Invest Like the Best with Patrick O'Shaughnessy - Doug Colkitt - The Evolution of Markets - [Invest Like the Best, EP. 255]

Episode Date: December 14, 2021

My guest today is Doug Colkitt. Doug has spent his career searching for and trading inefficient markets, first at Citadel’s high-frequency trading group, then for himself, and then as an operator building CrocSwap - a decentralized exchange or DEX designed to bring modern functionality to crypto markets, which is closer to what large traders have come to expect from a modern electronic market like the NASDAQ.    My interest in market infrastructure has continued to grow since my great conversation with FTX founder Sam Bankman-Fried. So my conversation with Doug covers the evolution of market and trading infrastructure. We unpack the trading stack as it exists today, dive into DeFi’s innovations, and explore the new category of single contract DEXs that Doug is creating. After learning so much from Doug about how markets function and how crypto markets should function, I became an investor in his new business via my venture capital firm Positive Sum. Please enjoy this great conversation with Doug Colkitt.   For the full show notes, transcript, and links to the best content to learn more, check out the episode page here.   ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes.    Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more.   Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here.   Follow us on Twitter: @patrick_oshag | @JoinColossus   Show Notes [00:03:31] - [First question] - Doug’s career and history working with markets [00:08:55] - Defining what a trading stack is  [00:13:41] - How HFT firms are such reliable money-making models [00:16:27] - What’s at the cutting edge of traditional markets that provides an edge [00:18:45] - The mechanical parts of infrastructure involved in building an exchange [00:21:00] - Classes of data that matter for operating an exchange [00:22:11] - Capacity and what good returns are as an HFT firm [00:28:45] - Overview of the mechanics of an AMM [00:31:53] - Earning a yield as a liquidity provider [00:33:59] - Other ways to think about AMMs and liquidity providers [00:36:42] - Key players in the AMM space and the evolution of them [00:41:20] - How asset holders can approach DEX tools and be liquidity providers [00:42:55] - The function of an exchange’s native token [00:45:25] - Token distribution and how to earn them without buying them [00:48:31] - How you receive payment for providing liquidity [00:51:31] - What CrocSwap will do and what a single contract DEX unlocks [00:57:36] - How CrocSwap is able to do this when other exchanges can’t [00:59:27] - What single contracts will improve for users  [01:00:43] - The impact CrocSwap will have for all participants writ large [01:02:28] - Whether or not CrocSwap will cultivate an ecosystem [01:03:30] - What’s next for CrocSwap in the near future [01:04:58] - The promise of DeFi and the future of blockchain technology [01:07:04] - Whether or not DeFi is a threat to centralized exchanges [01:09:52] - Defining what MEV is and why it’s important for DeFi [01:13:04] - Missing pieces in the DeFi world and how we can address them [01:15:24] - The kindest thing anyone has ever done for him

This episode of Invest Like the Best is brought to you by Teegas. I started hearing about Teegas when several of my close professional investor friends sent me passages or ideas they'd found on the Teegas platform. Conducting effective primary research shouldn't take weeks. It should take hours. Searching for answers shouldn't be lengthy, cumbersome process. It should be easy and nearly immediate. Expert calls should not cost $1,000. Teague solves these problems and makes primary research faster and better for professional investors. Teagis has built the most extensive primary primary information platform available for all investors. With TIGIS, you can learn everything you'd want to know about a company in an on-demand digital platform. Investors share their expert calls, allowing others to instantly access more than 10,000 calls on Square, Snowflake, or almost any company of interest. All you have to do is log in.

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Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunacy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Oshonnessy asset management may maintain positions and the securities discussed in this podcast. My guest today is Doug Colquitt. Doug has spent his career searching for and trading in efficient markets, first at Citadel's high-frequency trading group, then for himself, and then as an operator building Croxswap, a decentralized exchange,

or Dex, designed to bring modern functionality to crypto markets, which is closer to what large traders have come to expect from a modern electronic market like the NASDAQ. My interest in market infrastructure has continued to grow since my great conversation with FTX founder Sam Bankman-Freet. So my conversation with Doug covers the evolution of market and trading infrastructure. We unpack the trading stack as it exists today, dive into defy's innovations, and explore the new category of single contract dexes that Doug is creating. After learning so much from Doug about how markets function and how crypto markets should function, I became an investor in his new business via my venture capital firm Positive Sum.

please enjoy this great conversation with Doug Colkitt. So, Doug, this is going to be a really unique episode. You've been one of the people that's taught me most about the world of market infrastructure and how important it is to functioning markets, but also how interesting it is to traders, investment strategies, crypto, which we're going to spend a lot of time on. I think because you've had a really unique personal history, it's probably the right place to start with just a thumbnail sketch of the major stops of your career up through this point.

Because I want to lay out for the audience why you're the right person to talk about the evolution of markets and why this kind of emerging space is so interesting. I studied computer science and finance in school. And then out of school, I started working for a hedge fund Citadel. Most people heard of them. Steeler of constitutions. Maybe not the most popular nowadays, but definitely some of the smartest people out there. So I was really lucky to start my career there and learn some of the best people in the industry. It was actually around 2008 when the financial crisis, everything was going to hell,

including Most of Citadel. But the one group there that was consistently making money, making a ton of money, what's the HFT group. So it was kind of space everyone wanted to be in, especially around that time. So I joined the HFT group there initially working on what they call alpha signals, which is it was in statistical modeling to predict where the markets go. going over the short term. I was in Citadel for a few years and then left right around the flash crash. I decided just to go out on my own and see if I could build the whole stack myself.

And originally I was trading at the CME, trading the index futures and the bond futures for a while. That was pretty competitive. I kind of decided, okay, that's the most competitive ferry. Let me see if I can get a toehold there. And if I can trade that, I can trade anywhere. over time, just those markets kept getting more and more competitive. So for reference, I think at one point I was the only actual individual, not a trading firm who was authorized direct market access to the CME, right?

So you normally trade, you have to go through a broker, right? And you go through everything. But a small subset of people, usually trading firms are authorized to directly enter their orders to the exchange. And there's a whole process to go through there so you don't break the exchange. So at one point, I think it was the only individual. And then randomly connected with some people who were operating in Turkey. And this was right after their market went fully electronic or modern electronic infrastructure.

I met them just randomly online. But they were looking for someone on the Kwan side to help out build there. So went in a partnership there. We were trading Turkish equities. I don't know anything about Turkey. So I'd trade these stocks. I wouldn't even know what the stocks, what the symbols were. I said the other day, I just found out some simple.

that was like kind of one of her most profitable for why I always thought it was a soccer team or football club turned out as a steel company. But that's kind of the nature of HFT where you don't necessarily care about the underlying stock so much as you care about the market and price formation. So was in Turkey for a few years and again, similar story, right? When they started being fully electronic was very, very easy for one-man show or a small team to make money. And then overtime things keep becoming more competitive. So you either have to say, going to consolidate it, we're going to make big investments on the infrastructure to kind of scale up. So right around DFI summer in summer of 2020, just very randomly read an article

online about, and this was even before they called it M.EV, or at least as far as I was aware, they weren't calling it MEV. So I thought that was kind of interesting. I said, let me just try making this as a hobby. And I did. And then the botches, it started working pretty well. It was doing very, very well there for a while, putting more and more time into it and took over everything. From summer 2020 until spring 2021, right around when these new generation of Dexas come out, just for reference, the way Dex's work is, at least in the Ethereum spaces, they use this automated market maker system, which is instead of having active traders on the full order book that you'd see in like a traditional market, liquidity providers put in their capital,

put in a whole bunch of capital only in each side. And then they just have the simple algorithm that balances on adjust the price to keep demand and supply and demand in line. Simple mechanism, but works especially in constraint, blockchain. This next generation of Uniswap introduces this concept of concentrated liquidity. Instead of just putting in your capital and forgetting it, you put in your capital, but you set the price range that you want to trade at. As you can imagine, this starts looking a lot more like a limit order book. It's not quite the same, but you have this concept, okay, I'm putting in a price,

putting an order at a certain price, and then I'm a liquidity provider. or maybe I changed that price around. The one thing that you're missing in traditional AMMs is liquidity providers aren't contributing price discovery, whereas in NASDAQ or something, liquidity providers are one of the most active participants in the price discovery process. So I'm looking at this and thinking, hey, this is actually very similar to something I know about. I know how that process unfold.

