Odd Lots - Arthur Breitman on the Biggest Problems in Blockchain Design

Episode Date: May 20, 2022

We continue to see an explosion of interest and money flowing into the crypto/blockchain space. But recent price declines and the Terra disaster have raised new questions about what the whole point is. So ... what is the whole point? What is crypto good for? To get a better understanding of the state of the technology and the market, we speak with Arthur Breitman, the co-founder of the Tezos blockchain. The episode was recorded at the Milken Global Institute Conference in Beverly Hills.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. So Tracy, we are here at the Milken Institute conference in Beverly Hills. I know. It's very fancy. How's it been going for you so far? It's been fun. I talked a lot about it. I talked a lot about it. credit. I watched your panel about crypto and I have to say there were definitely more people at the crypto panel than there were at the credit panel. And also every panel that I've seen that's not about crypto. Someone asks a question. Yeah, like, oh, what's your opinion about crypto? Yeah. Like everyone, no matter what, people just like want to know about it. Someone from the

audience submitted a question about how crypto would impact inflows into investment grade and it, you know, interesting thought. Well, crypto is one of those things too. where I, regardless of, everyone gets an opinion on it, regardless. So everyone wants to know everyone's take, even if it's not their specialty. This is very true. But I'm very excited because today we're going to be speaking to someone who knows a lot about crypto, now just a tourist. And I think a topic that we haven't really talked about that much is blockchain architecture

and design. And, you know, all of these panels like everyone's talking to, it's like, they're super, like, fanciful. It's like, I was going to create this world of like openness and transparency. Right. And it's going to cut out all the fees and it's going to be so great. Which is really weird because when I think of blockchain, I think of high fees in low settlement or long settlement times and basically like all kinds of interesting tradeoffs than many things that are worse than the existing financial system. So I feel like people are jumping over some like basic architectural points in this whole conversation. Right. The other thing that gets me,

especially at conferences like this, is everyone wants to talk about crypto. Everyone seems to have an opinion about it. But I have my doubts about whether people actually understand the underlying technology and whether or not they're differentiating between different blockchains and things like that. I think people might understand the basics like proof of stake versus proof of work, layer two versus layer one or whatever. But like within those technology buckets, I don't think people are really thinking about the nuance. No, it's a lot of like, it's all just going to be really good and it's going to be really great for financial inclusion and democracy and all that stuff.

So anyway, let's have a real conversation about how these chains work and what you can do with them. Let's do it. All right. I'm really excited. Our guest knows a lot about this stuff. We are going to be speaking with Arthur Brightman. He is the founder and creator of the Tezos blockchain project, one of the sort of original projects that thought about smart contracting and, malleability in a way that, you know, much more advanced than or seemingly more advanced than what you can do on, say, Bitcoin. So we're going to talk about what you could do with the chain. So Arthur, thank you so much for coming on Outlots. And thank you for having me. You know, we've been interacting on Twitter for years and years. So I'm excited. I'm excited that

you're here. Yeah, me too. So, you know, like, what do you think? When you hear all these people at these conferences and you're here too, and they're like, oh, it's going to like be really cheap. it's going to lower the fees for everything. It's going to be super fast. Transparency, financial inclusion. It's going to save democracy. It's going to save the planet, et cetera. Like, what goes through your mind?

I mean, I think some of it is true and some of some of it is false. In terms of reducing the fees compared to traditional financial infrastructure, I actually think, you know, this is one of the real ones that we can actually do this. Yes, we can lower the entry costs for creating financial resources. products or financial systems make it a lot more innovative and develop these things much faster than they have in the past. I do believe that you can remove a lot of intermediaries. And a lot of the friction in the financial system come through the fact that you need to rely on trusted intermediaries. As an intermediary, you have oftentimes a big opportunity for fraud.

Right. And monitoring that fraud has a lot of costs. And also you have to deal with only a few people who are going to be trusted. If you can get rid of that, you can actually generally reduce costs. So I do believe this is part of the story. I don't know that it's going to save the planet and do all these grandiose thing. The story I have about this is I once gave a talk at some sort of dead-like events. And it was about the promises of blockchain. And I gave an example for some of the overhyped ideas.

And I said, well, imagine, for example, that we're going to put plastic back. are killing turtles, but the problem is we don't know where they came from. If we could identify who leaks a plastic bag, you know, it's solved a problem. So let's put the plastic bag in a blockchain and we'll save turtles. And I gave that as the example of like some of the nonsense you could see. And someone pitched me that exact ID the next month. That's amazing. Just going to fees, though, I mean, a very cynical person would say that the fees exist

because, yes, there are underlying costs like fraud and K1. I see an AML and stuff like that. But if you were being very pessimistic about the whole thing, you would also say that financial intermediaries, traditional financial intermediaries, they like to make money. And a lot of those fees are opportunistic. So I guess my question is, like, do those fees actually exist because of what the intermediaries are doing and the cost or because of the way the system works? And how do we make sure that in crypto, we don't end up with centralized intermediaries

that are going to charge big fees anyway. I mean, you know, I think everyone who's in business likes to make more profit and likes to charge more fees and people are going to charge whatever amount of fees they can get away with in general. So at some point, there's competitive pressure, right? And in finance, it's true that sometimes a lot of the competitive pressure is not present.

You'll have people pay, you know, 1% commission on a trade because they're doing it through a private bank and, you know, the trust of the private bank and do good execution and so forth. And that's nonsense. It doesn't cost that. to execute a trade. Not at all.

