Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Jeff Wu & Teddy Woodward: Notional Finance – The Fixed-Rate Lending Protocol

Episode Date: October 12, 2021

Notional is a protocol on Ethereum that facilitates fixed-rate, fixed-term crypto asset lending and borrowing. The core concept of Notional is fCash, a zero-compound bond defined by a currency type and maturity date. Notional’s liquidity pools are built by liquidity providers who contribute cTokens and fCash and act as counterparty to the lenders and borrowers that are active on the protocol.We were joined by co-founders Teddy Woodward and Jeff Wu to chat about the benefits and tradeoffs of fixed rate interest borrowing, how Notional operates, and comparisons to other lending protocols in the space.Topics covered in this episode:Teddy and Jeff's backgrounds and how they got into cryptoThe benefits of a fixed rate over a variable interest rate loanThe product from a user perspectiveThe role of liquidity providers in the protocolTradeoffs of using Notional as opposed to other lending platformsLender and borrower obligationsHow Notional maintain securityThe ERC1155 token standard which is implemented on fCashThe maturity parameter and how it's determinedThe Notional governance modelEpisode links:Notional FinanceNotional DiscordNotional on TwitterTeddy on TwitterJeff on TwitterSponsors:ParaSwap: ParaSwap aggregates all major DEXs and makes sure you beat the market price at every single swap and with the lowest slippage - paraswap.io/epicenterChorus One: Chorus One runs validators on cutting edge Proof of Stake networks such as Cosmos, Solana, Celo, Polkadot and Oasis. - https://epicenter.rocks/chorusoneThis episode is hosted by Sebastien Couture & Friederike Ernst. Show notes and listening options: epicenter.tv/413

Welcome to Epicenter, the podcast where we interview crypto founders, builders, and thought leaders. I'm Sebastian Kutio, and I'm here with my co-host, Freda K Ernst. Today, we're speaking with Teddy Woodward and Jeff Wu, who are respectively co-founders, as CEO and CTO of Notional Finance. Before we talk to Teddy and Jeff, I'd like to tell you about our sponsors this week. With Pereswap, you can beat the market price every single block. It's fast, highly liquid, and they just launched the Reef 5, which has brand new contracts and APIs. It has a modular infrastructure, which is more gas-friendly and now supports free approvals using Ethereum's permit messages.

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It's really exciting. Salana's liquid staking solution that allows you to stake and participate in Defi at the same time. So head over to chorus.1 and start your staking journey. Hi, Teddy and Jeff. Thanks for joining us today. Thanks for having us, Sebastian. Yeah, thanks for having us. So before we get started and dive into Notional Finance, tell us a bit about your backgrounds and how you became interested in crypto.

I started my career. I was actually working in banking. So I was an interest rate swap trader. And basically, you know, I started there for, for about four years at Barclays. And I really like trading, but I kind of hated working for a bank. And it seemed to me that it was very much the way of the past. And so I was sort of trying to figure out, you know, what, you know, what the new thing

in finance was going to be. And cryptocurrencies just seemed like an obvious sort of next step. Whereas, you know, because I was working in sort of finance post-financial crisis, And there were all these regulations that were making it very almost impossible to do anything new or interesting or creative, which, you know, there's a reason why those regulations were in place. But it was a lot more boring to work in that environment. And, you know, so I saw cryptocurrencies, which is a completely new thing. And just like, and it just seemed to me to just be like super exciting and intellectually interesting. and so I wanted to be a part of it.

And I left my job to trade crypto for family office in 2018. And then sort of towards the end, towards the end of that. So end of 2019, I wanted to get into Defi and I started notional with Jeff in January of 2020. So that's me. So Jeff, what about you and how did you guys meet? Yeah, so my background is more in tech. So I started my career in the Bay Area, working for a tech company doing data science

and working with distributed systems. So in around like 2011, that's when I started my career. And back then, kind of the hot new distributed system was Hadoop, which maybe some people remember, but that was sort of like the beginning of like the big data kind of movement, right? And so, yeah, so I spent a lot of time doing data science, data engineering, and, you know, that type of work. In 2016 and 2017, one of my coworkers introduced me to Bitcoin, and I just kind of naturally, like, became fascinated with the technology. And really, at that same time, it felt like, it kind of felt like the early days of, like, big data again.

You know, this is like a cool, new distributed system. It works at a much larger scale. and so it kind of got me excited again about something new. It didn't really like click for me as to like why someone would want to use blockchain or crypto until I started reading about MakerDAO. And that's when I was like, okay, this is like, there's a natural kind of product market fit here with with financial products, right? Like this really makes sense to me.

And so in 2018, I left my job and I took a new job at a new job at, Splunk as the product manager for their blockchain, for their blockchain team. So Splunk is, it's sort of a data analytics firm here in San Francisco. And, you know, I worked looking sort of at the blockchain crypto industry in general, looking for like business opportunities for Splunk. And so in the course of that, in late 2019, I met Teddy, actually at a Cosmos hackathon here in San Francisco where actually we met we met Sunny so this kind of I was at the hackathon too yeah all right yeah so we met I was just walking around taking pictures and like you know like putting stuff on Twitter I wasn't actually doing anything but I was there

awesome yeah that was actually surreal experience because I had been listening to epicenter a lot and and I was having trouble with the Cosmos SDK and like Sunny sat down next to me and started helping me and I was like oh wow this is like kind of surreal. But yeah, Teddy I met there just actually very serendipitously. And we, we, we just, I like, I had wanted to do, I, we had both seen compound come out like that very recently then. And we were, I think we both just wanted to do a fixed rate, fixed term version of that because we felt like that was like, I was like, like, variable rates are cool, but like a fixed rate product is something that is more compelling to like a mainstream audience. And so, and I also think like

from when we first met at the hackathon, like within the first 10, 15 minutes, we just hit it off. Like, we have a really good rapport in terms of like the kind of skills and expertise we bring. And I think they complement each other really well. And I think we also get along really well on a, on like a personal level. So, um, were you guys building anything at that hackathon? Yeah, we built a very early version of Notional. It's a fixed rate kind of thing using the Cosmos edge SDK.