So I kind of look at that and then decide, well, maybe I think there's a lot of advances there, but I think there's actually an opportunity to improve on the model. That's when I start my project prox swap at the time and have been working on that ever since. And then hopefully we'll be out pretty soon and people will be able to use it. It's such a cool history. And the right place to go from here is to discuss what I'll call the past, present and future of, I think you call it the stack. I'd love to introduce some basic concepts and then build on those things to really hopefully

have people that are less familiar with some of these topics, walk away, able to understand what is going on in the world of HFT liquidity provision, market makers. These are terms that everyone's heard, but I don't think really understands what's going on under the hood. So maybe you can begin by just describing what you mean by a stack. Let's go all the way to the most mature. I go inside of Jump or some very sophisticated HFT market-making firm that's trading modern electronic markets. What is literally happening inside those firms and why are they contributing to price discovery? I want to talk about the limit order book here as a technology.

I want to talk about their infrastructure. just give us a sense of the most mature what they look like today. Somebody really kind of wants to understand this field on intuitive level. What I always say is start with, I don't know if you've ever seen those shows about pawn shops. All the same concepts that apply on those pawn shops shows. It's the same concept. At any given time, right, some people want to buy, some people want to sell.

But most people, they just want to buy right now or they want to sell right now. They don't want to come in and wait around. That introduces this whole concept. You need a market maker. You need somebody who's willing to stand in there and be willing to buy when people want to sell, and vice versa. If I'm running a pawn shop, they're always low-ball. People come in and they low-ball them. They don't pay the full value.

They have to pay a little bit less than full value. And that's because a number of reasons. Number one, after they buy it, they have to go put it in their inventory. They have to go put in the back room and wait until somebody sells it. So that costs capital. And that's like risk where you have to commit that. You have to pay the overhead, all your employees in the store and everything for that process. People don't come into the store to sell the best stuff.

They're just selling junk. People are always kind of giving you their worst stuff and giving you your local offers. So market maker world, we call that toxicity. So you say, okay, people are trying to trade against you, but mostly they're probably trying to trade against you in the wrong direction. If there's bad news on, say, Microsoft tomorrow, there's going to be a big rush to sell Microsoft. So if you're just a market maker, put your orders out there,

and if that happens, probably your buy orders are going to get filled a lot sooner than your sell order. So all of a sudden, you're sitting on a bunch of shares of Microsoft, and Microsoft is going down. So market makers also have to be very aware of what's going on on a macro level, but more even so on a micro level. What they're basically doing is they're looking at the market on a very low level and saying, okay, there's way too much, way too much flow this way. That doesn't look like the normal market. I need to adjust my quotes. I need to get paid more because there's more risk for that. So because of that, you have to build up a very complex infrastructure,

kind of to always be watching every market, something's trading on, generating all signals and to predict where things are going. So I was go back to the pawn shop analogy, right, that somebody comes in, they want to sell something weird. The pawn shop guy's calling up 100 different people. He always knows somebody how to value baseball cards. So same thing, market makers have to build up this infrastructure to value things. And more importantly, to detect when market. are moving. So obviously very easy if markets aren't moving to, okay, let me buy at $10 and sell

$11. That's theoretically an easy business. But the problem is if you buy at $10, the market moves down and you have to sell at $9, then you lose money. So look at a big trading firm. They're hiring a lot of very quantitative people to number one, build the infrastructure, build the technology has to be very reliable. It has to be fast because they're also competing with each other. in the sense that there might be an opportunity out there or they want to compete to get their quotes out before other people do, because there's also, you get priority as your quotes get entered faster. So that's a whole other game in terms of that.

You hear about high-frequency traders are always obsessed with latency and shaving off microseconds or nanoseconds just because exchanges give you higher priority for the sooner you get your order into the exchange. So they have to build that and they also have to build these quantitative models to trade something and predict where stocks are going on a very short term because generally these firms don't keep big inventories. They're mostly in the business of balancing out order flow on one minute to 10 minutes. They don't want to take a huge position at the end of the day because that's not their business. There are maybe other people who will step in at that, but they're mostly there

to turn over their portfolio very fast and that keeps their exposure to longer term trends down. But they're very good at looking at the limit order book and the order flow to predict where things are going. The limit order book question for just a minute, I think it'll be an interesting one to explore, like whether or not that's the end-all, be-all of a market technology. But just to dig in a little bit more. So I was coming to this for the first time, I might have the question, geez, like this sounds like a really risky proposition that without real deep knowledge of, let's say, Microsoft in this case, your turkey example, right?

Yeah. Those as a sports team and it was a steel company, right? Knowing the businesses that are being traded is actually not that relevant. And actively, these firms may not have a view or really an understanding even of the businesses. So it sounds quite risky. Yet many of the best HFT firms, their sharp ratio or however you want to measure is incredibly high. You never have a losing day. They never have a losing day.

Just explain how that's possible in a little bit more detail. Is it the quantitative signals, the infrastructure, a combination of the two, like, why is it such a reliable money-making model? And I guess obviously what are the returns to scale? Because if it was this easy, everyone would do it. Say you have a coin and say it's a bias coin. So it comes up 51% of the time. We've had it's 51% of time, tails 49% of the time. If you just flipped it one time, you wouldn't bet that much money on it. You have a small edge, but you could lose very easy. So you're not going to bet a huge amount of money on that. But now let's say instead of flipping it one time, we flip it 10,000 times. And we say whoever gets their side gets more wind. So if I'm flip it.

a coin 10,000 times at 51% edge. Even though your edge on any individual flip is small, right, you're going to win this bet with very, very high probability. So when you look at like a firm, then you say, okay, how do they make money every single trading day? And the answer is they're not making money on every single trade. They're making money on 51% of their trades, but doing 10,000, 100,000 trades a day. And statistically, the law of large numbers says that, okay, It's going to be very predictable when you execute at that size. So obviously, that's how things work when things are going well. The problem is it's not easy to get to the point where you have 51%.

Kind of the one nice thing about HFT is in traditional asset management, you could have a strategy and you could think, okay, we're making money. And then over time, you might take months, might take years until you realize, oh, we're not doing as well, which we thought we would. HFT, you can kind of turn it on and you'll say, okay. A week later. Yeah, 30 minutes. this doesn't work. I got to turn it off. So it's definitely not a case that you're guaranteed to make

money because there's a whole risk to have to build up the infrastructure. I have to build these models and they're not knock them out in a half hour. You're investing a lot in building up the company and the infrastructure and the models. And it's definitely hard to get to the point where you're profitable at all. But once you are profitable, you're probably profitable every day just because you're making so many trades over time. That kind of averages up. So let's talk about that 51%. So what are the things sort of at the cutting edge in the traditional mature markets that people are doing? You don't have to name super specific proprietary things or anything like that. But what is sort of the nature of the models, the sorts of data, the sorts of features,

the sorts of labels in these studies that lead to that 51 percentage? Where might that come from for one of the firms that's able to achieve it? The one misconception is that all HFTs are market makers or liquidity providers. And that's actually not true. actually some of the most profitable HFD strategies are quite the opposite, but liquidity takers. And what that means is, just going back to example, at any given point, the market, there's a bid, which is the best price you can sell at if you want to sell immediately, the best resting buy order and ask, which is the best price you can buy at immediately,

the lowest resting sell order. Liquidity providers are putting their orders out there and letting them sit, and people are coming in and trading against them. So one basic way to make money is to do that, put your orders out there, wait for people to buy low, sell high, be patient, wait for people to come in and gallons your inventory that way. That's what we call market making or liquidity providing. But a lot of HFT firms actually make their money, they immediately cross the spread.

So they're going in, they're actually paying that premium to trade right away. That almost seems counterintuitive. Why would that make money over time? But what they're doing are they're building statistical models and they're looking at differences. So the simplest one you can imagine is there are the S&P index futures. they trade in Chicago, right? And then there's New York Stock Exchange, the NASDAQ, that's in New York, and that's where the actual stocks inside the S&P 500 trade. So if you have a very fast connection to Chicago and the index futures are much more liquid, the stocks tend to move along with them, right?

