The Breakdown - Complexity Theater: Why Luna Was the First Time DeFi Complexity Risk Was Transferred to Regular Investors

Episode Date: August 7, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   On this “Long Reads Sunday,” NLW reads: What Is Crypto’s Downfall? Its Complexity – Jameson Lopp Complexity Theater – NLW  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “The Now” by Aaron Sprinkle. Image credit: Cemile Bingol/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Sunday, August 7th, and that means it's time for Long Read Sunday. Now, before we get into this week's reading, if you are enjoying the breakdown, please go subscribe to it. give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure as always, in addition to them being a sponsor of the show, I also

work with FTX. Now, for this week, we are reading two pieces about complexity. The first is by Jamison Lop, well-known Bitcoiner, Bitcoin educator, developer, security expert, and leader at CASA. and the second is by me from 2018. Let's start with the much newer piece by Jameson Lop. What is crypto's downfall? It's complexity. But that doesn't mean Bitcoiners should close their mind to the wider blockchain industry. As in many financial markets, Bitcoin and other cryptocurrencies have seen their value

plunged so far this year. A handful of projects like Terra have imploded before our very eyes. This sequence of events has led many investors and onlookers to question whether there is a viable future for the asset class that was so bullish just a year ago. The pandemic brought an influx of new Bitcoin and other asset investors, many of whom lost big this summer. Most didn't understand the risks, partially because of naivete, but also due to the increasingly complex crypto ecosystem making it harder to understand. The warning signs were there for those of us who have been around for more than one market cycle. The reality is that each project is its own

unique animal, and not all of them are built to withstand the myriad threats that lie ahead. While it will take some time for sentiment to recover its premature to dunk on Bitcoin and the like right now. There may still be some potential to be found out there. In the meantime, there are several red flags to watch out for when vetting other projects. Experiments, pipe dreams, and scams, oh my! When Bitcoin began in 2009, it was in a league of its own. Since then, it has emerged as a store of value and censorship-resistant network with a market cap that has exceeded $1 trillion. Even with the recent crash, I believe Bitcoin's potential remains as bright as ever. I can't say the same for all the projects that followed. Today, there are more than 20,000 cryptocurrencies,

digital assets, tokens, and projects, all promising to be the future of finance. Each takes some elements of Bitcoin's design, blockchain decentralization, economics, mining, cryptography, and alters them to fulfill some other use case. As a technologist, I appreciate the experimentation that takes place in crypto. I'm less interested in the hype. New projects are always risky, regardless of if the people behind them are well-intentioned. Deadcoins.com tracks projects that folded and currently lists over 1,700 in its catalog. Remember that half of all startup businesses fail within five years. It's not surprising that we see an even higher failure rate in this cutting-edge technology

sector. Many projects will be unrealistically optimistic, but the only way to test if an idea works is to try to build it and see what happens. Looking at the bigger picture of risks, a 2018 report by Satis Group concluded that 80% of ICO projects launched in 2017 were outright scams, while 7% had failed and only about 10% look promising for long-term success. When people get interested in cryptocurrency, they often feel compelled like they miss the boat and are thus to find the quote, next Bitcoin. Entrepreneurs quickly wised up to the fact and began issuing altcoins in tokens with so much as a poorly

written white paper. This has created a vicious cycle of pump and dumb scams that do not reflect the hard work of many of us in this industry. If you've been the victim of one of these schemes, I suggest using this bear market as a time to reflect and learn about the underlying technology and its merits beginning with Bitcoin. Bitcoin has a proven track record, but I don't reel out the possibility that some value will emerge from the many attempts at crypto innovation. Scientifically, you can't prove a negative. Moreover, the market will continue to hone in on other valuable use cases developed through the successes and failures of other cryptographically secured protocols. The Siren Song of Centralization

A large part of engineering is about managing tradeoffs, like the need for convenience, speed, and security. Bitcoin was designed as a decentralized network that processes blocks of transactions every 10 minutes, give or take. Over the years, many parties have sought to improve upon this design in various ways. Some have tried to increase the number of transactions in every block. Others went after faster transactions. A number of projects have tried to plug other data from the real world into a blockchain to create sophisticated markets like derivatives. These efforts have struggled to overtake Bitcoin as the dominant store of value, because they usually introduce some form of centralization. Centralization is highly efficient, but it undermines

your efforts if your goal is to democratize finance or empower individuals. Centralization hurts projects because it tends to corrupt incentives for their respective communities. For instance, an Al-coin project might make it hard for everyday users to run a node and participate in the network. Or they could create an inner circle of validators as gatekeepers of transactions. If a validator is curing data to feed into a blockchain, it could be a single point of failure through bribery, collusion, or outright attack. Bitcoin's success has been predicated on its decentralization. Users can participate in the network without having to trust one another. They only have to trust the network protocol rules, which they can verify with whatever software they choose. This decentralization is

