On The Brink with Castle Island - Guy Young (Ethena) on a New Model for a Crypto-Backed Stablecoin (EP.459)

Episode Date: October 9, 2023

Guy Young, the founder and CEO of Ethena, joins the show to talk crypto-backed stablecoins.  How Ethena began with an Arthur Hayes blog post The origins of synthetic stablecoins on Bitmex The difference between Hayes' Nakadollar and the Ethena design Why synthetic stablecoins have failed in the past and how Ethena addresses this How staked ETH as the underlying collateral opens up a new design space How Ethena mitigates their exposure to exchanges with off-exchange custody Guy's backstory and entrance into crypto Why the circumstances are favorable for the success of a synthetic stable today Why the short leg of the Ethena position has to rely on CeFi for now Where the yield from ETH positive funding ultimately comes from Limits to scale on Ethena on the short leg of the trade and ETH staking Guy's explanation for where the yield from being long ETH comes from Correlation dynamics between the ETH yield and the funding rate Why it's important that crypto yields are somewhat negatively correlated with tradfi yields What protects the system when funding flips negative? How the system can react to constraints in ETH funding and ETH staking The possibility of adding Bitcoin as a collateral type Why Ethena distinguished the stablecoin and the yield-bearing component Rebasing versus accruing yield tokens How they think about different stETH derivatives Ethena versus stETH-backed overcollat stablecoins Why the supply of stablecoins is shrinking Will major stablecoin issuers become interest bearing? Ethena's regulatory strategy The BUSD security analysis from the SEC and how interest bearing affects that Why end users deserve yield in exchange for taking on the counterparty risk of holding a stable Why Guy is excited by Paypal USD Guy's prediction for stablecoin interest-bearing market cap Further reading: Arthur Hayes, Dust on Crust

Hello and welcome back to On the Brink. I'm Nick Carter. We're continuing our series on new models for stablecoins. I think we're calling it Stable Coins 2.0. Everything's changing in Stable Coinland. Nothing is going to be the same. And this is one of the main projects that really caught my eye and really got me thinking about Stables and how the kind of pre-2020 paradigm of Stables is unstable. I'm pretty excited to see the whole a crop of new entrepreneurs coming in with some fresh ideas or rather old ideas with new implementations. So today sitting here with me, I've Guy Young, the CEO and founder of Athena. Well, let Guy talk about it, but it's a synthetic USD stablecoin with some pretty interesting properties. Anyway, thank you. Yeah, thanks for having me next. So it's very interesting that this whole thing started with a blog post.

Or maybe it started before that, but, you know, infamously, Arthur Hayes wrote a blog post called Dust on Crust. He was talking about creating a synthetic dollar based on Bitcoin. You know, how could you create a dollar with Bitcoin as collateral? And am I right in saying that this concept basically came from the behavior of traders on BitMax back in the day? Like, is that a fair thing you say? Yeah, that's correct.

So I think if you speak to employees, you've been working. with Arthur at Bitmex from the other days. This has actually been an idea that he's been pushing there internally for a long time. If you remember back to those days, BitMex was actually a BTC denominated exchange. So the margining instrument for the derivatives on that exchange was typically Bitcoin. And that meant that if you wanted to get a flat position, you would actually have to put on the synthetic dollar position

by basically going short Bitcoin with a Bitcoin Pab. And so really, I think the evolution of Athena was not only really inspired by the blog base that Arthur had originally, but it's actually just building upon this core idea that traders have been using on Bitmex for a while. And what it does is essentially tokenize that basis trade and then allows you to sort of export it through defy into other exchanges. And then hopefully we think traditional finance as an actual product. Yeah. So the quote unquote bitmax dollar, you know, like a synthetic dollar position because Bitmex was a Bitcoin only exchange for a long time.

to work exactly on bed mex like there wasn't a concept of even spot bitcoin but it's like we would basically create an offsetting short position to offset your long position like sterilize the volatility and you get like a synthetic dollar right yeah that's correct so you put up uh whatever a hundred dollars a notional of bitcoin spot on one side and then you'd use the inverse perpetual on the other at the exact same notional so any change in the price of bitcoin uh left that position unaffected and that's where the sort of named delta neutral came from yeah You know, and it's funny because we actually invested in a startup that was doing this some years ago called value. And they were creating a synthetic USD for use in emerging markets with this exact same methodology.

But it didn't work. It didn't work. Because the funding would periodically flip very negative. So I think when I first heard about this concept, I first heard about Athena, I was like, well, it's not going to work. because, you know, sometimes the funding goes the other way. But so I guess maybe that gets us to like the question of how Athena is different. I mean, it's different from also the blog post that Arthur wrote. So what is it that you're doing different structure-wise?