But the reason that they're doing it is because, well, they feel that they need the trust of this very prestigious intermediary. If you remove that need, if you remove that notion of trust, I see you get something that's more competitive because, you know, if the thing is going to work regardless of who you route it through, and reputation doesn't matter all that much. It limits the ability for intermediaries to charge large fees. Now, some people will try, of course, especially. would say there's going to be a college industry of there already is in crypto of people who want

to deal with more traditional investors and who are going to reassure them that no, no, no, it's all going to be fine. I mean, we see it. You know, you can buy, you could buy Bitcoin and even hold it with a custodian if you're worried about self-custody risk, right? But nonetheless, you'll find funds which charge you, you know, management fees for holding this. So there's, there's, some people are always going to want that, but it's still, it's putting some pressure down on costs. Can you talk a little bit about your background and the founding of Tesos? Because you were a trader at Goldman Sachs, right? And so what did you do?

What was your position in traditional finance originally? And what did you see early on that you thought there was like an opportunity to port some of these ideas or the opportunity you saw in creating your own chain? Well, my background is in computer science and statistics. and my first jobs I was working on as a quant. So I started out in statistical arbitrage, and then I moved to 2009. I moved to Goldman to do high-frequency trading. I worked on ETF market-making, natural gas market making.

I also worked at Morgan Stanley and a few other places on these topics. I've also done some robotics after that, but it was quite different. The thing that attracted me to a group of currencies is it was at the intersection of a lot of centers of interest that I had. I have been interested in the theory of money and banking for a long time. So, you know, how does money arise? What makes good money?

What makes bad money? And I remember, you know, way before Bitcoin, you know, convincing myself that the best money possible is backed by nothing, right? If you use gold, for example, there's a problem with the fact that if demand for gold increases, you get more mining. And so, you know, that's a waste, you know, because gold is used as a monetary instrument. You know, in an ideal world, we would have mined all the gold and increased demand doesn't create. statement for all this because it doesn't serve a purpose to have more gold once you have a given supply. And I guess we could argue that having a CT in a monetary supply can have some value. But it's, I didn't see that way. And so when cryptocurrencies come around, I mostly notice

it's not as bad criticism around it. So people always say like, oh, it's backed by nothing. And I'm like, no, that's great. That is what you want with the currency. I was interested in the cryptographic aspect because I also had, you know, I have a mathematical background. I was interested in geography. the individual sovereignty aspect was also some things that appealed to me from a political standpoint. So I really attracted me early on. So you were one of the first ones to move from proof of work to proof of stake. Is that right? No, we never use proof of work.

Right. Sorry. I mean, you were one of the first to like actually do proof of stake. What was it, like, what was the opportunity there? And like, why did you immediately latch on to that? versus proof of work. I got interested in doing Tesos because of my interest in proof of stake. Around 2013, there were a lot of innovation in the space around proof of stake, smart contracts, privacy.

People were coming up with, it was an explosion of research and innovation around the space. And one thing I noticed early in the Bitcoin culture is that there was not a whole lot of appetite in trying to integrate any of these upgrade any of this upgrade into Bitcoin. And it's sort of a point of pride for them. Right, like that it's so, it's, the code is so ossified or that it's so hard to. There's a big, part of it is pride, but I also think part of it is sour grapes. You know, for a while, the narrative was very different. For a while was people in Bitcoin circles were saying, you know what?

All these alcoins is just laboratories. They're going to find the best, you know, ideas. And we can always integrate those ideas into Bitcoin. And we move from that to, oh, all those ideas are bad. And no, you know, we couldn't, we couldn't, we couldn't benefit. from any of them in Bitcoin, which I think is a little sad because a lot of these ideas are good and important and have how in product market fit. This is one of the like ironies of Bitcoin.

I think it's technology is going to save us in many ways, but also we don't want the technology to advance too much because we like it the way it is or we can't actually do it. And I understand the perspective. I think from the Bitcoin perspective, there's a big risk if you if you let people change the ledger that the changes that you end up having are not merely. technological improvements, but actually change the nature of Bitcoin and it change its economic properties. So I think what Bitcoiners, all of Bitcoiners feel is that if they open the door to technological changes, they're also going to open the door to social control of the economic

properties of Bitcoin, which is something that they absolutely do not want. So in some sense, they felt like they had to shut the door completely on, almost completely on changes in order to preserve the economic properties. Let's talk a little bit about what you see happening on chain. We had a recent episode of the podcast with another person who once did ETF market making or ETF trading, Sam Bankman-Fried, and he was asked to describe yield farming, and we thought we were going to get this sort of very complicated answer about, I don't know, something. But it turns out, in his characterization, yield farming is they'll pay you to put money in a box, and if you put money in a box before other people put money in the

box, then you have a bigger part of the box. And it sounded to a lot of people not that different from a Ponzi scheme. What did you think about that? Is that a fair characterization of yield farming? I think it's a fair characterization of the way it's practiced. You know, if you wait by volume or by prominence, then yes, it's a fair characterization. I wouldn't show the baby with the bass water. I think there's something there.

You know, the more generous way of looking at it is, let's say you want to launch a token, You want to distribute it in some way. You want to get some liquidity. So you use part of your token supply as a way to we need to incentivize people for providing liquidity for it. And you could see a company doing this. You could do this with equities. You could say, look, I have some equity. My business will be more appealing to investors if there's liquidity around this equity.

So I could set aside some equity and incentivize my investors to provide equity. The issue with that, that it seems to me, and I think we have seen this in crypto, is that once the equity is distributed, if your model inherently is about, I guess, paying for customers in the form of equity, then once all the equity is distributed, do you really have good customers or do you just have a base of people who are going to now go find the next company giving out equity for liquidity? And when I look at like crypto, you know, I look at all these like D5 protocols that were huge in the summer of 2021 and now they're like charts are way down. And I kind of get the impression that the game is, yes, you find the company or the protocol giving out governance tokens, they're called equity. And then at some point the equity runs out, and rather than sticking around, you just go find the next thing. Yeah, no, I don't disagree with that.

