Bankless - Alpha Leak | The Bull Case for Euler

Episode Date: October 8, 2022

On this episode of Alpha Leak, David is joined by Euler Co-Founder, Michael Bentley. Euler is a non-custodial, permissionless lending protocol on Ethereum with some interesting features you should know about. This episode was recorded in early July, but the alpha is still very timely. ------ 📣 Galxe | Explore Crypto’s #1 Credential Network https://bankless.cc/Galxe  ------ 🚀 SUBSCRIBE TO NEWSLETTER: https://newsletter.banklesshq.com/  🎙️ SUBSCRIBE TO PODCAST: http://podcast.banklesshq.com/  ------ BANKLESS SPONSOR TOOLS: ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum  ❎ ACROSS | BRIDGE TO LAYER 2 https://bankless.cc/Across  🦁 BRAVE | THE BROWSER NATIVE WALLET https://bankless.cc/Brave  💠 NEXO | CRYPTO FINANCIAL HUB https://bankless.cc/Nexo  🔐 LEDGER | NANO HARDWARE WALLETS https://bankless.cc/Ledger  ⚡️FUEL | THE MODULAR EXECUTION LAYER https://bankless.cc/Fuelpod  ------ Topics Covered: 0:00 Intro 4:20 Euler Explained 5:30 Compound vs. Aave vs. Euler 6:10 Limited Assets on Compound & Aave 8:56 Euler’s Approach 10:00 Euler’s Collateral Risk Strategy 16:20 Cross Tier Differentiation 17:56 Tier Walk Through 22:08 Euler’s Features & DeFi Importance 30:11 Other Euler Features 30:48 Status Quo of Liquidations 36:27 Competition 38:08 Launch Turbulence 41:55 Interest Rate Mechanism 50:47 Euler DAO & $EUL 52:37 Euler Resources 53:15 Closing & Disclaimers ------ Resources: Euler Twitter https://twitter.com/eulerfinance  Euler Website https://www.euler.finance/  Euler White Paper https://docs.euler.finance/getting-started/white-paper  Michael Bentley https://twitter.com/euler_mab  ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://newsletter.banklesshq.com/p/bankless-disclosures 

Welcome Bankless Nation to this episode of Alpha Leak. Alpha Leak episodes are where we go and dive into a specific project in the crypto space and just go from zero to 60 about what it's doing, what it's up to, why it's different, and why you might be interested in diving down the rabbit hole even further. Today on this episode of Alpha Leak, we're talking to Michael Bentley from Euler. And Euler is a money market, much like compounded Ave, also much like fuse as well, Rari's fuse pools. and Oilers trying to do the best of both worlds of these two different models

for producing a money market. We have the shared liquidity model of AVE and compound, and then we have the long tail of assets model with Rari Fuse pools, and Oilers trying to find out how it can have the best of both worlds to both enable the long tail of assets but also maximize capital efficiency. They also have some other things that they've tinkered with.

They've messed around with the liquidation mechanism and innovated on that, as well as the interest rates mechanism. as well, all in the name of preserving capital efficiency and making OILR a highly utilized money market in the world of DFI. They launched their DAO and their token just a couple months ago. The first application of Euler came online. I think in December is when Michael said it came online, which is like a hairy time for a money market to go online in DFI because since December, we've had like six, seven straight red months. So really getting stress tested in its first genesis

this on Defi, and it has held up very, very well. So I hope you guys enjoy this episode of Alpha Leak. And if you want other shows, if you want me to dive into other projects, other shows, other tokens, whatever, let me know on Twitter, and I'll do it an Alpha Leak on this episode if people request it the most. So let's go ahead and get right into this episode with Michael Bentley of Euler right after we get to some of these fantastic sponsors that make the show possible. Nexto is your financial hub for all your crypto needs. Nexto lets you buy crypto instantly with your credit or debit card or via bank. transfer. They also have an awesome advanced trading platform called Nexo Pro that pays you

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will experience faster transaction speeds with significantly lower gas fees. With Arbitrum's recent migration to Arbitram Nitro, it's also now 10 times faster than before. Visit Arbitrum.io, where you can join the community, dive into the developer docs, bridge your assets, and start building your first app. With Arbitrum, experience Web3 development the way it was meant to be. Secure, fast, cheap, and friction-free. Welcome Bankless Nation to this edition of AlphaLeak. Today on the show, I have Michael Bentley, the founder of Euler.

You probably, when you read it, you probably read Euler, but it's Euler. Michael, welcome to the show. Hi, David. Thank you very much for having me. Cheers. So let's go ahead and get right into it. What is Euler? Euler is a permissionless lending protocol on Ethereum.

Some of your listeners might be familiar with Compound and Arbe, two of the probably the most popular lending protocols on Ethereum. Euler is similar to those protocols, but with a whole bunch of innovations and things built in. that we've been developing over the past couple of years. So we can dive into a couple of those in the show, I'm sure. But more or less, that's it. It's a lending protocol. Users come and lend their assets, so the users borrow assets from those lenders and pay them in interest.