You can watch those index futures and when the price on those futures move, those contracts move, you can kind of use that to say, let me go buy up a bunch of stocks right now before they go up. oftentimes firms that are willing to cross the spread can make a lot of money, sometimes even more money than firms that are market making it. There are other things. Sometimes those firms get not necessarily billified, right, but people don't give them as much respect because they say, okay, market makers are providing liquidity. What are these firms doing? But often they're contributing to this price discovery process. When you went to, quote unquote, rebuild the full stack by yourself, what are the pieces of that? So what are the literal mechanical parts of

infrastructure, how do you classify them? Our code base and maybe like 100,000 lines of code or whatever. The actual strategy side, the glamorous side of it is maybe 10% of it, maybe 15% of it. There's a ton of work that just goes on getting the data feeds, right? The data feeds from the exchanges are not optimized to be easy to consume. They're optimized to be fast, but you have to listen to the exchange. You miss a message. There's a whole process to regenerate.

It is kind of bad. to do that. Make sure you integrate all the messages, build limit order book and your representations fast, obviously like the strategy that we talked about, even just simple things, almost that you think are dumb, can actually be fiendishly complex. So going back to it, right, you might put in your orders and interface with the strategy, the exchange gateway and say, okay, here's my order, let me put it out there, process it said, and then you have to keep track of it. You might put your order in, but one thing that's actually pretty hard to do is you put your order in and then your order comes through that data feed, it doesn't tell you, oh, these orders don't. This is your order. So you might get

okay, I'm responding to, oh, this guy bidding at the same price of me and maybe he got in before me. So I'm going to bid up. Maybe you get into a dumb like feedback loop trading against yourself. It's not that simple because sometimes the data feed comes in faster. Sometimes you get because they're two different systems. Sometimes you get the confirmation faster. So it's almost like a distributed systems problem from computer science. Some of these things are pretty hard to solve on because the way things are delivered, the order they're delivered and isn't guaranteed at all. And these systems have been pushed to be so fast that oftentimes you have to make these decisions in a pretty high-performance way. So ultimately it's about like so many data science

problems. Some large chunk of the problem is getting the data, cleaning the data, handling it, speed, moving stuff around, and then, like you said, only 10 or 15% of the actual code base might be the strategy itself? Yeah, the actual idea. Even on the back of testing it, it's not easy to build a simulator for this. You almost have to build the entire exchange yourself so you can run you. And what are the classes of data that matter in this world? There's order book data.

There's price. There's volume mentioned many times, like the abstraction that you could sort of think about the actual stocks with. At these horizons, there's not a. ton of things you can actually look at. If I'm trading on a, like I said, maybe even if you're holding time as minutes, but really, or maybe you're holding time as even seconds, but a lot of your horizon comes within milliseconds, maybe 100 milliseconds of when you can very quickly, your trade has to move in the right way within like 100 milliseconds or you're probably not going to

make money. At that frequency, there's not a ton of data you can look at. News doesn't come out every 100 milliseconds and really not much happens every other 100 milliseconds. All that really happens that frequency is orders come in, the book changes, and other stocks move. So I'd say those three things. The order book, the order flow, which is the rate that orders are coming out, and the price of other nuts just stocks, other related securities. So how other, you know, if you're looking at Microsoft, you might only see what's going on in Intel or vice versa. You have to get very creative in terms of how you drill those, because those aren't simple numbers, you know, just plug those into a spreadsheet. There's all kinds of ways to dice and measure those things.

And finally, how do you think about returns in this style of, I won't call it investing, I'll call it trading? What is good returns? What are limits on capacity? What are limits on free cash flow from a strategy like this? What is great? Returns are going to be very high and they're almost irrelevant, whether your returns are 500% a year or 2,000 a year, which might be actually be something you'll see.

But nobody's really going in and say, oh, I want 2,000 a year instead of 500% a year. because like you say, capacity constraints are by far the biggest limit. And right, you have sharp ratios, which are 30, crazy high sharp ratios. You're not optimizing for risk or capital. You're optimizing for I have a team of, you know, whatever, five, 10 people, and I need to make this much to pay them, put food on the table, pay for all my infrastructure. So really most people are thinking in terms of what are my revenue? P&L.

Yeah, exactly. P&L. It's like running a grocery store. the grocery stores and think about it. There's a sharp ratio. They're thinking about, oh, this is how much business we're doing a day. This is how much revenue. This is how much we need to pay or fix costs. So in that sense, it's actually kind of more prosaic than a lot of other strategies. And what is that capacity? Just thumb in the air. How much do you think like the industry

prints in revenue or free cash flow, pick your metric? It depends to what you classify as HFT, right? Because you can start going out longer horizons and the capacity increases, but so does the risk. And then you're back in the traditional all putting on risk. I'd say probably in the U.S., probably this year is actually better, but maybe a few billion a year for U.S. equities. And then if you want to go out longer, right, you could look at something like Renaissance Medallion, which isn't necessarily HFT, but I think starts getting somewhere in between like what I'll call StadARP, which is longer term, HFT, and maybe a little bit longer horizon, but obviously the returns are very consistent

over time. And they might do over $5 billion, just one. one. So depending how you define it, it could be anywhere from two to 20 billion, I guess. It's kind of a big range. I'd love now to hear your thoughts just riffing a little bit on the importance of market making as like a function in markets and the technology of the limit order book itself. You raised an interesting question one time, which was basically like, is this the final technology? Like, is this the best underlying piece of infrastructure that drives markets that we can think of, or might there be a different way of doing this? And so I'd love you, just to riff on the pros and cons, I guess, of the limit order book as a technology,

sort of where it came from and what the future might hold. Well, you said actually in the beginning, it's pretty interesting. What is the benefit of market making? What's the benefit of liquidity? And a lot of people criticize, okay, why are all these rocket scientists working for trading firms they could be curing restless leg syndrome instead or something like that? Liquidity is important because I have some security and I want to go to sell it, going back to it.

If I want to sell it to you, right? And there's not agreed upon price. It's pretty hard for us to do that deal if there's no kind of market because you don't know, okay, what does this guy know that I don't know what's like a normal size? Is this like a weird trade? If somebody calls you at 2 p.m. and wants to sell you a million shares in Microsoft, you say, okay, somebody calls you at 2 in the morning and wants to sell you a million shares of Microsoft.

You say, well, okay, I don't know. That seems kind of sketchy. I don't know if I want to be on the other side of that function because there is no market open and kind of doing something weird. Well, it's important, right, because it kind of generates this contingent. price over time. And even if you're not using it, it's important to have it so that like anyone could just look at the market and say, okay, this is the fair price. There's kind of this ongoing price discovery that happens. And when that breaks, that's kind of a hard thing to restore,

which is actually you look at the markets in the morning when they open. Liquidity is always a lot less. It's always a lot more expensive to trade. Price has moved. So people have debated 24-7 markets are not. In terms of the limit order book, I think it's been a very successful technology. And it's been very good. And before it, just for context, it used to be this dealer system. And you call up some guy at Nizzi, and he has the whole thing just on his book or whatever. You know, it depends on the market. But it wasn't very transparent. And I think there was a lot of opportunities for it. Not necessarily shenanigans. So people didn't necessarily see what was going on. So one of the biggest advances of the limit water, both is very transparent. Here are all the orders. Everyone can see them.

If you put it in, you'll get matched against in this priority. We define it ahead of time. And Obviously, it's a very elegant technology. It matches people in real time. It's easily solvable. The biggest challenge to it today is going back to these automated market maker systems, and they're not perfect. But one thing they've done very, very well on is less liquid, longer tail of assets. So we're talking about HFT firms, and it's very high touch operation.

