On The Brink with Castle Island - Kyle Davies (Three Arrows Capital) on finding value in DeFi (EP.120)

Episode Date: September 2, 2020

Kyle Davies, co-founder of Three Arrows Capital, joins the show. In this episode we discuss: Kyle's perspectives on layer one blockchain protocols and how smart contract platforms are evolving The decentralized finance (DeFi) landscape, and where Kyle sees the biggest opportunities The blurring of the lines between centralized and decentralized finance platforms Learn more about Three Arrows Capital: https://www.threearrowscap.com/ Follow Kyle on Twitter @kyled116

Today on the podcast, I sat down with Kyle Davies, co-founder of Three Arrow's Capital, a hedge fund focused on crypto assets. Kyle and his partner, Suu, are two of the most thoughtful people in the industry, and they're at the leading edge of many in the projects in the defy category. In this conversation, we discussed a range of topics, including the current state of defy, the blurring of the lines between centralized financial services and defy, in the current regulatory landscape and the potential implications that this will have on projects and companies in this industry. This conversation was a lot of fun, so without further ado, here's my conversation with Kyle Davies. Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American

International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. Evanington has pumped 75 billion pounds more to Britain's ailing economy with a new round of quantitative easing. You print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called a Bitcoin. Bitcoin.

Kyle, well, thanks so much for joining the podcast today. Absolutely. Thanks for having me, Matt. So much to talk about and you guys are involved in so many parts of this industry. So we'd love to just start it with a little bit of background on three O's capital and how did you get into this industry? Three O's. We started it eight years ago.

we actually started in FX markets. And for us, it was kind of the story of dabbling at first. And starting from a point of arbitrage, so we were looking at the futures basis in 2013. It wasn't really a big desk for us. We were very much focused on other assets. And it wasn't really until the last market cycle, 2017, where we realized we really should have a desk. And then 2018, we pivoted the whole firm.

And now that was pretty much all we do. And when you started in FX, was Bitcoin even on your radar? What was your kind of origin story of even understanding what this stuff was? For me, it was just an asset that had arbitrage. So we were looking at the BTC China trade. We were looking at the normal futures basis that exists today, except at the time it was on icy bit versus spot. I think the thing about a lot of trades is actually, if you boil them down, they're actually

pretty consistent. The future is basically exist in commodities, FX, a lot of different asset classes. It's just more how you execute it, where you're trading, how you finance it. It's very much a financing game. For us, it was not digital gold. It was not about decentralized web. It was very much about a asset that had arbitrage and that we knew we could trade. Yeah.

Well, that makes sense. And certainly it's worked out well. So you're a Massachusetts guy, but you're now in Singapore. So what was the backstory there? And talk a little bit about just Singapore as a jurisdiction for doing what you're doing. So we moved to Singapore for FX reasons, actually, when we started our fund. And the reason there was we were trading emerging market currencies, what is termed non-deliverable forwards. So these are restricted markets that settle in dollars.

Singapore is very much a hub for that. Furthermore, Asia is a hub for that because that's where a lot of restricted markets are. So China, India, Korea, Taiwan, Malaysia, Indonesia. these are all restricted markets. Each one of them has a pretty vibrant and pretty liquid NDF non-delivable forward market. So that's why we're here. But yeah, it turns out it's actually a pretty good place to do crypto too. We're a regulated fund by the monetary authority of Singapore.

Our auditor, our fund admin, our regulator are all pretty favorable towards crypto. And furthermore, there's a lot of projects here. So in Defi and outside of Defi, there's actually a lot of founders or teams based in Singapore or around the region. Yeah, we're noticing that too. And certainly a lot of talent is moving there. Is there something that's recreatable in terms of what Singapore is doing? Is there a playbook that other jurisdictions should be paying attention to? I wouldn't say that Singapore is one yet for crypto. I would say it's doing well, but I don't think it's submerged like the number one jurisdiction. Like it's really not. There's some new regulation coming out that they just announced the FATF regulation, which is unfavorable towards a lot of