why Bitcoin has grown as a form of money. Too complex to compete. Complexity is the enemy of security. The more moving parts you add to a system, the more potential points of failure. It doesn't necessarily do a lot of good to create a magical smart contract platform if you can't prevent abuse or denial of service. Sometimes impressive white papers fail to translate into effective projects. Perfect can be the enemy of good. According to Slow Mist, the most common forms of loss after scams are flash loans, congestion attacks, and contract vulnerabilities. All of these are a result of systems that have created fragility due to their complexity. It is more challenging for developers to write robust code when the total number of possible interactions users can have with the code increases exponentially.

Discipline is underappreciated in technology. It's hard to create a system that works as well as Bitcoin. It's designed to do one thing and only one thing well. be sound money. A grandiose vision needs grandiose implementation, and that's hard to provide in a decentralized fashion. Building an open, permissionless network is the equivalent of building a plane while you're flying it, and developers have to be careful not to tilt economic incentives in the wrong direction. Each step in building something needs to be checked for stability and security from both internal and external threats. Furthermore, complexity increases risks for users.

Plenty of private keys have been lost due to user error, as co-founder and chief technology officer of CASA, a Bitcoin security provider, I strive to find ways to accommodate users from all walks of life. Simplicity is king. Bitcoin is changing the world as a tool for individual empowerment. As for crypto, the unknowns grow every day with each new project. The space has grown to an extent where no individual can vet the technical nuances of every project, so it's reasonable to maintain some curiosity along with a healthy dose of skepticism. As you venture into the Cryptoverse, strive to balance optimism with realism, and you'll be on your way to finding Veris and numerous, strength in numbers. All right, so that was Lops piece. Thank you, Jameson, for A, all your contributions,

but also B, the specific post. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's neexo.io. Eager to make more informed decisions around crypto, chain aliasis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence,

and investigations support for all crypto assets. For organizations like Gemini, Crypto.com, and BlockFi, Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at chainalysis.com slash coin desk. The breakdown is sponsored by FTXUS. FTXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees.

one of the largest exchanges in the U.S. FtXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use Referral Code Breakdown to support the show. Now we go back to September 12, 2018, with a piece that I wrote back in the glory days of Medium and the 2018 crypto winter, when people would actually, you know, read stuff. The piece was called Complex. And it was written at a time not this similar to now, when people were finally accepting that we were in a bare market, and it was time to learn the lessons of the last cycle. Complexity theater is when the presentation of ideas is complicated in order to make those ideas seem more valid. It is not limited to the crypto space, but has wreaked a very particular havoc here. Luckily, it doesn't have to be this way.

In bull markets, people spout wisdom like Oracles of Delphi and lay claim to success as though blessed by divine sight. down markets, meanwhile, favor the critics who definitely pick apart the intrigue in excess of the previous phase. As important as price resets are, this critical review process has an equally important role in the long-term health of any asset class. Through this process, we reset norms and expectations and hopefully provide some bulwark against repeating the same mistakes again in the future. One standard of the ICO era that has been recently drawing ire is the white paper. Linda Shee recently tweeted, the Bitcoin white paper was nine pages. Your white paper doesn't need to be 10x the length to get your

ideas across. If it does, I think you're trying to build too many things. Token projects started writing white papers at the outset of their projects for one reason. Satoshi did it. Now it's perhaps worth noting that Bitcoin didn't actually use the white paper to raise money, but here we are. Holding cynicism aside for a second, there are some good reasons that white paper stuck as a communications tool. What you can explain in a pitch deck is limited, especially when it comes to exploring new technologies and new economics of human organization. There's a lot to be said for supplemental collateral with a bit more room for exposition. As white papers moved away from their technical roots, however, and into the center of the fundraising

process, they became less about exploring new concepts with peers and more about convincing investors to buy. That shift brought a tendency towards complexity that was less elucidation and more obfuscation. Complexity theater is when ideas are explained in an overly complicated way in order to make those ideas seem more robust, intelligent, and worthy of attention. Importantly, complexity theater can be intentional or accidental. While intentional complexity theater is more odious, accidental complexity theater can actually be more damaging. The ICA craze was a wash in complexity theater of both the intentional and accidental variety, and demonstrates why it's not just an annoyance, but an actual problem

for the crypto space. First, complexity theater has higher stakes when it happens in the context of a mass expansion of retail participation in risk capital. In professional markets, one could argue that complexity theater is simply a sales tactic, that experience investors should be able to see through. But crypto wasn't a professional market. In fact, a meaningful part of the ICO boom was attributable to pent up demand on the part of mainstream investors to participate in the early stage technology investing that they had been locked out of due to accredited investor rules. What they found in crypto was an emergent technology field that is by nature immensely technologically complex. It is so genuinely complex. It is so genuinely complex.