Yeah, sure. So I think there's basically two small adjustments that we made to Arthur's idea. We thought that basically using Stake-Deth as the core asset rather than Bitcoin, for the spot like of that transaction made a bit more sense and was actually uniquely enabled by some of the developments that we saw at the beginning of this year with with with with Chappella and the reason for that is you've obviously got now a positive carry to that side of the trade where you get paid to be long uh ETH on one side and so that yield has ranged somewhere between four to six percent through this year I think there's two interesting sort of outcomes of that which is

a as you're pointing out it gives you an additional margin of safety to cover for of those periods of negative funding that you described. And so where you do typically see positive skewer in ETH funding, where it's on average, deeply positive. So you get paid roughly 7% over the last three years to be short ETH. Adding on this additional margin of safety means that during those stress periods, you do have an additional buffer there. I think the second piece, which is a bit of a byproduct of this transaction,

is when you put on that position of a long-staked deposition with a short perpetual, you're not only creating that synthetic dollar that I described, but you're actually having a yield component that can be tokenized as well next to that. And we think it's actually pretty interesting because we sort of look at the real world and see the US Treasury is basically one of the most important financial assets on earth. It sort of sits on the balance sheet of every major bank, pension fund, insurance fund, and actually sovereign balance sheets as well. But we don't really have like an analogous asset that sits within defy right.

You sort of have the whole of defy running on cash, which is like USDC with no yield. And I think it's quite exciting to start thinking about what happens when you have a crypto native yield that can be tokenized into something that can then be used to compose through the rest of defy as a reserve asset. So that was like the first adjustment that we made. Just think about Stake Deth instead of Bitcoin. That's not to say that we won't sort of explore Bitcoin further down the line. But I think it just makes sense to start with Stag Deth. The second change was actually around the underlying custody of the assets. So Arthur was pretty explicit in his post that you sort of needed to access centralized

liquidity in order for this into scale. So just for your context, open interests on centralized exchanges ranges between 25 to 30 times more than you see on decentralized exchanges. So I think if you are wanting to grow and scale the product that can get into billions, you sort of have to accept the fact that centralized liquidity is needed to achieve those goals. And I think post-FDX, I felt quite uncomfortable. with basically taking users assets and just leaving them on an exchange. And so we're sort of it's waiting in trying to find a solution that allowed us to disaggregate

their custody from the execution and settlement on those exchanges. And so we've seen some pretty interesting developments on the custody side where you're able to separate those two functions and essentially hold assets in a custodian and then mirror them on to centralise exchanges to take out that position. We think that that's a pretty interesting unlock to reduce the counterparty risk to exchanges. and was sort of a small adjustment again to the idea that Arthur had. Yeah, it's interesting that there's a few just market structure things that have changed, which kind of made this possible, I would say, in a safe way,

like this notion of off exchange custody, which is like kind of funny that that's like a new thing. I mean, that's kind of how things should work, in my opinion. That's how things work in Tradfai, obviously. The notion of exchange means it's like vertical monolith that does custody and order matching and margin and like everything is kind of crazy in my opinion. And research and BCC and abruptly. Yeah, right, yeah.

And they invests in the coins, and they list of the coins. Yeah, it's remarkable. It's remarkable. And it clearly there's an unbundling occurring. People have to see unbundling. So that's happening. So that's one interesting piece. The other thing is eith staking now works.

as a concept didn't really, you couldn't really like do the ETH carry trade before. And now as of this year, the whole thing works for your purposes. So these pieces fell into place. And now you can actually do this, which is great. I also forgot to do your background. So let's rewind. And you tell us briefly just like about your story of ingress into crypto and also just briefly what you did before. Yeah, well, I mean, I think the product is more interesting than that, but I have to go through it.

So I started out in traditional finance. I was working a hedge fund in the US, investing across the capital structure into financial services. So looking at everything from broken banks to insurance companies, fintech, and then specialty finance as well. I'd gotten to crypto in 2019 with a friend who was a defy founder. He showed me a defy back then, and I was sort of immediately interested and invested into it on the side of my day job all the way through. until midway 322 when when lunar collapsed. And Arthur actually had another blockhead post which came out a week after Luna. And that was actually the original piece, which I sort of read.

I was quite inspired by and decided to resign from my job to start thinking about Athena. So yeah, that was the backstory. And I think it was with Arthur, being someone that I've sort of looked up to and respected for a while within the space, he sort of informed a lot of my thinking when it comes to crypto and yeah, I sort of read the post and thought this product was too important to not exist in the space and even though previous situations and attempts at it didn't work, didn't mean that it wasn't worth sort of trying trying again. Yeah, that's what entrepreneurship is.