Right. So this is, you know, DFI basics, right? People put collateral in. They borrow against their collateral. People do this all the time with compound in AVE, which is a competitive market to try and penetrate. So we're going to talk about some of the strategies that Euler has to penetrate what is already like a pretty saturated market with compound and Ave.

What would you say is like the main differentiator between compound Ave and oiler? I would say it's the risk framework that oil is implemented. And the risk framework, which we'll dive into, is a consequence of the fact that we're permissionless from the outset. And by permissionless, we mean that anybody can create their own lending and borrowing markets on this protocol. and that creates a whole host of problems and a whole host of attack vectors, and that leads you from the outset to have to really think about risk in very different ways and really to consider a much bigger scope of possibilities. And so our risk framework, I think, is extremely comprehensive.

Yeah, let's talk about why can't a money market like AVE or Compound just list every single token under the sun? Like, why can't we have every single asset inside of Avey or compound? Yeah, great question. There's a range of possible answers to this. I think probably one of the biggest reasons is comes from oracles. So an oracle is a place where you go to to get the price of an asset. And you need to know the prices of assets and a lending protocol so that you can say, how much can a lender, you know, how much can I use a borrow?

When they put in $1,000 of collateral, you want them to be able to borrow less than $1,000 of assets. Otherwise, if they could borrow more than that, they would just keep the difference and walk away, right? So you have to really know the prices of assets and getting the prices of assets is really difficult. Both compound and Arveh rely on Chainlink oracles. Chain link is a third party that aggregates prices from contributors and puts those prices from centralised exchanges and a variety of other places on chain for users. Unfortunately, it's very difficult to establish a chain link oracle. It's often quite expensive to put prices on chain like that over the year.

over the course of a year. And so you can't just have chain link comicles winning for every asset. It just wouldn't be economic to run that kind of system. Because of the gas fees, right? Like every single Oracle for like every single price feed. And like there's thousands and thousands of assets on Ethereum. And if we want to put all of these assets into a money market like Avey or compound, every single one needs to have their own price feed.

And the way that chain link works is it publishes that price feed on a transaction on chain, which costs gas. And so like you have to multiply the number of, transactions by the number of assets. And so like assets like I mean USDC WBTC, ether, like the main, the big assets. Like there's enough demand to borrow these things that it's economically viable to put these price feeds on chain. Like we can pay those those gas fees. Chainly can afford it. But for like the long tail of assets, the many, many, many thousands of other assets, like there's not enough utility in borrowing these things to justify the on-chain price feeds. So that's like one

one restriction, right? Is that a good way to summarize it? Perfect. Yeah. It's, I mean, it's extremely costly, as you mentioned, I saw some estimate that in March 2020 when there was this big, you know, volatile period, Black Thursday in the crypto ecosystem, for a single price feed, it might have cost a million dollars in gas fees just to maintain one price feed. So, yeah, you can see that in volatile periods, it's expensive to take this approach. So what... And in volatile periods are when the price feeds are required the most. Like, that's when you need, that's when Defi needs these prices to be accurate or else Defy will fall apart.

Absolutely, yeah. So what's the alternative? The approach that oil uses is, it uses decentralized price feeds that are read from the Uniswap, decentralized exchange, Uniswap version 3. And what's cool about this is that Uniswap runs all the time. It's never offline. And the prices are generated by traders themselves. We don't need to specialize third parties or keepers or any, any, any,

other third party to come and put those prices on chain. They're just on chain because people are trading using Uniswap. So using these price oracles has some challenges, which we can maybe dive into later as well. But ultimately, anything that's listed on Uniswap is a decentralized, comes equipped with a decentralized price article, an oil can then use that to establish prices for assets and then build upon that to allow people to lend and borrow assets. Okay, yes, we'll put a pin in the gameability of a uniswap market as a price feed. We'll talk about that later because that's definitely something to discuss.

But this is like the big, in my mind, the big of two reasons, how Euler can allow every single asset in Ethereum to become part of its, in part of its vaults, right, in part of its money market. Because it uses uniswap for a price feed instead of chain link. and so Uniswap has, in proxy, Uniswap is an Oracle, right? Like, what is the price of this token on Uniswap? Euler consumes that data for price feeds and allowing Oiler to have more assets inside of its application. So that's like one main difference. I think the other one, though, as to like why can't AVE or compound just list every single asset under the sun is like collateral risk?

And so in my mind, these are the two big things that prevent a money market from being able to list every single asset. Can you talk about Euler's strategy with like a collateral risk? Yeah, sure. So we've got the state of oil as it is today and then where it's going in the future as well. So I can give you a little bit of sort of an alpha leak about about that as well. But you're absolutely right. If you were allowed everything to be used as collateral to borrow, you know, you could borrow against any old, any old asset, any old, you know, the latest dog coin or whatever that people are kind of aping into, things would go wrong extremely quickly. And that's because these assets are extremely volatile.

and essentially the collateral backing all these loans would quickly evaporate in periods of volatility. And that would affect lots of assets at once. In fact, it would lead to what people often refer to as contagion, where one loan fails to get repaid. That kind of drives the, you know, a process called liquidation happens, which drives prices down further, which means more loans are then under collateralised, which means more liquidations, prices fall and so on. Yeah, this is really bad. and most assets generally aren't suitable for use as collateral. The way that Euler addresses this is through various mechanisms around risk isolation.