There's a lot of, it's very circular. The way I phrase it sometimes is that you see a lot of innovation in DFI from a technological perspective or even from a financial engineering perspective. but the point of defy cannot just be to trade defy tokens. And right now that is mostly the point of defy. So I think you need to anchor it to some actually, you know, real use case in where real demand comes from. So historically Tesos has avoided defy, right? You haven't been that involved in it in the way that, say, Ethereum has.

But I think you started something last year called liquidity baking. Is that right? Yeah, absolutely. Can you explain that? How is that different to the other bad yield farming all the way down type D5? Of course. So first of all, I would challenge the fact that Thesos has this queued defy. The way I say, Tizzo is not sentient.

It's a project. And they are Defy protocols running on Tezos. The Tezos Foundation helps in general the growth of the Tezos ecosystem. We distribute grants and we've given some grants to some DeFi projects. So there's no animosity or anything against the defy. I think it has had a little distraction on Dezos and on other chains for a variety of reasons. But yes, so liquidity baking is interesting. It was a modification of the protocol itself.

So at the protocol level, an amendment was passed and ratified and voted on by the validers of the network that would take a small fraction of the, very small fraction of the, tokens maintain on every block and then use that deposit that into a pool to incentivize liquidity provision between Bitcoin and Tess. So the idea is that you have a little more inflation

in your protocol. I think it comes down to about 0.3% per year. So, you know, it's not very, very meaningful for, you know, something that has a daily standard deviation of like about 5%, you know, like a few percent. So it's 0.2% per year, but it incentivize people to

be willing to provide liquidity between Bitcoin and debt. And the point is that, first of all, these are not gigantic yield. The point is not to try to attract people with giant into yields or the point is not to try to bootstrap something new. It's just, it's a cost. You pay a very small cost in terms of inflation and you get something in return, which is equity provision. I want to go back to the box for a second because in theory, the box could become a bank, right? So in theory, we could all put money into the box, so we get some equity, and then in theory it could start, I don't know, making loans or doing something with economic purpose, something that actually creates value such that defy is not

just trading of defy tokens. Right. This is like the SPAC argument, right? You're sort of putting money in a box that might become something. But is anything becoming that? I mean, we have, there's a famous crypto SPAC. You basically have something that's nonsense. You get a high valuation and then you turn that into actually making it works.

We've seen some people attempt that. I don't know that anyone has really, really, really succeeded at pulling out of the crypto spec so far. But it was an interesting move. Certainly, like, people pointed at project like Chainlink, for example. Yeah, yeah. You know, started out a little, you know, not very coherent and then started, you know, hiring serious academic and, like, doing really serious work in cryptography for this. So, you know, it remains to be seen whether or not that's pulled off. But for me, it's more about, it's not about how serious you are, it's more about, you know, at the end,

of the day, you know, it's about value creation, like what value are you creating? And it can't be completely internal. Another way to think about it is sometimes I'll visit a small town and I'm thinking, what are the exports of this town? Right. So you have economic activity. You have restaurants. But the restaurant is for the people who work here, so they have to work on something. So at the end of the day, you know, what do you export? What does defy export? Yeah, that's a good question. Right. You know, what, what are you doing? Are you, because if you're looking at, there's a cynical view of financial markets that I really reject, which is the idea is that all the financial market is just a

giant casino, everything is zero sum. It's a very popular view, but I don't, you know, financial markets are very important because they help get liquidity, you know, secondary market gets liquidity and it helps capital formation for companies and companies actually build things. So there's generally value in financial market. It helps companies that do things and build things.

And unless you're actually doing this in some ways with Defi, it's going to remain incestuous and it's going to remain circular. Since you said this, since you're not a fan of Defi for the sake of Defi, can I broaden this out massively and ask what is the use case of blockchain? And we ask this all the time. And, you know, yesterday Joe was on a panel with Algaran and they announced a big partnership with FIFA. And Joe asked the... FIFA president, well, what are you guys going to be doing in this new partnership? And he basically said, we don't really know. We have a bunch of ideas. We're just really into crypto and we want to be

a modern company. And we hear so many of these partnerships. And I feel like it's still kind of unclear what it is that you can do with a blockchain like Tezos versus traditional technology or financial architecture. Yeah, absolutely. So I think for me, the most basic use case, and maybe the most important one is censorship-resistant store value, like being able to store wealth in a way that isn't anyone's liability. Because if you think about it, if you have a bank account, that's still the bank's liability. If you have a brokerage account, you probably don't even own, you know, the shares in name. And even if you did own the shares, it's still the company's liability.

Right. Right. Right. There's very, very few assets, which are not someone else's liability. You have real estate, but it's not easily portable. You could own precious metals. but again, you know, as bare assets are kind of complicated. So it's unique in his respect.

It's a bare asset that you can transact with across the world. So that's a second use case making very easy cross-border payments, very cheap, coarse-border payments without intermediaries. And I think, you know, if you live in a reasonably free country, it might not seem like a big deal, but as soon as repression starts turning on, you're pretty glad that you have a censorship-resistant store of value. That viewpoint often gets a little derives.

write it because people will point at people holding Bitcoin or these other cryptocurrencies and say, well, look at them, you know, holding Bitcoin on exchangers, they're not concerned with that. Well, maybe they're not, but maybe they think that other people are going to be concerned with that. And they help set a price for the store of value. So I don't, you know, it's basically either using the store of value or speculative on the fact that people are going to use the store value. And I think that's completely fine. So here's my other very broad question, which is, do people actually care about decentralization in crypto? And then second, Secondly, how do you measure decentralization?

