed out, the APYs for these protocols reduce. And that's kind of, the APYs for these protocols are why we saw so much capital and new people and new excitement flood into defy in the last few months was because like, Yearn was offering 50% APY because everyone was using Yearn.

Starting point is 00:54:00 And same thing with Uniswap. Like if you, you wanted to add liquidity into Uniswap because, you know, the banana farm was incentivizing liquidity to go there and therefore more people would trade bananas. And, and then the fees would get added to the Uniswap pool and the APY for the Uniswap would go up. But then fees, then we hit like 400 Guay, and everyone, like you are saying with this article, everyone stopped transacting. And kind of like how you were just talking about with the 2017 ICO mania, it's a little bit of a game of musical chairs, right? Like the only reason why the APY is there is because everyone else is trying to access the APY. And in order to access the APY, you have to make the transactions.

Starting point is 00:54:42 And so it all kind of ended up falling apart. And I think that's one of the most interesting things about this article. and what's recent in the DFI ecosystem is that so much of DFI right now depends on economic activity. And what your article is showing is there's going to be this natural break that happens every so often that's going to dampen economic activity on DFI. Yeah, I think that's very astute. And you're pointing out the pro-cyclical features that a lot of us noticed. I didn't really have the time to kind of write a full analysis of that. a few other kind of sources of reflexivity that I notice in defy.

Starting point is 00:55:23 But I think people are attuned to that now. I guess, you know, there's some potential good news, though, right? I mean, maybe we'll get to this. But if you believe that, you know, the efficiency, the economic density of transactions is going to vastly increase with some of these technical innovations around the corner, then maybe Ethereum isn't doomed to suffer these pretty vicious business. maybe that cycle can be attenuated. So that's going to be the really interesting thing

Starting point is 00:55:54 that I'm going to be looking out for. I definitely see roll-ups has a reservoir of economic activity that as the L1 gets congested, like people can flock to roll-ups. And I think we'll talk about that later. But Nick, in your article, you use this analogy, this poker analogy that kind of put different characters of different poker skills around the table.

Starting point is 00:56:19 And I'm hoping you could go through that analogy here because I think it relates pretty strongly to what I was just talking about with the returns on DFI. Yeah, very much so. And the analogy is basically a layperson version of Andrew Lowe's adaptive market hypothesis, which if you haven't read that paper

Starting point is 00:56:39 and there's actually a whole book about it, strongly recommend it very much informs the way that I think about markets, which is to say that market participants. are heterogeneous. You know, they're very different. And in Defi, I think this is very much the case. You have, you know, you have really elite players, and then you have some less sophisticated kind of retail punters that are involved. And it's kind of the same where a poker player in a casino, you might have, you know, amateurs that just want to hit the felt and grinders or semi-pros or professionals. And if you're a professional, you want to select. You want to still.

Starting point is 00:57:16 the locus table with the most fish, essentially, you know, with the most amateur players. And if those amateur players lose all their money, then it's kind of less lucrative to sit there as a sophisticated player. And the point here is that if you think about fees as the Rake, the Rake being the kind of the fee that the casino operator charges, although this isn't exactly how Rakes work, so just bear with me with the tortured analogy, if you might, massively hike the rake, then players with smaller bankrolls, it's not worth it for them to participate in the game. And then the pros and semi-pros and grinders are left playing against each other, and it's kind of less lucrative overall. And that's actually what happened in online

Starting point is 00:58:01 poker as they got kind of banned in the U.S. and people had to move offshore and it became more challenging. And a lot of those retail users had lost their bankrolls. And I guess their wife or girlfriend told them they couldn't play online poker anymore, the game got more competitive, and there was basically less alpha to be found. So kind of the same thing in D5, you know, you've got these funds that are quite sophisticated. They're active in market. If the retail users leave or defer transactions because fees get pretty high all of a sudden, now it's kind of the semi-pros and the pros playing against each other. And that's kind of more challenging and there's less easy sources of return. And again, this is a little bit more speculative. I don't have a ton of

