Unchained - After April's $606 Million in DeFi Hacks, What's the Fair Value Yield Rate?

Episode Date: May 3, 2026

$606 million in DeFi exploits in one month. Two of the space's sharpest risk thinkers debate whether lenders are being paid anywhere close to enough. ======================================================== Thank you to our sponsors! Coinbase One 20% off first year of annual plan + $50 Bitcoin bonus. Offer valid until May 31. coinbase.com/unchained Citrea Bitcoin changed how money works. Satya changes how Bitcoin scales. citrea.xyz/unchained ======================================================== One month, $606 million in exploits. And yet DeFi lending yields for blue-chip collateral sit close to SOFR, as if nothing happened.  Tom Dunleavy, head of venture at Varys Capital, did the math and concluded that fair risk-adjusted DeFi yields should sit around 12.5%. Adrian Cachinero Vasiljevic, co-founder of Steakhouse Financial, thinks that number paints with too broad a brush, and that for the right primitives, with the right collateral, the market rate might actually be close to correct.  Host Laura Shin queries them on the TradFi equations that underpin the debate, the DeFi-specific risks that those equations miss, and on whether depositors are sleepwalking into tail risk they cannot fully see. Host: ⁠⁠⁠⁠⁠⁠⁠Laura Shin⁠⁠⁠⁠⁠⁠⁠, Host / Unchained Guests: ⁠⁠⁠⁠Tom Dunleavy, Head of Venture, Varys Capital — @dunleavy89 Adrian Cachinero Vasiljevic, Co-Founder, Steakhouse Financial — @adcv_ Learn more about your ad choices. Visit megaphone.fm/adchoices

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Your bank is charging you to use your own money. I switched. Go to Ether.Fi slash Unchained to claim your discount. Today's topic is how DeFi rates can properly compensate for risk. to discuss are Tom Dunlevy, head of venture at Varus Capital, and Adrian Caternoevo Vasiliovich, co-founder at Steakhouse Financial. Welcome, Tom and Adrian. Thanks for having me. And us. Hey, Laura. So this month is probably going to go down in crypto history for DPI hacks.

And when I say that, I'm also hoping that that's the case because I'm hoping that this is the peak and not just like an appetizer. So I'm just going to list. I just did a quick search to figure out what are all the hacks that have occurred in this month. So obviously, drift and kelp Dow. There's also Ria Finance, Wasabi, Sweat Foundation, PulseFall. By the way, some of these were like literally in the last 24 hours. Crestow, Aftermath, Singularity, Finance, Hyperbridge, NodeFi, Eroswap, Cowswap, Perlend,

Giddy, Syndicate Commons Bridge, Lendhub, Zeta Chain, Jewdow, Scallip, Volo, Quant, Kipselli, Juicebox. Now I'm getting in the really small ones, juice, Box V3, and Theta Nuts. So you guys, that's a total of $606 million in exploits. Obviously, so we're mainly going to be talking about defy lending. Obviously, not of these, not all of these directly impacted lending, but as we saw with Kelpdow, that doesn't always matter in a world where, you know, as what happened in that case, defy lending ended up being part of the step for the hackers to cash out. So nationally, like, this has led to a lot of conversations around what is kind of like the appropriate risk or how you even price the risk of, you know, borrowing and sorry, of lending and defy.

So Tom, you wrote a piece on this that went through some calculations of what you thought the fair yield would be. There's been a lot of response to that. But it wasn't the only piece. There was another one as well. which we'll get into in a bit. But why don't we just have you start with you explaining what inspired you to write the piece and how you think about this problem? Yeah, thanks for having us, Lord, because I think this is a really important conversation.

So I spent, you know, a number of years in traditional finance, specifically in fixed income. So looking at defy yields for my entire time in crypto, which is now over five years, I've always kind of scratched my head and not really understood why yields were effective. effectively so low. And if they were higher, it was generally because there was some subsidization with points or other mechanisms that we would classify as maybe not true yield for the underlying asset. But, you know, this came about specifically because of the hack. So I saw the hack and I said, you know, it's obvious to me, at least, that we're not assigning risk premia correctly. So why don't we disaggregate that and step through what the correct

risk premium in my view potentially could be based on some level of data that we've seen. And when just to give, you know, listeners a framework here, right, if you're pricing a bond in traditional markets, you look at the risk-free rate, which is generally proxied as U.S. treasuries and as Adrian noted and others noted to my response. And my threat is, you know, you can adjust that based on time horizon. So maybe use an overnight rate or something if you're looking at more short-term yields. But then you add on risk premium after that. So illiquidity risk, some level of default.

risk, whether, you know, depending what market you're in, some yields for convenience or what have you. And each borrower is going to have their own subset of risk premium that important to them. But at a high level, there should be a baseline of some level that we as an industry agree are important to understand. And this is how you price risk across treasuries, corporates, loans, private credit, whenever. You take the risk for yield and you add on levels of risk premium. And that's where the basis of the analysis started. And, Adrienne, how about you? How have you been thinking about this problem?