And again, I asked the question because this happened again at Milken, but Kathy Wood from Arc was talking about the new thing they're working on is some sort of systematized way or systematic way to actually measure decentralization in crypto. So how do you actually do it and doesn't matter? So if you're looking today at the behavior of price setters in markets, whoever is, you know, the marginal buyer for cryptocurrency does not. about decentralization. That's an next thing that's been pretty clear. But I believe that for these systems to present some values, they need to be decentralized. Otherwise, they'll be out-competed.

You know, if you have some use case for your blockchain, you have to ask yourself, you know, what do I do that Amazon-AWS can not do better as a service. And I think the answer to that often time is going to rely on decentralization. So there's been a decoupling in a sense that people don't care. But at the end of the day, when the rubber hits the road, decentralization does matter, but I think we're going to need to see more cases of blockchins being insufficiently decentralized and running into trouble for people to start caring.

How do you measure it? Decentralization. Yeah. There's many ways to think about it. You can have the, I would say, desirate decentralization where like, well, you know, there's no single parties in charge. But then the fact of decentralization is like,

not only is that true, but on top of that, you know, no party is too prominent or has too much. of an impact on the network. And then you could be looking at it in terms of the most narrow sense would be the consensus algorithm, who can attack the integrity of the chain. But it could also be, you know, who has influence in this network? Who can, who has the cloud to suggest hard for example?

It could be who is building infrastructure that's critical for this. So you have many, many degrees of that. So just on this topic, I mean, There do seem to be benefits and drawbacks to decentralization. And we've seen, for instance, with Ethereum, Ethereum has a figurehead in the form of Buteran. And they have been able to do some stuff relatively quickly that probably a truly decentralized protocol would have difficulty doing. And I think Tezos has a unique governing structure where you are quite decentralized from what I understand. So has that been, like, how do you feel about that?

Has that been a drawback or is that a big benefit of the protocol and how do you weigh those two things? Well, I think in general decentralization is a cost, right? And there's benefits associated to that cost, right? So I think it's worth paying, but it feels almost like an insurance premium, you know, right? You pay the insurance and you pay the insurance and you say, why am I paying this insurance? And then you have a fire and you're glad you paid for the insurance. So it's very easy to see the cost of decentralization and the benefits are not always as obvious immediately. in terms of Tezos, we have a governance procedure that allows for upgrades to the chain.

So anyone can propose an upgrade on a Tezo's chain. And it's set to a vote. And if the vote passes, and if the vote passes, it happens over three months. But if the vote passes, the upgrade is adopted. There's a side effect, though, because in order to have a mechanism that completely automated upgrades through voting, a lot of engineering work from the very beginning went into making easy upgrades. And just as a side effect of that, that's a side effect. a benefit,

unrelated to the decentralization. It's just the fact that it's really easy to do hot swaps of the protocol has led us upgrade faster.

We've had about nine upgrades in the past three years and we have the tens of upgrade being voted on right now. I want to go back to Tracy's question

about use cases because, okay, store of value, I get it. Cross-border payments or payments, I get it. But on the other hand,

like, I kind of think Bitcoin. solved those problems. And so, or to some extent. And so when I think about like a smart contracting platform and when I'm here at Moken and everyone is talking about we're going to be trading real estate on the blockchain or virtual worlds and, you know, virtual land and where like, you know, your cartoon ape can live or whatever, I want to push further on like what can we do with a blockchain that we can't do with a traditional database. And what that's going to look like? And what that's

going to look like and what applications are going to take off and actually change society? Or, as you put it, and I really like the phrase, and I'm going to steal it from now and it's like, what are the blockchain's exports going to be? Yeah. And I think, you know, the most natural, the highest impedance match is store of value. And then we go down from there, but there's still a lot of values that's present. So we, you know, we did, there was a fair number of security token offering on the Tizzo's blockchain. And a lot of them have come from the real estate world. And they were people...

Sorry, the what world? Real estate world. Oh, yeah, okay. There were a lot of people tokenizing real estate on blockchains. And they weren't doing it. You know, it was not an innovation now at a bank saying like, oh, we got to do something with blockchain. You know, they came from people who actually had the mean and actually had the use case. And they saw the value.

And I don't think it's impossible for a centralized system to do this. But having a system that secure, that's automated, that's global, I think. the global aspect, the fact that it just works, and you have this entire infrastructure around it, you have wallets, you have custodians. Think of it as some sort of layers that plugs in into a large ecosystem that supports it. That lowers your cost.

So there's value here. It doesn't come straight from the decentralization. I see it comes from the network effect of having a generic platform where you can build all sorts of things. So I have a dumb question, and I think I've asked this before, which probably makes it extra dumb,

but when you actually tokenize something like real estate or a JPEG that becomes an NFT, what exactly are you, like, what are you buying? Because my understanding is you're basically buying a database entry and then there has to be some external body like an open sea that points you in the direction of it. And also just to add on to it, in theory, there needs to be some legal recourse, right,

such that the owner of that token actually is entitled to the cash flows of the property, whether that's in the rent or in the sale of it, as opposed to whoever just happens to be there, it takes them up. There's a lot of arguments around this space, and I've been guilty of that, that if you follow the argument, you will reach very strong conclusions,

and then there's always some solitude. You see, like, oh, this could be centralized, and therefore there's no value. So, for example, the legal resource is a really good example. Sometimes you'll hear, look, there's no point in having tokenized real estate on the chain because at the end of the day, you're not going to be able to, you know,

if you want to assert your rights, you'll have to go to a court, you'll have to go to like whoever the issuer is. They can refuse to honor it, so all the security of the blockchain is for naught. And I think that's taking the argument way too far. You know, there's a saying that possession is nine-tenths of the law. And in some sense, smart contracts is automated possession.