Starting point is 00:58:51 data to back this up. I just wanted to build intuition as to why the loss of retail or call it uninformed flow or unsophisticated flow might actually be pretty destructive to the kind of liquidity environment and make it less attractive to participate in general. So yeah, in the defy space, we saw, you know, a ton of new people come in, you know, install Metamask, make their first purchase on Uniswap. But they weren't doing it with, you know, they didn't come in with $50,000, probably. They probably came in with a few hundred, maybe a thousand, maybe a couple thousand. Something relatively smallish. And, you know, because they heard about some defy token that was going to moon and they wanted to go to Uniswap to purchase it. And but then we have like these, you know, very, very, very, very. we have these very experienced firms, these very experienced whales that have been in DFI, have been in Ethereum for years now, who are, you know, crypto-native and have all their wealth in crypto, and they just have the advantage, right? And so as soon as gas goes up to, you know, 300 Guay, the people that just came in to make a quick buck with a couple hundred

Starting point is 01:00:03 dollars on Uniswap, just get priced out. And the only people remaining are just the D-Fi whales. Nick, you made another, I guess, a fallout from the article or some speculation. This relates to something that Kyle Samani talked about called Defi's invisible asymptote. So is there some kind of an invisible asymptote here, kind of a ceiling that Defi can't get through due to scalability on the base layer? Yeah, and I wish I'd, a couple of people pointed this out to me, I feel like maybe I should have referenced this in the article, but the truth is I hadn't seen that one before I wrote this. But I guess I'm, so Kyle's view is, you know, to the extent I understand it,

Starting point is 01:00:50 is that, well, this is why this is evidence for creating a new base layer blockchain with a lot more capacity and then building defy there. So the reaction to this so-called awesome tote is probably where me and Kyle differ. I'm probably of the opinion that that can, The constraint is the mother of creativity. And if it weren't for the constraint, we would never learn or we wouldn't be incentivized to build efficient systems. That try and increase density. And increasing transactional density is the whole game here, in my opinion, as far as I'm concerned.

Starting point is 01:01:28 That's the challenge. That's what roll-ups seek to address. That's what side chains would address. That's what any deferred settlement system or sub-ledgers. You know, and if you look how the traditional payments infrastructure works, it kind of works like that. You know, you have ledgers nested within each other and layered on top of each other. You don't have everything settling to the same exact ledger database. You've got layers and layers and layers.

Starting point is 01:01:57 And that's how I expected to go with public blockchains. The base layer probably does resemble a settlement layer. And then you have these, you have deferred settlements, or batch settlements. And to me, that's the kind of roll-up idea. Now, the question is, can you reconcile that layered model with the really nice qualities of defy? That's really the big critical question, in my opinion.

Starting point is 01:02:23 Or do you need final settlement for each transaction, kind of immediate final settlement, base layer style final settlement for defy to work? And I don't know. that's the question I would pose to the Ethereum's. Can you roll up a FI a DFI contract and have it feel the same from a UX perspective as the default way that they work today? And if that's not possible, I don't think that's the end for DFI, though. I just think what it entails or implies is that the average transaction size will just be structurally pretty high, and it just won't be as suited for retail usage.

Starting point is 01:03:05 But, you know, Ethereum can always produce more block space, for instance. But, yeah, I think, let's say there is an invisible awesome to it. I don't think that dooms defy, just think it means that you're, you know, it's more suited for kind of larger style transactions. It seems like, and I'm going to grossly oversimplify, I think, but like there are almost three schools of thought on this, right, as to where the transactions ultimately go. go. So everyone who's been priced out of settlement on a main chain like Bitcoin or Ethereum, well,