I mean, we don't think about it in a very, we don't think about it very differently, actually. So as curators, one of our main responsibilities is to underwrite the collateral markets that we expose the bolts to. And in order to understand what, and the way that we segment the risk of the bolts is broadly speaking around liquidity.

So larger assets, larger, safer, et cetera, assets with better credit risk profiles. We would call prime and longer tail or less liquid assets with an element of credit risk, but mostly liquidity risk, we would call high yield. So we think about it in very much a similar way. We have this risk management framework published on our documentation site and we update the ratings once a day, you know, based on how the issue or changes and so forth. And generally, what we try to do is be what we call really boring. So there is a temptation in the curator space to accumulate TVL by pushing the API as high as possible.

And we try to take a more boring approach, be a little bit more conservative, and limit the amount of credit risk that we expose the vaults to. Because our view is fundamentally that this primitive of on-chain repo is sort of the bedrock for future traditional, that the distinction between traditional finance and defy will eventually sort of dissolve and that this architecture is suitable for doing repo transactions. But nobody talks about breaking the buck on money market repo overnight.

And so I do think I agree with Tom completely that we have to go to a place where these types of transactions can be done with a transparent appreciation of the rate. that both sides are taking. I think that's really at the crux of the issue where we agree the most, right? Yeah, so I have no fundamental issues that with the to maybe touch on like the article, but I feel like the article, like there's a lot of commentary on Twitter. People have written articles back and forth, like people can read those and like I'm happy to like talk about my response or Tom's article and what have you. I feel like maybe the more interesting part is like the conversation between us and where we think there is more or less risk. So like one of the areas that I felt could have used a little bit more detail

was being a bit more specific. Tom had this general framework for defy yields. Our view is with primitives like morpho that allow isolation of risk, this actually makes it easier to price that risk and to allocate accordingly. So one of the things with Lucas article as well, when he made his calculation, you know, our benchmark is sort of the, the Coinbase Defi Lend experience where Coinbase users can borrow against their Bitcoin using Defi Rails. This is a pretty substantial loan book. Priced, like between slightly over Sofer at the moment, it's at like 4.3 or 4.5. It ranges near Sofer. And in our view, this is pretty much the market pricing what this repo transaction probably should be. It's not to say that it's riskless.

There are certainly a number of risks that could, you know, substantially impair the lenders on the other side of the equation. But the main point was like fine, but we should probably get more specific and avoid tiring the whole space with a broad brush. Sorry. Okay. Yeah. Yeah. We're going to get into those weeds more toward the end. But let's just start with like, because I noticed both Tom and Lucas piece.

So for the audience who didn't hear, so Luca Prosperi wrote on a substactor Rhodes about this topic as well. And both he and Tom started with calculations of how Tradfai calculates this type of risk or equations, I should say, of how Tradfai calculates this type of risk. So why don't we just like start with that? Because I think having that contrast between how Tradfai does it and then what is different about DTF? and what factors need to be added into the equation to come up with a fair value, I think, like, that process in and of itself is really, you know, educational. So, yeah, either one of you can go first here, you know, talk a little bit about how stratify typically calculates this type of risk. So I think there's two things here. The empirical academic observation, which is useful as kind of a

baseline, and then there's the actual market rate that folks are trading against, which some would call them more true rate. Now, the, it's called the academic observation looks at the probability of default and then the loss given default. So what is the probability of default for each individual risk premia that we can assign? And then what is the loss given default of each one of those individual risk premiums? So we have a, I call it 10-ish-year history of DFI. Fantastic. Obviously, there's a lot of regime changes in there. There's a lot of technology changes in there. So that's certainly not as reliable as a traditional finance bond market, which has had a hundred plus years, despite, you know, some changes in there. Folks would be, I think,