So sure, you could have legal challenges, you can have all sorts of things, but it reverse the burden. I think it's an example who says that smart contracts reverse the burden of the lawsuit. And that's really interesting because you'll get transferred to title of something. You can start doing things because, hey, you know,

it works with lending protocol. It's integrated in everything. And if people somehow think that, you know, you're not entitled to it, they have to sue you and they have to claim it back as opposed to you saying like, hey, I need this. And you see this in the traditional financial system in a form of escrow, right?

If you have a small party dealing with a large party, and they say, like, look, if you don't pay us, there's no way we're going to be able to sue you, right? So you use escrow for that. And I like to think of smart contracts as automated escrow. Escrow exists because the two parties don't trust each other. So the solution that you're creating is basically trying to fix that trust problem. But I guess, like, I guess my question is it goes back to that what are you buying aspect. So I buy tokenized real estate. I still have to trust the person who's selling it to me

because there still has to be an entry somewhere or there still has to be a centralized party that's telling me that this database entry points to that thing over there. Absolutely, but I still say you trust them with less than if you were just signing paper documents. So it's a matter of degrees. Absolutely.

And in some sense with the JPEGs and the arts, I think it's more trustless in some sense with it because there's nothing tangible, right? It's not like somehow they can say, no, you don't own that, you don't own that saying. Because what you're buying is a, I think if you buy a piece of art, for example, and just to be sure, a lot of people buying JPEGs are just buying it because they see it go up and they say, like, I'll buy it and then I'll say it tomorrow. There's a lot of gaming associated with this, right?

But there's also a genuine art community. There's like generally digital artists who are minting digital art and selling it. And the argument that I like the most here is like, okay, So digital art is a saying, and that's not going to go away. People want to collect it. People always want to collect art. So what's the alternative? Before that people would collect digital art and they would receive a paper certificate saying, you own, you own this piece.

You're not going to put it on some corporate database. You want something that's going to be here for the long run. You want something that gives you some meaningful form of ownership. So the best substrate for that is a blockchain. So I do think there's a really good impedance match for art, digital art and blockchings. Let's talk a little bit more about what the future looks like. And, you know, Tezos is an Ethereum competitor. And a lot of the things that you can do at Tezos, you could do on Ethereum and presumably on Solana and Avalanche and the finance chain and all these and Algarand, et cetera.

Is your view, there's a question that I was wondering, like, in your vision, is there one chain that wins out? Is it, I mean, you would want it to be Tezos, but are we going to a, are we going to a question? towards one chain that's the winner, or is it, as they say, a multi-chain world? So again, to my point, there's absolutely arguments where you can say, well, you know, there's network effect in having one chain. There's, and, you know, like, you have more security, you have more assets, more composability. So one chain wins all. And there's limits to all these absolutely argument away.

Like to think about it is, as, you know, if you have salts in a solution and then you let it crystallize. If you crystallize very, really quickly, you get something like glass. If you crystallize very slowly, you get a few big crystals. So the lowest energy state is just like one big single crystal. But you're not going to get to the lowest energy states, because at some point you'll have things that crystallize. So what it means is that, yes, we have a multi-chain world, but the applications on the chains will say because they have their own network effects. So I don't think we're going to have chains that specialize on a use case in technical sense, there's no way you can meaningfully say, oh, this chain is the best technologically speaking

for sports, and this chain is the best technologically speaking for finance. The designs are largely going to converge, to converge. However, if you have a lot of really, really popular applications which are talking to each other and form their own ecosystem on a chain, they're not necessarily all going to migrate away from one chain to another, just because they can get, you know, Epson and more security in doing so. Can you talk a little bit more about that interoperability point, why is it so technologically difficult? Give us a really easy to understand explanation of why it's so technologically difficult

to make the chains work together. The main thing that a blockchain does is maintain consensus, right? That's a hard problem that they solve. And if you want to have two chains communicate with each other, they need to be in consensus with each chain. Each chain needs to know what states the other one is in. But at this point, to have them being consistent,

with each other, you would need to have all the validators of one chain, be all the validators on the other chain. And by the time you've done that, you've essentially merged the two chains. So fundamentally, bridges that port state from one chain to another are hard. You are either increasing the computational cost on your network or you're losing security properties. And we've, some of the big hacks, and we haven't, I don't think we've talked about it on this show before, but some of the big hacks that people hear about in crypto lately have been on these bridges, right? Yeah. So can you talk a little bit about, like, what's going on?

How are they, why are they, why is security inherently difficult and what have exploiters discovered about the weaknesses inherent in these bridges? So, first of all, the bridges are a big honeypotts because in general, the way a bridge work is you're going to put all your assets in, on a chain in one little pot. And then you're going to mint a representation. of those assets on the other chain. So you have a big pot of money that's sitting there. So first of all, you are a really good target for high.

So I lock up, say, $10 million worth of value on Ethereum. And then I mint $10 million on Tesos that represents a claim to that $10 million on Ethereum. That's right. So that's a lot of money. All right. So that's a honeypot. But that's the first saying. It's like, you know, what motivates security attacks is.

is money. And the second thing, so it depends. Not every bridge is created equal. And then some bridges have way more secure design. If you look at the entire cosmos ecosystem is built around the idea of having these bridges, light client bridges between chain.

Now that's more secure than other approaches. But a typical approach is you're going to have a set of signers. So a lot of people, a set of people who are going to monitor both chains, are going to see what happens. And then they will sign messages saying, like, yep, I got deposit on this chain. and you know, you find the other chain that deposit happens, and vice versa.

But those signatories have the power to take away the funds because they could pretend that the deposits happened, that never happened, or that a withdrawal happened, that never happened. They need to be in consensus. They need to follow the two chains. But there's a lot of attacks you could do. First of all, you know, if you have, I don't know, the polygon, for example, so polygon is an L1 chain that markets itself as an L2 chain on an Ethereum.

They have $5 billion. Sorry. explain that. Just quick diverge. What do you mean? It's an L1 chain that... Yeah, so Polygon is an L1 network. And the proof is that they are actually investing in L2 solutions.