No one ever really has an original idea, I think, or like very occasionally. But like normally it's about taking ideas that failed because the market wasn't ready for them or the technology wasn't there and reapply. them to a new context. It's like a constant story of failure with the same idea and then eventually the conditions are such that it can work. So I think that's the that's the theory here. Now there's so much to cover I think I don't know where to start. So in terms of the short leg of the trade, you made the decision to go for the open interest at the centralized exchanges because with the dexes it's too small basically yeah that's correct and I think one

thing people forget as well is that uh decks is can't even be thought about as sort of like a single pool of liquidity either so uh the largest decks is all sit on different chains right you've got um synthetics and optimism GMX on arbitram and then diva dX doing their own out chain on cosmos so when you actually look at through it like in the perspective of if you're sitting on a single chain and trying to put the product out that we are right now. It's not even like a one to 30 difference in terms of open interest. It's probably like a one to 300 when you're comparing to single exchanges. And so until you find like a unified layer to aggregate our liquidity on chain, I don't think that this concept sort of works. It's not to say that we don't get there

eventually. We are sort of integrating with a couple of exchanges on chain. It's just we took the approach of saying, I'm more, I'm all focused on producing a product that's actually scalable. And useful for millions of people now. We make explicit trade-offs in order to unlock that scalability. And I just want to be honest about what those trade-offs are to our users. And then we sort of walk back from that point towards decentralization when we feel like the market has matured sufficiently on chain. We just want in a position to sort of rest the whole fate of our sort of project on decentralized exchanges, you know, growing orders of magnitude higher than they today. So yeah, it's it's not where we ultimately would hope to be, but I think it's a place that we

can sort of eventually get to once the market matures. And you've been able to strike deals with the centralized exchanges to be able to access that liquidity whilst custodying the coins themselves outside of the ages of those exchanges? Yeah, and it's been a process that we've sort of been through during the funding raise as well, where as part of them coming into the transaction, I made it sort of clear that we would have special requests in order to actually put on the transaction. We explained why we're doing it. We're explaining why we think it's particularly safe, i.e. we're not sort of using leverage on the shorts. We put like particular constraints around the accounts that would exist there. And so it really was a pitching process to sort of say,

do you believe that this product is fundamentally useful and important and should exist within the space. This is what we need you to do to help us support that vision. And these are sort of the constraints that we can put around that to give them peace in mind. So yeah, it was a reasonably like a long process to get that or not. But we think sort of a worthwhile one to give our users what we think is a really good product. So in terms of the funding rate, right, the fact that shorts generally get paid to be short. Can you explain like why conceptually this is a thing? And And also, are there other commodities where this is the case where you consistently get paid for being short?

Yeah, I think there's probably two good reasons that we could point to within crypto. So I think you can think about that funding rate as really just the demand for long leverage within the system. So everyone who's within crypto wants to be longer than one X their net worth because they believe in it. and everyone who's outside of crypto thinks it's a rat poison Ponzi and doesn't want to lend capital into the system. So it's like a very classic capital demand imbalance between the two.

And so you can also see this express, I think, through option markets where typically when you look at equity, put call skews, they actually are sort of leaning towards a put side, i.e. when people are hedging with options against equities, they're paying more for the same delta on puts. Well, on crypto, it's the opposite. People are paying more for the same delta on calls, which is actually just an expression of the long biased nature of crypto, i.e. people are in the market. They always think it's going up, and they're willing to sort of pay for that leverage. And you don't only see that express through the purpose market, but also the option market as well.

For this to be the case, it doesn't have to be the case that crypto always goes up. It just has to be the case that market participants are biased long and that there's an under supply of capital to those participants that want leverage. Yeah, exactly. That's it. There's a bias to be long. It's a firm-driven market. And not enough capital has been supplied to the space to push down that to sort of counteract that force. TPD exactly where Athena plays into that. Because obviously, if we grow, that's a counteracting force to that dynamic. But yeah, as it exists today, that tends to be why you see a positive funding rate three time. I think there's another more technical reason that sits below that as well, which is the existence of baseline funding. So when funding is sort of within a band, on a lot of these exchanges, trading between a band, it sort of flips and reverts to a preset number. So on a lot of the key venues like finance, Pibet and BigGad, if it's trading within a band, it naturally flips to positive. 10% on an Andalized basis.

And so even when it's even within that band, sort of the default number that it's going towards is plus 10%, which obviously helps to drag up a number to make more positive through time. So there's sort of, I'd say, behavioral like reasons and explanation to that. But then it's sort of like a very technical reason as to how they're calculating the funding on these perpetual contracts. Why is that, why is the default plus 10%? I've actually asked this question to a few of the exchanges and never got like a very clear answer. I think the best explanation that I've heard from someone else is that they obviously are naturally long spot inventory on one side.