So you look at the stock market today, most of the volumes in the very, very biggest themes. And small caps are very thinly traded just because nobody wants. to deal with the headache of running a strategy and some name that might only trade like a few times a day. It's just too much to kind of maintain the limit order book there, maintain all your quotes, adjust them. So one of the nice thing about AMs, and it made it very automatic. So you don't have to have professional liquidity providers. People can try to just put their money in and there's this mechanism that automatically balances things and for things that might only trade a couple times a day. I think it's been a very successful mechanism. Now, I think limit order books are

still better for things that are liquid, but there's kind of a lesson there where liquidity that isn't professional, democratic access to liquidity providing is pretty useful in certain cases and something to be thought of. And maybe the problem with limit order books is they kind of lock out somebody who just wants to come in and say, I want to provide liquidity. I'm willing to buy when people want to sell. I'm willing to sell when people want to buy, but I don't have $10 million to go set up a trading firm in Chicago. I want to put $10,000 instead. And maybe I don't want to 30 sharp returns, but maybe one sharp returns to do that, right? Because I'm willing to step in. So there's really no kind of on-ramp for somebody who wants to do something like that. And even in very

liquid markets, you can see this because the problems we have with modern systems is, right? You have flash crashes where things work very, very well until going back, all these HFK firms, they don't hold huge inventory. So when they get completely filled in one direction, there's no quotes left. And nobody's been invested in the infrastructure to, quote, automatically. So there's a huge profit opportunity to split nobody's stepping in and putting prices back in line just because access is so undemocratic to that strategy. Maybe talk through the literal mechanics of automated market making. If it is an innovation that improves on the limit order book, at least in certain parts of the market,

I think it's worth spending a minute understanding literally what is happening. So I think a limit order book is self-explanatory, right? It's a matching engine. Orders go in. they're intelligently matched, like you said, with a predefined rule set. So it's like, I'll call it like a very fair system. And all it relies upon is that the orders going in are not, I guess there could be problems with those that could be spoofed. They could be something wrong with that. Maybe that's worth spending a minute on. But let's use that to contrast against what

literally is going on inside of an AMM. So just walk us through this new technology, the literal mechanics. A very classical AMM, this was actually Vitalik, the founder of Ethereum. He just kind of made a blog post and it came up with this whole mechanism, just brilliant guy. Okay, here's just a mechanism. Someone built in it. And then they didn't. Was successful. So the mechanics are classical system, very simple. It's what's called a constant product curve. And it's a pair. So, you know, let's just think euros and dollars. So they grow, okay, Microsoft trades. But really, Microsoft trades is a pair against dollars. So sometimes it's easier to think in terms of some of a pair of Forex because that's good. We have euros and we have dollars and there's always an

equal amount of value between the two in the pool. So just say for now one euro equals one dollar. So we put in a thousand euros, we put in a thousand dollars. They're equal value and we have an equal amount. And then let's say you come in and you say, I want to convert $100 to euros. So what you're going to do is you go to the pool, tell the pool, okay, here's $100. dollars. The pool's going to try to balance that. The pool's going to determine how many euros can I give you? And it's going to try to balance that. So the pool is going to give you about 100 euros back because they're about equal value. That's fair. But it's going to give you actually a few less euros back. I don't know. You can do the math and balance it out. But at the end of the day,

right, the pool's going to have about $1,100 in it and 900 euros because you put your $100 in it. Now there's 900 euros left. And now the price has changed and because there's more dollars and fewer euros, that means the price of euros has gone up in that ratio. It's a very simple mechanism where the price is just adjusting based on the ratio of the assets in it, and it's always just keeping that product the same. Where that falls down is it's not that capital efficient. You can think of something where maybe the price doesn't deviate too much. Like, you might think of, say, dollars against something that's almost always equal to a dollar. The problem is you have to put in equal amounts of both sides. It has to be able to support any price from

zero to infinity. But maybe the thing you trade only trades between 99 cents to a dollar. Right there are these kind of dollar, quote unquote, stable coins. And theoretically, they're always pegged to a dollar. So you have two dollar stable coins trading against each other. It's kind of inefficient to put all this capital in there from zero to infinity because the price is probably never going to step outside of this narrow boundary. So if I'm a like, liquidity provider in an AMM. I'm going to keep referring back to kind of your examples that you've given to have some continuity here. I'm the person with $10,000, not the $10 million I need in Chicago.

And I want to go earn almost like it feels like a yield on that $10,000 by contributing, let's say it's an ETH Bitcoin pair. Just to bridge into the crypto world a little bit here. I've got Bitcoin. I'm willing to put Bitcoin into this pool. And what you're saying is it's capital inefficient because if it's the full curve, because I'm just sort of blindly putting, I don't know, 10 Bitcoin in there or something. And then I'm a liquidity provider and the price is handled for me. If someone wants to trade, they want Bitcoin and they have Eith and they want to do a trade,

just sort of doing it on my behalf and giving me some benefit. Yeah, you can think of one as doing it on your behalf. Probably the easier conceptual way is that you contribute to the pool and then you have own some pro rata share of the pool. And then that pool is going to accumulate. like you mentioned, I actually forgot to mention the original example, right? The AMM's charge a fixed, usually a fixed percent. So they have some fee.

So when someone comes into trade, they get that, but they also pay a percentage be on top of that. And that might be somewhere. Let's just say 0.1%. So you also pay a feed of trade. And that's exactly what you're alluding to, right? You earn a yield because as a contributor to capital to that pool, you receive your pro rat a share of the fees that the pool generates.

Now, on the other side, it's the same problem with traditional market maker faces. You're always trading in the direction that people don't want to trade on it. Going back to that Bitcoin ether thing, if the price of Bitcoin is rising relative to ether, that means traders are going to be coming in, buying Bitcoin out of the pool, putting ether into the pool. So the pool's always rebalancing in the wrong direction. So people have kind of worked out the math with this, but the function, instead of having a linear exposure to the underlying asset, it's a square root exposure.

the price of Bitcoin quadruples, right, you might only get 2x that return. But in exchange, you're getting this yield on your capital in the pool. Sorry for all the questions, poking and prodding at this new way. I do think it's important because so much of the decentralized exchanges in crypto are automated market making systems. If this becomes, then obviously we're going to talk about what you're building in a minute here with Crockswap, but if this becomes a dominant technology for trading digital assets, the way it works matters. So if I'm putting same example of the 10 Bitcoin into the pool, is a way of thinking about this, that this is sort of just decentralized inventory contribution.

We're just relying on rather than a single firm. We're just sort of gathering all the necessary inventory to do these pair trades. And like in your earlier example, there's a bid, there's an ask, and there's a spread, and the market maker is providing liquidity in that spread. So therefore, we're sort of just doing the same thing. but the inventory is just coming from a lot of different places. Yeah, that's definitely a component of it. Because obviously, if I'm training Bitcoin to get Ethereum rate, there has to be Ethereum

there for me. Part of what you're getting compensated for is exactly what you said. I have this. I'm providing it to people, this inventory to people who are willing to get it. But I don't want to overlook the price discovery impact here. Because if you go to markets, most of the trades, crypto markets or traditional markets, most of the trading at any given time isn't trading because people actually need that asset. We can look at the CME people trading oil. Most of those people trading oil futures are not actually

going to be taking delivery of oil in 30 days. They're there basically to express a view, express a view on the price. Crypto markets, you can kind of see these perpetuals, which are kind of analogous to futures have taken over a lot of the market share. And there's no delivery there. There's no way to express view on the price. So the other way to think about it, I think, is that the LPs are betting that the price won't deviate too much between the two because the LPs are sitting there. And as long as the price, some people call it imperman, what I described before, how you can move.

And then you're always kind of moving on the wrong side. Some people call that imperman loss because in an AMM context, as long as the price comes back to the original price, you won't lose anything. And some people think maybe that's not a great marketing term because maybe it hides the fact that, yeah, you could lose out on that if it doesn't move back. but we'll call it impermanent loss or IL. In some sense, if I'm a liquidity provider in AAMM, I'm short IL. I'm betting that the price isn't going to deviate too much, or the ratio between these assets.

So Bitcoin won't deviate too much from Ethereum in terms of the ratio of their price. So being an IL is kind of expressing a view in that sense. I think this price is stable. I'm betting on it being stable. It really is relative to how many other people are betting on. So now we can talk about the evolutionary or iterative, of the technology of Dex's as you see it. I know you left, you had this experience with trading Turkish equities. There was an opportunity there. You were enticed back by the Defi opportunity as a

trader first, trying to make P&L for yourself and building a lot of infrastructure to accomplish that. But then you sort of shifted your interest towards being an infrastructure builder, supplier, provider, or however you want to talk about it, because you saw an opportunity to improve on some of the state of these decentralized exchanges that are fueling so much of the volume in the crypto world. So before we get to Croxswop and the ways in which you and I have talked about this really cool category name for what you've created, which we're calling single contract decentralized exchange or decks, I want to understand exactly what that means. But first, just walk us through what have been the evolutions of AMMs themselves that are meaningful.