Starting point is 01:03:37 where do their transactions go? And if I'm understanding something like Kyle's take is that, of course, they go to a new blockchain that maybe I own a portion of, but a new blockchain that has solved the scalability issues and is much faster than Ethereum and has very high transactions per second, right? So that's one school of thought that the transactions, move to a better layer one with higher transactions per second. The Bitcoin school of thought, in the absence of something like a lightning or some way to scale with base chain security, those transactions might move to a side chain or to crypto banks, essentially, to exchanges that then use Bitcoin as a settlement layer on chain. I think Ethereum's hope is sort of this

Starting point is 01:04:27 third school of thought that, again, you know, constructs. are sort of the mother of invention here, that roll-ups will be that that scalability layer. So that essentially technology like roll-ups and state channels and plasma, but mostly roll-ups seem to be coming to the forefront will be a way to use these transactions and scale these transactions with the settlement guarantees of the base layer. And thereby still preserve this idea of a decentralized bankless. transaction layer. I think that's kind of Vitalik's hope, right, that that will happen. What's your take on those three schools of thought? Do you agree with the way I laid that out there?

Starting point is 01:05:13 Yeah, I think that's a very fair characterization. Obviously, Bitcoin is or heterogeneous as are Ethereum's. But so, yeah, I'm still holding out hope that Bitcoin is able to scale in a more a trustless way. Obviously, I'm trying to persuade exchanges to reduce the amount of trust that we have put in them, the kind of variety of methods we can talk about, but also it would be great if we could continue with this kind of increasing economic density on Bitcoin as well. So I haven't, you know, fully given up hope that we, that we can scale trustlessly with Bitcoin too. But yeah, I think your characterization is pretty complete. In effort of keeping L1 security, but having scale, you started your article off with the metaphor of the governor, right, where there are these weighted balls and the energy from the steam engine spin the balls around. And as the balls spin slower, the valve closes and as it spins faster, the valve opens. And this finds natural equilibrium with how to govern the steam engine, right? And you're connecting this to the cyclicality.

Starting point is 01:06:30 of fees on a blockchain where fees go up, people stop transacting. Then when people stop transacting, fees go down and then people start transacting again. But there's a number of L2 solutions, which I think can act as reservoirs of this energy, right? And so the balls on the governor, they're weighted, but they're still relatively small. And so an alternative model of a governor exists called a flywheel, where a flywheel picks up the energy of the system, persistently when the energy is created, and then when the energy dissipates, you can tap into the energy supplied to the flywheel in order to keep the energy in the system moving forward.

Starting point is 01:07:09 And this is how hybrid vehicles work, right? So when you're driving your Prius and you hit on the brakes, the energy gets captured from that braking and gets put into the battery. And then when you later, when the red lights turns green, you put your foot back on the gas and the energy and the battery goes into the engine to move the car forward. And so as Ethereum is generating this economic activity, it also generates its own brakes. But with roll-ups, roll-ups can act as this L2 reservoir of more transactions, right?

Starting point is 01:07:41 And so as the block space in the L-1 becomes more and more in demand and pushes out smaller transactors, well, they can go and run to optimism and optimistic roll-ups, where there is basically infinite block space because of how rollups work and how optimism works. And they can get onto the optimism chain and transact on the L2 and kind of wait for the tide to go back out. And I think an optimistic-centric view of Ethereum has this natural flywheel effect where the energy boils on the Ethereum main chain and it pushes energy into the optimistic roll-ups, and as the main chain releases its energy,

Starting point is 01:08:22 the activity back from the roll-ups goes back into the Ethereum main chain. Is that kind of how you see roll-ups as a system, or do you kind of just see it as a scaling solution? No, I think that's very well put. And from my kind of investigation into roll-ups, I had a similar conclusion. I think that I don't know if it's going to be Zika roll-ups or optimistic roll-ups that are more.