And if they ever want to go flat against that spot inventory, they'd want to get paid against the natural sort of bias of the market. And so if you're an exchange sitting on a billion dollars of PTC and you kind of want to get flat against some of that, it'd be quite nice to get paid by taking the other side of that position, other side of that position to. to get flat. So that's really the only explanation that I've heard that makes like beg sense to me. But yeah, I haven't had the historical sort of context as to why you have baseline funding at those levels. Yeah, you know, it's interesting. I think post credit crunch of 2022, it's worth interrogating the ultimate source of yield. And so like given that there's a yield here, it's worth understanding like a child where the yield is actually driving. from. And like if it's a tokenized treasury, like, okay, it's like very clear. It comes from the, you know,

government creditors of the U.S. government needing to be paid to lend to the U.S. government. That's fine. With your trade, there's two legs. There's the funding rate, which was actually I didn't know the answer. So that's, that's very helpful. And then the reason why there's a yield for stake teeth, people outside the ecosystem like Bitcoiners, they're always very skeptical. oh, where is this yield coming from? It must be Ponzi. What's your explanation for why ETH is yield? Because you also decompose that into constituent parts too.

So what's your conceptual reason why you're paid for being basically long spot ETH? Yeah, I guess with ETH, it's slightly different way you're sort of securing a network. And then there's two components of that yield. You've obviously got just the inflation rewards that are attached to that, which is just new ETH being sort of printed and given to you, which I think is less of a real yield when you think of it in like traditional terms. And then you've got like actual execution level yields, which is people paying for fees to use the network underneath it.

So I think the analogy I've always used when I'm trying to explain it to people from Tradfeyers, like if you own the equity of like a payments network, for example, and you're getting a dividend yield at the bottom for people like actually using that network, I think it's a reasonable sort of comparison now. but that component of the e-state yield is obviously not the entire piece. There's obviously just inflation and rewards that sit in there as well. Yeah, plus M-AV as well. We didn't even talk about M-A-V, but that's a portion of the yield as well.

So how correlated is the ETH yield and the funding rate? Yeah, I think the correlation analysis we've looked at, and I think this is actually probably one of the more interesting pieces of this sort of basis trade is you typically see like a weak negative correlation between these yields and rates in the real world. So conceptually, that makes a lot of sense, right? When you saw rates go to zero across the curve, QE, you saw rates on chain go in the opposite direction because people wanted to get longer crypto. And so that natural, like, long positive bias that I was describing became more extreme.

And so whether that was on-chain yields or actually funding on centralized exchanges, is you actually saw that number average, like above 20% on ETH contracts at the beginning of 21 for like six months. And then, of course, like as rates come down, people trade more shit coins on chain and the MAB and the execution rewards. Obviously, go up for ETH. And so stake deeth yields go the opposite direction for a given level of steak D. And so that is actually quite interesting that the yields here actually negatively, weekly negatively correlated to interest rates in the real world. world. Well, I think that's interesting is because where we stand within crypto at the moment is you're seeing a lot of projects basically trying to import the yield off chain on chain after you saw basically everything on chain collapse. But I'm generally of the view you sort of want to be building something looking forward 12 to 18 months in the future and think about where is the world going to be there rather than where it exists today. And I think the interesting dynamic is to think when rates eventually do come down, whenever that is from five to four to three, the rates in this product sort of go in the opposite direction. And I think that that negative

correlation there is actually pretty interesting to not only people within crypto, but actually allocators who sit outside and sort of value that diversification. Yeah, totally. So from the perspective of someone that has crypto and now they have the choice of lending via tokenized treasury to the US government or lending to like basically the Ethereum protocol itself or to people consuming leverage. Now you have a nice diversification opportunity. Yeah, I think that's a reasonable way of summarizing. One of the byproducts of having the custody solution in place that we do have is people would obviously compare some of these, like they would talk about the funding rates and centralized exchanges as sort of the risk-free rate of crypto, which is obviously a laughable concept

because like the credit risk of these exchanges is like anything but like risk rate. One interesting, as I said, second order impact of having this custody piece is that you've actually sort of like reduced the credit risk to those exchanges, right, where you've got the assets and this whole basis trade has actually got credit risk to the underlying SBV within those custodians rather than the exchanges itself. And so you sort of move towards something which is a more clean sort of version of that risk rate that I was describing. So the main thing that protects the system when funding flips negative is I guess one thing is that like there's still sort of like presumably positive eth yield which is the other leg of the trade which and you know

I guess is support during those times I guess the other thing is you're going to have like an insurance fund is that part of the contemplated structure yeah that's exactly right you've got the first layer which is Stake D Fields, you've got an insurance fund that's going to be not only capitalized on on day one through basically just raising capital, but then also on an ongoing basis through the life of the product. So if you look at historical data and see the positive skew and see that you on average get paid more to be long than short, you can sort of accumulate that insurance fund three time and not only have to capitalize it through raising funds. The last comment on happened, this is actually one, which I actually has to be able to.

I think might be slightly missed, which is we are not like sort of afraid of the funding rate. It's actually really perhaps really in there as what I think is quite an elegant piece of the mechanism design itself. So that negative funding rate, you can sort of think about it as an exogenous interest rate to the system, which actually helps to calibrate the supply of the stable point itself. So if it's growing too quickly and you're pushing down funding rate across the market, naturally it's going to become less and less interesting for new users to step into it. And so it has a really nice way of sort of calibrating the growth. And it, I think, is in contrast to some of the, like, super reflexive designs that you've seen in some of these stable points of the past.