On Euler, there are three tiers of assets. There are those assets that can be borrowed against. They're called they from the collateral tier. You can lend, you can borrow and you can use those assets as collateral. And there are currently only seven assets on Euler that can be used as collateral, which include the usual candidates like Stateable, but also you know big blue chips like Ethan and Bitcoin. Yeah, beyond that we have these other asset tiers and where things can't be used as collateral and furthermore there are some restrictions on what you can do to in sort of a margin trading environment.

And by default when people create new lending markets on order they end, they begin life in this kind of restrictive, restricted kind of mode where they can't be used as collateral. And so that allows this permissionless aspect, essentially risk isolation. Things by default can't be used as collateral. And then through governance, you can actually promote things to be used as collateral. So that's the state of oil as it is today. A lot of people do want to borrow against longer tail assets, though. And that is a legitimate function that the market can potentially service. A few other protocols have tried to enable this in the past with varying degrees of success.

people might know about cream and Rari fuse pools and so on. I think the way the oiler will develop in the long run is that there will be a kind of main oiler protocol and then beneath it something akin to like a Rari fuse type pool system where they have these little baby oilers that essentially get established below the main protocol and liquidity will flow in through the main protocol into these baby oils and that will enable people to borrow against a whole load of assets without posing additional risks of the main protocol. Yeah, so the way I've explained this to some people is that oiler is really going, trying to go after the best of both worlds between Rari and compound, compound or AVE. The compound and Avey are interchangeable for these purposes, where you have what you call like baby oilers, where you have the highest risk assets, like the isolation assets,

that are allowed to be borrowed against in isolation. And it's not connected to their main hub of Euler, but it's just like this one market. It's like one Raleigh fuse pool. And then Euler governance can allow these assets to go up into like a more premium tier, right? And so you have like isolation tiers, which is like the riskiest assets.

Then you have cross tiers, which is like the medium assets. And then you have collateral tiers, which is like the thing. that like behave like money, basically, Bitcoin, ether, stable coins. And so in these isolation tiers, that's like a Rari fuse pool. And then like the collateral tier is something like AVE or compound where like it's a shared liquidity model.

And the beautiful thing about AVE and compound is that when you like borrow or when you lend USDA to the protocol, you lend it out to simultaneously people who are putting up Bitcoin collateral, ether collateral, like, you know, unic collateral inside of compound. And so it's very like capitally efficient because the same amount of USDA supplied to compound is shared behind a variety of borrowers. Because these borrowers have all put up good collateral, like Bitcoin Ether, like these money-like assets. But you can't do the same thing for something like extremely risky.

Like if you did it for every single token that was just and permissionlessly allowed any token to become collateral, you would have like the event of somebody would like, mint a bunch of tokens, start providing liquidity in uniswop to create a price, and then that token could just be borrowed against inside of, like, Euler, but then because this person made this token, they could, like, infinitely mint a bunch more, and then that token as collateral inside of Euler would go to zero, and then they borrowed all that UCC and ran off with it. And so, like, this is what, while there is this need inside of DFI to have these,

like, one-off marketplaces, like Rwerefuse pools, you can't have this connected to the main hub because you need to prevent that contagion. In my mind, this is where Euler is trying to get, oil is trying to get the best of both worlds, where it has these isolation tiers, but governance allows these things to elevate into better and better collaterals.

I think you might have mentioned cross tiers, but can you go into cross tier, like the middle tier and how what assets go into cross tier and how are those different from the other two? Yeah, so the, The first tier is isolation mode where you can only borrow that asset in isolation. The cross tier, although we kind of colour in this orange colour and it looks kind of like a middle tier, it's probably still quite close to the lower tier, closer to the lower tier than it is to the collateral tier.

Essentially, cross tier just allows you to cross margin trade. You can put up collateral, borrow multiple assets at once. And your whole collateral will be at risk at this point. You could be borrowing, say, Shib and Link and Uni all from the same account. and essentially your whole pool of collateral will be at risk if one of those loans goes wrong. In the isolation tier, you would put up some collateral and you'd borrow a ship, and that would be it. If you want to borrow a link, then tough, you have to go and set up a new account. That would be a real pain, of course, and if you had to fund multiple Ethereum addresses and so on,

and people don't like doing this on Companavé. So another innovation that I'll mention very briefly is that to enable this, because we're isolating, forcing this isolation on people for riskier assets. We do also provide this feature called a sub-accounts. And these are accounts that actually belong to an Ethereum address, but within the context of Euler and its protocol can be used as like an entirely new account. And so you can fund like multiple positions at once from a single Ethereum address inside Euler. Beautiful, beautiful.

Okay, so just to go through it one more time to make it like crystal clear, you have isolation tiers, which if you want to use these assets as, or if you want to borrow this particular isolation tier asset, you put up collateral. And that collateral is then locked into that one position, as in that collateral cannot also be used for another asset. It is just one account. You put like $1,000 of Ethan, and then you can borrow this one token. And that $1,000 of ether you have this collateral can't be used as collateral for another token. Then you have cross tiers where you have $1,000 of Eath, and that can be collateral for multiple tokens. But those tokens cannot be collateral because they are not of the collateral tier, which is like the third and highest and best tier.