surprised to learn that most bonds still trade bilaterally and a lot of times through spreadsheets and phone calls. So there's still a lot of, you know, still inherent bias in there and the traditional markets hasn't changed over time. So that's generally the framework. And then the way I thought about it was taking that risk free rate and then assigning individual risk premium on top of that. And we can get into that. What has it makes sense, Laura? But, you know, the framework is lost given default and how often these are going to default depending on what you're looking at. So it's sort of like, yeah. So I completely, like, this is a completely orthodox framework. Like it's a very rational way to think about the marginal lender. So if you're a lender with $100,

at what rate would you not be willing to lend, provided you believe the assumption for, expected losses is X, right? That's kind of what Tom's approach was. And here, again, like, I do think it's important to try and narrow down. So, like, okay, not to, not to slam AVE. I'm not super personally familiar with AVE, but it's also a model that we haven't spent a lot of time thinking about because it's pulled. So it has a characteristic where a lot of these factors are confounding. Because you have cross collateralization in this lending market, it provides for a lot of capital efficiency for the user because they can take out a loan with the collateral that somebody else can borrow, essentially, which was part of the reason the concession was able to spread so

quickly. We've only really worked with the Morphal isolated model, which kind of meets our philosophy of what defy could be, which is, or what it should be, which is, you know, it needs to be really ossified. It needs to be really small and hard. These risks are real. Like all of the risk premier that Tom is alluding to in his article, Oracle, you know, admin keys, all of this. Where what Defi does best is very little and as stupidly as possible with as many guardrails as possible. And we call this distinction a crypto guarantee versus a social guarantee, which would be an admin key, for example. And in tradable, you have very good safeguards against, you have very good social guarantees.

So if something goes wrong, you take them to court, you recover your assets. Crypto doesn't have that dependency because you depend on a settlement layer that does everything very quickly, finalizes very quickly, and doesn't require an intermediary to settle the transaction. That unfortunately also means that if something goes wrong, it goes wrong. Dig and immediately. And it propagates extremely fast. which is why we believe that having primitives that are smaller in surface, more difficult to manipulate and do fewer things,

but just consistently and better, it's kind of like the Uniswap V2 and V3 model of like, it's just an AMM, there's no governance, or minimum governance, or minimum governance that doesn't really change how the thing works. And Morphu is kind of in that vein. And what that allows is actually more transparent pricing around risk, because candidly, I would not have been able, if I had the time, I still would not have been able to come up with a view on what the rate for Abit should have been.

Quite a clear view on what I think that over collateralized Bitcoin lending rate should be, which is pretty much where it is. Yeah, just something more contained and easy to parse. So now let's talk about what risk exists in defy, that doesn't exist in Tradfi, which Tom's piece went into and so did Lucas. and there's probably more risks than what you guys identified. But Tom, why don't you go ahead and start with what you called out? Yeah, and just to briefly extend Adrian's point, I think it's very important to disaggregate what is curated defy and Adrian and his team do a fantastic job,

avoiding a lot of the risk parameters that we're going to touch on here because they're a curator and they are effectively paid to under right risk. But, you know, that's somewhere like 2 to 5% of the overall DFI market. And correct me if I'm wrong there, Adrian, but, you know, the majority of DFI is actually does not have that risk profile. And that's kind of what I was getting to, right? You have the majority of DFI that needs kind of this blended rate to appropriately assess where a baseline level of risk should be up and above these, let's call them very high

quality quasi, you know, corporate bond type, you know, loans that Adrian's underwriting. So just to get into a few of the things here that, you know, I identified and I'm sure there are more and that I may have missed, but you start with that risk-free rate. And then you add on, let's call it, I call the technical expected loss, which is, you know, hacks or exploits or whatever. And I just basically use the same framework that I outlined before. It's up the aggregate amount of defy-TVL. And I said, annually, what is the default rate? on that. And historically, it's been about 0.5 to, unfortunately, this year, we're looking towards a 2% annualized rate on D5 defaults. And while recovery rate, the other part of the

equation has been really strong in Adrian's pools, right? I think you said it was almost zero. Sorry, almost 99.99% in terms of recovery rate in broader D5, that's actually not the case, right? I mean, both Korea is not returning anything. And then you have white hats and others who maybe return 10 to 20% historically. So that's a lot of. got me to about another 1.5% risk premium on top of, you know, the risk-free rate. Oracle manipulation, another one. I don't know if you guys remember, Ramego markets, cream, et cetera, same calculus there. How many exploits and how many hacks have we had specifically due to oracles and outlining what you've had on the recovery rate side? And I think this is