crypto rate. I think people forget, but a lot of the early exchanges actually were founded in Singapore. So Itbit, for example, was founded in Singapore. Coin was founded in Singapore. Both of them got their banking pulled on them in 2015. Itbit went to New York and got a bit license, and coin went to Tokyo and became regulated there. They didn't even go to weird jurisdictions. They went to like New York regulated, Tokyo regulated. So yeah, I think by and large, Singapore's kind of had a checkered history with crypto, and they seem to be on the right side of it now. It's not a given. It's really not. It's Singapore Inc. Yeah. Well, that Fadif rule that you mentioned in the set of rules that are coming down as a result of the travel rule, that's going to be

interesting to see how that all works out. Do you have a perspective on what that's going to do to the industry yet, or is it just too early to tell? I don't have a strong view. I'm not a lawyer. My inclination is that it's not going to affect funds, but it will affect projects and potentially users of those products do. But I don't know. I mean, I'm really not a good forecast for these kind of things. Yeah, want to transition a little bit and talk about some of your portfolio. So your portfolio page is really good because it kind of spells out the different pockets of the industry and you have exposure to a lot of it, obviously. So I noticed that you have Bitcoin, Ethereum, and Pocod. So I'm curious, what is your kind of thesis around just the layer one blockchains and what's your

general point of view on these assets competing with each other or collaborating with each other? Right. So these have been relatively. longer-term positions for us, and those are our largest positions, too. So Bitcoin Ethereum being the largest by far. And our thesis there generally is that there's going to be lots of experiments, but some of these experiments have been running for longer than others. And Bitcoin itself is an experiment, right? But I think the idea here is that there's a Lindy effect to a lot of this. And a lot of people talk about the Bitcoin Lindy properties, but Ethereum is also to a certain extent as well. Like what people are building on it and it's more battle tested.

That's why DFI is built on Ethereum. And there's other places that it could be built that are already live and have been live for a while and it's just not there. And then the assets are on Ethereum, people trust Ethereum and it's composable. There's lots of benefits of it. And there's new things that are coming out that are helping with scalability. Our bet basically is on KokaDOT, but there's others too. And it'll be interesting to see how that plays out. Yeah. So speaking about that, so you mentioned that all of the DFI stuff is happening on Ethereum right now, yet there are, the past two years, we've seen just a broad swath of Ethereum competitors, Ethereum killers, whatever you want to call them, largely backed by VC firms.

What do you see happening here? Do you think that we will live in a multi-chain world where defy is built on multiple different chains here? Is it winner take all? How do you think about it? I don't know. Like the end state, I've got to ask a venture capital. I've got to ask you guys what you think the end state's going to look like. But for me in the near term, if I just ask projects where they're building, I usually get a twofold answer. The answer is, well, we're launching on Ethereum, obviously, because it's the only place we can launch and we want to be interoperable. But then they start talking about scalability and they start talking about either layer twos or other protocols. They have to have a plan, right, especially if they're higher volume and they're worried

about more gas fees. So I think no one can rest on their laurels here. I don't think Bitcoin can. I don't think Ethereum can. I don't think anyone can. But I just think Bitcoin has the largest head start. I think Ethereum has a large head start. And I think the next projects that are coming out, they're going to need to prove themselves. And there will be winners in this space for sure. But I just don't know to what extent ETH is going to build out. And I don't know to what extent projects will actually need a lot of these scalability or if they are just more happy being interoperable. One thing I wrestle with a lot is think about some of the head start that Bitcoin had just around doing a fair launch. And that's really difficult to recreate.

I wonder if we'll ever be able to see something like that ever again. If you tried to do a fair launch right now, you'd have a bunch of VC firms buying up A6 and trying to mine all of the supply on the first day. In a similar way, Ethereum had a big head start just in the fact that Vatelic was on a plane for two years talking to developers. And it has such a vibrant developer ecosystem. And that's going to be really difficult to kind of port those developers away. Do you see any of these projects even closely competing for developer minds?

share versus Ethereum at this point? I think it's all competitive. I really do. And I actually think that there are certain things that kind of don't need to be as shilled. And I actually think Ethereum really does not need to be because it's actually useful. Now, it's actually being used. Things that are used don't necessarily need to be shilled as hard. Bitcoin does, by the way, because it's different.