And conversely, obviously, when the funding rate gets too low or slightly negative, that's going to be extremely, like, obvious to the users, right, on the other side where they can see that. And it makes very little sense to be holding the product on an ongoing basis. And so it is quite a strange user behavior to think about it where you see that this thing is slowly going to start eating. into your principal when the insurance fund is done. And you continue to hold it, right? Right. You probably see that, decide I'm going to go into something else. And in the process of doing so, you're going to have to redeem from the protocol,

which lifts the shorts that we have in an exchange, and then allows the funding rate to mean revert again, a back above zero. And so really, like, it is a risk, and I don't want to dismiss this risk, because it is something that we should obviously discuss and try and, like, get our arms around. But I would say that it's really part of the design. that we sort of want users to be responding to it, and we think helps to sort of calibrate the supply in a more secure way.

Yeah, this is an important part of understanding the system for me as well, was realizing that you're not committing to a rate. You're not like indiscriminately at all costs committing to pass on a certain rate. Like you are letting the system react. I think there's returns to scale and there's disconyies of scale. on both on the both ETH staking side of the trade and the short side of the trade, whereby as more capital flows into the system, it pushes down the yield. Is that fair to say? I mean, that's like a mechanical thing with ETH staking, right?

And on the funding side as well, I think that's accurate. I think it's completely reasonable to think that all else equal, like across the market, if we were to grow into the billions, you would compress the yields on both sides of those equations. What I would say, though, is you sort of, we did look at sort of the interest rate sensitivity that you saw during a pretty unique period at the back end of 22. So if you remember, there's that Heath proof of work, arbitrage trade, where you'd get the airdrop for being long eth, and so traders were long, spot, eth, and then short the future to collect that sort of risk-free air-drop.

What was quite interesting about that period was that open interest actually went from 10 billion to 16 billion in the space of two weeks. And if you looked at sort of what was the incremental impact of adding a billion dollars of OI on the funding rate during that two week period, it's obviously overstating the impact because like six billion and two weeks is like more than you'd ever expect from the stable coin. It's more like six billion over a year or something. You saw basically every additional billion dollars that was added dragged down funding by two percent. So I think directioning what you described there is absolutely what you see in the data. what I would say, though, is that over a longer period of time, and as sort of the derivative

market around ETH grows, we would obviously expect that impact to be reduced. I think the other thing to point out is if you look at the growth into the derivative market last cycle, it roughly like 16 X on ETH from like the beginning of the last cycle's bull market to the peak. And in that period, as I said, you saw funding actually like pushing to the 20s when, when the market was like 16xing. And so there are really quite powerful countervailing, like counteracting forces that can come in here on the opposite side of that,

where, yes, we might be a force that's sort of dragging down those yields and pushing in the wrong direction. But really it's like it's the broader cycle and inflows of like demand to actually be long-eath, which is a much stronger effect against that. If and when we see another cycle come through. So you can kind of plot in your head the yield opportunity on one axis and the market cap of the Athena stable coin on the other axis. And it'd be like a negative association, presumably.

Yeah, I think that's fair. Yeah, if you assume no growth in the derivatives market, it will like you demand coming into Bitcoin. Yeah, but so that's obviously multivariate because the sort of like crypto economy can expand over time as we expect it will. and there would be just more fundamental capacity there. Have you worked this out?

Is there like a market cap size you expect here for this thing to settle out? And is there a size at which it's like basically starts to be uneconomical? Yeah, I think look in the world as it exists today, assuming like no growth or any change going forward. I think like low single digit billions associated with steak teeth is sort of where this thing starts to come into some constraints. then you can start thinking about different assets. So obviously Arthur's original idea was Bitcoin. The derivative market around that is roughly two exercise of ether, as you'd expect. And the collateral base there is obviously enormous.

So I think you can quite easily push into the $10 to $20 billion range if you start to broaden the assets that come in. It's just you're going to be doing that at a worse marginal economics than obviously starting with stake to Ethan. So I think the way we're thinking about this is ultimately that is the vision, right? we want to get to ETH and Bitcoin as assets that come in here. You just need to think about the sequencing as you're running this business right, because I think as you pointed out in the beginning,

it's quite difficult to get Bitcoin to work from zero. You've got a very classic sort of cold start problem there, which is, A, how do you build out that insurance fund in the beginning? And B, how do you actually raise capital for that insurance fund? Because you're sort of taking naked risk that Bitcoin never goes into negative funding, while you haven't got that sort of base embedded yield to actually, you know, produce a revenue stream. And so the way we're thinking about this is start with something that could look like a pretty interesting business on day one that spits out a lot of cash. That's something that's very fundable and allows you to sort of raise capital for that insurance fund.