distinctly different than sort of the technical, you know, code-related issues. So, you know, folks said I may have been double counting there. I still don't think so. I think there's code-related issues and there's specific Oracle-related issues and those are two different attack vectors. Next one I added on top was the governance and risk premia for the social layer. So this is everything from Drift to Ronin to Sweat coin. I mean, I think it was like literally this morning or yesterday. I mean, and you can extend that to buy bit and others. Same sort of calculus there. That is in my mind clearly different than the others. And then there are a few new risks, which we're starting to appreciate right now.

So these are the re-hypothication and collateral risks that you have when you have this, let's call it, exotic composability collateral. So insert your few letters and then ETH after it, right? And then like using that as collateral in another protocol, those risks are really, really hard to quantify and underwrite, particularly in a business like Adriens, which is why I think he doesn't accept some of these collateral, like rightfully so. But a lot of DFI does. And they don't understand those risks and they're just taking them on. Then I added a few others, you know, kind of regulatory asymmetry, which I think you could argue about if that's a real risk or not.

And is that diminishing as you have clarity with clarity and genius and others? And then just sort of like a plug figure that you have in most traditional financial models, which incorporates a level of uncertainty in your model. And you could just think of that as like long-term capital management. If folks don't remember that, right, like these are the smartest hedge money managers in the world, they went to like 12 sigmas and how they did the risk models, but there still was that like complete uncertainty that they had at the tail end of the model that caused the entire thing to collapse. And most models have a traditional plug figure at, you know, one, two, three percent

for that. So that's why I got to my 12 and a half percent number and there's certainly a range there. And as I outlined, I think it's really dependent on who you're doing business with and your counterparty risk and the protocols you're using. But it felt like a pretty good baseline number from my assumptions that I kind of out led there. So Adrian, what, go ahead and outline. the risks that you feel Tradfi, sorry, that Defi has, that TradFi doesn't. I mean, I don't fundamentally disagree with the list. I think Tom did a pretty decent job in being quite exhaustive about all of the sources of risk.

Enumerating them is very complicated because you often, like, you don't know if there are some new risks around the corner that you hadn't imagined before. I think the probability of default and loss given default model is maybe more intuitive for like a simple explanation. And I think it illustrates very much the sort of unique risks of defy, which is, you know, you have a situation where the probability of default is very difficult to define. You don't know at what point, like if you're holding the kelp. You don't know at what point an attacker is going to exploit one or many vectors to eliminate it and to create the insolvency. And the issue with defy, given the fact that the crypto rail is decentralized and uncensurable, is that the loss of default is almost total.

So this makes it very, very difficult to actually quantify in that way. And I would say this, so from this perspective, I think the operating model relative to traditional finance has to be completely different. And one of the reasons that we've perhaps seen so many of these hacks is that you've had operators who, in wanting to build essentially a fintech product, applied a mentality or a point of view or perspective that's relevant in Tralfi and probably would have been just fine as a neobank product, but when translated to Defi, exposes the vulnerabilities in a catastrophic way immediately as soon as there is one, right? it doesn't you can present this as a risk or as an opportunity because I also think that the flip

this is the dark side of the coin of defy which is actually with defy you can build systems that execute automatically with no intermediaries with marked with full margin compression from this intermediation where for example one of the what we we recently worked with with S&P to issue a formal credit action, a credit rating on Sky ecosystem as an issuer. And one of the early sort of mind shift that we had to sort of coach them through was when they were asking, where's the court who's enforcing? The reality is that in the premise of a crypto defy settlement layer is that you don't need that second order of social guarantee enforcement, the rules are in the ideal.

the rules are defined up front. The participants know what they are agreeing to, and the enforcement is automatic. And I think, again, coming back to sort of the uniswap or the Morpho model, when you have a system that works very well, like over collateralized Bitcoin lending with stable coins, you have a market, it has predefined risk parameters, it can't be changed.