You know, if you're an L2, you don't invest in L2 solutions for scaling yourself. But a lot of their marketing initially was like, no, no, no, no, Bill and Polygon is just like billing on Ethereum because we're all part of scaling Ethereum. But their incentives are at odds with that of the Aetherium ecosystem. All right, keep going. It's been a good growth hack to say, like, no, no, we're complementary. to Assyria, but everyone's competing. And so the Polygon contract is a five out of eight multi-sig.

And it has like a few billions of value. Like if you're holding a signature and you have. So there's eight people. Yeah. And in theory to access those billions, you just need to get five of them. That's right. Okay. Just high stakes.

Yeah, yeah. And so yeah, it's high tech. And you're not, where you put this signature? You're not going to put it in your apartments, you know. You need to be able to access it, so you can't even put it in a bankroll. So you need some sort of probably some data center. But even if you have a data center now, you have to think of like, well, who has access to it? Right.

You know, when there's billions, if your attack is worth billions, the budget that you have for actually tricking things. I mean, you have people being kidnapped, for example. There's a lot of, I mean, for billions of dollars, it's not, you know, it's not impossible. People have been kidnapped for a lot less than that. So that's, you know, there's a lot of risk. associated with running a bridge. If you look at Axe Infinity, for example, so they're not on Ethereum, they're running a clone of Ethereum,

and there's a bridge, and they were hacked for like $800 million or something like that. And it's easy to look at this and say, like, ah, ha, ha, you know, silly and NFT games, they got hacked. They're probably sloppy with security. And I have no idea, I have no idea what's backing it, but I've seen a bunch of people say, like, apparently the evidence points at them being like North Korea. Because, you know, for 600 million for North Korea,

that's a lot of, that's meaningful. money. But if your adversaries are nation-states, that puts the, you know, that puts the security. And you don't really have the security problem. The way that blockchings are designed, the security works a lot better. You know, everyone's responsible for their own safety. You don't have this giant honeypot of all the funds of the one bridge, which are in the same place. This actually reminds me of something that I wanted to ask you. And it gets back to the multi-chain versus absolutist argument or tension. And I guess, Tess is. Tess has been around for a long time and you know you've been doing this for a while you're well

known in the industry you've talked to a bunch of people you have different partnerships what is it like actually going out and selling the technology to a company or convincing some sort of entity to use it like what is that i guess endeavor like and how do you compete against something like ethereum or salana or whatever yeah so you know in general it's i i don't go around to companies who have no interest using blockchains and sell them. Like, you should be using, you should be using, because in general, there's some existing interest.

I'm sure some blockchains do that. I mean, there's probably a few of them at this conference. Yes, it's quite possible. But, you know, by and large people are, you know, even every large institution has at least, you know, every bank since 2013 has like an innovation center that actually wants to do something. So there's already, you know, like at least some existing interest

and some ideas of doing something. So it's more about like, you know, why should we use that? what should they use Tezos as opposed to any other blockchain? And then, you know, we rely on some of the good attributes of Tezos, which is a very strong decentralization, the fact that we have a really good software stack for building secure application.

It's, I think, a lot easier to verify the security of contracts written on Tezos and on contracts that use solidity, a good developer community. Sometimes it can just be handling. Sometimes people say, you know what, I've tried to build on this chain, and I couldn't find any help, and being able to go to these people and provide technological expertise makes a big difference. And I want to get your take on another big thing that's going on in crypto right now

that's attracting all kinds of controversy and medium posts and tweets. And that is the chain Luna. And it's like this. So the deal is, in my understanding, you'll explain it better, but there's a chain called Luna and they have a stable coin called UST. and you can get 20% on USC if you buy this coin and then like stake it and people are making it tons of money and it's going up. And then also I think the Luna Foundation is buying a bunch of Bitcoin like billions of dollars worth to build this war chest to hold the peg. Because to hold a stable coin's peg, there's a lot of interest in stable coin architecture and design.

And some people think like this is like going to blow up. And someone once told me it's like all the stuff that you're worried about with Tether, you should. be looking at Luna and other people who are super bullish on it. What is your read of this situation? I see more talk about this story than a lot of other things right now. Yeah, I have a, you know, I have a, my, my theory is no convertibility, no parity. So you cannot, if you cannot convert your assets from, from your dollar, simple coin into dollars, you're not going to have any form of parity.

Right. And it's such a powerful law. I mean, even, you know, you saw it in equities. The classical example is, um, uh, shell royal Dutch, uh, where after, you, where after a merger they had shares trading in Amsterdam and sharesering in London and there's the same equities they give shareholders exactly the same rights and one traded for years at like a 15% discount to the other and they're the same instrument but because you cannot convert one into the other so if you don't have if you cannot just hope that people

are going to be rational you need arbitrators to be able to come in and use the arbitrage so with a lot of fractionalized with a lot of like fractionally backed stable coins the arbitrage can do that to some extent. But the system relies on constant growth in the number of people who want to hold a coin. And if you don't have this growth, and if you have, as soon as you go through a contraction, and people start asking for redemption,

then the system collapses. So that's how basis, for example, it's built, and that's how, or wanted to be built. Luna is a little different. What they're doing, essentially, is they're saying, okay, so we have an idea of the price of Luna in US dollars. and so anyone who comes in can issue some against,

you know, can burn some LUNA and issue some UST or do the opposite. And we're going to, you know, pay 20% because, oh, that's great, you know, it will. It's a growth. It's a way to grow. The difficulty with that is there's no limits to how much UST can be created. And the LUNA holders are actually paying for those 20%. You know, the 20% are coming from somewhere. Now they're happy to do it because they're saying, well, you know, the growth and the demand and the

