The Wolf Of All Streets - The Global Crypto Derivatives Landscape | Dan Gunsberg, Hxro Network

Episode Date: January 22, 2023

What are crypto derivatives and how will they evolve in the future? How is regulation defining this new industry? Join a fireside chat with Dan Gunsberg, the co-founder of Hxro, and arguably the best person to talk about crypto derivatives.  Dan Gunsberg: https://twitter.com/hxrobtc ►► JOIN THE FREE WOLF DEN NEWSLETTER https://www.getrevue.co/profile/TheWolfDen  GET UP TO A $8,000 BONUS IN USDT AND TRADE ALL SPOT PAIRS ON BITGET FOR ZERO FEES! ►► https://thewolfofallstreets.info/bitget   Follow Scott Melker: Twitter: https://twitter.com/scottmelker  Facebook: https://www.facebook.com/wolfofallstreets   Web: https://www.thewolfofallstreets.io  Spotify: https://spoti.fi/30N5FDe  Apple podcast: https://apple.co/3FASB2c  #Bitcoin #Crypto #Trading The views and opinions expressed here are solely my own and should in no way be interpreted as financial advice. This video was created for entertainment. Every investment and trading move involves risk. You should conduct your own research when making a decision. I am not a financial advisor. Nothing contained in this video constitutes or shall be construed as an offering of financial instruments or as investment advice or recommendations of an investment strategy or whether or not to "Buy," "Sell," or "Hold" an investment.

Most people in the crypto space simply use derivatives as a speculative tool, a way to gamble on the price of Bitcoin and other assets. But derivatives have a much more important purpose. And it's important also that we bring them into crypto. Nobody's working harder at making that happen than Dan Gunsberg, the CEO of Hero Exchange. Hear about what they're building and why it's so essential. What's up everybody we are back after that incredible conversation about metaverses and nfts and how to invest as a beginner this uh fireside chat once again no fire no fire i don't i still don't know why we have to call them fireside chats.

It's like contractually obligated to call it a fireside chat. But we're going to be talking primarily about the derivatives market in crypto, what exists now and what's being built to make it more efficient and bring it up to the level, frankly, of other markets. My good friend Dan Gunsberg, you've probably been on my channel as much as any other human being on the planet. Last time we did this was at Consensus in Austin, and we literally did our interview at Topgolf. He's a scratch golfer, so it was very embarrassing for me, to be quite frank. We should start, obviously, from the beginning, I think, since a lot of people are beginners. Why do options matter in the first place? Why do derivatives matter? What's their purpose in the market? Sure. Well, first of all, thanks for

having me. My name is Dan Gunsberg. I'm the founder of a derivatives protocol project called Hero, which is spelled HXRO. My background has been mostly in proprietary derivatives trading for most of my career. I got into crypto in 2015. I was prior to that the chief operating officer of a large proprietary trading firm for a few years and then got into crypto and kind of went down the rabbit hole from there. So why are derivatives and options important? So first of all, when we talk about derivatives, like options are just kind of one segment of it. Obviously there's options, there's futures, there's swaps, which are all kind of a whole

different thing. And then with crypto, there's kind of been the creation of, uh, you know, a few years back, they started creating perpetuals, um, which was kind of like a continuous future, a future that didn't really have an expiration. It was just based on the funding rate. So, um, the main, the main reason for, for derivatives, um, when you think about it in a traditional sense is really, um, having an economic reason to hedge. And, um, you know, if you're reading risk books to put it bluntly, and maybe this is fair to Vegas, like effectively what they are are side bets. And in the same way that you may buy insurance for your home, for fire insurance, for kind of outlier events, things like that, derivatives were created ultimately to provide these kind of quote unquote side bets that allowed large companies, farmers who had crops that they wanted to hedge, lock in a forward rate on what they were charging per bushel of wheat or for their corner, for