complex, in fact, that professional investment firms are reconfiguring themselves by hiring developers and technical experts. For some ICO projects, complexity theater became an intentional strategy to shock and awe investors into investing in things they didn't fully understand. To make the problem worse, even projects that weren't trying to prioritize complicated explanations over substance, inadvertently contributed to an overall market attitude where perception of complexity was rewarded over the ability to clearly and concisely articulate how new technology would work and for whom. The great irony of Complexity Theater is that presenting complicated ideas simply is much more difficult than

complicating simple ideas. If the bilking of retail investors is the most obvious pain ICO complexity theater caused, there is another significant downside just coming to light now. Complexity theater crowds out the space for actual complexity. The crypto space has become so fed up with overblown claims, hyperbole, and technical posturing that it is increasingly soured on even genuinely interesting projects. This base-level cynicism makes it nearly impossible. possible for thoughtful, diligent, technically robust projects to differentiate themselves. Perhaps then, the only choice for those projects is to stand out through what they do and not what they say. In responding to media assertion that he thought wild crypto growth was over, Vitalik Bouturin made the

point that the next wave of excitement won't come from simple awareness but from genuine value. To be clear, I never said there is no room for growth in the crypto ecosystem, Vitalik said. I said there is no room for 1,000x price increases. A 1,000x price increase from today means 200,000 trillion in crypto, or an entire 70% of today's global wealth being in crypto. What I actually said is that because large portions of the population have already heard of crypto, further growth in crypto in any sense must come from depth, i.e. actual usage, and not bringing in more attention. In other words, complexity theater is a communications problem that doesn't have a communications answer. That's a good thing. With skepticism as high as it is, the only answer is to execute.

And so, for lucky, the space heals. So like I said, that was written in September 2018. And really, it hadn't been until a month or two before that that some people gave up the ghost on ICOs. They were still trying to make ICOs a thing long after money had started to abandon them. Now, the interesting thing, if we're looking back and trying to ask, did crypto avoid this problem the second time around, I think that actual complexity, more than complexity theater, has been the challenge.

In other words, I don't see any more a lot of leading problems. the way that projects were leaders in 2017 and early 2018, doing this sort of purposeful obfuscation through complexity. Instead, what we have is an industry, particularly in the context of DeFi, that is by definition complex. And part of where that complexity comes from is one of the central, potentially powerful transformative elements of DeFi, which is the composability of protocols and platforms. Composability refers to the idea that protocol X plugs into protocol Y, bridges over from one layer one to another layer one, etc., etc., etc. It's the idea of money Legos. The upshot of that complexity and composability is that a fascinating

array of things that can be built that fundamentally challenge and expand our sense of how finance can work and how value can flow natively on the internet, how it can be programmed to flow natively on the internet. The downside of composability is, of course, that when one thing breaks, it can break a lot of other things, too. For a long, long time, I've argued that one of the best things about defy, from a broad mainstream view perspective, is that it had such high technical barriers to entry that although there were many hacks and exploits and challenges, those problems largely affected a group of enfranchised people who understood at least broadly the risk that they were taking on and the type of experiment they were involved in. The issue would be if a less

sophisticated audience was exposed to the same risk. I believe that one of the ways that we could view the collapse of Terra and the Luna ecosystem is as the first time a big mainstream audience was exposed to the risks of Defi in an accessible mainstream way. The reason for that, of course, is that all you had to do to be exposed to the risks of that ecosystem was by the underlying asset. Because so much of Luna's growth had been predicated on the dynamics of the protocols built on top of it, the interplay of the asset with things like UST, simply holding Luna was enough to be exposed to the risks in that particular defy ecosystem. That's very different to ETH, where the value of ETH was, yes, of course, enhanced by the fact that it was used as the

base chain and the based asset of DFI, but was not predicated specifically upon designed tokenomics in a defy mouse trap. There is a lot more that we could get into here on this and lessons learned and what it means for the future. But I think that it does show that the way in which complexity risk impacts crypto has shifted. I think it would be wise of us to use part of this spare market at least, to figure out how that type of complexity risk is evolving and whether there's anything we can do to cut that off, especially from newer or less sophisticated investors. For now, I want to say thanks again to my sponsors, nexo.io, chain alysis and FTX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.