Starting point is 01:08:46 popular, but I do see the most of what reservoir for those on-chain transactions to the extent the chain is congested. I think the really salient question is, what is the nature of a transaction on a roll-up, specifically what are the settlement assurances of a roll-upized transaction as opposed to base layer transaction? And how easy is it to, you know, make those transactions kind of interoperate with other related systems. Do they have the same composability guarantees? That's kind of the number one question I have. What are the prospects for rollo-opizing, you know, wholesale defy contracts and making

Starting point is 01:09:28 them communicate, you know, clearly and efficiently? But, yeah, I mean, certainly the vision of roll-ups seems pretty compelling to me. I guess the question is how it interacts with defy and practice. I do know that the ETH online event that is currently going on right now, that there are a number of teams trying to figure out how to find workarounds for the withdrawal period, making rollups a step in the right direction when it comes to having similar capabilities and assurances and guarantees as the L1 blockchain. But you're totally right. It is uncharted waters that is currently in research phase right now. Yeah, that was kind of my conclusion from looking at optimistic roll-up specifically. K roll-ups are a little more black boxy to me, and I haven't really understood them completely.

Starting point is 01:10:16 But with OR, it seemed to me like I wouldn't consider an OR transaction final until that, you know, unhappy case period had elapsed, even though most transactions won't have to, you know, you'll have the happy case where there's no conflict or anything. So to me, that like seems slightly different from, you know, your standard of theorem transaction, which maybe settles in a few blocks. I agree. It's kind of like it's pseudo settled until then. Can we talk about something else?

Starting point is 01:10:49 So some people listening to this podcast are like, hey, like what's the deal with expanding block space to just handle this? Some chains have done that. How are other chains handling this problem? So it seems like Bitcoin and Ethereum are similar in that they've said, look, there are constraints on the amount of block space that we have in a given time period. But other chains talk about, you know, free gas, like no gas transactions or super high transactions per second where the gas is cheap. And, you know, many of these are labeled Ethereum killers and that sort of thing.

Starting point is 01:11:29 But do you have any thoughts on or a critique of other chains that are advertising low or zero gas fees? Yeah, I mean, frankly, no other chains. have meaningful levels of usage such that we can evaluate their claims empirically. So plenty of other chains made, you know, gas or block space effectively free. And so they kind of subsidized block space and made tradeoffs on validation. And then they had a lot of transactions, but it wasn't really economically relevant. If you actually look at the composition of these transactions, it's kind of like junk data being inserted.

Starting point is 01:12:10 So we haven't really seen any of these other alternatives tested in the wild. But yeah, my stance on this is pretty consistent. I think metering resources using fees as that kind of gating function and keeping block space scarce really is the way to go here. And I think in the long term, you're going to have great returns from maximizing economic density of transactions. as opposed to just naively trying to increase block space and making validation really costly, which to me, you get back at the same traditional financial system where you have a handful of super nodes that control everything. And that doesn't really seem very new or interesting to me. Yeah, so why is it important for anyone to be able to run a node?

Starting point is 01:13:03 Well, we're getting to like, you know, the, you know, the philosophical fund. of blockchains here. And I guess it probably depends on your perspective. But I think the whole point of these systems is that you can participate in them without too much trust required. And you can audit the supply of these assets. And you can verify that an inbound payment is genuine. You know, you can reduce the cost of counterfeiting very low or the cost of detecting counterfeiting. So to me, the blockchains are all about, first of all, they're monetary nature. and then they're all about verification, verification that a transaction is valid.

Starting point is 01:13:46 And if you can't do this as an individual, then you're probably going to get taken advantage of at some point. And if we want to render the hierarchy flat, I think we have to make nodes cheap, or at least reasonably cheap to operate. So that's kind of my stance always has been. You know, like people give Ethereum shit for the cost of running a node,

Starting point is 01:14:08 but I've certainly seen much pricier nodes out there, which are virtually impossible to run even on, you know, really high-end enterprise infrastructure. So, Nick, this has been awesome to understand your thoughts on kind of economic density and how those articles came together. Well, we've got you. We want to do some, get some of your quick takes in like a lightning round, or as David and I sometimes call it, the roll-up round.