whatever. And that really is what kind of perpetuated this idea of derivative markets. And over the years, the way the market structure has worked, and because of the advent of things like margin and whatnot, it became a tool for speculation. And I think kind of relating it back to crypto is you see more of its use case in terms of speculation and kind of like taking a view, a levered view on price. But I think it's still so early in the crypto space where we're now just getting to this point where you can, we're actually starting to use these derivatives for hedging purposes. So miners are using it to hedge

a forward rate, you know, to lock in a price of their, of the Bitcoin that they're mining or whatever cryptocurrency that they're mining. And once you start doing that, you start creating these kind of more time-based derivatives, which are like what we would call expiring futures or forward rates. And once you start doing that, you can start trading the relationships of them, which is something that our project works kind of heavily on in terms of our protocol. What that does is it is a way to really inject liquidity or a market participant who's doing something other than just speculating or something other than just hedging. And maybe I'm probably getting too far ahead here because it's

going to get too advanced, but that is a key component of the liquidity development and the developed market structure around it. Ultimately, that's what they're for. And I think the speculative aspect of it, again, is something that has been very dominant in the crypto space. But over time, you're going to start to see more and more of the economic reasons to be using. So then versus legacy markets, where obviously you have all these complex products and structures that you can utilize for hedging and for speculating as well, obviously, where currently is the crypto infrastructure for that, and what still needs to be built to get up to that level? Yeah. There's obviously the two sides of it. There's a centralized side, which

you see in most centralized exchanges. Most of the volume that you're seeing out of those exchanges is coming from derivatives, mainly from perps and futures, expiring futures. I think Binance is the number one player. But then there's the DeFi side, and that's where a lot of the real kind of, what I would say is more where the innovation is coming from right now, and a lot of what's being done, and obviously, again, still in a very experimental stage.

So it is very ripe to, you know, we always have kind of accidents going on, more or less, where there's hacks or exploits, which, you know, are for the better part, they're horrible in the moment. But, you know, I think our hope is that when you look out 10 years down the road, and I do try to think about this as a founder, as like, what does this world look like in 10 years from now? And how does something like an on-chain derivatives protocol help change the fabric of the global derivatives landscape? And so then that gets me into things like dispersing and disintermediating systemic risk.

And how do you use on-chain derivatives to solve things like that? Right now, most of that activity is done on centralized exchanges. You're starting to see more and more happen in DeFi. And DeFi is also allowing for some really cool innovation too. You're primarily building in DeFi? We build 100%. Right. So you've obviously chosen that as the horse for the future. So why build in DeFi? Sure. So our real take on that is that we're building at the primitive layer. So what we're building is very focused on the plumbing. So we're building the risk engines, the settlement procedures, the kind of the equivalent of like in the centralized world, the clearing procedures.

How do you guarantee settlement between two counterparties without having an intermediary there? Having that done on a smart contract. Then really where we spend, again, most of our time is on our risk engine, because ultimately that's everything. A lot of the problems that you see in crypto are exploits of risk engines. Either that or human error, but human error is kind of a whole different topic. But it is an interesting problem to solve because you have to figure out how to solve it with doing things like that can kind of allow for that infrastructure to be something that is on the order of what exists in the traditional space.

Otherwise, it doesn't fully make sense. So you kind of need to at least try to figure out how to come close to what exists in the traditional space and then what is the added value of DeFi. So for us, our real take on it is really about this dispersion of systemic risk. And when you think about the worst type of events that happen, systemic events in the marketplace, they're usually the result of human error and from a small group of market participants who had to make some type of decision at some point that maybe in the moment was right or maybe in the moment was wrong for moral reasons or