If you convince, I think Hasu likes to call it a Nakamoto scheme. And the idea is that if you are talking to more people and convincing more people and you make more noise, then more people will buy it. But that's because generally speaking is being used as collateral to trade and or being held. But if you're talking about Ethereum, yes, it has gone through a phase where there was also the case. But I don't know if that's going to be the case going forward. And I don't know if that is the case right now anymore because people are using Ethereum that don't want to. They would like to build in a more scalable way with higher throughput, but there's no choice for them. If they want to launch today, they are launching on Ethereum.

And if they want to hitap pools of large liquidity, and if they want to have large assets staked on them, it's going to be on Ethereum. So I don't know how long that's going to be. That is a moat right now, but I mean, I don't think anyone wrestling their laurels. I think people are always building. I just think a lot of this stuff is Lindy to a certain extent. And yeah, I don't know. that's the current state. Yeah, I want to stay on that DFI track a little bit, actually. And so you're a

fund that's quite active in DFI. So what's your kind of overall view of what's happening in this category right now? And if you think about it from an investor's perspective or trader's perspective, what are the best opportunities? Well, I should say first, I should preface this by saying we have a portfolio manager that trades our default portfolio. So my view actually is not so important. It's much more his view, and I can tell you broadly what he's thinking, but more or less the way I'm looking at it is the first wave is where you could build, and you could only build on Ethereum. People have looked at other things. I think Cosmos has been around for a while, like actually all of DFi's on Ethereum. There are other projects that haven't had a shot yet. One might argue that Solana or

Pocod or NIR, those guys are coming up, and they are now having projects built on them. We will see how they do. And I'm not averse to that. Like I have invested in Pocodot, right? But I think, like, if we just look at the track record, obviously the U.X hasn't been the main problem. It's been other things. It's been like, can you stake certain assets in a certain way? And can you benefit from the yield of all protocols? Yield aggregators are a very big thing right now. Wi-Fi is doing, right? Yeah. And can you then use the collateral that you have to trade or stake it to provide liquidity for other people to trade? And I think that has been the main concern, and that is the current state of D-time. I think that better U.S. is getting better or will continue to get better, and maybe the more

specific use cases, like very high throughput or whatever else. But then the question, obviously, is also why not just go trade it on a centralized exchange? That's always the question. So there's also an extent to, like, so if you could trade super high volume in a very low-latency way, clearly that experience is even better on a centralized exchange. So given that people have built defy to what it is today and are using it to what is today, Gini swap trade 200 plus million to what it is today with a horrible UX, like relative to what you can do in a lot of other places.

Like the UX is pretty bad, but people are still trading. So obviously it's not the hook that draws people in is not the ultra high throughput or the very low latency or, the very low, like, that is not what has drawn people into defy. It is something else. I guess that's my main point. With these new things coming out, I am bullish to see how they come out and like how people use them. But I would just say that's not the reason why people are using it today. They're using it despite the other side. Yeah, I think what you're saying is really important. It's something that I've really wrestled when I try to explain what's happening in Defi to people

that are more in the traditional financial services world. Because I think if you look at it just through the lens of here's a new type of trading technology and new types of exchanges, it just looks inferior across the board, right? It would be like looking at the early days of the internet when it took 30 seconds for a page to load and being like, hey, this is just a terrible way to read a newspaper. This is never going to work. But it clearly was just a building block. What about stable coin yields?

I guess that's kind of my question is when you look at this space, do you think, think that these are just kind of like market structure opportunities that we're seeing right now. And that's really what is drawing people in in terms of, hey, you're able to yield a lot on a stable coin. And so we're seeing a flock of traders come in. But longer term, I guess, what do you see as the more kind of enduring things about defy? Because I would argue that we'll probably start to see yields come down as market structure develops and things get more mature. So some of the things that are really interesting now probably become less interesting at scale, if that makes sense. Yeah, I guess the way I'm thinking about it is like you've got a centralized exchange, let's say, that has a funding pool that you can provide liquidity into. Some can, some can't. So you have an overnight rate there. And then you also have maybe like a derivative platform. And then you've also got like a spot platform. And this single centralized exchange allows you to participate in maybe those three things. But it itself is a rentier. It itself extracts a lot of that value.