And that is preserved for, like, I keep on saying like money-like assets. And the reason why I say that is like money-like assets are money is like highly decentralized. It's highly liquid. It's highly available, like global marketplace. Like you know the demand for these things are there. And so it's very safe for a money market to have money-like. assets as collateral. And so again, that's like the USC stable coins, WBTC, Ether itself. And like I could even see like many, many more defy blue chips kind of elevating themselves to collateral tier,

like things like Avey and Uni that we kind of assume aren't going there. I don't know if they are in the collateral tier yet. But just like a comment on just how defy works is that like the more money like your asset is, whether it's a, whether it's like a defy token or actual money like USC, the more money like it is, the more like good collateral it is. And so like when Euler governance determines like what assets belong and what tiers, it's like the collateral tier that's like the money tier. And everyone wants to be in the collateral tier. Am I on track here? Yeah, more or less. In fact, I would say, I mean, my opinion on this, I'm super, super conservative when it comes to collaterals and when you mentioned like adding new collateral tiers

like DFI blue chips, the real problem with those is that when you use something as collateral, you have to guarantee there's always a willing buyer out there to take on board that collateral if someone's debt need to be paying. Now, unfortunately, even for D5 blue chips in liquidity crises, like the ones we've had in the past couple of months with 3 AC and all the rest of it and Celsius happening, the number of willing buyers for those tokens has decreased dramatically. So, on oil, we pushed through a governance proposal before the project started to decentralise to actually decrease the collateral decrease,

yeah, the collateral factors on a few assets. And we actually removed Matick, the token, from the polygon project, outside of the collateral tier. And that's not because we, you know, we don't like Matick or don't like the project or the team or whatever. Unfortunately, if you plot the liquidity profiles for this on decentralized exchanges, you can see that it was an extremely liquid market for a long, long period. but in recent times it suddenly became in a liquid market.

And that's really dangerous. If someone would say $10 million worth of MATIC could put that up as collateral and borrow, say, $5 million worth of, you know, USDC, what you want to be able to do at all times is guarantee that you can take that MATIC and swap it for USC. And if there's no liquidity on decentralized exchanges or there's no willing buyers for that MATIC and willing to make that trade, then unfortunately it's not suitable for you. as collateral. So yeah, I'm super conservative when it comes to clattuals. I think risk first and then capital efficiency second. And like I say, I think in the long run we'll have this

additional functionality, which isn't the oil, but which has these kind of siloed pools where people can then use some of these longer tail assets in a silo pool as collateral in the future and borrow against them in a siloed sort of risk managed isolated environment. Right. And, Well, definitely after we've seen these drawdowns for the last six months, everyone's kind of like repricing how, repricing risk in a different way. It's like, oh, yeah, like, yeah, let's be a little bit more risk-averse these days. Okay, so like these are the, in my mind, the two features that really stand out about oil that differentiate it from things like compound Avey and Avey and Rari.

And so you have on-chain pricing oracles from Uniswap V3, and then you have this more flexible asset collateral tiers that allow for just, like more higher fidelity with what assets can do what, you know, inside of a money market. And so these properties, these features of oil are just open up assets to the long tail, right? Like we can now allow for the long tail of assets to gain access to compound and Avey-styled money market features. Can you talk about like this as a strategy and what this can do for defy and how this

is useful? And overall, just like why accessing and providing financial services to the long tail of assets is important? Yeah, sure. I mean, from the outset, I mean, we wanted to create a permissionless lending protocol. We wanted something that was uniswap like without these kind of gatekeepers. And I don't think, you know, the chain link system is extremely functional. It's worked very, very well.

But it does end up a side consequence of the way that system works is that essentially what the chain link kind of system decides is worthwhile having an Oracle for ends up being a kind of a process that also determines what you can lend them borrow. and that doesn't really seem appropriate. So philosophically, I think it's aligned with the kind of vision of decentralized finance to have a system where anybody can lend them borrow any asset, depending on their own risk appetite and so on. So there's that as a starting point. We want to kind of eliminate the gatekeepers from the system. On a design point and what this means for actually building a protocol,

it's super important because when you start by assuming that everything can go wrong, you build a protocol that's far more robust in my opinion because you have to check every little feature and so I'll give you an example on when other projects are forked the compound protocol compound fantastic project it was the inspiration I used to sort of get into a defy with oiler but it wasn't built with all sorts of crazy markets in mind

it was built to service a smaller number of markets and that's absolutely fine from a design perspective but it meant when new projects came to fork the code, the code wasn't suitable to be used for certain types of assets. On the other hand, Euler assumes the absolute worst about your token. If you list it on Euler, we assume that you're malicious, that you're a scam,

that you have weird functions that do stuff that they shouldn't. If we ask for the name of the token, we assume it does something weird and tries to scam the protocol, right? Every little thing we have to assume can go wrong, and we assume this hostile environment from the outset. And so that means that Euler was built as a protocol with a whole new bunch of defense mechanisms in place to handle malicious assets.