When a borrower or a lender come in, they know exactly what the rules are, and therefore are able to price it much more efficiently. In my view, one of the ways that we can actually get to a more transparent pricing around the whole of Defi, which Tom is sort of looking for, is by doing that, like actually going simpler

and then building more complexity on top through these simpler modules. You can build very complicated, you can build a very wide range of rich complexity with simple primitives, but the primitive itself needs to be super hard. It needs to be ossified. Like the

Nicola from Maker had this concept of incentive compatibility and what can go wrong will go wrong as part of it like his framework of thinking of building and define I think that mentality I think can move the space forward but as to whether the rates is like 12 and a half or seven we take more of the view that

yeah we don't spend that much time looking at what other curators or what other venues do there's enough enough to do with our pools as it is we feel like the market rate, like you can argue with the market, but the market rate is the rate is the rate. And the high yield rate is six or seven. So like that is what the rate is. There is maybe a question of what is the rate that the next marginal lender will require in order to get in? I think that's a reasonable question to ask.

Our view is that they will eventually come and they are eventually coming, but it won't be with Pintech hybrids ported onto crypto because they create these operational security nightmares. It'll more likely be, for example, replacing the ledger for an asset-backed financing platform and having it run on smart contracts to create that efficiency. but keeping the governance and the keeping the governance as minimal as possible and maximizing the immutability of that layer so that at least the transaction between two parties can be said to be, I hate using the word safe, but safe. Okay, well, I wanted to ask you to elaborate on, you know, what your objections were to Tom's

piece because I definitely saw like, you know, so Tom walked us through. how he calculated it for his essay. And I saw you felt like he was double counting something. So explain, you know, what your views are on how he calculated it and how you would do it differently. Yeah, what I tried to do, I picked up his, and I don't want to dwell on this too much, because I don't think necessarily that the framework is inherently wrong or anything.

One of the issues that I had with his article was in calculating the, so on the lost given default and the probability of the, default, it seemed to me that he had taken elements from other risk premium and computed them in the first term. And if you stripped those out, it so happened that you actually came across the rate for the high yield, for our high yield bolts. Like in my framework, when I say prime, I mean Steakhouse Prime. I'm sorry to chill on your podcast, Laura, but like when I say prime, I mean Steakhouse Prime. When I say high yield, I mean stakehouse high yield. I don't know what anybody else is doing. And yeah, when I stripped out these two terms,

It seemed to me that, oh, I guess this isn't what the marginal lender is actually pricing high yield. I don't disagree at all with the way that this might be priced for a pooled lending market or X, Y, Z, E, or what have you, on which I agree. There is far too, like, there are so many hours in the day. I can't, you know, I just can't. Yeah, I'm guessing that you don't allow RSEF, or you didn't for backing or? We had a, in one marginal market, we maybe had some dust on Unichain, which we exited very quickly, nothing else. The biggest risk for us was honestly, mostly the contagion from AVE, because so many collateral issuers were using AVE as a source of funding. The liquidity drying up, we were reasonably confident that the solvency issues were quite constrained because we mostly focus on stable, coins and the AVE issue was like kelp-eathe to Eth, but there was always the risk of cross-collateral

contagion or the illiquidity freeze putting pressure on a redemption mechanism for an issuer. Like we saw a bunch of issuers see a lot of outflows and that much pressure on like the liquid asset if it's locked up in AVE pending resolution of the kelp thing and create a solvency issue on collateral's downstream. Yeah, for us, the the stress. was more around that because other other collateral issuers had exposure to which so yeah tom is completely right in the sense that the composability of defy creates a lot of these connected surfaces which you have to constantly be on your barren okay so you know so you don't like object to the

basic structure of his of his equation it's more like just on the margins there were a few things you were equivalent with yeah yeah i mean the my My biggest objection was the resolution. So we strongly felt that there was more, like it would be more beneficial to try and have a little bit more resolution to what exactly you are trying to price. That it's not necessarily this, and on this I maybe have the biggest disagreement with Tom,

that I don't think you can actually say that there is a defy yield. Like there are different types of defy yield, just like there are different asset classes in Trotify. So it's very difficult to just like paint the whole thing with one brush when you have like Bitcoin over collateralized and you have like high yield and then you have everything that's not stakeholders, which I completely agree should have a huge risk premium. Like for sure. Yeah.

I think this speaks a little bit to the evolution of the asset class, right? If you just think about like high yield bonds in the 80s, like they were materially mispriced for decade plus. And that's how Mike Milken and all these others made a ton of money. Mortgage back securities, obviously clearly mispriced going into 2008. And now we're at this new asset class that has a history of maybe a decade, if that, and we're trying to price individual risk premium for a really short data series. So there's going to be large percentage point differences.