So if it started as this capital inefficient zero to infinity price, talk about what's happened since, and who originated AMM in the first place, you mentioned Vitalik, but who commercialized it with the greatest success? So what are the big players out there? And how have they gotten better through time? After Vitalik throughout the idea, the first AMM was Uniswap, Hayden Adams from Uniswap. I think the legend is he kind of read that blog post said, let me just put that together. And then Uniswap was born in. It's really hard to overstate the growth rate in this category. So even like a year ago, the whole space has grown probably more than a thousand percent. just the past year. So going back to like the beginning of 2020, this was a very, very niche field. So you have a lot of different protocols. But to be honest, right, it wasn't a huge amount of volume. So have Uniswap and they pioneered and a lot of people said out of this will never work. Nobody will use it. And they kind of showed, yeah, actually people will use it. There's actually a lot of demand, especially what we talked about that long tail of stuff not on Coinbase.

Exactly. Because traditionally you came up with a token, right? You have to get listed by Coinbase or finance or whatever. And until you you do. You actually have very little liquidity and it's hard to buy it. It's hard to sell it. So I was kind of revolutionary in the sense that a uniswap did and this whole space did is permissionless. So you don't have to go to uniswap and get approved to list your token. You can just go create your own pool. You just interact with the protocol. Nobody's going to stop you. So I think that was pretty revolutionary and drove a lot of growth. And then in 2020, the space kind of starts exploding number of protocols that came along. But one of the big ones is Curve and going back to it, they were, I think, the first people to tackle this capital

of inefficiency problem. And Curve very narrowly focuses on, I want to say narrow, but this is obviously a huge segment of the market. They focus on pairs where the price is stable. So, like, for example, you have USDT and USDC, which are both pegged to $1. Putting the full curve on that doesn't really make much sense. So curve uses kind of a different market, same idea, the same curve, but it kind It pretends, oh, we have more capital than we do, but that's fine because the price never deviates too much. So it's much more efficient in terms of you don't need as much capital to support trading. So Curve has been very successful in the space. I think they kind of showed that there's ways to iterate on this core idea. Obviously, in the Solana space, it's kind of a different

blockchain. So people have innovated there and give them a lot of credit in terms of Solana blockchain itself is a lot higher throughput than Ethereum. So in Solana, you can stand up full limit order books and they actually have full limit order books running on that blockchain. But the problem is you're not interfacing with Ethereum where maybe 90, 95 percent of the organic user activity is. But I think they innovated a lot in showing, hey, you can actually run full order books in a defy context. That will work as well. I'd say Uniswap V3 itself, Uniswap kind of innovated on themselves. So you've got to give them a lot of credit for that. What is pretty revolutionary. And Uniswap B3 isn't necessarily an automated market maker anymore because there is a lot more

complexity and this concentrated liquidity idea where instead of providing liquidity from zero to infinity, I'm going to pick my price. So I'm going to provide liquidity from 80 cents to a dollar 20 or whatever. And I only have to contribute capital to cover that range. And then theoretically, I'll gain all the fees in that range. But if it goes outside that range, I think people are still trying to figure out that model. I think we have to build better tooling, but I am pretty bullish on concentrated liquidity in terms of I think price discovery is better. And I think ultimately, liquidity will be better than classical AMF for a lot of cases, maybe not necessarily for the less liquid cases, but for a lot of the more liquid cases. How do you think that

crypto market participants that are not infrastructure builders that could never dream of building a Dex, but nonetheless are interested in defy and maybe being a liquidity provider should think about this. This maybe is where we could talk for a minute about the amount of assets that are in these protocols. We could talk about staking and the returns to staking. What is the perspective of the asset holder that wants to be involved in this system? What do you think they should expect? How should they approach all these protocols and tools? I guess I'd preface it that there's probably a huge range when you say that it could be anyone from someone from 500 bucks that they want to earn some money onto multi-billion dollar hedge funds. And the whole range is actually in the space

now for sure. I think most people are probably approaching it as a income yield product. And you're thinking, okay, I'm in crypto. I have these assets and I want to generate a yield on them. And most of it's understanding the risk factors to staking and kind of what we talked about before with IL and what are you exposed to what are your cash flows look like. So I think that's probably the first thing. Because a lot of people take the simplistic view, okay, here, let me just look at my APYs, my yields on like every single pool, but some of the pools come with more risk on different sides than other pools. So I think ultimately there's going to be better tooling and better frameworks, but there's probably a major room for improvement in the space is just

kind of translating, better communicating, maybe coming up with more of a common language than just, oh, the yield is here, the yield is that, but papering over some of the IL issues, I think. The space could improve on a lot. When we think about the function of a protocol, like a uniswap, that's fully decentralized and permissionless, uniswap has a native token. And I think one of the things to always ask about crypto protocols is the relationship between the job being done and the native token of the protocol. I'm just using uniswap because it's the most well-known example. What is the function of a native token for a decentralized exchange protocol?

Why does that need to exist? Native token is almost shares in the company. Just go back NASDAQ. There's NASDAQ the exchange, but there's also NASDAQ, the stock. The stock itself trades on NASDAF the exchange. So the same thing. There's uniswap the protocol, and then there's uniswop the token. Uniswap the token also trades on you to swap the X protocol.

So basically these native tokens behave almost the same way that stock and a company would behave. They behave. They're almost like equity in the protocol. So number one, they entitle you to revenue generated by the protocol. Most of them do. Some are revenue list, but most of these protocols, a certain percent of the fees generated go to the token owners.

And like any other company, that's the cash flow. It's a cash flow series, discounted cash flow. You can model that. The other thing is they give you governance. A lot of these tokens will have certain parameters that you can change around. For example, Uniswap has different fee here. So you're allowed to create a pool with a 0.3% fee. There's a pool with a 0.05% fee.

And just the other day, they voted on a pool with a 0.01% fee. That was a vote by the token holder. So somebody created a proposal. And then anyone who held Uniswop tokens could vote on the proposal and then it was approved. Now the protocol supports 0.01% fee. So you can also think those are like governance rights in stock. You can vote for board members. Where that gets interesting, though, is DFI is takes finance and then does a bunch of crazy stuff on top.

Where it gets interesting is sometimes certain cases people have created tokens that strip the voting rights away from the cash flow rights and people will sell those. end up. Curve is an example of this. So Curve will give out rewards inside it with its native token and to support certain pools over other pools. So if you're a token and you want to get a lot of liquidity, obviously, it helps it curve boost your rewards on top of that. Now there's this whole market where people stripped out voting rights on the Curve token and they're selling those and that new tokens are buying those to get their token supported on curve, but then you're still getting the income on it. So there's all kinds of iterations of that game being played in Defi World, which is kind of interesting kind of I think it's fascinating, right? It's like live experimentation of the speed of crypto in terms of governance and organization of capital. What do you think about the ways in which someone can earn, let's say a Uniswap token, a UNI token? Is it just maybe enumerate the ways that you could do? Obviously, you could buy it on Uniswap itself. How do the tokens originally get distributed? And are there ways to earn them without just buying them in a market and holding them because they're associated with some yield? When people create these tokens,

and whatever, the original team, the original investors, some are allocated to them so that like any startup, Mark Zuckerberg has a certain person on Facebook shares or whatever. Generally, these tokens are community. So you don't want to understake how important community is in the DFI space. People like using protocols that they culturally associate with. So generally, these protocols try to decentralize, which means getting their tokens out to a community of people who really believe in the project and want to be attached to it and have some sense of ownership over it. So we're talking about Uniswap specifically the way they got their

community-owned tokens out to the market was they did something called an AirDrop. So basically, they didn't actually have a token up until last fall. But anyone who used Uniswap prior to that or in a certain way, they basically looked up the nice thing about the blockchain, right? Everything's transparent. You can see all the addresses they've used Uniswap. They went through before and said, okay, these are all our users up to this date. Without previously announcing it, all of a sudden, every one of those users had so many uniswap, airdrop tokens in their address when they woke up the next morning.