Actually, we took first prize there and that kind of encouraged us to keep going. Okay, cool. And so you switched over because you were building it originally, I mean, the prototype or like proof of concept was on on Cosmos. And then what made you decide to pursue

it on Ethereum? I mean, I think in, so that was late 2019. At the time, Defi was still quite young then and all the activity was on Ethereum, so this seemed like a natural fit for us.

Okay, cool. Actually, I think this t-shirt I'm wearing now and I got from the conference and I like my daily water bottle is like the water bottle from that hackathon. I have like lots of swag from that conference for some reason. I was going to wear the t-shirt, but I couldn't

find it. I guess I had a question for you, Jeff, about your sort of Pax experiences and something that I often find myself thinking about because I'm not at all sort of like familiar with, you know, the big data industry or like that sort of like ecosystem. And I wonder if there's anything that, you know, what are the things that you took away from that experience like working in that industry that apply to crypto? Because like I think in many ways are similar, but like in many ways are also different, like the types of infrastructure on which, you know,

blockchain's operator, like, it's totally different from the types of things you were mentioning earlier. So, like, what's the parallels there? And how does that apply in the crypto space for you? I think one is just like, they're both distributed systems. Like, big data computing is, it's distributed across, you know, I mean, kind of a cloud environment, but sort of the general principles of, like, state across multiple machines, message passing, you know, consensus.

They're applied in similar ways. So there's like a lot of like kind of low level kind of technological kind of analogies between the two. So that's one. I do think from an engineering perspective, working in blockchain is is both fun and frustrating. I mean, if you're in the big data space, you sort of always have like at your fingertips unlimited compute and unlimited storage sort of endlessly. But on the blockchain, right, like that's not the case. every bite you use, like cost money.

And there's like a lot of congestion. And so kind of flipping from like one like, you know, endless supply to like very limited supply is like, it's an interesting engineering challenge. I think it's quite fun. I would say that's kind of the big difference. Yeah. For sure. Cool.

So let's talk about Notional. So you're already alluded to it. So Notional is a fixed rate lending and borrowing product. call. Maybe let's talk about this at a high level first. So why, why is the fixed rate something that's desirable for customers? I mean, I think that, you know, the fixed rates are really desirable because they give people stability and certainty and the ability to plan for the future. You know, and you can sort of, if you look at traditional financial markets, you see that the, I amount of fixed rate debt compared to variable rate debt is just like overwhelming. I think

like something like 90% of the U.S. debt market is fixed rate as opposed to variable rate, which shows that, you know, empirically, it shows the importance that both borrowers and lenders place on sort of stability and certainty. And, you know, just like if, you know, if you think about it, it's very challenging to do anything beyond, um, you know, a very short-term time horizon if you're working exclusively with variable rates. Like if you want to take out a loan, you know, even just use an example from sort of your everyday life, you know, if you want to take out a loan to buy a car and the rate that you're, the rate of interest that you're paying on your loan fluctuates between 2% one month and 10% the

next month, it's very, very difficult for you to plan. and, you know, know if you can afford that, right? So, so, you know, if you extrapolate that forward to, like, you know, if your rate of interest is fluctuating that much every sort of every day or every month or it has the potential to, I mean, it's very, very difficult to, like, commit to, I'm going to borrow something for five-year, you know, take out a loan that's, like, with five-year maturity. Just because, like, you have no idea. I mean, it just makes it very, very difficult to do anything.

but something that's extremely short-term. And so I think that, like, you know, fixed rates beyond just sort of bringing in sort of a more, a user base that values certainty and stability can also just really expand, like, the capability of sort of the DFI system to enable use cases that are sort of more long-term and just, like, enable, like, new kinds of behavior.

Yeah, so I think that's what we're really excited. about. So Teddy, can I ask something about legacy financial system? So basically, I totally see that for consumers having fixed rate loans is highly desirable just because loans that people typically have to satisfy often are a significant portion of the money they have to spend, right? But what you're doing in essence is that you're buying insurance. or you're buying some sort of financial product that that gives you a fixed borrowing rate.

Whereas if you actually got the borrowing rate that was just the borrowing rate over the day, you would probably on average pay slightly less, right? So basically, if you say 90% of our loans are fixed rate, is that consumers or is that also companies? Because basically if I'm a big company and I kind of operate on that, level, I can take larger financial risks and kind of shave off like a couple of tens of a percent somewhere, right? Yeah, so I think that's actually not necessarily the case.

So your assumption here is that essentially by fixing your borrowing rate, you're paying away some expected value, right, in return for getting this certainty. Yeah, exactly. That's exactly what my assumption would be. Is that wrong? Well, I mean, it's not necessarily, it sort of depends, I guess, like, really like super trading-y about this. Like, it's sort of like depends in aggregate who values the certainty more,

borrowers of lenders, right? It's possible that, you know, for example, the lenders may, like, value the certainty more than the borrowers, and then theoretically anyway, they would be sort of willing to pay away some expected value in return for the certainty. And so it's not necessarily, but I think that, you know, in reality, it's just, it doesn't quite work like that. You know, so like, for, you know, for example, the ability to borrow at a fixed rate is not just a, it's not just a, like a bet on where the sort of variable rate is going to be over the terminal loan. because, like, for example, you know, if you borrow, if you know what your fixed rate on your borrowing is,

it gives you the freedom to pursue perhaps a certain type of investment that you feel like only might generate this amount of return. And the fact that you're able to fix your financing costs gives you sort of the confidence and like the sort of minimal aggregate risk such that you will pursue that course of action. Right. So it's less of a like, you know, there's a given amount that I'm going to borrow anyway. And like should I borrow variable or fixed? It's also sort of like, you know, I want to borrow fixed because that will allow me to take on, you know, this other investment opportunity, which maybe has a capped upside return.