And I think the promise of defy as it stands right now is that you can kind of unbundle that to a certain extent. And you can have a lending platform and you can have a decentralized derivative platform. And you can have a spot platform. And you can have a lending, a borrow and lending platform. And you can have, and these can all be different. These can all be different pieces. So you can have actually three lending platforms that are all competing. And then you can have five decentralized derivative platforms.

But you can have a bunch of these together. And then you can have aggregators. and then you can have like, let's say, one that aggregates to the best yielding platform at any given time, like, for lending. I think the promise right now is that the users can, in a sense, become the owners, and can in a sense benefit from a competitive, decentralized platform, right? So, like, the yields right now, thanks to a lot of this yield farming stuff, is super high. But if you just want to hold a stable coin, you can do that, it just yields a hell of a lot higher. D-Fi than it does in centralized finance.

Like imagine you could then take that and you could go use that as collateral potentially to trade on another platform. So instead of your collateral yielding zero, which it may on certain exchanges, or if they're generous, they give you some yield, now it could be the best of yield of all the other platform. Yeah, so I think that's part of it. I think it's scary how layered it is because one piece could flick, could cause that cascading effect.

But as it stands right now, it hasn't happened yet. And the promise is beautiful. So I think the community is just going to have to go through this and understand the risks and probably appreciate audits someday. And we'll see how that works. Yeah. So the community ownership to me really is the big breakthrough here. And you're starting to see these yields, I think, as a result of just that new monetary asset that is created to facilitate that ownership. So as that asset increases in value, obviously these yields are going up. I guess a couple of derivative questions off of that. One thing I'd be curious to get your perspective on is just governance and kind of how decisions are made on these platforms and how people vote on changes. Do you see that as something that is important? Do you think about it? Is it just kind of too early to have a point of view on how protocol changes and updates to these platforms will work in the future? I think it is important. But I agree with Vitalik's post.

I think he's done it a couple times where he said protocols should start his dictatorships and then become. communist later or something to that effect. And I kind of agree with that. So you start off, maybe he said did they become democracy, but yeah, you start off where there's probably a lot of centralized control and the better ones maybe give up more, but it's still

going to be fewer parties. It's going to be like 10 or so parties that control everything, probably less. But over time, especially if you allowed some liquidity mining, before you know it, the liquidity miners actually have a material control, or at least a material vote. And then, hopefully there's some

utility that comes in too. And then the users, the users will also get material vote. And then so like over time, the dream is that it moves kind of from this oligopoly down to more of a democracy of the users. And because they had early rewards and maybe they still hold some of the tokens, if the community is strong, then users become the owners. And that is like this beautiful utopian vision that is a lot of decentralized finance. The users are the owners. I think that experiment's still playing out, but in some ways it already has. I mean, if you look at some of the early D5 projects, the only reason they are still going strong is because they have a strong leader and very strong followers.

And that's because they were rewarded early. They keep being rewarded and they have a material impact on the governance. So this is another way to say it. It's very hard to hold something up 2x. It's even harder to hold up 10x. But a lot of these are up 100x now. So who is holding stuff up 100x? Well, it's only if you have some control over the governance.

That's the only way you could really do that in a large way. And I think the reality is they do. They have material ownership, usership, and governance. Yeah. When you talk about some of these gains that we've seen in Defi and just the growth of the segment writ large, it has not been because of institutional adoption. It's not because there's a bunch of byside firms that are like piling into this stuff. People always talk about the institutions are coming, but they're nowhere close to DeFi, in my view.

I guess my question to you is, is this a category? that necessarily needs institutional kind of long only allocators in order for it to be interesting, longer term? How do you think about that? So I think the beauty of it is the users are the owners. So I think if you are not a user, but you want to be a speculative owner that has sick games, you are shit out of luck right now because if you're not a user, you may not earn mistaken rewards, for example. There are actually some firms, not going to name them, but that have been in some of these for a while, but didn't stake because for regulatory reasons or, they're not trading firms or whatever. But the staking rewards are like high double digits. So