Starting point is 01:14:32 So the first is this. there are now almost over, actually over a billion tokenized Bitcoin on Ethereum right now. So it's like 1% of Bitcoin's supply. What does that mean? Is that bullish for Bitcoin, Ethereum, both? What's your take? Mutually beneficial. I think it's good for both chains.

Starting point is 01:14:55 It's good for Bitcoin. It gives people a different way to engage with Bitcoin. I might question the trust guarantees of that peg and the trustlessness and so on. But leaving that aside, I think it's, it, you know, is a interesting way to potentially transact with Bitcoin in context that you couldn't before. So I think it's good from that perspective. From Ethereum's perspective, you know, one problem I notice with Defi is kind of a lack of high quality collateral to use in the system. It seems like people are trying to insert Bitcoin now because it's got fairly nice volatility characteristics maybe compared with some of the newer, more incipient tokens that exist there.

Starting point is 01:15:42 So it makes for fairly good collateral, too. So I think it's good for both systems. Recently, BitGo instituted proof of reserves. But then on Twitter, Nick, you said that this isn't that big of a deal. A, why should we care about proof of reserves and why does B, BitGo's implementation of it matter less. To me, proof reserves mean something fairly specific, which is if you are a depositor and you have a custodial relationship with a deposit taking institution, you want to be able to verify that they, A, have assets corresponding to your liabilities, the IOU that they owe you,

Starting point is 01:16:21 and B, that your liabilities included in that kind of attestation. So you want them to prove your assets, and then you want them to prove that they specifically have a claim, or that you specifically have a claim on those assets. So that's just like a pedantic point. That's what proof reserve means to me. Maybe it's going to get this more general definition. To me, the Bitcoin situation is like you're comparing an on-chain, you're just comparing one blockchain to another.

Starting point is 01:16:56 You're comparing the supply of some UTXOs on Bitcoin. to supply of tokens on Ethereum that are a claim on those UTXOs. I wouldn't necessarily call that a proof of reserve. That doesn't mean it's not important. It just means that it's kind of a different process. Maybe you do need an intermediary there to obscure the specific UTXOs where Bitcoin is custody in the coins. I don't know the specifics there.

Starting point is 01:17:22 I haven't really looked into it. I think it's elegant and good that all you have to do to ensure the trustlessness of that system is just compare some Bitcoin balances to a token balance on Ethereum. It just seems like a different process than like the classic proof of reserve that I have in mind, which is more applicable to deposit-taking institutions. Are proof of reserves and smart contracts with transparency on chain basically converging? Are they kind of the same thing, they're accomplishing the same purpose? Well, your classic, um, Proof reserves unfortunately tend to require a third party at a station, like an auditor, basically.

Starting point is 01:18:05 And there's almost no way around that because you have to account for the full liabilities of the exchange. And you have to kind of make sure they're not cheating. So a proof reserve in like the classic sense is not a fully trustless or kind of crypto economic operation. Whereas if, you know, you're comparing balances on chain or you're auditing the, collateral quality for Maker, for instance, and all of that is on chain. That's kind of a native, like anything that's crypto-native is going to be easier to audit because that's the whole point of blockchains. Now, that said, there's always going to be these dependencies on outside systems,

Starting point is 01:18:44 which is where these kind of attestations or proofs of reserve come in. Like, for instance, for Maker, if you wanted to audit the collateral quality, you'd actually want to drill down and audit the dollars in the bank accounts back in USDC, for instance. And that's when now you have a dependency on an accounting firm or this outside attestation. So it's kind of hard to get away from that fully. You know, like I think that's maybe like one critique some people would have of like Defi is that it has reinserted dependencies on these like not fully trustless systems. Like in the case of Maker, for instance.

Starting point is 01:19:23 Whereas, you know, you get these really nice like risk management and auditability qualities if you are dealing solely with like crypto-native collateral. Will Ethereum 2.0 be delivered as advertised? Will something named Ethereum 2.0 be delivered, almost certainly? I don't know. As currently advertised in its current specification. I mean, just based on history, my guess is that the specification changes again. But granted, I don't really know too much about it.