And I think you can look up over 10,000. A lot of money, because some of these people are just small traders and then got these big air drops. So it was kind of a nice benefit for them. So there's air drops, and that's, I think, the most classical way. Most protocols, Uniswap did not, but most protocols now do something called liquidity mining, rewards. And that's basically where they have a special incentive program where, okay, somebody's staking

liquidity or using the protocol and somewhere contributing capital protocol contributing liquidity. And going back, we were talking about fees. And not only are you receiving fees generated from the exchange itself, but you're also receiving native tokens for providing liquidity. So it almost be like if I was a market maker at NASDAQ and every day I made a market, NASDAQ gave me X number of NASDAQ shares for making the market that day, I guess would be. be the closest analogy. Another fun example in this space was something called a vampire attack that sushi swap. So sushi swap is kind of competitor to Uniswap and they got very big, very quick. They did something called a vampire attack. And this was last fall. They cloned Uniswap. So it said,

we're the same functionality as Uniswap. Come use us. If you move your liquidity from Uniswap to on this date, you'll get a huge number of sushi swap tokens. And overnight, they stole almost 50% of Swap's market share with that scheme. That's actually what Uniswap didn't have a token before, then that's actually kind of what kicked them into high gear and did the airdrops of all kinds of politics there. I just love these little details. So let's imagine that Uniswap did have one of these reward programs. If I'm a liquidity provider on Uniswap, I've provided Bitcoin, let's say, to a pool, how am I receiving my fees? So let's just say it's one of those pools that has the 0.01% fee or whatever on trading. Am I receiving that in Bitcoin and Eith and something else?

What is the actual way that I'm receiving payment for my service, for my provision of liquidity? You're providing capital in that pool, and then that pool is collecting the trading fees. It depends. The old B2 is slightly different than the B3, but basically there's a pot of trading fees that accumulate over time. And then the mechanism will say, okay, you enter the pool, whatever today, and you exited it a week later. And this was like the accumulated rewards rate when you started and this was the accumulative rewards rate when you end it. here's the net rewards over the time that you were active. And so here's your pro rata share from contributing that. And which currency are those calculators that were received in?

These pools actually give you the option. I can pay in Ethereum where I can pay in Bitcoin. So the pools will accumulate rewards on both sides, depending how the traders. That might also be a different thing, right? It would almost be like if you were trading Microsoft on NASDAQ. And NASDAQ, you obviously pay your fees in dollars, but it would almost be like if I could pay my fees in Microsoft shares, trade a million Microsoft shares. I pay my, here's five Microsoft shares.

So you can accumulate rewards on both sides of the pairs. And then every liquidity mining program is different, but it will say something. If you were providing liquidity over this period, you'll get X number of uniswap tokens for every X units of liquidity you provide it forever long. And then you just multiply that out. And they say, okay, you put in here, you took out here. We also owe you these number of uniswap tokens for contributing to the pool. And then the way that the cash flow associated with,

holding a U and I token works is what, just on some interval, I have a right to some part of their overall revenue or something? You and I has actually not technically turned on their protocol fee yet. It's built into the code and they will turn it on, but they technically haven't turned it on yet. But so you go back, there's a 0.3% pool. So let's say you come in as a trader and you want to convert to make the math simple. One-Eth equals one Bitcoin. So here's 100-Eath. Give me my Bitcoin and I'll pay the fee of Bitcoin. So you put in 100 ETH, you get 100 Bitcoin back, but you're going to also pay a fee in Bitcoin, so really you get 99.7 Bitcoin back. So the pool keeps 0.3%, 0.3 Bitcoin for itself. So of that, some fraction goes to the liquidity providers in the pool. So it's usually 1-6 is the take rate. 0.25 Bitcoin will go to reward the people in the pool, and 0.05 Bitcoin will go to, quote, unquote,

protocol fees, and those protocol fees are basically profits for the unique stakeholders. And then that will accumulate to a treasury. And then either that can be paid out like a dividend or it can be reinvested into all kinds of things, like any company. Fascinating. Okay. We have done an incredible amount of setup to get to a new category, which we're calling single contract decks. And I'd just love to hear how you think about this category, why you've gone to the effort to build a new decentralized exchange. with all this unique knowledge that you bring to the table. So what was so interesting to me when I met you was this deep background in HFT and market making

in the most mature electronic markets. Maybe one of the first things you said to me was, look, like in five years, I would expect that the Dex world feels to a big, sophisticated market maker like NASDAQ does. What if we can be a part of that transition? So just talk me through at a high level what Crockswap is going to do and do differently than others. and then we'll get into this idea of a single contract decks, which obviously implies that other decks is not single contract,

why that's important and what it unlocks? Number one, I think concentrated liquidity is the future, and because of all kinds of reasons, it's a lot more advantageous. So the first thing Croxwell wants to enable is take that change with concentrated liquidity and push it further and what does that mean? Number one, I think things need to be a lot more frictionless. So I don't think we talked about this, but on the blockchain, take any type of action, there's what's called, quote unquote, gas fees, which are basically

the blockchain itself will, they're not paid to uni, they're not paid the liquidity providers, they're paid to the miners or eventually the validators, but to include data or action, Ethereum's like a computer, right? So to do any type of action on a database, a ledger, yeah. Yeah, exactly. It's like a database. And to do action on the database, like same as like AWS, you pay to take actions. So as demand for Ethereum has gone up, unfortunately, the gas fees have gone up and people

working on scaling solutions, but they're never going to be free. It's always going to cost money to take any action. One of the issues with concentrated liquidity is the gas feed, unfortunately, have been pretty high. And I think that's kind of heard this idea of active price discovery. AMMs have kind of worked in this very high-cost gas environment because you put in your liquidity, you set it, you forget it, you come back a year later, and maybe the gas fees aren't too bad because you're only doing it once, right? But let's think of what a high-frequency trader looks like in a traditional market. literally you might cancel 99% of your orders. So that means to do one trade, I have to do 100 different actions,

100 different transactions. If something looks like that, I have to do 100 different transactions on the blockchain if I want something that really looks like high frequency trading. So that's incongruous with high gas fees. So one thing we're trying to build crock swap is to make it much easier for what a high frequency trader would look when they're quoting something like this. And you might look at, okay, I do want to put in a range order. I do have some view on the price.

But I want to be able to change that pretty quickly. And so I need to be able to change the price. And also maybe I need to be able to change my feed care. And that's almost like widening the spread or narrowing the spread. Because when you look at the pools have different feed tiers, you might say, OK, I want the lowest feed here when I think the price isn't going to move a bunch because I'm just going to be collecting a bunch. But I want to hire feed care because I want to get paid more because I think the price

might move a lot more in the next 30 minutes or whatever. So I need to be compensated more for my liquidity. a high frequency trader would be looking at something like this and saying, how can I make this active? How can I move things around a lot? And unfortunately, the current decks is either don't support concentrated liquidity or if they do and you try to do it. There's all kinds of frictions that exist to kind of this active liquidity provider. So Croswop is basically taking those frictions away from a number of different angles. But first and foremost, going to this idea of a single contract decks, I think is very important because, Taking a step back, as far as I know, every Dex is every pool is a different smart contract.

The problem with that is if I want to move anything from, and say going back to the example, I want to move from the Bitcoin Eath button instead of being at 0.3% feet here, I want to be at 0.05% fee tier. To change my quote, I actually have to take my liquidity out of the higher pool, burn my position, take it out. All those tokens come back to me. That constitutes a lot of gas cost to transfer those tokens. Then I have to go and transfer those tokens to the other pool, and I'm paying a bunch of gas to move there. And right? In high frequency, world, that'd just be very simple. Narrow the spread, widen the spread. You do that 100 times a second. That's a very heavyweight operation for something that should be a lightweight operation.

With a single contract, you don't need to do that because pools themselves live on the same contract. So there's still internal data structures that track those pools, but luckily, the single contract decks can just say, okay, this is how much net out the position. So you can execute this long string, arbitrarily long string of actions and net out the positions at the end that significantly lowers the frictions to kind of that active liquidity provider. I think it's both gas fees and also even something like taxes. Yeah. Every time you do any of these transactions, another example is talking about the liquidity provider stuff, but let's even just say, even on that side, right? Every time you do one of those

things, that creates a taxable event because technically the tokens go from the pool back to you and then back to another pool, and you technically have to realize that creates a taxable event, and then that potentially creates all kinds of downstream tax effects if you were holding the tokens somewhere else. Another example I always use is oftentimes when you're trading from, say, X to Y, there's not pool between X and Y. There's usually a pool between X and ETH and Y, so in anything, you might say, okay, trade token X, give me ETH, I'll send the ETH back, and then give me token Y.