obviously that's irrational. It's basically not supposed to be like that. It's supposed to be the early users, early contributors are rewarded for making it better. And then are rewarded in two ways. One in inflation, token rewards, but also in ownership and also in governance. I mean, at the end of the day, like a lot of it's, how well can you like hold hands and huddle? Well, you can hold hands and a lot better if you control the thing with governance and you have material ownership and you are rewarded all the way through. You know, it's easier for you to make a strong community. And I think some of these actually have pretty strong communities. Yeah. One of the things I wrestle with just in terms of that institutional kind of adoption, obviously there's just big pools of capital that are

interested in crypto, but I think the narrative around defy is a little bit difficult for them to get over. It's one thing to wrap your mind around digital gold or like non-sovereign wealth stories. It's an entirely different thing to explain yam farming and things like this. What about just trading? What about just being like on Uniswap? You're not farming on Uniswap. Those guys are not owners yet. And users are not owners on UniSwap right now.

But it's trading like 200 plus million a day. But in a lot of non-Defi-oriented people are trading it just because that's like you want to go buy your tokens. Like that's where you do it. People do the same thing on IDEX too back in the day. And I think it's just actually useful. It's actually like the actual use case. And then maybe it pulls them in, maybe it doesn't, who knows.

But the goal of these protocols is not to reward this dodgy old institution that just wants to like buy, hold and get sick gains. It's supposed to help build the protocol, not by lots of VC funding, not by lots of founder ownership. It's supposed to reward it by giving it to the community. It all works because they help with the governance and they become the owners and eventually, like hopefully they build them. Yeah, so I think this community ownership over financial market infrastructure is a big theme. And I think that that is something that people will be able to kind of coalesce around. I think it's almost feeds into this frictionless capital markets kind of future that we're going to live in where things are transacting more peer to peer. I guess one barrier to that right now, though, if you look at defy, would be if you're looking at it through the lens of a traditional centralized finance perspective, you're looking and you're saying, okay, well, show me how best execution happens. And how do you onboard customers with KIC and like all these things that just don't exist in defy. And so it's sort of just a completely different thing.

I don't know. I think the hook is two things right now. These are the two main areas that we've invested in or three main areas. It's borrowing lending. It's trading. Simple products, not options, but just Delta one product spot and soon to be Delta one derivative. So futures and perks. And then the third will be stable coins.

Our portfolio is heavily in those three areas. And I think arguably, in some way, all three of those have actually made compelling, competitive use cases right now. And it may not be the entire platform, but I can name at least one firm in all those categories or at least one use case in all those categories that like a non-DFI believer would still want to trade this because it is actually a better spread, better experience, something for them, right? Right.

You mentioned kind of the centralized exchanges a few minutes back. And I want to talk about that because you guys are investors in. Deribate, it's one of the fastest growing companies in the space. How do you think about that centralized exchange landscape and what that looks like now and where you think we're going? Yeah, I think that right now, it's still hard to compete with a lot of centralized exchanges in terms of throughput and latency, lots of normal things that centralized exchange would focus on. But I think particularly for options, there's many Oracle collateral reasons why that has been hard. We made a very small investment in one. But we generally have kind of tried to

away from that space because it's already a hard space to do well. I mean, there's been many, many comparators of Deribit. There is one winner, 90% market share. And then if you were to look at the CME, CME has also, I think, second biggest market share. Only Americans, mainly institutions. You put just up two graphs of the open interest. It's one for one. So it's hedged down to Deribet. So really, if you look at Deribet's market share, add the CME, probably add everything else because it's all hedged there. 100%. It's just not an easy market to do for collateral reasons, for liquidity reasons, for quoting all the strikes at the same time. Because you don't just hedge one dot on the curve.

You hedge all the strikes, all the tenors, all that. And for that reason, for collateral efficiency reasons, it has tended towards one window. And shockingly enough, they only have a couple products. They've got Bitcoin and they've got Ead. And they've only got futures, perps, and options. That's it. So there's a bunch of stuff coming out soon, which they'll be announcing.