stable coin creates visibility for the ecosystem, it creates hype, and it creates market gap. But there's limitations to how that works. What they don't do, which you need to do, is you need to be able to set the interest rate in a way that's going to balance the supply, and the supply should be determined by what's packing it, and the demand, which is, you know, how many people actually want to hold this stable coin, and they don't have a mechanism like this. Instead of building this mechanism, because you could do that, you could do something, where you say, look, we want to have no more than 30% of the market cap of Luna being into UST. And if we have more than 30%, then we'll lower the interest rates, including, you know,

potentially going negative. And if we have less, well, so there's a mechanism that work. Instead of that, they're going, instead of that, they're going and say, no, we're going to buy Bitcoin, which is, you know, if you're going to have also some centralized ownership, and go and buy, you know, go and buy some U.S.C. Yeah. So dollars, like, why would you back? What's the rationale for doing, what do they? say is the rational is headlines.

Oh, okay. Wow, we're the biggest holder of, we're the biggest holder of Bitcoin, how cool is that? Or potentially the idea that, well, maybe Bitcoin appreciates and that helps us with our unbacking problem. Yeah. Since you mentioned arbitrage there, I was wondering, given your

ETF market making background, do you see a lot of parallels between the world of crypto and an ETF trading? ETF trading, not not per se, right, not directly, but just having a general financial background, I think is helpful when looking at a lot of

Defyp protocols and understanding how they work or don't work. I have a question, and again, it's sort of about these parallels. So one, people got hyped up about blockchain's early 2021 when the Robin Hood stuff was going on

and people started learning about payment for order flow and they're like, oh, you're giving a penny or a millionth of a penny on every trade to some high frequency trader jumping ahead of you and so forth. But crypto or blockchains themselves and Ethereum and other smart contracting platforms have this concept of MEV, a minor extractable value. And if I want to place a trade, you know, blocks only happen every once in a while. And in theory, that trade goes out there and everyone can see it.

And a miner can jump ahead of, I think is how it works. So essentially jump ahead of me and get a better price on that execution and then sell back to me and I get a worse execution. How big of a problem is this? Can you talk, and how does it work on Tesos? And what are the sort of things that people should understand about the power that miners have or how MEV comes out of the system? Wow, that's a big guy.

I know. These are things that we haven't really talked about before. You're good at explaining these things. So I figured I would just give you a bit more. I'm happy to hide to dive into it. So the first thing to understand is that, order flow is not fungible. Order flow that comes from retail

trading is not the same thing as order flow that come from Goldman Sachs or that comes from a fund manager. If I come to you and I say, hey, I want to buy this equity from you or this shares from you. Sure, sure, you know. Or maybe maybe no lie, but if Goldman Sachs come to you and say, hey, don't you want to buy this

from us? This is like retail flow is much more desirable because we're all dumb. It's not even that it's dumb. It's like it's just not in form. You're buying, you know, you're it because either maybe you're gambling or because you're saying like, I like this stock, I want to buy it for retirement and so on so forth. This is not like you have just received some information for a wire about something and you've done all of that. And now you know that the execution is going, the price can go down. So it's quite different. And once upon a time,

you didn't have to mix all the order flow together. So if you were a big fund manager and you have this large S&P fund and you need to rebalance and you talk to another big fund manager and they need to rebalance and then you strike a deal. because you know that the other person is not trying to screw you, right? So they're trying to do this. You're trying to solve a mutual problem. Yes. And also, you're going to repeat business with them.

That's quite important. And that's, you know, that happened upstairs in I see. And then at some point the NCC looks at this and say, well, you know, we see all these big trades happening and they're very advantageous. But the retail. This is reg NMS, right? It is reg an MMS, yeah. The retail guy doesn't get access to that. So we're going to put everything on the electronic exchange.

Right. And brokers will have to route to which of every single, you know, which are going to do that. of exchange has the best, you know, the NBBO, the best being asked. And a lot of institutional investors, when they started doing that, they had no idea how to do it. So now they start showing these big orders or even, you know, if they chop them up, they don't do it in a, they don't really do it in a way that hides the amount of volume that they want to do. And they get eaten by high-frequency traders who appear as a cottage industry as soon as the regimeness has passed. And so a lot of a lot of these big

cell side people get very, very upset at it. And if you read Flashboys, it's a very one-sided book that looks only about the cell site doesn't interview a single person on the efficacy trading side. I remember there's this crazy bit in Flashboys where he was talking about he was about to do

like a retail trade and he was about to click like order or buy and then he saw the price move on his screen and he was convinced that it was because Goldman Sachs was front running. his, his, like, tiny retail trade. And it's bizarre because it's also presented, I think, like, in 2010, as like, oh, I'm uncovering this big secret.

And I'm like, I started working in Coleman's, like, 2009, because people were talking about this on TV and I saw it was cool. So, you know, it was on CNBC. It's not like they were uncovering a big conspiracy. And, you know, people adapted, of course. So they started using execution brokers where, you know, they will say, no, we'll take your order, chop it up and then put it on the exchange. But so now as a result, what happens,

is you get internalization of flow. So you get this retail flow. Right. And if you send a retail flow to the exchange, the retail is going to get a worse price because the exchange doesn't know anything. The exchange says, whoa, whoa, wait a second, we don't know who you are.

You could be retail. You could be a hedge fund. We're going to be giving you wide quotes because we don't know. Whereas as a broker, you know the order flow is not toxic. That's a word that's used for like informal flow. It's not informal order flow.