Starting point is 01:19:58 So I'm not very well placed to opine on that. Last one for you, Nick. So the current, I guess, dip that we've seen so far, Bitcoin Eath, kind of a price stall. What's your prediction? Does that continue? Or is this kind of a dip moment in 2020. Or 2021 is going to be great. The weird thing is that the, you know, crypto investors seem to be looking to macro factors.

Starting point is 01:20:21 And they seem to be looking what the dollar index is doing and the likelihood of Congress, you know, passing additional stimulus, which is funny that we have these like dependencies on these outside things. So we're kind of like a very small ship floating on a very large and chaotic macroeconomic sea. So like the endogenous crypto factors maybe don't matter as much. So to a certain extent, it's like catalyst driven. It's like who wins the election, how aggressive is the Senate in terms of like injecting new dollars into the U.S. economy, which is weird to think about. But generally speaking, think, you know, the large caps are in a good position. I would say Eath is probably more exposed to, you know, the little crypto-native economy, it's cultivated on its own chain, although that's

Starting point is 01:21:11 already experienced significant deleveraging. So maybe it's going through that process right now. But yeah, it is weird that it's like we're looking at crypto as a bet on negative real rates and like to what extent, how deeply negative are they going to be? But yeah, obviously I have a positive view on it. So recently Square just announced that they put $50 million of Bitcoin into its reserve, making it the second publicly traded company to own Bitcoin. But also, Square is run by Jack Dorsey, who, you know, we might as well just call him a Bitcoin maximalist.

Starting point is 01:21:50 Is this a big deal or is this not a big deal? It's not a big deal in terms of price impact, like one marginal 50 million. dollar buy doesn't move the needle that much these days, which is pretty astonishing when you think about it. But it's a big deal in terms of signaling. It kind of normalizes Bitcoin as this balance sheet asset. It's not what I would do if I was running a publicly traded company, to be frank with you, but clearly he wants to send a message to his peers, basically, and send a message about his commitment to Bitcoin. So from a signaling perspective, I would say it's pretty interesting. Nick, thank you so much. It's been an absolute pleasure to have you on to talk about these concepts

Starting point is 01:22:31 related to economic density, explaining your work, explaining your articles, everything else. So glad that you are writing about both Bitcoin and Ethereum these days. David and I've got to come up with an episode title, but something that that captures some attention. How about this one? Nick Carter says Ethereum's only for Wales. How will that do? I see, I don't know if I said that. Don't do that. We will be very measured in the way we're going to be fair. I'm trying to be fair to both the corner theorem. I mean, obviously I have like my opinions about stuff, but of course. You do a good job with it. Yeah, yeah, just kidding. You do a great job and it's always fun to have you on.

Starting point is 01:23:15 Nick Carter. Thank you for coming in front of the bankless nation. Once again today, we really appreciate it. Thanks, guys. My pleasure once again. All right, guys, actions and resources, two follow-up articles that we will include in the show notes. One is Nick's CoinDest article about the World Computer and the Financial Network that he did not name, but is great reading material. The second is the article that we talked about for the majority of our time with Nick about fee cyclicality in Ethereum and also with Bitcoin. We'll also include a link in the show notes to the Adaptive Markets Hypothesis paper that Nick

Starting point is 01:23:53 mentioned from Robert Lowe. So make sure you dig into that as well. well. Finally, we need some more five-star reviews from you on Apple iTunes. David, we're doing well, but we need a few more, right? We are going to get the bankless podcast to the top of the iTunes charts as Defi grows. But in order for us to get that done is we need those five-star reviews. So if you could go to wherever you listen to podcasts and give us those five-star reviews so we can grow the bankless nation, we would really appreciate it. All right, guys, risks and disclaimers. of course, Bitcoin is risky, ETH is risky, crypto in general is risky.

Starting point is 01:24:29 You could lose what you put in. None of this was financial advice, but we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.

Bankless - 36 - The DeFi Blockspace Cycle | Nic Carter

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