just bad judgment. And that led into something that ended up metastasizing into a much greater problem. And so our take on it is, can you solve through on-chain derivatives, and through a network-based governance model, the dispersion of that, like taking away an opportunity for a central point of failure that could metastasize into a real problem. That's kind of like one of the main things that we really focus on. I mean, alluding to a situation like Luna, which collapses three arrows, Capital, which collapses Voyager and Celsius, those were all human error to a very large degree to your point. But if what you're building existed at that time, how could that have theoretically been used to mitigate some of that risk? Uh, 100%, um, because of, uh, transparency, it's usually a lack of transparency that kills the horse. So when you are doing these things on chain, and then for us, at least, one of the solves that we

made has really been doing what we call inline risk or real-time risk. So every time a trade is made, is executed in our infrastructure, the risk of the entire network basically recalculates. So a trader or a wallet that has a position on the health of that wallet will be known to the end user, but it will also ultimately be known or it's discoverable through the blockchain. And then we take all of that and roll it up to look at, like, what does the big risk picture look like? And giving access to the network and all of its participants on the health and state of this,

you ultimately end up in a place where hopefully you have tens of thousands or millions of people that are looking at this and using it and saying, okay, something's wrong here. And you see it quickly, you see it early, and then you can, through governance, take action to help remediate the problem. Much of what you're building keeps coming back to managing risk, right? Allowing every entity at every level to manage the risk, which can be hedging against a position or taking a different approach. And one of the problems, which you've already alluded to, is we've sort of seen this endless

hacks, exploits, et cetera. How do you, even if you're managing risk from a conventional perspective, how do you manage the side of it where literally your entire wallet could just be drained and your funds could be gone, even if you've appropriately position sized or utilize uh derivatives to hedge your position it's a really hard question to answer um you know the there's kind of these different ways that there's there's a concept of a hack like there's a you know there's a bug in code that gets exploited and then there's just like market manipulation type things and like if we kind of take what happened unfortunately with like mango last night which for people you know anybody that is deep into the space is probably aware of what

happened um that was really a function of i mean there's a function of a few things first of all i think the the perpetrator or or somebody related actually put the exactly what the exploit was in their discord like months ago or weeks ago initially months ago and then again like i think on october 5th and then somebody actually followed through with it but i think you know on that element you kind of have to take a step back and realize how small this space is. And it can feel like, you know, Mango is an unbelievable project built on Solana. Very smart engineers. But, you know, you put a perpetual swap on a token that does $300,000, $400,000 a day of volume. It can be pretty easily manipulated. And because there is not this

like deep, heavy regulatory thumb or, um, or furthermore, like, uh, there just isn't not enough governance wrapped around like risk controls. Um, you end up in this issue where somebody can come in anonymously and run the price up on something, which is, if you did that in a traditional market, you're going to end up in jail. That type of thing is still there. So as a founder, as a team, or as a community, you have to take this more cautious approach. And I would encourage everybody to always try to think about what does this space look like? What do you want it to look like in seven years from now or in 10 coming from the traditional space, it's, it's helped me a lot. I spent years dealing with risk of a large trading firm as a COO, and then also dealing at a pretty deep level with some of the biggest derivative

exchanges on the planet. And so you understand like what basic guardrails are needed, like what exists in TradFi that you want to bring over to the DeFi space and apply those same rules or same elements because they work. And when you add those to the elements that become value add from DeFi is, I think, when you start to really see magic. What are some of those elements that you would like to see brought over from TradFi that perhaps don't exist yet? I think it's simple things like market maker protections, which is like a way to protect liquidity. I think if you went on Twitter today and said market maker protections, you would get canceled because you're going to be in one of these positions where everybody's saying like, screw the market maker. They're there to take your money. And, but that's what they're really there to do is for you to, for them to, they absorb risk.