And I think in the long run, that we'll put it in good stead in terms of being able to survive in this hostile environment that defy often is. And then, yeah, in terms of what can be done with the assets once you have these lending and borrowing markets, I think today the functionality for the long tail is somewhat limited on Euler. mostly you can borrow assets from the long tail and if you want to borrow assets from the long tail what would you be using that for well mostly it's it's people hedging positions it's actually traders essentially borrowing and then selling the underlying assets for short positions so we do see some activity on this in the ecosystem and that kind of mentality has been building through these

bare markets really one particular trade that was really interesting to people was shorting state teeth for instance and hedging out that misk. People already had exposure to steak teeth may know about the, you know, the volatility in that particular market recently. We're using oil to borrow and then sell state teeth and kind of that against state teeth falling against teeth. So that was an interesting use case for an asset that we haven't really seen on compounded RV.

In the, you know, that's a limited use case though. It's really just for traders. I think it does generate some benefits for holders of these tokens. If you're fundamentally long, your precious long-tail asset, you should be quite happy if you want to hold onto that asset for the long run. You should be quite happy to let somebody borrow and pay for the privilege of shorting it, right? Earn some interest to let some speculator kind of bet against your project. I personally would be happy to do that for lots of tokens.

But in the long run, people still want to be able to borrow against some of these assets. and that's where the future of oil is, you know, provides some functionality there, I think. Like they do on these rar refuse pools, you can deposit the asset. Let's say it's a long-tail asset or some kind of meme coin. And then you can essentially say, I'm going to use this as collateral to borrow USDC from somebody else. And the USDC depositor, you know, will probably expect a higher interest rate, right? They're essentially taking on board more risk because you're using a riskier collateral to, to service this loan.

But ultimately, I think that's a, you know, a big use case as well in the long one. It's allowing people to take these two types of trades, these long, short trades against one another. Yeah. Yeah, there's a whole host of possibilities that can get unlocked, especially as that long tail gets built out. If you've been listening to Bankless,

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What are some other unique properties of Euler that we haven't discussed yet? Yeah, I think one of the really is a ton of stuff. I think one of my favorite features on Euler is the way we completely redid the way the liquidations work. Liquidations are one of the most important and fundamental features of a lending protocol. And I think the system that was originally developed for compound works relatively well, at least worked quite well for a time, but has started to show cracks. And so oil, yeah, I've totally redesigned it to have a new system. So before you explain it, can you kind of just explain what's the status quo of liquidations in money markets for a compound in AVE?

Like how does a position in AVE get liquidated? Yeah, sure. So let's say you deposit your collateral, you've got $1,000 and you borrow $500 of something. Now, let's assume you're the asset you borrowed starts to increase in price. So it might increase up to $800. At that point, the protocol starts to look at this position and go, hold on, if it keeps going to go in the same way it is, you're going to have more debt than you have collateral. So at that point, the protocol allows a liquidator, which can be anybody, to come in and repay the loan on your behalf. And so what they will do is they'll take $800 of your collateral, and they'll swap that for the $800 of the asset you borrowed.

they'll repay the loan and leave you with the difference. Now, nobody's going to do that altruistically, right? We're all nice people, but no one's out here wanting to waste gas on paying other people's loans for them. So usually the protocols need to offer some incentive for that purpose. And what they do is they have a fixed discount, usually 5 or 10% of the collateral asset, and they allow the liquidator to buy the asset at that discount. So you can think of this as a bonus for. for the liquidator.

On $800 worth of collateral, the liquidator might get an $80 bonus, and they get to keep that for themselves. So, and that's a 10% bonus, right? So this works really well. It sounds quite nice, right? It's a really effective mechanism to make sure that the protocol stays solvent

because loans get repaid when they start to look at risky. The big problem, of course, is that if you take that loan that I just described and scale it up and now imagine that you've got somebody, like Celsius or somebody borrowing, you know, depositing $100 million worth of collateral and borrowing $80 million worth of assets. Now take 10% as a bonus for the liquidator and it really starts to look painful, right? The Celsius are going, well the heck, we're losing, you know, millions of dollars in liquidation bonuses. Of course, it's completely unnecessary as well. Like liquidators

don't need to be given, you know, millions of dollars worth of bonuses in order to have this incentive. most people would be would happily perform a liquidation which ultimately costs you know a small amount of gas they'd probably be happy to do it for a thousand dollars for instance and furthermore yeah when you get these big bonuses the liquidators often don't even get to keep them you have this problem where um essentially the most of the bonus ends up going to the miners through a process called a priority gas auction or through something called minor extractable value where the miners are able to kind of take most of the bonus away from the person doing the liquidation. So that's the problem. And it's not good for the protocol because it means that more debt is repaid than is necessary. Or sorry, more collateral is removed from the system than is necessary. It's not good for the borrower because they end up losing more assets.