But, yeah, I think, like another way to say it is the U.S. like we said, for defy, like not so great in a lot of ways, yet still it is trading a lot. For options, you got a platform that until March of last year only had Bitcoin. Literally Bitcoin, future per option. That's it. And still, absolutely dominant in the space. So despite having nothing else, no shit coins, no ICOs, nothing else. And I think that just speaks to how hard it is. We just saw that team. We like the guys. And it's our largest equity investment. I want to tease out a little bit what you're saying, because I think it's really insane. insightful just around how the growth in the CME product and some of the more regulated exchanges

in the United States actually benefits the likes of Deribate. Can you speak a little bit about that in greater detail just around the hedging of these positions on Deribit and exactly how that works? I think they're just different users, actually, because if you look at the margin requirements, the CME is very high. Like, actually, all the U.S. regulated exchanges are pretty high. And then if you look at what you need, you need a brokerage account. You can't just open an account directly with the exchange, no KYC or whatever. On Deribet, below a certain minimum, you can non-KYC on, and above that, you need a KYC, but it's pretty seamless. It's just like one exchange. For a CME broker, you need to onboard first with that broker, then negotiate commissions,

and if you want to trade high frequency, you need to set up co-location, you need to set up a lot of things. Yeah, I think just by and large, what that's tended towards is its institutions, and it's mainly U.S. because Derbitt doesn't have U.S. users. So, yeah, I think those are the users that have been on there, but 90% of the market share is on Derbit. So, like, obviously, if you want to go hedge your option, if you're a market maker and you just got hit on the bid, like, where are you going to go hedge that? You have to hedge it on Derrick. Generally speaking, that's the way of liquidity profile goes. So speaking a little bit just around the quality of the infrastructure that you use to manage three arrows, when you think about just the critical

kind of market infrastructure that a fund needs in order to execute trades and move assets around, when you compare crypto to other asset classes that you've been involved in, where are we now and what type of improvements are on the horizon here? I think it's getting reasonably comparable. So in FX, for example, you would expect every connectivity to be fixed. You would expect everything to be co-loaded. You would expect aggregators. And you would expect service providers all the way down,

like people to help you manage all of that depending on how sophisticated you were. And a lot of the times your broker will help you manage all that too. In crypto, it's still not quite there. Like, I think most exchanges are getting to the point where they have Kolo now. But even still, like, the throughput, the dropping during like periods of high volatility are not easy because they, I think a lot of these exchanges, they're managing different problems. There is a beauty to having brokers because then you have fewer touch points to the exchange, which means that you can manage much higher volumes.

You don't have like, I don't know, 5,000 people connecting all at the same time. You've got 100 and you can manage those. Yeah, so crypto is definitely solving a different kind of problem, and they've chosen to do that, mainly not via brokers or memberships, generally just to allow everyone to connect all at the same time. But yeah, it's definitely changing. And how do you guys handle your defy business? I mean, this is just a totally wild west thing, right? There's no kind of order management platforms for defy, I don't think. Yeah.

So for that, we have a separate manager that looks at it. But it's more a question of security and secure operational procedures. things like that, and then analyzing credit risk and more contract risk and yeah, and then having a thesis. Like I think one of the big problems, one of the reasons we were able to get into a bunch of deals is we did not have the baggage of flipping lots of stuff in 2017, which a lot of funds did. Reality is like I think if you looked at these investment rosters, now it's the hoddlers. It's like the people that A, either have like never sold a token of which there's like one fund that I can think of that we've co-invested with. or framework. There's others that generally are known to work closer with teams and generally help with

tokenomics or distribution or something. You've got to help. You've got to provide some value because at the end of the day, they're not raising that much money. These rounds are pretty small. So, like, the way we've thought about it is just that manager has his own thesis. It's been very much longer term. He holds things up 10, 100x and still hold them and still has, like, target prices higher.

And the only way he can do that is because he's involved in the government. and he's involved in the ownership structure and it is like a community. That flipping was definitely something that we saw a lot in the kind of previous run-up and the ICO boom and bust is that there were just not aligned incentives with early stage investors. It would be like having a seed investment and then just dumping it into the A round, right? It's just incompatible with how entrepreneurs want to engage with their investors. Yeah, and I think that kind of weeded out a lot of investors because it's actually very hard to get into rounds. now if you're known as the guy that flips everything like on the second half.