And then at that point, you can sort of make the decision, do you want to be a profitable business or do you want to be a protocol? And at that point in time, I think you can then decide do we add these other assets at worse economically. And mechanically, what's the structure? So you actually have a couple of products, right? You have the stable coin, then future. Is that fair to say? Yeah, so we've quite clearly delineated between the stable coin itself and the yield component. So it looks functionally similar to dye and s die that you see at the moment.

We've done that. There's a couple of different reasons. One is regulatory driven. So I think just to be clear, US users and stuff can't be accessing that yield. and we just need to make sure that we're taking the appropriate messages there to make sure that that yield component is clearly separated. But we think it's quite interesting to actually be able to take that yield instrument that I described and then use it to compose throughout defy. So wherever you have the USDC sitting on a balance sheet, whether that's backing another stable point like dye, whether that's back another staple point like frax or sitting on money markets,

we think that this is a much more interesting and natural asset to be sitting within those defy applications as well. So it doesn't make sense to hold something that's like completely centralized with no yield or something that's been more censorship resistant, crypto native and has an embedded yield that can sort of sit behind and on top of your own balance sheet and drive those businesses as well. So we're quite excited about having that and being able to sort of use that separate token throughout defy. And is the yield token rebasing or does it accrue? Yeah, it accrues. So the rebasing piece just makes it slightly less efficient to use throughout like liquidity pools and throughout DFI. So what you've seen with like StegD with Lido, which is probably the most like popular rebasing token that you've seen in DFI. They need to wrap it up anyway into something that looks like an accruing token to use in AMMs and stuff.

So yeah, we're copying, well, using something that looks very similar to SDI, which is a yield accruing token. Yeah. It kind of blew my mind the other day when I realized it's very challenging to use native steak teeth in Defi. I think Defi is moving in the direction where it now contemplates the existence of rebasing tokens, but it's still more complicated. Yeah, I think from a user perspective, it's actually more ergonomic to actually just hold that single token that sort of rebases.

But it's actually, I think, from a developer's perspective, just a bit more painful to work with in other applications. So which ETH-staked derivative are you favoring at the moment? No favorites. I would just say that a lot of this sits outside of our own control. So obviously it's massively driven by exchanges of requirements for these things to be liquid and how basically the depth and liquidity of those assets is sort of the most important piece. So Lido-staked-Eath is really the only thing that you can use at scale on centralized exchanges.

outside of their own staked ETH products. So you will know like Binance, OKX, coin base, they all have pretty big liquid staking tokens themselves. And so part of what we're doing is using some of those products as well. If we're putting on the position on that exchange, it obviously makes some sense to use those products. So there's a lot of staked, eith-backed stable coins that are coming into existence that already exist.

We've got Prisma, Liquity, how's this suite, this Libra, this raft. They're all different for the most part. How do you compare yourself to the sort of over-collateralized, staked, eth-backed stables? Yeah, so I think probably the biggest difference is around the capital efficiency. So, as you know, with those type of platforms,

you're putting up collateral on one side and then borrowing the stablecorn and the other. Typically, if you look at the sort of effective collateralization, of those protocols, it runs into sort of the 200%, on average. So you're putting up $2 of Ethereum or stake Ethereum versus every dollar that's being brought into existence. So that's just obviously a fundamentally capital inefficient way of creating stable coins. And part of the issue is that it's like basically inexorably linked to the demand

for leverage on Ethereum on chain. And so obviously using a delta new. mutual design allows you to put in just one dollar collateral to create one dollar of stable point on the other side, which we think is a pretty powerful difference. I think the other piece is actually just structurally think about the yields as well. So if we think about why is it that we've seen stake ether merge as an asset that's backing all of these stable coins on chain, really I think it's just important to remember that like stable coins are ban sheet driven interest rate sensitive businesses where if you don't

have an embedded yield, you don't really have a product or a business. And obviously the dynamic that's probably been the most important thing in the last two years is you've seen Fed fund rates go from 0 to 5% while rates in crypto obviously collapsed from 15 to 20 to less than 5. And so really like all every stable coin issue who's sitting on chain basically face like an existential question of do you want to centralize and start owning like U.S. treasuries directly or RWAs or do you want to onboard stake deep in like a capital inefficient way through these CDPs? And so you're sort of stuck between this dilemma of like, do you want to centralise or do you want to use steak teeth in these sort of over collateralized models? And so stake teeth really, you can just think of it as like the internet bond on chain where it's sort of replacing U.S. treasuries because it's the only sort of asset that's large enough and durable and scalable enough to sort of provide a yield for these stable point businesses. So yeah, I think that that's like one big piece around the scalability. the yield, obviously, we incorporate steak-death yields, but then you also have the basis that we described on the short-feet contract. So that's something that's obviously non-incorporated