It's not good for the liquidator because it goes to the miners. So you've got a system that's really just there benefiting miners and people using these MEV pots. So what does oil do differently? We have a system whereby the bonus that the liquidator gets starts at zero and then rises as the position changes in value. So what this means is that the bonus, the percentage bonus that the liquidator get usually depends on the size of the loan. For really small loans, the bonus might need to be 10%. It might need to be that the liquidator gets $80 to cover their gas fees and make some profit. but if you've got an $80 million borrow, you still only need, you know, a few thousand dollars

probably to pay it to sell that loan. And so the bonus will end up becoming a fraction, the percentage bonus at least, will end up becoming a fraction of the actual loan taken out, massively to the benefit of the borrower. It also benefits the protocol because more collateral remains in the system. So the protocols remains more solvent. And the liquidators still win. Yeah, we actually have a system which,

I won't go into as well, because it's also quite technical, but which essentially kind of stops, even amongst this smaller bonus, it actually even stops the MEV bots from trying to steal that smaller bonus from the liquidator as well. So we call it an MEV-resistant liquidation process. And this is a little bit like a Dutch auction of sorts, right, where the bonus starts small and then grows larger over time. And as soon as that bonus becomes sufficient, where an interested liquidator is sufficiently interested, then it gets liquidated. And so it's like trying to optimize

for the minimum amount of capital loss throughout the whole system, where the borrower loses, pays the smallest amount of fee possible, and there's minimum amount sent to MEV miners, and the liquidator just takes whatever deal that is, the soonest deal, the smallest deal, that they are actually interested in taking. And so this allows for a depositor to feel more comfortable depositing more money into

Euler because they know that if I do get liquidated, I'm going to be liquidated for the smallest amount possible, allowing for more capital efficiency in the space. So it's kind of just like an elegant mechanism that, you know, that optimizes for the most efficient amount of liquidation possible. But what's preventing something like AVE or compound just integrating this? as well. Why can't they just follow this model too? Yeah, I mean, they probably could do. Obviously, one of the nice things about DFI is that the code can be kind of borrowed

from other protocols. And so, yeah, if it does prove itself as being a resilient mechanism for liquidations, I expect other protocols to do this, we have actually seen some, like the guys, Angel have also used this process in their liquidation flow now. They've kind of inspired by the old. protocol of design this into their Euro base stable coin. So I think we will see more protocols adopting this type of approach, to be honest. I wouldn't be surprised to see future iterations of Companine Arbe have a new liquidation module

that at least borrows from these ideas. But certainly right now, Euler is more competitive on that front. We've done some analysis on retrospective liquidations, and you can see the liquidation bonuses are much, much smaller on Euler in general. For instance, we had a million dollar die liquidation. Our position liquidated some time ago. And the liquidation bonus paid was $4,000, which as a percentage of the loan is really quite small.

Arguably, if there was a more competitive environment for liquidation bots, this was quite early on in the protocols after its birth, really. Yeah, I think in the long run you'll see more competition, and even that $4,000 might be brought down to an even lower amount. yeah it's super cool right now and definitely definitely benefits borrowers yeah this the timing of oilers release on main net kind of reminds me of maker dows release when maker maker mackerdow released on main net in December of 2017 at the top of the market and then you know minted people will go in and mention a bunch of dine a bunch of dye at like one thousand dollar east price and over the course

of the year that one thousand dollar east price fell down to 80 and like maker dow was given like for for its Genesis event in Ethereum, just the biggest stress test ever, because it launched at the top of the market. And so it was just a test on, like, the liquidation efficiency of MakerDAO, turns out it survived with flying colors. And Oilers is about the same.

Like, you guys launched, when did you guys launch? And, like, how has the whole, like, market turbulence impacted Euler? Like, how has Euler operated during, like, all of these, like, turban times of high volatility? Yeah, it's, we launched in,

that we first applied the protocol. think in early December. And then we started with just, I think, two or three collateral assets and then progressively soft launched the rest of the protocol. And there's still bits now that are still being launched. So it was definitely an iterative process. We wanted to do it feature by feature, part by part, to kind of mitigate the risks because lending protocols do generate significant risks, if not done, you know, done carefully. But all through the process, the protocols performed admirably and it's been as you mentioned there's been I would say probably three major stress tests for the protocol since its conception yeah which has been fantastic to see it perform you know whilst there's

been drama going off elsewhere in the ecosystem yeah defy protocols like oh my love just been sort ticking away doing exactly what they should do the real testament to the the way that defy works that it can just withstand such hostile environments I don't think you'd see many trad-fi sort of institutions withstand the kind of pressures that most defy protocols come under. And, yeah, oil has performed sterlingly all the way through.

Yeah, that's definitely been the theme that we've been talking about at Bankless is like all of the CFI companies are breaking and all the DFI apps are doing just fine. But usually when we say these things, the defy apps, people in their heads think like, all right, un-swaps still exchanging, compound still online, OVe is doing great.

But like, it's also worth noting that Oiler is right there with them also didn't break and is also brand new. Right? And so, like, also has the minimum amount of Lindy and still didn't have any problems. Like, you know, granted, inside of crypto, like, things break all the time. There are rug poles all the time. But also, it's worth noting that there are times when something can come to market in, like, an extremely hostile market environment.