So I think it's actually really important to have a longer term thesis and be able to work with teams and provide some value in some way, whether it's staking yields, governance, or design or something like something. You've got to provide some value. You can't just buy. People don't want people that buy a model forever. They also don't want them to like flip. They want them to provide some value because it's supposed to be community. Who's on the cutting edge right now for mechanism design when you look at this industry, who really gets how to design these protocols and how the monetary asset works? We work with two teams pretty closely.

So one of them is Delphi Digital. They have a research product. They also have a token design product. But we work very closely with them. I think they've been at the forefront a lot of these. And the other one would be gauntlet, which has generally been more research focused, but has also been very much involved in the DFA community, both on the governance and the design and research.

and I think both those firms put out really good content. Yeah, I agree. They're both great, both New York based, I believe. One of the things that I kind of riff on with Nick from time to time is, you know, as you alluded to, there is a lot of smart contract platform risk here. There's a lot of potential things that could break with a number of these protocols. And we're going to get to the point where more and more smart people are going to start looking at these things as the bounty increases, just the total market value.

So how do you think about that risk and how do you kind of, Think about it from an underwriting perspective even when you have the ability for really smart people to figure out how to break some of these things in front run them. Yeah, I think it depends. Like it certainly will happen, but it depends on how it happens and who it happens to. Because if you think about it, if you looked at the top gas users on Ethereum for the past like three plus whatever years, there's Ponzi schemes all over it. They're just in China. And so they're not affecting you. They're not affecting me.

They're like remote. and somehow we like annoyed that the gas is high sometimes, but we kind of don't care. Those people are losing money, and somehow we don't do anything about it. So I think that's kind of the point here. If a large defy protocol were to amass 500 million of assets from you and me or from people that are doing this full time,

and it goes down, like that would be devastating, right? Like we would potentially pull out. We would potentially try to have all sorts of legal action if we could. Like, there would be very large consequences. But if you're going after, like, small retail in some small area and it's like outright quantity, somehow there's, it's very remote in our brains, even though it's happening on the very same platform. I always find that a little bizarre.

But yeah, so for this, like, I think it depends who it happens to. Like, the parody hack was pretty big one, right? It affected, like, people that were very central to the Ethereum community and, you know, probably set a lot of people back. Like, maybe they thought very hard about how they think about smart contracts going forward. I think the same thing would happen here. Like if there were to be a similar style hack that happened to like the inner community, then that would be like a huge problem, right?

And it would set everyone back and we'd have to rethink everything. But yeah, if there's like weird forks and weird places that get hacked, I don't think it's going to affect anything because the stuff goes on all day long. Yeah, well, it definitely goes on all day long. And there's probably some really just smart young people that are just spending most of their day trying to figure out how to do some of these things. So it's kind of this public bug bounty system that we're all sort of benefiting from, I suppose. But I think like a lot of defy investors are getting more conservative.

There's lots of buzz on Twitter about whatever the latest, greatest, field farming thing is. But I think generally speaking, if you look at the money that's going into it or like where it's coming from, it's getting much more sophisticated in terms of thinking about the risk. I don't think people are just dumb throwing money at the wall anymore. Yeah. That's interesting.

And we've been fortunate the first couple projects that have launched that were like very well audited. Compound is the one I'm thinking. So yeah, like we had a benevolent start. let's say. Yeah, I hope it continues. How do you think about some of the regulatory pieces of this industry? I mean, I mentioned the institutional view of kind of best execution and KYC. And for DFI, you're dealing with people that are engaging with holding their own assets already. So they're not using a broker or any type of intermediary. They're directly interfacing with a protocol. So there actually is no like KYC with these protocols to begin with.

How do you think about that? Is that going to be the case forever? How do you see this evolving? And I guess I'd also be curious if your perspective, if by some measure the whole industry needed to come under KYC, is there still product market fit there? Is there still something interesting? I think some project better or some do worse at that. But I think it's a spectrum.

I think that decentralization is very much a spectrum. It's not A or B. And you can always look at the far extremes. But I think the reality is it's very hard to build the actual extreme. without some intermediary steps. And I think, yeah, it's going to be on the community to gauge that risk, basically, and decentralized accordingly. If I'm thinking about, for example, a exchange,

they can very much solve the gas problems right now. All they need to do is they need do off-chain matching. But then off-chain matching is obviously a centralized attack vector. The question is like, okay, so that off-chain matching, is it resistant in some way? And is that sufficiently resistant? And I think that's the spectrum that people are playing on right now. And I think the answer is not A or B.