You transfer, when you do it, when you execute a trade, you're actually transferring risk onto another party and take, taking it off of yourself or adding to your own risk. And they're willing to, you know, to, to give you that, to basically take the other side of that risk own risk. And they're willing to give you that to basically take the other side of that risk for you. And the vital role that they play is when nobody else wants to provide liquidity, they need to be there to provide liquidity so you can maintain an orderly market. When you have an illiquid market and everybody backs away, or somebody comes in with a fat finger, they meant to put in a $100,000 order, and it's some OTC desk that has very deep pockets, and they put a $10 million order in, and that market takes off. There's nowhere that has,

at least in the DeFi space, that has protections put in to give market makers a confidence to say, hey, we're okay putting out, and we need this in options too, because there's so many permutations. You have to actually, what's called mass quote. You're not just quoting one market, you're quoting thousands of markets simultaneously. You don't have this picosecond, ultra-low latency trading world that exists in TradFi today. You have this normalized speed. Even Solana is fast. It can be 400 milliseconds when the thing's humming.

That can really put market makers at a disadvantage. If they're disadvantaged like that, their liquidity is going to disappear, and this market will not evolve. Having something like MMPs put in, potentially having global limits over how much risk can be taken across the entirety of a network based on the insurance waterfall, the amount of how deep are the insurance pools? What does that risk waterfall look like? And having some type of existing ratio. I think on a per wallet basis, again, having some type of limits. Another simple thing, too, is like is throttling withdrawals. These are just like kind of some basic ideas that I think at first they sound a little like not, you know, not innovating. But I think we need to do some things as a, you know, the marketplace as a whole has to really think about this.

And in order to kind of continue, continuing to push the technology forward. You know, when you get into an issue where somebody gets exploit, when there's an exploit and that can't be covered, it's a problem. You know, right now, we put capital blocks on accounts. We're rolling out our derivatives. They're new, not available in the United States, just a disclaimer, unfortunately. But the idea being that you want your insurance pools to be some ratio so the network participants have more and more confidence in your system, in your network, knowing that they keep wanting there's something goes wrong, they're going to be covered or at least mostly covered. And that is a hard thing to do because

everything in crypto, you want to move 170 miles an hour to build an insurance, the proper insurance waterfall. It takes time. Yeah. We like to move fast and break things, but that works in industries where you're not controlling people's net worth. Exactly. Exactly. Exactly. And I think the more that the better we get at doing that, the more proactive we can be with regulatory bodies. We're doing a ton to educate regulatory on use cases of like, why do you use blockchain? Yeah.

I have a question. Sure. I trade options based on the equities market. It's open from 9.30 to 4. Obviously, the crypto market is 24.7 365. So for your platform for trading crypto-based options, is it 24.7? Yeah.

The infrastructure that we built is all because it's all crypto, so it's just 24 hours. Yeah. It's available 24. The market's always moving 24.7 365. What time then do you use for your expiration date on a day? So at what point do you say this is...

So like an expiring future has an exact date and then it's just all based on UTC time. Yeah, so it expires at like 0000 UTC. It's been interesting to watch since you started the evolution of the platform. It's almost night and day. Um, you had a product basically that was a binary choice based on a timeframe as to whether you thought the price of an asset would go up or down moon or wrecked, right? You literally pushed a green button or a red button based on a timeframe and you were

right. Weather price went up or down. This is a slight evolution from that. Major evolution. And yes, absolutely. And, um, you know, when we first started hero, we, we wanted to build infrastructure. Um, the technology didn't exist at the time, like at the blockchain layer. So to, to really do it, I mean, there was pretty much a theorem and it just didn't have the throughput and the cost structure to do what we wanted to do. And finally, like in 2020, when we saw Serum was built on Solana and said, wow, well, you know, somebody solved to like build an on-chain order book. We can start really going down this path. And we set off from there. And obviously, like the platform side, hero.trade, that is evolving.