And I'll know that because my borrowing rate is fixed, my profit's going to be positive, right? Or like I'll have a reasonable expectation. So I think it's honestly just like more complicated than, you know, just you're speculating on what the variable rate is going to be over the duration of the loan. It's just more complex. So walk us through the product. I'd like to start with, you know, what the product looks like from the user perspective and then maybe we can dive into, you know, the more technical aspects. But first, actually, I'd like to ask you how much liquidity is on Notion. Yeah.

So right now, we've had, you know, kind of fluctuating liquidity. I think like right now we're in the order of 10 million TVL. So kind of, you know, what we've been doing as a company. So I'll give you a little bit of background. So we launched Notional V1 in January of this year. And we've had, you know, I think between $10 and $20 million of TBL since the launch. And what we're doing right now is we're, you know, kind of got our heads down building Notional V2 and we're just getting set to launch that. So Notional V2 is going live in three to four weeks, fingers crossed.

But that's going to be, you know, I think that that'll be a big step up for the protocol because we're sort of making some significant changes to the protocol as well as launching our token in our public liquidity mining program. and we anticipate that, you know, this set of changes is going to really be a big step forward for Notional. Cool. So then walk us to the product. Like what what can I do as a user of this product, you know, if I'm a lender or a borrower and what does it look like for me and maybe, you know, contrasting that to what people may all already be used to, which is, you know, AVE or compound or some of these other lending platforms? Sure. Yeah. So basically, like the core concept in Notional is what we call F-Cash. And that is kind of like a zero-coupon bond in that it is defined by a currency type and a maturity date. So for example, December 1st, 2021, USDC is an F-Ch token that matures on December 1st, 2021. Okay. So this F-Cash token is transferable. It's tradable. And on December 1st,000, and on December 1st,000, that matures on December 1st, 2021. Okay, so this F-Cash token is transferable. And on December 1st, 2021, it can be redeemed for one USDC on Notional. So effectively, December 1st, 2021, USDC represents USDC at that specific future date. Okay?

And the way we enable fixed rate borrowing and lending is by allowing users to trade between USDC today and USDC in the future as sort of represented by this F-Cache. this F-catch. So if you're a lender, you can sell your USDC today and purchase USC on December 1st 2021. And the exchange rate at which you make that trade between USC today and USC on December 1st implies a fixed interest rate over that period of time. So that's like the basic way that this works. And the way we sort of facilitate that trading is we have liquidity pools, uh, on chain where we have, you know, USDC on one side and US, or December 1st, 2021 USC on the other

side. And you can sort of trade between them. And we have liquidity pools for different currencies and different maturities. So, you know, we have USC December 1st liquidity pool, you know, a USC March 1st, 2022 liquidity pool, for example. And so we have, as a user, you have multiple options, you can borrow and lend, die and USC at several different maturities. So in a way, you're not actually, so the protocol doesn't fix an interest rate, but market mechanisms do kind of like they would in traditional financial systems. That's correct. And the way I think about it, and, you know, for everybody listening, I'm a trader, so it's probably

not the way that everybody else thinks about it, but I think about it less as borrowing and lending than buying and selling cash in the future. That's the way that I think about it. And yes, it is market determined. Right. So we have these liquidity pools. As people borrow and lend, they move the prevailing interest. And do you guys have basically liquidity providers or market makers that kind of emulate what a currency market would look like on a legacy? system? I suppose. It's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, can actually use the, to, to the sort of traditional financial system. Yeah. And the liquidity providers, um, what, what's in it for them. So basically, and I'll talk a little bit about Notional V2 here because we've sort of changed the

way we've changed the way this works a little bit. But basically, the liquidity provider earns interest on the capital that they put into the system. So in Notional V2, liquidity providers actually provide C tokens instead of the underlying token like die. They'll put in C die. So they earn interest on their capital plus trading fees. So anytime someone borrows or lends, they pay a transaction fee that goes to the liquidity providers, you know, very similar to Uniswap. So the liquidity provider is going to earn interest on their capital via compound. They'll earn transaction fees from borrowers and lenders on Notional. And they'll also earn sort of, you know, in Notional V2 anyway, liquidity incentives in the form of our governance.

Okay, maybe let's talk about the governance token in a bit. But does that mean that the borrowers and lenders effectively get the same rates? So basically, because there's no spread? So there is a spread and the spread is the transaction. Yeah, but that's a one-time thing, right? So it's not. That's correct, yeah. So it's like a true market rate and borrowers and letters get the same market rate.

as opposed to something like a compound where there's structurally a spread between the lending rate and the borrowing rate that is not the case in Notional. There's there's like one interest rate that both borrowers and lenders get. So what are the, I mean, there must be tradeoffs to using Notional as opposed to another, you know, lending platform. What would you consider those tradeoffs to be? Okay. So I guess, so, you know, I would compare it to something like, to something like compound or AVE. And the tradeoffs, I mean, I think from my perspective, I think that the most significant tradeoff is going to be just the fact that compound and AVE have been around for a while and they are lower risk, therefore, right? I think that smart contract risk is just an undeniable thing that anybody has to reckon with in DFI.

and if you're launching a, you know, a big, ambitious new platform, you know, like Notion will be two, you know, people need to think about smart contract risk, right? And a thing that, you know, Compound and Abe have is that they've been around for a while. And, you know, this most recent thing with Compound notwithstanding, they have, you know, built a very strong track record of security. So I would say that that's like, you know, that's probably the most significant tradeoff that I would see. Yeah. I just want to add a couple of things here. So one is that I think one misconception that we've seen a lot with Notional is that even if you're like lending or borrowing fixed on Notional to, you know, three or six months, you're not locked into that for the duration of the term, right?