Okay, but now you're receiving ETH from the pool, which has nothing to do with your trade. You just want to convert X to Y. I'm sending EF back. You have a taxable event in EF because there's an up and down transfer to your address. And if you're holding ETH in your investment account somewhere else, you have to realize a profit on that if you're using first in FIFO accounting. So that creates all of these deleterious tax effects. And as more institutions get into it, that's obviously going to be a bigger issue.

So in terms of avoiding frictions on that side is also undervalue. What made this possible? Like, it just seems so obvious that if you could have every payer and sort of like you said, any arbitrary new thing you wanted to do in a Dex all happen in a single contract and therefore pay way less in gas and pay way less in tax, it seems like the obvious way to do it. So why didn't others do it this way? And how are you able to do it? A lot of pain and suffering basically in engineering to get it there.

Ethereum basically imposes a little. limit on how big any single contract can be. And that's to keep the blockchain healthy. There's all kinds of reasons you can talk about. But long story short, Ethereum imposes kind of this limit on a smart contract's basically a program that exists on the blockchain. So you can't make the program. You can't make the smart contract bigger than this size. So it says like 24 kilobytes. So I always want to say there's a story like the original developers like Super Mario on the original Nintendo and they were like trying to fit all their code in. And actually some of the level code apparently was also program code.

So they're trying to make their program code also like appears like blocks or turtles or whatever. But I always want to say, I want to find those guys in higher than because I'm sure they'd be great Ethereum developers. Just a lot of engineering. That's where it's kind of been going back when I was doing MEV trading because that's obviously you kind of compete on gas usage there and you're kind of trying to push the limits of Ethereum engineering.

So used a number of tricks from there. And even actually in general, in high frequency trading. So one thing that employed on Croxswop is this concept of the hot path and the cold path, and that actually comes from high frequency trading because when you're engineering things to be very low latency, you want to think very carefully about, okay, this is what I do 99% of the time. So if I can make this 10% faster at the cost of making the 1% case two times slower, that's a great tradeoff to make. So I think you kind of just have to understand the entire stack from bottom to top to know,

what are the tradeoffs I can make, and whether these tradeoffs are worth it or not. What is the impact of all this? What do you estimate the improvement in or reduction, I guess, and friction will be as a result of this single, everything happening in one contract and improving on the way the Dex has worked today? What will it mean for its users? For the trader's side, in terms of the gas cost 10 to 20 percent lower, and actually we can get up to 25 percent lower fees on that. A lot of because with a single contract deck is also the cool thing you can do is you can hold your collateral directly at the deck. So going back to if I'm actually need the Ethereum out, I can take it out. But if I'm just there to engage in price discovery and I'm trade Bitcoin

against Ethereum and I want to do 30 trades a day, 300 trades a day, there's no reason for me to keep sending these tokens back and forth to me. I can just say, hey, tell the exchange, can you hold the balance for me? Don't bother transferring the tokens. I'll take the tokens out at the end of the day. We'll settle up, which is kind of how markets. work when I trade Microsoft on NASDAQ. Microsoft doesn't go in and out or just NASDAQ, we settle up at the end of the day. So you can get 20 to 25 percent cheaper for kind of active trade, but on the LP side, really excited because over 50 percent reduction on the gas fees. And in some cases, as much as 70 percent, if we're talking about these, I want to move my quotes

around. Well, set aside taxes is yet another advantage for taxable traders and providers, but those are huge numbers. What impact do you think that has? as like typically when you reduce frictions, it has nonlinear impacts on behavior and activity in technology. Reduce 50 percent. You don't expect double the activity. It's something way, way larger than that. So do you think of the liquidity providers as sort of your customer and that it just so happens

that because of this much more efficient way of building this thing, that traders also benefit? Everybody's really a customer. One of the things of building a market, it's an ecosystem, right? and you can't just say, oh, I'm only going to deliver on this part of the ecosystem because am I going to do institutions? We're going to do retail trading. Well, the reality is if you only have retail trading, you're not going to have any liquidity because retail people aren't great at providing liquidity. If you don't have institutions, two trading firms don't want to trade against each other all day. They don't want to trade against retail. So you really need both sides

of it. I do think there will be a pretty substantial change in behavior. One of the problems with Uni v3 is that people aren't moving these positions around. And what happens is the positions go out of range and then they forget about it and a week later. And actually, that people think about, oh, okay, the position's out of range. I can just forget about it. Well, really, you can't because you're still exposed to that toxicity effect we talked about before. Right. If I put in a limit order, even if it's away, right? Market moves through me, I can get filled in the wrong direction. So it's been a problem in terms of just because it's so expensive to move once you put these orders in, it's so expensive to move them around that people have had a pretty bad user experience and no one's

using it in the active price discovery way that I think people were originally hoping that they wouldn't. I think this kind of reduces those restrictions on that. And how do you think about some of the other answer or things that we've talked about, like Native token, for example, do you think that that is the right model where there's a crock token that gives its holders some rights, some incentive to be better participants or spread the word about the exchange. You said it's an ecosystem. A market's an ecosystem.

How do you cultivate that ecosystem using the tools in your toolkit? I think the token is definitely the right model. Markets a network. The value of a network scales with the size of a network. So let's say something like Facebook. Why is Facebook? Well, it has good technology, but it's valuable because I go to Facebook. All my friends are on Facebook.

So going back, how much value did the first participants in Facebook add to that company, well, probably pretty substantial when you think about it because the fact is they got them from zero to 10,000, a million, whatever, that's a huge increase. So I think native token rewards for your early users kind of aligned incentives because they are building that network. And I think that's the right approach to take. And what's next for CROCWP? What do you think are the most interesting decisions to make potential improvements even to your own system? You mentioned Uniswap has already improved itself over time. The way I see the single contract, is this is the beginning, but I see it as a foundation for improving the technology over time.

And it really unlocks a lot of things, a lot of potential that is a lot harder to do in kind of the older architecture. For example, once you have a single contract tax, all the collateral in the exchanges at a single point. So one thing that Defi has not caught up to on the centralized exchanges is trading on margin, trading with leverage perpetuals. And I think there's obviously the centralized exchanges have shown there's huge demand to trade with margin. That's kind of hard to do in a defy context, largely because the capital is all over the place and 10,000 different contracts. But once you have a single contract decks, all the capitals at a single place.

So I think it becomes a lot easier to kind of add that technology on top and margin people and more importantly, cross-margin people between markets. And that becomes pretty critical for price efficiency because there are a lot of specialized traders who are doing, they might use a lot of leverage, but it's not that risky because, you know, they're shorting one asset and going long, another asset, but they're very correlated. They might be using a lot of capital to bring those two things back in line, but they're not taking that much risk. So it makes sense to the market to enable them to lever up those positions and increase efficiency

that one. If we abstract away just from these individual decentralized protocols, just to defy more broadly, someone that's been such a deep participant in it, how do you think about its purpose? promise. Where do you think this all goes over the next five, 10 years? We've talked mostly about infrastructure and how markets function and how they work. We haven't talked much about like the things that are actually being traded. I'm just curious, obviously, of a history of maybe caring less about what the assets are and more how the market works and how things are connected. But if you step back and look at the promise of defy, what do you see? Like if you think forward

five years, what's exciting about what might happen in this ecosystem? To be honest, I think right now It's obviously just crypto assets. We're talking about Bitcoin and Ethereum. But to be honest, I think five, 10 years are just going to start being real assets start trading on defiant. And there's no reason to stock can't tokenize or at least a portion of its stock and make that into it Tesla. There's no reason we can have a Tesla token that could trade on crockswop the same as any

other token. I think it has a number of advantages that the most basic one is just being a globally integrator. Anyone who has a blockchain can access it. There's not barriers across the globe. So it makes it very easy to add. access global capital market. So, you know, I think of something like Turkey, right? If I told you, oh, this stock in Turkey is like really hot. Everyone I know there says like, I was going to explain, would you go to Turkey and open a brokerage account? You never do that. You never do that in a

million years. So especially like for middle income countries like that, kind of assets they're out of the way, hard to access. Does it necessarily make sense for them to have their own segment at market and run the Borsa, Istanbul, and deal with all the headaches there? Does it make sense? Let's just tokenizer assets and access to global capital market. So one thing I think blockchains are like any technology you can look back, but the scalability doubles, I don't know, 12 months, 18 months, 24 months. The scalability keeps, so it's a lot with Moore's Law that way. Every computer capacity keeps doubling a few months bandwidth.