It's actually going through a name change and stuff. And those parimutuel markets that Moonwrecked game was based on, it's funny being here and there's this Expo G2E going on next door. We've been approached by tons of gaming companies and sports books and stuff that they're actually now taking that parimutuel market creating their own widgets

and then putting them on their on their sites so they're which is one of these funny things about derivatives and kind of one of our theses is like over time there's going to be this big convergence of things like sports betting and trading and you're already seeing it in things like betfair and platforms like yeah predictive markets yeah they look like trading platforms when you trade in-game when you play uh do in-game sports bets like those are real markets the largest market maker in the world is uh in these things is a is a firm called sesquihana, who is actually the largest options market-making firm on the planet. They have an offshoot called Nelly that is the largest market-maker

for sports in the world. I remember when you first described it to me before you were able to really build on Slata and build the infrastructure, it was sort of, and we're seeing this all over crypto in general and blockchain, it was sort of the crossroads between trading and gamifying trading, perhaps would be the best way to describe it. Yeah, I feel like we were like the first ones there. Yeah, a very familiar interface for people who love gaming that they could also use to trade without complex knowledge.

That was the idea. The idea was, because we couldn't build this more complex stuff, we were like, okay, what do we want to build on here? We were in the middle of this nasty bear market in 2018, and we weren't trading or doing anything. We were just picking our spots. And then we're like, well, we want to build, so let's figure this out. We came up with this concept. We ended up creating this thing called the floating strike option, which is the most anti-crypto thing, but we somehow got a patent on it. So created that option. And then from that, we were like, well, let's figure out how we can

create a front end that really is like kind of fun. And, and again, you know, can't offer it to the US unfortunately, but, um, and, uh, we put it out and kind of caught lightning in a bottle with it. And it was, it worked well because it, you know, it ended we put it out and kind of caught lightning in a bottle with it. And it was, it worked well because it, you know, it ended up getting us funded and kind of got things moving. And then, uh, that all evolved into, um, into what's become hero network today. Right. So speaking of evolution, obviously you're into the process, but not the end, what is the end game look like? You know, like, let's say that, uh, you have millions and millions of trades being settled, tens of millions, hundreds of millions on a daily basis? Let's say that you have millions and millions of trades being settled, tens of

millions, hundreds of millions on a daily basis. Let's say that you have the throughput and the cheap fees that allow that to happen. What does this look like versus other markets? I think the end game where I would define success is that in the global derivative space, you have three lanes. You have this incumbent existing kind of tech stack and regulatory stack that we're all familiar with, like how the CME operates, ICRX, things like that. You have this direct access, and then you have DeFi. as this derivatives infrastructure primitive layer where you more or less have this kind of B2B2C model where we have X number of applications that are building on top of it

and sharing in all these different derivative market types and all of that liquidity bottoming out into the marketplace and having it being completely run and managed by community, not by a foundation. And I think that's the end game. My goal is to become as irrelevant as possible. Yeah, exactly. You guys are probably wondering why I didn't ask the obvious questions about regulation that I was dying to ask, but that's because we're doing a panel later today with Dan and Adan Yago to talk about the place of regulation, especially in these

markets. So we will get to that. My final question is why are craps tables at the wind fixed against us? I don't know, but I did notice something. I just kind of, I guess an anecdote, but they have these bets. They're called small, tall and all in the middle. It's like a prop bet. And that you basically have to roll all the low numbers, all the high, everything but the seven before a seven comes up. And if you bet that all, it pays like 151 to one. And i went on wizard of odds and the actual real odds are 189 to one so if that tells you anything about how all of this gets built they're offering you 100 151 to one which you're gonna go holy shit 151 to one but there are kids from mit in the back that are like, yeah, well, we just sold you 151 to one, but we own it at 189 to one. So there's a, a 30, a 38 point spread that we're taking every time you put a dollar in there aggressively

selling that bet. By the way, everyone at the table was betting it and they were trying to get anyone who wasn't to bet it. But I'm now shocked that you're telling me that I don't have an edge at the casino. How novel they do How novel. They do say the house always wins. So guys, we're going to be back again once again. I have another panel coming, but in a little while, we will be back to discuss regulation and get into that side of this conversation. Everybody, Dan, Dan Gunsberg, AKA Gunny. Thanks guys.

Thank you. Thanks man. It's go.