And if you build it right, like, it works just fine. That's pretty cool. Yeah. I mean, it's super, yeah, super exciting for me as well. And there was a nerve-wracking period. I bet. You know, it's not ideal circumstances to launch something new. But yeah, I mean, it's even better for us, though, after the fact, to come through that with flying colours.

I think it helps lend credence to the kind of work and all the efforts that have been put into making sure that oil is robust and secure against all these nasty environments that it might potentially face. Yeah, it's a great validation of all that work that we've put in ultimately. I always say that things that survive these kind of periods, you know, when everything's going up and everything's just fine, you can get a lot of garbage kind of floating up as well because they just come under no stress test whatsoever. So you can have protocols that list anything as collateral that haven't like, you know, audited their smart contracts properly and so on.

And it's only when things turn, actually that you really start to see who did their homework and who actually put in the efforts to make sure these things are robust to all environments and not just, you know, favorable ones. Absolutely. Let's move on to another cool property of Euler, which is your guys' interest rate mechanism. Can you talk about what the status quo for money markets is with interest rate mechanisms

for like compound and AVE, how they charge interest based on like a particular algorithm and then how Euler is different? Yeah, sure. So I'll start by clarifying and saying these, our interest rate mechanisms are live today. That's one of the features we will progressively, aiming to roll out and I can explain why that is but yeah I'll tell you about how interest rates are generally in the market on lending protocols so usually if you take a pool that's got say a million

dollars of supply in it and you have you have some borrowers come along the interest rates usually determined as how what percentage of the pool is being borrowed at any one time so if it's 10% of the pool that's being borrowed you might get a 10% interest rate if it's 50% being borrowed, then that interest rate might go up to, you know, 40% or something. And if it's 100% borrowed, then the interest rate goes up yet further. And it might go up to say 100 or 200% or something. Usually, it's an exact kind of relationship, though, between the percentage of the pool that's borrowed and the interest rate that you get out of the other end. There's like a one-to-one mapping there. And what that means is that whoever was in charge of sort of setting the interest

rate model at the start of the process has to kind of get the market dynamics right. They have to kind of map this process onto the market in a way that makes sense for that market. If you set the interest rate to increase really steeply as a function of the percentage borrowed, then you're kind of making the cost of borrowing more expensive. And that might inhibit the market from ever getting started. Like if we just have a really steep slope for how much the interest rate increase, increases as a function of the borrowing, then you might just never get any borrowers because everyone's just like, oh, holy, this is too much. So you set a more shallow slope, right? You think, oh, well, we'll just decrease the rate. And if you set a more shallow slope at the rate,

which interest increases, then you can get too much borrowing. You've basically underpriced the cost of borrowing for the market. And then everyone comes in because it's super cheap to do it on on this protocol. And then the pool gets 100% utilized. You know, there's no more lending supply left. And that's a really bad news, that's really bad news for the lenders, because A, they're getting less interest than they really should be for the market rate. And B, you know, if you own 10% of that pool, if you're deposited, you know, $100,000 and you want to go and withdraw it, you can't because that your assets are out there right now being borrowed by somebody else. So, yeah, you need to get strikes on middle ground where you want the pool to be somewhat

borrowed from, but not entirely borrowed from. Ideally, you want something like, you know, maybe 60, 70, 80% of the pool to be borrowed from at any one time. And that kind of maximizes the interest rate for the lenders while still allowing most people to just withdraw. So, yeah, it's hard to set those functions. It really is. You need governance to be on top of their game. And you need the markets to be kind of predictable. And that's usually not the case in crypto. Things are very unpredictable, as we know. So what can you do differently? This was the very first thing I started looking at when I started working on oiler back in March 2020. I was looking at how compound worked and thinking,

how could you do this differently? And I realized that there's a system you can use that works similar to the way that the thermostat works in your home. It uses a branch of maths called control theory. And the idea here is that the, you know, if you think about a thermostat in your home, it's measuring the temperature outside all the time and then trying to increase or decrease the temperature inside your home

to keep the temperature inside the house fixed. And with interest rates, you want to do the same, but you want to keep this percentage of the pool that's being borrowed from roughly fixed. You want to keep it around 70%. And you can actually do that by adjusting the interest rates. If the percentage of the pool that's being borrowed from goes above, say, 70%, you want to increase interest rates to prohibit more borrowing and make it more attractive to lenders. And so that brings on board more lenders, it stops borrowing, which then brings the interest rates back down so that the utilization stays at 70%. and you can have the same type of process happen below. Like if you end up having really low amounts of borrowing from the pools,

you can reduce the interest rates. That prohibits more lenders coming on board and also stimulates more borrowers because it's now cheap to borrow from oiler than, you know, cheaper on oiler than it is elsewhere. And that brings utilisation back up to the 70% target. So, yeah, this is a new type of mechanism that's similar things have been trialled more recently as well.

But I think we were one of the innovators of this idea. And it's something we'll be, you know, proposing to the Dow to roll out at some point this year when the conditions are right. Right. Users who are, or excuse me, listeners who are familiar with Rye, the stable coin Rye, this is also how Rye works as well. Like it uses, it's a self-referential, like, input. And so it uses its own data to kind of inform interest rates.