into the economics of these other projects. So we think that there's been like an unlock on scalability, and then the actual union economics could potentially look more attractive for what we're doing. It's interesting. I think you can pinpoint it very directly that moment that crossover happened where the trad-fi yield came to surpassed. the crypto native yield, that's when liquidity is sort of being sucked out of the stable coin sector and the market cap of stable sort of sell off. I don't know if I count Terraluna as part of the market cap, but let's say down from 150 billion or so down to where is it in 120-ish billion today. Yeah. I think it's still shrinking, actually. I haven't looked in the last

couple of days. It's still shrinking. And it's funny because like the big centralized stable coin issuers, they are sitting on a gold mine in some sense in that their cash was paying them zero and now it's paying them whatever, 550 bibs. But at the same time, their business model is kind of going away because the supply is shrinking because people are like, okay, well, the convenience yield of holding the stable coin isn't high enough to induce me to stay in the asset. So I'll just go back to Fiat. And so my view is they're being forced into a choice like they'll have to as these new insurgent stable coins that yield that pass on a yield whether it's from trad fire from crypto like as that challenges their business they'll have to move towards interest bearing or they'll just slowly become obsolete

what do you make of the choice that the big non interest bearing stable coin issuers face yeah I do think it's different it's basically it's the story of like like Tether versus everyone else. So I think part of what you're pointing to and it's something that I think we've discussed in the past, which is there is a different stickiness between UST holders and interest rates instead of USCT holders just because of their ease of access to some of those traditional finance rates are described. That's true. Tether is like the weird outlier where somehow they're at all-time highs despite paying zero. Yeah, exactly. And I think part of the reason behind that is they really attained like what can be considered the holy grail which is they are actually

money like tether is the base pair on on transactions on these exchanges so sitting on as sort of the the other side of the main bitcoin and eth pass on exchanges it's used as money on tron on eith and when you go to like third world developing countries it's actually used as money i don't think you can sort of extend the same to USTC where it is embedded in a lot of those financial applications and in defy but it hasn't sort of infiltrated into exchanges in the same extent that UST has and that just gives like UST basically an enormous ability to basically not pay out on the other side because it's actually used as money and I think it's something we've spoken about in the past which is the holder base looks very different where it's it's typically like large Asian holders Asian entities

holding Tether and they have less ability to go out into money market funds or treasuries in the US. And so I think my view is Tether isn't such a strong position. They're always going to be able to basically internalize all that yield. And what that creates is basically one of the best looking business models that's ever existed, right? It looks like a bank which pays zero on the deposit side and earns like 5% with no liquidity risk, no duration risk and like no credit risk because it's just the US government on the other side. And I think the number of the, last number I saw was 60 employees sitting in there running the whole thing. So that creates like a pretty incredible business model for them.

And I think that they've got an interesting moat around what they do. I don't think the moat is impenetrable, but it sort of allows them to actually keep more of that yield versus some of these competitors. Something I think you've seen. And it's really probably going to be circle USC who feel most of the sort of pinch through that dynamic that you're describing, which is new entrants coming in, providing a functionally similar. product, but then paying out some of that yield. I think you've seen some of that pressure with some of the various that you probably saw on Coinbase in the last few weeks where it wouldn't surprise me to see them sort of start

to have to externalize some of that return over the next sort of top to 30 four months. Yeah, Coinbase is now paying, it's not called a yield, but it's like a marketing expense is how they're coming for it. So it looks like they're passing on the interest. But according to the accounting, it's actually marketing. So, yeah, I agree. They've reacted. I think they see where this is going.

The challenges in the U.S. You basically can't do this. I mean, you can't pay yields to U.S.D.C. holders off platform to U.S.D.C. holders on chain, not without probably significant modifications to the protocol. And, I mean, we were looking at deals about interest-bearing. stables in the US. And it became clear to us over the course of 2023 that it wasn't going to work. So most of these new businesses, these new stables that bear interest, they're just going to be XUS as far as I can tell. Yeah, I think that's fair. That's how you're approaching it as well,

right? Yeah, that's right. We're not in the US. And yeah, I think that's a very fair assessment. I mean, I think part of the case I was bought against, or what we saw with, with, with taxes and BUSD going shut down. It was actually BUSD being classified as a security as part of that, and that paid like zero interest. So I don't know how you could look at that piece of history and think that you could get away with paying interest when that didn't and was classified as security. Yeah, and it's funny because the BUSD security analysis was farcical, in my opinion. You know, I thought it was absurd. But there's different tests. People don't know this, but it's not just all about Howie.

There's another test called the Reeves test where it's different kinds of instruments. It can be alleged to be securities. I think they were probably relying on the Reeves test in that analysis. But it certainly becomes easier to make the case as the regulator if there is an interest component. In fact, it's trivial to make the case at that point. And this is something that perturbs me

because it's basically another force for offshoring the crypto industry, offshoring balance sheets from the U.S. having it go. I mean, we were both in Singapore recently. Like you saw the energy there and the excitement, but it's also a very sad story. I mean, the US is just being descentered as the center of the global crypto capital markets. But I don't see anything that's going to change that. Yeah. And the other interesting, I think different perspective on this is, I think actually withholding the interest from users on the other side actually does them more harm than good. But like it's basically harmful if you think about the fact that they are taking risk to hold

risk to hold this product and it is not risk less. And I think we stole that in multiple occasions in the last 12 months where the users are taking that that sort of risk of DPEG and they get none of the return on the other side. And so actually there should be some compensation for the risk that they're holding. And, you know, Circle is put in this strange situation where they sort of are told you can't distribute that return. But at the same time, it probably on a risk adjusted basis, it makes more sense of the user on the other side, right?