Stuff like that often seems like a toy. Like at the beginning of this, there's like a stupid little toy. We can't run anything. With that kind of exponential improvement, it's not very long until it starts replacing legacy systems. What do you think about this as a major threat to NASDAQ and to NICE and to all the other centralized exchanges in crypto? What are the things that might survive this? How do you think the existing players will evolve to match it?

What is a better product? Let's just assume all the protections were in place, which is a big assumption, I know, in crypto world. But let's assume that there was a world in which that was the case. It's hard to argue that capital formation of markets shouldn't be global in 24-7, which obviously decentralized exchanges would bring. So how do you think NASDAQ and I see, you know, you've dealt with these institutions a lot in your career. How do you think they'll react?

I don't think necessarily it's they have to survive or die. I think you're going to start seeing a lot more technology where defy markets can integrate on centralized markets. So another thing I didn't necessarily, we didn't talk about what the crock swap is we have technology in place where we can create sponsored pools where it would be some pool that can be created with arbitrary permissions to use. the pool, but we'll always have the permissionless pools, but we can also create theoretically sponsored pools where, okay, some, let's say Binance comes in, right? And Binance says, we want to access defy liquidity, but obviously that's kind of hard to do in the current context because they can put out in a quote, but they can go to trade against Uniswap and the price by move, right? But Croxswap has concept of sponsored pools where finance can create a finance pool subject

to the approval of the croxswap token holders and they can say, okay, if you want to provide liquidity in the finance pool, you can't. do that. And because it's on the blockchain, it's very transparent over time. This is how much you're earning. This is how much finance is giving you. This is whether finance is pushing you over or not. Finance knows, okay, we can access that liquidity in a permission way. So we can show those quotes on the finance exchange. So if somebody wants to trade, they don't necessarily have to go to Croxwap. They don't even necessarily have to have their own wallet. They can go to finance and then access that liquidity and then finance transparently accesses that liquidity on the back end. So

Cool thing about defy is people call it Lego blocks for money. So it's very composable. And I think that's kind of been one of the biggest advantages of the ecosystem as people focused, how do we compose systems rather than one system trying to take over, exclude everything else. So I think the centralized exchanges will find that the technology for them to interface into kind of those liquidity pools on different ways, we'll keep expanding. And it will be an opportunity for those that are open to it.

What about NASDAQ? NASDAQ. There's this whole system in the U.S. called reg NMS where kind of already this exists where, okay, if there's a better quote at Nizzi and NASDAQ's trading it, then NASDAQ has to route your quote to Nizzi and that kind of makes sure everyone gets like the best quote available. There's no reason, right, you can't have a defy exchange that's also eligible for protected quote status talking about the future. One thing we haven't talked about in the world of crypto is this concept of MEV, which is an acronym

now that seems to kind of be everywhere, but probably most people have no idea what the hell it means. something to do with the order in which you're going to get filled or participate in a blockchain. Maybe just describe what MEP is and why it's an important concept and how it might fit into this overall ecosystem of DFI and DXs. And as you have been doing so nicely, kind of relate it back to some of the points that we've made before. There's a blockchain, right? And traditionally in the network, I create a transaction, propagate that transaction out to everyone in the network. and then miners or validators are actually building the chain, building the blocks on the chain,

and they kind of have leeway to decide how do I want to construct the next blocks? Additionally, when you think back, okay, this is like Bitcoin, I'm sending money from Doug to Patrick, and that doesn't necessarily matter too much if the next transfer is reinserted. But with D5, right, we started building more complex systems where minor changes in the order of how transactions are included in the history have huge, effects on the profit or trading strategies or anything else. So it's funny, MEP actually stands for a minor extractable value. The miners themselves weren't actually participating in it for a while is basically traders who would, they know the miners are kind of very predictable. We always include

the highest gas cost thing first. And then if there's a tie, we include whatever we see first. How I got into it where, okay, I'm a trader and I can put out a trade and I know the minor will include it a certain way and then I can get a profit advantage. And, you know, that might be a lot be something, okay, a big trade's coming in and I want to trade in front of that. Someone's going to buy a ton of Bitcoin right. Obviously, I want to trade at the lower price before he pushes the price up. Or it might also be something like, oh, the price is going to dislocate on this one decks. So I know, okay, this guy's going to push up the price at this decks and the other

decks is going to have a cheap price. So let me go buy a Dex B and sell a Dex A and kind of lock in a risk free profit. So there are a number of strategies, but it's the idea of if I'm very good at getting my trade in the right way, then that's a profit. opportunity. That actually, it ties in pretty nicely with HFT. HFTs are always specializing in, oh, I got to be very fast, execute with very, very high precision. And when you think of, you go to Robin Hood or whatever, you don't exactly care about the precise. You don't want to get a good fill, but exact details don't matter. So I think of them both as like strategies where people who

invest a lot in very, very high precision of how their trades or their transactions are executed, earn these outsized profits. So one of the problems, I think, in terms of why each kind of so much MEP exists in the first place is people come up with all kinds of crazy algorithms to prevent it. But to be honest, the user experience hasn't been great in preventing it. It's fairly easy for a lot of these deckss to prevent people from getting front run or getting attacked, especially the type of MEP where they're losing value.

But they're not really built into the front end, the application level, the interface level of the systems. So I think a lot of the way to fix it is build better systems on the front end to stop users from making bad decisions that can be exploited in the first place. What other meaningful missing pieces of infrastructure are there in the Defi world in your view today, especially things that you aren't building or aren't interested in building? Where is the maturity really low and how might we address it? The biggest thing in Defi that's where the demand exists is there's huge demand for stable coins. At the end of the day, right, people want dollar backed. People want some sort of something

that behaves like a crypto asset, very easy to transfer, very easy to hold. You can secure in a wall, but is pegged to one US dollar, right? Isn't going to fluctuate up and down. Especially middle income countries, right? People want dollar assets in like Brazil or Turkey or Nigeria, right? Don't necessarily have access to the dollar banking system. So some of the more wild D5 protocols basically exist to kind of fill this demand for a stable point. They're custodial state of coins like Heather or USDC, right, where somebody is depositing money in a bank account in the issue of coin that backs up, but then there's also this concept of like algorithmic stable coins. And we have die, which is you deposit overcollateralized and you

deposit more whatever collateral and then you get back a dollar backed stable coin. There's a mechanism to keep it in line. People are kind of getting into all kinds of crazy mechanisms to just get as many stable coins out there as possible and undercollateralize things and things that might behave riskier. So the biggest thing in the ecosystem is somehow just getting more stable points out there. I don't even know maybe that's a central bank digital currency, but there's huge demand for it. And I think, right, if that demands not satisfied, people are going to keep doing riskier and riskier things to generate synthetic stable coins. It sure seems to portend what you said earlier, which is the demand or desire to have more

traditional things on blockchains. The reasons you want a dollar are not probably dissimilar to the reasons you might want a Tesla coin in your example earlier. I think that's something that's really interesting and something to heed. Like if there's overwhelming demand for effectively a digital dollar, that's probably going to be demand for digital everything. All of a sudden, that makes the addressable market for blockchains like, God knows how much bigger. I just find that fascinating.

Right, right. I think you'll see more and more assets live on the blockchain or something similar will live on the blockchain. And if you don't give people some avenue to access those, they'll figure out another avenue and might not necessarily be right away or riskier, I guess. Well, Doug, this has been so much fun. I've in the past learned so much from where you're building, but also just your experience in the nitty, gritty of market infrastructure. I had a conversation a little different than this one with Sam Bankman-Fried from FTX,

and the subject was kind of similar, like the role that infrastructure plays in markets and why lower frictions are so important. And so really excited to see the work you're doing come to light and appreciate you, educating us all on HFT and markets and exchanges and decentralized exchanges. I ask everyone the same traditional closing question. What is the kindest thing that anyone's ever done for you? I don't know if it point to one particular thing, but my dad was always an entrepreneur growing up. And I think he's always kind of encouraged me to go out and build something. Don't necessarily go along a path or just go along where someone else has built something and don't be afraid to

try new stuff, take a risk. So I definitely credit him. for a lot of my journey. I don't know what it's necessarily been better, but it's definitely been a lot of fun. I love it. Well, Doug, thank you so much for your time. Great. Thank you. If you enjoy this episode, check out join colossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.