So one thing about Notional is that you can, you know, lend and lend some money. And if you need to withdraw that money, you can sell that F cash back into the markets and get your money out. And you'll be able to sell it at sort of the current market rate at that point in time. So that's, you know, one thing that we've heard with compound. Oh, you know, like compound, I can always get my money out. Well, that's kind of similar with Notional as well. And I also say one tradeoff on the downside here with Notional is that since you, you are going through a liquidity curve, both on lending and borrowing.

You know, the gas fee on the lending side is going to be similar to the borrowing side, right? So on both sides, the gas fees will be a little bit higher. I think on compound, since you're just wrapping C tokens, it's cheaper on the lending side. But, you know, for us, that the action is about similar on both sides. So you'll pay a little bit higher gas fee. But I think those are the main differences. Yeah. And what happens at the maturity date?

Like, are you expected to have paid off your loan by the maturity date? And if you haven't, what happens? You get liquidated or what happens then? Yeah, yeah. Okay. So basically, and just for your listeners' clarity here, so I'm going to be talking about Notional V2. Okay.

So given that we're watching this pretty quick, or pretty soon rather, and we've changed a few things. So in Notional v. 2, if you're a lender and you reach maturity and you haven't rolled your loan forward, what's going to happen is that immediately upon maturity, you're going to switch from earning a fixed rate to earning the variable rate. Okay, so immediately upon maturity, you're no longer earning, say, 6% fixed. Now you're just earning the variable compound lending rate on your cash. Okay. So there's no action necessary.

That's what happens as a lender. Now, as a borrower, it's, so basically the way Notional works, it's very important in order for us to ensure that lenders can pull their money out when they're entitled to taking their money out, we have to make sure that borrowers essentially make good on their obligations, right, and pay their debts by the time that they say they're going to pay their debts. So if you're a borrower and you borrow until March 1st, 2021 or 2022, rather, and you can roll your debt forward if you don't want to actually repay your debt. So, so, you know, let's say it's April 1st, you can decide, okay, so I'd really rather keep my debt open. So I'm going to roll my March 1st debt into, you know, March 1st, 22, or 2023, rather.

So you can roll your debt forward. Now, if maturity does come and you haven't paid your debt, what's going to happen is that a third party can roll your debt forward three months on your behalf. So essentially, you will be forcibly auto-rolled forward by three months at a penalty interest rate that's like at the moment we've decided upon a 250 basis point. So that's 2.5% penalty to the current market interest rate. So, you know, if the three-month interest rate was 6%, your debt would be rolled forward at 8.5%. So there's like a little bit of a penalty that you're paying for not paying on time, but you are not going to get liquidated. Your collateral is not going to be seized. Your debt is just going to be rolled forward.

That's interesting. That's quite different from the experience, say, like on a typical, like, on a typical, uh, protocol where like you borrow the money and you just like pay the interest for as long as you're there and you know if you pay it back whatever like you're you're paying the interest on the on the principal so when when this happens who are these third parties that get to kind of carry over your loan for the next three months and are they there's some kind of incentive mechanism here for them to do this or uh yep that's correct uh so it's it's kind of like a liquidation function and like you know we would expect the same kind of people who are

going to be doing liquidations are going to be doing this sort of rolling forward. And the incentive is, you know, so we said that there's, you're, you're borrowing at this penalty interest rate, you know, two and a half percent over sort of the market interest rates. That, that settlement penalty is the liquidator's incentive. So they essentially lend to you at a two and a half percent premium to the market rate. And then the expectation is that they would lend to you. immediately sell that F-cash that they got from you on the on-chain market and just capture

that spread. Okay, I see. And you already talked about the fact that everything is collateralized. So can you talk about the choice of collateral and what the collateralization ratio is? Sure. So this is going to be something that will change on an ongoing basis. But we are going to launch with, so we're launching with the same four currencies that we have live on Notional v1. So eth, wrecked Bitcoin, USDC, and die. And all four of those currencies are going to be lendable and borrowable. And they're all going to be eligible as collateral to collateralize loan in any one of those currencies. And the initial collateralization ratio for like a USDA debt collateralized by Ether, for example.

We're going to start off conservative. So we're starting off with a collateralization ratio that is roughly 150%. So it's a, you know, a slightly more conservative collateralization ratio, but that sort of reflects the fact that, you know, this is, we're launching a brand new protocol and we want to get comfortable before we sort of start making that ratio a little bit more aggressive. And then for the actual collateral types, So, you know, we're launching with those four, but the collateralization framework on Notional v2 is very flexible.

So we will have the ability to deploy new collateral types, and we very much intend to do that. So that's going to be, from a business standpoint, we expect to launch a new batch of collateral types pretty close following the launch of Notional V2. So we will definitely like continue to add support for new collateral types that sort of fit within the risk framework of the protocol. So yeah, so I mean, you know, this stuff will, you know, we we do a lot of this kind of risk work in-house. And, you know, it's something that I think we put a significant emphasis on as company and we want to put an emphasis on as a community, sort of risk management of the protocol. And so I think that these collateralization ratios and new collateral types, you know, these things are going to be fluid. And we definitely, definitely intend to make notional as capital efficient as can be without sacrificing the integrity of the protocol. And we want to enable people to borrow against as wide a variety of collateral types as we can safely onboard.