It's a little bit of a self-referential loop to create this output. And so this is, correct me if I'm wrong, but this is like one of the many strategies in Oiler to become like a more permissionless governance minimized lending market, right? By not having this like fixed rigid interest rate mechanism and instead having this like control theory based interest rate mechanism, that's like something that we don't have to leave up to governance anymore because this thing just, govern itself. It's literally called a governor. There's this device that really allowed for, what's it called, steam engines to work. And it was a mechanism called a governor that when the

steam engine would get too hot, the governor would open up and let this exhaust out. And then when it would cool down, the governor would close and it'd keep the heat inside. And it was just like naturally balancing mechanism that made the steam engine not explode. And so like we see the same like self-referential like equations built into Rye, the stable coin to price Rye. And now also you guys are using it at Euler to have like more stable interest rates or maybe more volatile interest rates, but more stable asset utilization. Asset utilization being kind of like the important one from like a protocol revenue standpoint.

Because if you can keep that revenue, the asset utilization inside of a money market like oiler high, that means like the system can charge fees on that more stably. Right. if you can maintain that high utilization rate and have that be stable and not have that fluctuate all the time. Like the area under the curve of how many total, what's like the total supply of assets to Euler will maintain a more efficient and higher level

allowing the system to charge more fees on it, right? It's just like when Uniswap allows you to concentrate liquidity, it generates more volume, allowing Uniswap to generate more fees. And the same strategy here is that this interest rate mechanism for Euler allows for more assets to be deposited and utilized so it can charge more fees to the users. So it's just like an economically advantageous system. Would you agree with all this? Yeah, more or less, I think that's pretty much right. I think you can think of a pool that has zero utilization as being like liquidity on un-swap that's out of range. It's just, you know,

kind of unutilized capital and it's capital inefficient to have that. You know, really for capital efficiency purposes, you want utilisation always to be in some kind of Goldilocks zone, where the lenders are always earning an interest, right? Are earning some interest, you know, earning yield on their deposits. So you really don't, you really want to try to avoid low utilization or costs so that, you know, the protocol's kind of working effectively. And ideally in the long one, this is how this will work. It remains to be seen if this will work in practice, by the way.

I'm really intrigued to see how this works when it goes live. It does depend on a few factors that should be mentioned. So you really need people that arbitrage interest rates for this to work most effectively. So you need people that are really sensitive to these changes in interest rates. If they go up too much, they kind of stop borrowing. If they go down too much, they start borrowing. So it's clear that we see that for some assets. You know, with yield aggregators like yearn finance,

will arbitrage interest rates quite effectively across protocols. But yeah, will we see this? for all assets for long-tail assets. It remains to be seen. So, yeah, this will be something we'll be proposing to the Dow to kind of trial on an asset-by-asset basis and see how effective it is. Yeah, Michael, let's talk about the Dow aspect of Euler.

When did the Dow launch? And can you just talk about the Dow details and the token details and all the details around these things? Yeah, the Dow has now been live. What are we talking, a couple of weeks? I was extremely ill when the Dow launched. The last few weeks for me, being like a blur.

But yeah, the Dow is now live. People can make proposals and they can vote on the proposals of others. There's a token that enables this functionality called oil. I call it oil, but it's actually, the ticker is EUL. So, yeah. People, the users of the protocol receive oil or EUL when they borrow from the protocol. So if you're one of the kind of core protocols users, then you receive governance rights

whilst you're using the protocol just as kind of passively and then yeah you can make proposals and vote on how the protocol works in the long one on some of these contentious issues like should something be used as collateral on various factors controlling

like risk in the protocol and on some of these bigger questions like should an asset use you know a reactive interest rate like the one I just described or one of the kind of of old school interest rates like we see on compound and Rave. Yeah, may also be able to vote on things like the oracle that an asset uses as well.

Like there are some markets where it's clear that maybe an asset might be better serviced by a chain link comical than a uniswap one. And so that's an integration that we think might be useful as well. People can vote and say, okay, clearly chain link's doing a great job for this asset. So let's use, let's kind of upgrade or switch out the unoswap. oracle for the chain link one in this particular case. Okay, awesome. Michael, if people want to go learn more about Euler, where should they go?

I would follow the Twitter accounts of myself and Serifim. So you can, yeah, you can find me at Euler underscore MAB. I've forgotten Serafims, but you can come to our website as well and check it out. Euler.finance is the one that we, the main interface to the protocol. and app.Oyla. That's where the users can begin lending and borrowing assets. But, yeah, all the documentation, I would really recommend people to read the white paper. That's at docks.oiler.finance.

Well, Michael, of course, thank you for coming on and explaining Oiler to me and the Bankless Nation. I appreciate it. Yeah, thanks very much for having me. Really enjoyed it. And hopefully we'll have another chat, another day about some other stuff. Absolutely. We'll get all those links into the show notes as well. So if you're watching this on YouTube, we're on the podcast.

The link should be in the show notes. So you can just go click those things there. All right. Ricks and disclaimers, everyone, of course, crypto is risky. Defi is risky. You can lose what you put in. We are headed west. We're on the frontier.

It's not for everyone, but we are glad you are with us here on the bankless journey. So thanks a lot.