So you can give it a better price. So you're going to match it internally. You're going to give it a better price in the NBBO, which you're all, you know, lot to do that. You're going to report the trade to the exchange. Or you're going to give the customer the NBBO, but actually you internalize it for something better. So the customer feels like, oh, I haven't paid anything, you know. Right. But actually, you've made money because you can

quote tighter on your internalized flow than you could on the exchange. So retail really won out out of this. Like the small retail guy who's like just spying single name stocks, market's much more liquid for that. I would say the losers out of this have been large institutional traders who now have to either use execution brokers or dark pools. So here's a very broad question based on that very long and detailed answer. But what is crypto trading like behind the scenes of exchanges? Like how transparent is it and what sort of execution are people getting? Right.

And the M.AV aspect. So it's like what are the equivalent? Like how big are some of these? So the equivalent to MEP is putting your giant order on the exchange. and everyone knows what you're about to do. And so people can get, you know, people can get ahead of you. The difference is that if I put a giant order with my broker, at the very least, the broker has a fiduciary responsibility towards me.

You know, I'm his client, and so they have to do things a certain way. Whereas I don't have any fiduciary relationship with a minor. Right. Now, there's nothing stopping people from building these relationships. You know, as a trader, you could go to a block producers and say, I want you to promise me that when I send you an order, you're never going to include, you know, you're never going to show to anyone else and you're going to be forever.

You could do that, which people don't do it. Do you think that's going to happen? No. Oh, you're done? No, I think what's going to happen is people are going to build better protocols which are going to remove some of the extractable value. Do you think regulation will come to the space? Will the SEC, for instance, get interested in best execution for retail traders and crypto?

So I don't read T leaves. I think it's possible because, people have made MIV into some sort of moral issue, which I think is dangerous. You know, the words saying like, oh, the minors are exploiting people. They're taking advantage and so on and so forth. One thing that I think would be more helpful to frame it as. And again, I said it's like, if you want a fiduciary response. You know, if you want a fiduciary relationship with your minors, you should ask for it.

What I would worry about is a regulation that says that by default, as a minor, you have a fiduciary responsibility with people, which I don't think you should have. What about if I have a fiduciary responsibility with a broker? that, for instance, is providing me crypto exposure through my 401k as I think someone is doing now. I forgot the name. But, you know, various people are starting to do this in a sort of more regulated way. How does that fit into the execution? Well, in that case, of course, you know, the broker should not favor another client or themselves

in doing the transaction. Now, but if they trade, and just to be clear, this happens for on-chain trading when you use the five protocols. It's not an, it's not an area clean issue with trading on centralized exchanges. I think, first of all, a lot of it comes from the latency of chains. The more latency you have, the more MEVs there's going to be because quotes are not adjusted in real time. So it's partly a fraction of that.

And the way in which protocols have been designed, if you are in a system where you can't adjust quotes really rapidly, you need to build batch transaction mechanisms. And they're harder to program. But once you have this, you can reduce the MEV on its chains a lot. I think we'll see that happen. Just going back to the turtles at the beginning of this discussion and plastic bags on the blockchain, I was packing up my apartment in Hong Kong a few months ago, and I noticed that a bottle

of balsamic vinegar that I had that I never used was it was on the blockchain, right? You could trace it to test its validity. And a big existential question here, but is the future just everything on the blockchain and how do you differentiate between the importance of having something like plastic bags being tracked and traceable versus having something like a store of value that people are using to hedge against inflation or for whatever reason? Well, I think there's more value in the store of value aspects and the supply chain applications. A lot of the supply chain application we see on blockchins. You honestly are stone soup.

You'll see IBM go to this people and say put everything on a blockchain. But if you digitalize your entire chain, right, where you have, you know, like you can scan cure codes and do all of this and put it in the system. And then, you know, like, you've solved 99% of your problem. And then you put it on blockchain, you know, why not? But that's not really what's driving the value. I believe there's value in digitizing and having photographic signature on supply chains, absolutely. I don't think the blockchain adds a whole lot to this.

All right. Well, Arthur Brightman of Tesos, thank you so much. That was a great conversation. I feel like the, we have really good conversations with, like, like the people who actually did some time in the tradfied trading world. That seems to be like the sweet spot for people who can explain things. So thanks for coming on Oddlox. Thank you for having me.

Thanks so much. I think that was great. I guess I said that at the end there, but I do feel like the best explanations and conversations we have on this space are often with someone who did some like time trading and some legacy institution and can sort of, I guess I would say like translate some of these ideas. Absolutely. back and forth. But I also feel like there's a tendency in crypto for people to talk about

like all these issues are brand new when in fact they have been, you know, very diligently thought out many years before by traditional financial institutions and there's a reason why, you know, they do it a certain way. But execution, for instance, is something that's been top of mind for a lot of people for decades. I still think people should just chill out. It's like, it's just a penny or it's like it's just a fraction of a penny. What's the big deal? The other thing that I liked from that conversation was the description of defy. Yeah. You know, the question of what is the export here? And we've talked about it before, but like what exactly are we doing other than dealing and more defy? Well, you used to make fun

of me because early on in some of our first defy conversations, I would like, well, the whaling expedition and it's like is the protocol actually, you know, it's like VC, like got its roots kind of in funding whaling expedition. I never made fun of you. I just questioned why. you were obsessed with whaling expeditions all of a sudden. Fair enough. But anyway, like, that is, like, you know, it's, or they're pointed out, like, it's not that exciting if it's just tokens, trading tokens, trading tokens, and more tokens. Yeah.

Or it's not that world changing. Or boxes. Or boxes. Or tokens, tokenized boxes. Yeah. All right. Shall we leave it there? Let's leave it there.

This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthalthalth. you can follow me on Twitter at the stalwart. Follow our guest on Twitter, Arthur Brightman. He's at Arthur B. Follow our producer, Carmen Rodriguez, at Carmen Armin.

Follow the Bloomberg head of podcast, Francesca Levy, at Francesca today. And check out all of our podcasts at Bloomberg, under the handle, at podcasts. Thanks for listening.