Okay. Maybe let's talk about the governance and how to add collateral types in a number. bit in the frame basically in in the context of the token also and but just just for wrapping this up so what happens if my loan is underwater yeah so if your if your loan is underwater basically if you have become under collateralized you are eligible for liquidation so what a liquidator can do is they can purchase a portion of your collateral and you know deposits the currency that you owe, right? So if you are taking out a USDC loan

collateralized by ether, your liquidator can purchase some of your ether and give you USDC in exchange for that ether. So basically, you know, by doing that, they're gonna reduce the risk of your account and recilateralize your account. And what's the penalty? Yeah, so the initial penalty,

we're going, with for, so basically the liquidation penalty is going to vary by currency. Now the liquidation penalty for ether, the sort of the initial penalty we're going for is 8%. So, yeah, so that is the liquidation penalty. One thing, I know that we're talking about collateral here. And so one thing I wanted to mention, I think Teddy can describe this better than I can, but one thing about Notional, which is different from compound in Avey, is that in Notional, your collateral can also be liquidity provided into Notional F-cash markets, right? So like Teddy mentioned, ETH is both tradable in these F-cash markets.

So, you know, you could deposit ETH that would be wrapped into C-Eth as your collateral, But you can also deposit ETH and have it turned into liquidity, which is being provided on those ETH markets. So you'll be earning additional sort of yield on your ETH while it's being provided as collateral. So one thing about Notional, which, you know, I know we're talking about a very high level here, but there's a lot of depth in terms of the collateralization framework, which allows people to sort of collateralize not only liquidity, but also lending, right? So you can be lending ETH out at six months and be borrowing against it. So there's just a lot of ways to, there's actually like beyond just the currency types.

There's also like different sort of subcategories of each currency of how it can be represented as collateral. I don't know, Teddy can probably explain this. Yeah, yeah. So I'll just kind of like follow on that a little bit. Thanks, thanks, Jeff, for sort of bring that up. But like, but yeah, so if you want to take out a USC loan, and you've got ether as collateral, you can just deposit the ether into Notional and borrow against it. Or, like Jeff said, you can earn yield on your collateral while you're using it to borrow against, right?

So if I've got my ether, I can actually lend it at a fixed rate on Notional and then use that loan to borrow against, right? So I can lend it. I can also provide liquidity on Notional. So we haven't talked about this yet. But in Notional v2, we have this thing called N tokens, which is sort of our version of Notional liquidity tokens. So you can mint N tokens from your Ether. So you can provide liquidity to Notional and then borrow against that liquidity you've

provided. So you can earn liquidity fees. You can earn note incentives and then borrow against it. Right. So we think that this is like, you know, it took a lot of work and it adds like a lot of code to make sure that this works. But we think that this is like a pretty killer feature because essentially what it means is that you are giving up nothing as a user, right? So there is no dead weight from your capital. Right. So like your collateral can always be earning an attractive rate of interest. So you never have to like just put up capital and not earn anything. on it. And we think that that is pretty critical. And it's like, it's something where it's like, you know, if you look at the decentralized, like, OTC lending businesses and crypto, they don't give you any. So when you borrow USC and you, you know, collateralize that with ether or wrapped Bitcoin, they just take your ether. They don't give you any interest on it. Right. And whereas,

like, so, so on Notional, this is an objectively better thing because you are earning. all the possible sort of interests and returns that comes from your collateral at the same time as you're using it to collateralize your loan. So we think that's pretty cool. That is cool. And capital efficiency is something that is notoriously important to defy users. But this kind of brings me to a question for Jeff. So Jeff, Jeff, in terms of security, I mean, so basically this is this is often a criticism that's levied against defy, right? Basically that it's a house of cards and as soon as one card falls, the entire house collapses.

And I mean, we've seen that even tried and tested protocols such as compound and compound had a huge bug last week. And I mean, it wasn't catastrophic and it paid out too much in fees and so on. So basically it wasn't a catastrophic failure, but it was pretty severe bug. So how do you go about mitigating this risk for your protocol and your users? Yeah, so I would say just like broadly the way kind of the way we think about

notional the product and like everything we do, you know, our priorities like number one is security. Number two is capital efficiency and number three is like user experience. And we kind of evaluate everything we do sort of in that frame. And so I think security, especially in DFI, like, it's sort of, it's just software quality, right, at the end of the day. And software quality, that's sort of like the highest level that you can, like achieve. And that comes like kind of critical components of like good software quality I think are well known. You know, it's it's good documentation. It's naming your variables cleanly. You know, it's like being a really good, like conscientious approach. like first and foremost. And then it's testing, right? It's just like exhaustive testing in like different scenarios. And then even beyond that, you know, and like a lot of kind of issues, you know, that are ongoing. But at the same time, it's one place where users and like developers, all value

security like very highly, right? And you kind of don't see that in sort of like the more traditional software space. Like security tends to be something on the best. back burner. And so I think it's nice that users actually value this and pay attention to, like, you know, the audits and, you know, and care about those things. So, you know, along those lines, you know, it's also not just testing, but it's audits. And it's also like adopting new technology, right? So we're working with Sertora on formal verification and like kind of some of the newer kind of like fuzzing tools coming out, which sort of expand the capability of testing beyond just like just what we're kind of writing, you know, right off the bat.

So I think we're always looking for ways to just get more confidence around the code and just kind of ensure that it is doing what we intended to do. Okay, so basically if I step back one step, if you look at each individual module at each Defy Lego brick, even if each individual Lego brick is structurally sound and well-engineered and has clear APIs and inputs and outputs and no intrinsic bugs, I mean, if you combine enough Lego bricks together, you can still get a structurally unsound system, right? So basically, and to me, that's also a systemic risk that kind of we as an ecosystem kind of need to think about how to go about this and how to protect the users who even despite the fact

that maybe each individual brick is fine, but if you actually stack them in a certain way, it ends up being very much not fine. So do you have any measures in place or any thoughts on how we as an ecosystem should address that? Yeah, I think that's a great question. I would say what happened with compound, you know, was, I think for me was an eye opener, right? Because we, You know, we're integrating with compound. It's a, it's a dependency here. And, you know, unlike some software dependencies where you can sort of hard fix a version, right? Like compound's going to change.