I think it is very much mind share of the community, what they believe at that time, basically. Like I can think of some projects that are very, very well decentralized, that have zero volume on them and others that are like not so well decentralized, but have a super strong community, I have tons of volume. So I think it is a mind chair game. I agree. That's a very nuanced answer.

I couldn't agree more. I think one of the things that I'm always saying is that this, is not necessarily all about decentralization for decentralization's sake. They're just a means to an ends, obviously. But one of the beautiful things about this technology is that it allows you to hold central third parties more accountable in unique ways. And so I'm thinking about things like proof of reserve and attestations that you actually hold the asset and that you're moving the assets around in the way that you say you are.

So I think the surface area for merging decentralized finance with centralized finance is actually probably under explored at this point. and will be a big growth area. Yeah, and I actually think it's actually quite important that it is a vector. It's not like there should be one ideal that we're always going to hit that like final ideal. Because if you think about it, if it were, let's imagine that there was like a purely regulated world and a purely like decentralized unregulated world. What the regulated world would do is they would just cut it right in the middle and say anyone who's over there,

your Bitcoin's now tainted. If you move them over here, they're tainted. I don't believe them anymore. And that would be a problem. So I think it's actually very important that it's quite a spectrum and that you can trade anywhere you want. And that actually is the ultimate freedom. I think that's one of the things that people are really worried about with this kind of travel rule guidance that's coming down is if you're taking coins off of a centralized exchange and you need to identify where they're going, does that somehow give the regulator the ability to do that taint analysis and to really have black market coins and white market coins? I mean, that's a big risk.

I think it's a huge risk, actually. And I think the way that you so hope that is you make sure that there's not a fine line. You make sure that it is a very, very blurry line. And you say, hey, like, these coins have been on a decks. They've been on a decentralized lending platform. They have been on a coin base. They have been in my fireblocks account or a vault. They've been all over the place.

They're just bitcoins. They're the same bitcoins that everyone has. And obviously, if they've been then chain analysis tracked to like a drug lord, well, okay, now those are tainted. Those are blacklisted. But all the other stuff, no, that's not. We value our freedoms and our personal freedoms. And that's why through this blurry spectrum, we are able to do this. Right. Yeah, it's the equivalent of digital cash. I do wonder in the context of we had this big excitement wave around privacy coins. And I think a lot of

that has been has tapered off. I think the usability has been a big challenge with a number of these layers. But I wonder if we'll start to see a resurgence in projects that are trying to do privacy at the wallet level for Bitcoin and Ethereum and things like coin joins, just as a way to achieve some of what you're saying around having it be a blurry line. I think it's important because like the privacy coins were banned in a couple places, right? So if you make the line too finite, you can actually just like countries can ban it. So like I actually think the goal is not a fine line of this perfect decentralized like untraceable world. The goal is actually a very blurry world, but in a very decentralized way, such that people have freedom.

I think that is the freedom. Yeah, that's really well put. So, Kyle, you've been super generous with your time. I guess my closing question to you is there is so much going on in this industry and you guys are at the forefront of so many different pieces of it. What content and sources of information are in your regular rotation and how do you just keep current on what's going on here? If you like longer form stuff, especially with defyri-related, then go some sort of, subscribe to Delphi Digital. They've got some long-form reports that are pretty good. If you want to just see what's treading on Twitter, there's lots of people posting over there 24 hours a day. So, yeah, I don't know.

We try, like, it's my full-time job, so I try to do it all. But I think it just depends what your interest level is. Yeah, that makes sense. And where can people follow you and stay in touch? Twitter, DM's open. Kyle, well, this was a pleasure. Thanks so much for joining us. Thank you so much. Thanks for listening to another episode of On the Brink with Castle Island. To find out more about Castle Island, visit Castle Island.V.C. To listen to all of our podcast episodes, please go to On the Brink-Podcast.com

or just click on the tab in our website. Thanks for listening.