Yeah, like what would you ask to be paid in a exchange for being an unsecured creditor of circle. For me, the number is above zero, you know. What do you make of PayPal, P-Y-USD as it's called? Are you excited about this project? Yeah, no, I think it's obviously incredibly interesting to see that a firm of that size and prestige is actually coming into the market at this stage of the cycle, right? I think that that's probably the most important piece for me, which is this is not one of those, uh, that's, loud marketing campaigns that you see at the top of the cycle where it's a Starbucks NFT or whatever it is, which seems a bit meaningless. This is like a business taking a very

thoughtful decision about their business over the next 12 to 24 months and really think about the technology, I think, at a deeper level and how it impacts not only their existing business, but what they can sort of deal on a go forward basis. So to me, that was actually the biggest takeaway, which is that they're engaging with this technology when hype is at an absolute minimum rather than maximum. And I think that that's just a very strong endorsement for stable coins in general. I don't really have differentiated views in terms of what size they sort of grow to in the next few months or years. They obviously have incredible distribution.

The question is like how hard do they want to push that product in the context of their existing business? Because I think there's a very strong case to say stable coins actually are a very real threat to actually the business model that they have. and there's a real question around whether this is like growth or whether it's actually a defensive move for their existing business. So I think if the number is like 100 million, a billion or 10 billion, it's actually really just a question of how do they see this product sitting in the broader context of their own business as it exists today and how hard they want to push it, given that.

Yeah, there's a very, very interesting blog post from J.P. Conig. I don't know if you saw it comparing PayPal's non-crypto, let's call it a stablecoin, aka just balances in the PayPal app. So I would argue they issue two stablecoins, one where the liabilities circulate on their own proprietary database. That's called just using PayPal. And then the other stable coin, which is a stable coin where the liabilities obviously circulate on an open-loop blockchain.

So I see that as an extension of their business as well. J.P. Koenig made the point that because stablecoins, are the way that they are and they're regulated in New York or at least this one is. The PayPal stable coin is much more secure

from the perspective of a user than the orthodox PayPal product where there's a lot more exotic stuff on the asset side, a lot more duration, a lot less liquidity on the asset side.

It's only like 30, backed by short-term treasuries. Whereas the stable coin is bankruptcy remote specifically. That's very clear under the New York trust that they're using. And it's 100% backed by short-term treasuries or maybe there's a reverse repo element in there as well. It's also basically cash backed. And so it's kind of weird that the two products are almost identical like functionally. But then because one of them is stable coin, it's way more.

secure than the normal business which just tickled me to no end. I found that very amusing. Yeah. Well, Guy, this has been really great and, you know, ever since I learned about Athena, it's been like a mind virus for me. So it's been very interesting to kind of walk through your thoughts here and understand the mechanics. I'll ask you the same question asked Peter Johnson on our on our prior episode, which is how much of the market cap of stable. Do you expect to be interest-bearing within, let's say, two years? Yeah, so unfortunately, I'm not as bullish as you, but not that far off. I think 10% is probably like a reasonable area for that to go to.

I think it's like just under 2% at the moment. But I do think that stable coins themselves have a 10x in them over the next three to five years. And so 10% on a 10x on like stable coin market cap is still a pretty big number. it's basically the size of the whole stable coin space at the moment. I just think a counteracting force of that is just going to be tether. I do think that they continue to be dominant. And I don't see them paying interest just because of the privilege that enjoyed through the years. They don't seem interested in that at all.

You guys are launching. You're not live just yet, right? Are you about to launch? Yeah, that's correct. So we'll be out in about a month. It's going to be a pretty slow and controlled rollout, where we're just sort of using internal funds and making sure. that it's all secure and ready for public.

And then we'd be coming out probably a month after that for public funds to come and test. And you are on Twitter, your leptocertic, right? So thin tails, I guess, right? Is that a reference to Athena specifically and that you very much want the thinnest tails possible? Or is that just a good sense? It's not actually I think Yeah the background for that

It was just more That's where I think the magic happens Is usually in the tails It's when people are sort of underestimating Either the downside or the upside thing So yeah There was no sort of Nothing more special behind the name

It's one of those things You create the name And then you like immediately Regoded a month after When people are wanting explanations Well this has been great I can't wait to see you come up with here And the growth of Athena

Thanks for joining us It's been awesome Thanks so much, man. Cheers.