It's a dynamic sort of dependency. And so I think it's something that, you know, we, at least for me, my takeaway was that, you know, I need to be, we, you know, I need to be paying more attention to what's happening there and sort of what, they're doing on their side in governance, right? And I think that I think that's true of a lot of protocols, which depend on compound. And, you know, I, you know, and, and I think that's, you know, I think at the end of the day, right, as we sort of become more interconnected, you know, I think it's sort of, it's in our best interest to make sure that compound is working well and working healthy. You know, we depend on uniswap for people to be able to kind of trade out of positions during liquidation.

So that's, you know, another thing that, you know, we are going to do. We're going to monitor the liquidity pools on uniswap and curve and make sure that they're deep enough for our liquidations. And, yeah, I think we just kind of need to be vigilant as sort of as a community in a system, right? Because, yeah, I totally agree. We're all dependent on each other. I'd like to ask you about the F token and or F cash token. I read that there's a, you guys have built a token standard or you're leveraging an existing

token center called the ERC 1155. I had never heard of this token standard. What does it do exactly and how is it different from other tokens you may be familiar with? So I think most people are familiar with the ERC 20 token standard, which, so something about the ERC 20 token standard, which is nice and makes it easy to develop against and understand, is that something like USDC is always going to be USC. It's never really going to change. We can pass it around to all of us and it'll sort of, it's going to remain USDC.

One unique characteristic of F-Cash is that it matures. So on a particular day, December 1st, you know, 2020, 2021, it's going to convert from a promise to like actual, like, redeemable USC, right? And so it sort of doesn't adhere to the expectations that you would have of an ERC20 token because it changes at a very distinct point in the future. In addition, like one thing that we want to do with Notional and one like important piece of Notional is the ability to trade and create F Cash at different maturities, right? So we have the three and the six month in the one year. And one thing we haven't talked about and is available Notional is the ability to actually lend and borrow at dates that are. in between those different points in time, right?

So you can actually lend in OTC markets at nine months or eight months if that's something, if that's a product that people want, right? And a really cool part about Notional is that we can actually value that and value those F-cash assets and let you borrow against them. But, you know, sort of the scalability issue of creating ERC 20 tokens for each one of those dates and like, you know, having different token contracts from like a technical perspective, it kind of becomes really cumbersome. And so that's why we chose the ERC 1155 standard,

which we think fits the nature of the token much better. So the key thing about an ERC 1155 token is that it's identified by an ID. And so each identifier will be like the currency and the date that sort of identifies the F-cash asset. And basically you can call that contract saying, I would like to transfer, you know, December 1st, USDC F-Cash, and it'll sort of be able to locate it properly and transfer. And what that does is it gives the developer a single contract, single point of entry, for transferring all different types of F-cash assets.

And that's kind of, it makes programming and kind of like understanding system like a lot better. And one analogy, I think for this, that kind of helps make it more clear is that, you know, in traditional finance, you know, if you're going to trade something like an equity, you go to the stock market, right? But if you're going to trade something like a bond, something with a fixed term, fixed interest, like you go to different markets, right? You go to OTC desks or you just go to different markets. And they're not like, they're not sort of intermixable in the same standards, right? And I think that's something very similar here, right?

This is a different type of asset. And so I think it requires a slightly different standard to make a good experience for the developer. So it creates a token which has properties that, where you have common properties, but there's like a non-fungibility between different characteristics of the same token. So it's like one contract to manage different fungible tokens that are not fungible amongst each other. Is that like a good way of the start? Yeah, yeah, that's great. So great way described.

So USDC on December 1st is fungible with all other USDC, on December 1st. But USC on January 1st is not fungible with USDC on December 1st. So that way, you know, you kind of have these kind of stacked maturities that are going out. They're fungible within themselves, but not between. Talking about maturity, who defines these maturity periods? And I suspect its governance. So maybe we could talk about that a little bit and how all these maturity dates get

get defined. So again, this is in Notional v2. In Notional v2. So one thing about Notional is that when you provide liquidity, it gets distributed across the different F-cash markets. And so that has the effect of fragmenting liquidity across these different pools. So one thing that we didn't want to happen is have it get fragmented across too many pools. So what we've done with Notional v2 is we sort of hard-coded like a F-cash market cadence

that will go from three-month to six-month to one year to two-year to five-year to ten-year and then to 20-year. So that's sort of like the defined cadence of the F-cash markets going out to the future. And governance will sort of enable, like turn them on as we go forward. So we're going to start with the first three. three months, six month, in one year. So that's what users will be able to lend and borrow on the liquidity pools. But, like, as I mentioned, with the actual, like, token standard underneath there,

there is the ability for, like, OTC trading, like direct trading between two parties at sort of dates in between kind of those liquidity pools. I don't know if you want to add anything to that. No, I think that's pretty good. Yeah, so there's like, we have this sort of predefined maturity cadence, which references a reference time that rolls forward every three months. So basically, you know, you might have January 1st, let's see, what would it be? I suppose it would be December 1st, March 1st, and December 1st, 2022.

Those might be your liquidity pools. And then once you get to December 1st, those dates would roll forward. They would all roll forward. So then you'd have March 1st, June 1st, and June 1st, 2022. So every three months, the active maturities for the liquidity pools are going to roll forward three months. When do you plan to introduce the longer cadence ones? Because, I mean, these would be also super interesting to see how people gauge the future of the ecosystem, right? So basically, if you're going to buy a 20-year fixed loan on

the defy product, this has so many externalities that go into this beside what you think money is going to cost for the next 20 years, right? Yeah, yeah, yeah. So I think that, you know, I think it'll be a little while before we get to 20 years, if I'm being completely honest. I think, you know, basically our intention here is, you know, there's a lot of things to consider when we activate one of these sort of longer data maturity. So as Jeff said, we're launching with a three month, a six month, and a one year. So the next thing to turn on would be the two year, right? And when you turn that on, it's very, very difficult to, and I think technically it might be impossible to turn it off. but, you know, basically it's hard to go back on it, right?

And so once you turn it on, you need to sort of support it in perpetuity pretty much. Now, because of that, you know, it's not a decision that we take lightly. And kind of the downside, one of the downsides of turning on one of these longer dated maturities is that you distribute the total liquidity amongst a greater number of liquidity pools. So you're sort of fracturing liquidity. So there's like a very tangible downside to opening up one of these longer dated maturities. But so basically we want to be sure that, you know, people really want it prior to, prior to turning it on. And the way we like are going to sort of figure that out is by, you know, so in Notional Re-1, we had a three-month and a six-month maturity.

and we saw that, you know, the vast majority of the activity was in the six-month. So this sort of made us believe that, you know, what people really want with fixed rates, they want long durations. And so that's why we're launching the one year at launch with Notional v2. And so we're going to go see and see what happens. You know, like, is the majority of the activity going to be in the one year? And our users are going to tell us that they want even longer date maturities? So, you know, I think that a lot of it is just sort of like, you know, we're extending the maturity horizon with notion of V2.

We're going to see what people think, see, you know, like listen to what they tell us. And if they do want a two year and we're satisfied that there's going to be a decent enough amount of activity to justify putting liquidity in that two year, then, you know, we should be able to turn it on. That makes complete sense, but it kind of leads me to my next question. who is we? So who decides what's the governance look like? Good question. Okay. Yeah. So we have, in Notional v2, as I alluded to earlier in this podcast, we are issuing a, you know, the protocols governance token, the note. And, you know, like are the governance decision making, so protocol upgrades and risk parameter changes, that's all going to be subject to on-chain voting by note holders, right?

And so, you know, we've pretty much forked compound governance. And maybe Jeff can say a little bit about exactly any kind of differences between the way our governance module works and the compound governance module works. But before we get there, I'll just say a little bit about, you know, the sort of the token distribution. So, you know, no folders are going to be making these decisions. And we are really, you know, we really believe that ultimately, you know, we want notion to be foundational infrastructure for this new financial system. And so we want to distribute and governance of protocol and to decentralize control. And so to that end, we have earmarked about 55 to 60

percent of the total token supply for the community to be distributed mainly through liquidity incentives, but also through a foundation that will support the community with ecosystem grants and sort of development grants. But basically, you know, over the next few years, we plan to distribute that, you know, majority of the tokens to people that aren't us, basically. And so, you know, we plan to progressively decentralize the effective control of the protocol. Yeah. And then, Jeff, I don't know if you want to say a little bit about, you know, our governance system from a technical standpoint.

I mean, the government system will work very similar to compound, you know, in terms of voting and the way it can make changes to the protocol. I think, you know, this is an area, I would say, is, you know, there's a potential for us. to up, you know, as a protocol as a kind of community to decide to upgrade and change that to, I guess there's, you know, tons of different governance models out there. So, you know, I would just say like, you know, where we're starting is kind of like starting point and we'll kind of see what the protocol needs to do from a governance standpoint to kind of change that. One thing that the way we're parameterizing it, I think this is kind of like maybe interesting is like, So compound currently has like a seven day cadence.

I think everyone's kind of aware of this now of actually getting changes through. So one thing, you know, we're healing aware of is that this is a new protocol, you know, as we go out. And so we want to be able to make some changes quicker. So we're going to shorten that time cadence for us to be to about two and a half days in the beginning. And as the protocol matures, as we feel more comfortable of that, we'll kind of elongate that time cadence. It's so, you know, just as a way to kind of represent the maturity of the system. Yeah. So, but otherwise, I think it works pretty similar to Compa.

One thing that I thought would be really cool here is if, you know, because like lots of people, I'd say, have positions in Avey and they may want to move those positions into something like notional to benefit, like basically from a better interest. rate or at least a fixed interest rate. Is there a way or are there products that you know of or like, you know, without having to code your own flash loan contract where basically you could say, okay, here's my position on Ave, I want to move it over to compound. This is how much gas it's going to cost,

but it's going to happen and I'm going to be able to move all of those positions there in kind of one transaction. Because that's something that I think like I would use. Yeah, absolutely. So I think Instadap does this between compound and Ave, although I'm not like entirely certain. But we,

Actually, as part of like the code that we've open sourced for Notional v2, there's a, there's a flash loan contract that will move your compound, you know, variable borrow into Notional. And then essentially like flip you from a like a variable rate into fixed rate borrow in a single transaction. And then also on the flip side, actually, if you're holding C tokens and you actually just want to lend at a fixed rate, you can actually just posit those into Notional and receive F2. cash in return. And so that you can actually flip your variable rate loan into a fixed rate loan directly. With the AVE integration, since we're not using AVE as the underlying money market in Notional V2, you know, swapping from AVE is something that is possible. And we'll definitely look into, it's something that, you know, as Teddy alluded to, as part of like building the community. Those are the types of things that I think the foundation would look to

supporting through like development grants and things of that nature. So maybe let's zoom out to the ecosystem a bit. In your view, what are the next milestones that will hit in the defy system? So I mean, this week we saw that Sebastian helped me out here, French bank. Society General Forge. Yeah, here we go. Made a maker proposal. So, I mean, what do you, I mean, so basically, Teddy, as someone coming from traditional finance,

what do you think the next year is going to look like? Okay, yeah, so that's a really interesting question. I think, you know, first of all, let me just say that, you know, obviously I'm biased, But I do think that that Notional V2 is going to unlock some really cool stuff in Defi that you haven't been able to do. So I'm just going to say that real quick first because basically, so these F-Cash tokens that we've been talking about, they allow you to define and manipulate cash flows at specific future dates where you have guaranteed liquidity via the Notional infrastructure. And that's something that you've never had before in D5. And so you're going to be able to, like, create, you know, really cool sort of fixed income

secured. Sorry. Fixed income products. Like, for example, coupon bonds, right? So you could, like, you could essentially bundle a number of these F-cash tokens together such that you could buy a bond that would give you fixed payments on a periodic cadence. So you could have, like, you could, you know, lend $100 for two years and you'd, you'd, get fixed payments every quarter, right, as opposed to, like, taking the entire payment at the end,

right? And I think that that's something that's really cool. It's obviously a super popular product in traditional finance. You can't do it in defy today. And something like F Cash allows you to do that. So that's just, okay, so that's just my little thing on a national head to say. Now, I think, like, from a more sort of macro perspective, yeah, this is going to be really, really interesting. year to come for DFI. Because I, you know, I still talk to a lot of my two friends in traditional finance. And, like, even some of the more conservative ones, like, they're coming around to D5. They really are.

And I think, like, it's past the point now where, you know, we've hit the big numbers. And so we've gotten people to pay attention. And we've sort of, like, I think proven out, like, some real product market fit here. And the longer we stick around and like these things continue to work, like just the more undeniably useful, like this space starts to look to outsiders. Right. So I think that the number, absolute number one thing that people, that has made sort of more mainstream users wary about Defi is is the security risk. Right. So the idea of like, because you just think about how weird it is, right?

So it's like, I'm going to take my money and I'm just going to like put it in a computer program, right? And there's nobody I can call if like things don't work as as they're supposed to. Right. It's like a really weird thing. It's like a psychological barrier that you need to get over. And then really the only way to make people comfortable with doing that is is time. Right. And it's time that these things are operating and they're operating correctly and people are getting their money back when they're supposed to.

Right. And, you know, we've had time now where these. systems have been operating safely and securely, right? And I think that, you know, over the next year, that will just continue, like, that will continue and, and people will become sort of more confident and less worried about sort of smart contract risks. And I think that, you know, we're also seeing innovations in sort of like the defy insurance space that are going to get people more comfortable, which I think is like super interesting. And, you know, basically the, the the thing that's that's the barrier to entry is is risk, right? So it's smart contract risk. It's

regulatory risk. And I think over the next year, you're going to see like a significant diminishment in both of those risks, right? So like one just with additional time and and sort of new insurance solutions coming to market for defy that's going to reduce the smart contract risk. And then kind of the other thing is, you know, like a lessening in the regulatory risk. Because I think that, you know, like I saw like a headline that the FDIC is looking to potentially insure stable coin issues, right? Or like offer insurance to stable coin issues or to like approved stable coin issues. And I think that like, you know, there is a recognition that that that, that, defy is important and I think regulators in the U.S. are, you know, going to be offering some

actual clarity within the next year in this space and that's going to, I think, make a lot of people sort of more mainstream users much more comfortable. So I think that, you know, in the next year you're going to see like a lot of the risks and barriers to entry significantly reduced. And that's not even talking about like, and I hadn't mentioned, but like the, you know, layer two solutions coming online. So I think like, like, Like a year from now, you can see like a lot less more contract risk, a lot less regulatory risk, and lower gas fees because of layer two. And I think if you put all those things together, then it's like defiance is like a no-brainer. And it's objectively superior to traditional finance.

And so I think it's like a super exciting time. I totally agree on many parts of what you just said. the one issue where I feel like my personal feeling is more or less diametrically opposed to what you just said is regulatory, right? So basically, to me, the feeling is that regulators, especially in the U.S., are not moving in a great direction. I think that, well, I think it's up for debate, I would say. I mean, I think that, you know, people have obviously.

Obviously, like, some of the stuff from some certain officials has, like, caused concern in crypto space. But I think that in the U.S., what you've actually seen is, like, significant pushback from people who are very, you know, like, pro-crypto and pro-innovation in the U.S. I think that there's, like, a non-negligible, you know, number of politicians that are really on our side. And that, I find very encouraging. And I think that there's a growing recognition from sort of what we've seen.

You know, yes, there are people who are against crypto, but I think that there is a growing recognition that this space is going to be, you know, extremely important. And like, just like this thing is growing extremely rapidly. This thing is going to be big, right? And I think that there's a growing recognition of that. And there are a lot of people who want to make sure that that the U.S. has like places a stake, places a flag there. So I think that, you know, I'm really actually pretty optimistic from that standpoint. Okay, that's good to hear. It's always nice to hear people be optimistic about the regulatory environment.

So Teddy, Jeff, when is Notional Version 2 coming out? Yeah, so we're targeting first week in November. Yeah, so that's what we're targeting. I think we'll do it. So I'm, again, I'm optimistic. I see Jeff chuckling in the background. So we'll look out first week of November. And where can people find out more about you?

Where can they go and partake in governance and in liquidity mining and so on? Yep. So you can visit our website, notional.finance. You can follow us on Twitter to hear all the updates on what we're doing. That's at Notional Finance. And you can also just jump in our Discord and ask us questions. We're all there. We're very responsive. Discord. Notional.finance is the link there. And yeah, and, you know, keep in touch and let us know if you had any questions or, you know, any stuff that you want to see us build. Cool. Thank you guys. That was super interesting.

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