I think it's just important to understand where the broader risk premiums sit. And then the debate and discussion should be how do we reduce each one of those risk premium across the board? So, you know, Adrian's done a great job and saying like, okay, here is maybe like the highest high quality, DFI that you have in this pool. but I do think it's still important to agree on what the broader subset of the market should have as kind of a baseline yield. You have this traditional finance. You have like, okay, the corporate bond, let's call it ETF or mutual bond or whatever it is that has a blended rate. Then you have the aggregate, the U.S. Aggregate Index, which actually like the biggest proxy for bonds in the U.S.

And it actually contains a bunch of different credit risk profiles. It contains a third treasuries, a third corporate bonds, and then a third asset back securities. So that is sort of like the rate I'm thinking up here is like, if we're really, we're going to take sort of like a general blended yield in bond markets, that's the US aggregate index, in D5, maybe we need to get something a little closer to that, just for folks to understand as they're putting incremental dollars in, like, how does this compare to what I would be doing off-chain or even elsewhere on-chain? And if we don't have like that general risk profile, it's really hard to make underwriting decisions across the board.

All right. So in a moment, we're going to talk about some of the other ways in which calculating risk in TIFI is different from TradFi, but first we're going to take a quick word from the sponsors who make the show possible. If you gave me $50 right now, the first thing I'm buying is a pair of espadrilles. Coinbase 1 member month starts with 20% off your first year of Coinbase 1, plus a $50 Bitcoin bonus when you spend $100 with a new Coinbase 1 card in your first 30 days. It's one month of more, more rewards and prizes all month long. Coinbase 1 is the ultimate membership to make the most of your money. And I know because I'm a happy Coinbase 1 member. It gives you zero trading fees on thousands of crypto assets, 3.5% APY on USDC, boosted staking and lending

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your holdings at 4% or less, which is super useful if you don't want to sell your assets. You can also earn on all major assets, up to 8% APY, just by holding. And moving money is just easy. No hidden transfer fees, no friction. It just works globally. If you want to check it out, go to ether.fi slash unchanged to claim your offer. That's ether.fi slash unchained. Back to my conversation with Tom, and Adrian. So as I mentioned earlier, you know, Luca Prosperi had written a longer piece as well on how to calculate this risk. And he identified a few other issues that are, you know, relevant in defy that are not relevant in Tradfai. He talked about how like in Tradfai in the equation, you would assume that the debt matures at a specific point in the future. He talked about

how in Defi with a collateralized debt obligation, you know, you would see that the value of the collateral is kind of continuously being observed. So that that point of time is like not something that's really existing really in crypto. He talked about how in TradFi you would assume there's this sort of like continuous path and asset prices. But obviously with crypto prices that have limited liquidity, they can violate that assumption. And he noted that in Defi, you have to account like, oh, sorry, this is actually repeating the point. But anyway, so basically, he's just talking about like different, you know, distinctions that exist in Defi. Oh, we're talking about how in Defi, there's an act of rebalancing, et cetera. So, you know,

I wanted to like just have you expand a little bit. on how those kind of factors should be accounted for. The one last thing I'll say is just, you know, Luca basically came to the same conclusion that Tom did where he said, you know, even on blue chip crypto collateral, like ETHUSDC, he felt lenders should be demanding like 250 to 450 basis points spreads over the risk-free rate. And then he said, quote,

over collateralized lending on liquid crypto-native collateral is morphos bread and butter and represents the vast majority of its TVL. However, we observe consistently narrower spreads by 5 to 10x over the risk-free rate versus what rational lenders would require based on appropriate mathematical specifications. So I was curious, like, for your thoughts, if you agreed or disagreed. I can go first. I had the biggest issue with Luca. He's a friend. Yeah, but this is where I disagreed with him the most. where he, so you brought up a few interesting points first. Like what Luca fundamentally did was try and model, everybody's trying to come up with a model of, here's what I, here's like the spherical cow, right?

Like we're going to model just this perfect thing and then try and see how it matches reality and adapt model afterwards. And his view was that defy lending or repo lending in general was kind of like a put option on the underlying collateral, and he used pricing models from that world, from that universe, to try and price it. And where the biggest methodological error that I had with it was he assumed that there was a loss to the lender every time there was a liquidation fundamentally, where in reality it's an incentive balancing mechanism in the way that morpho works,

where if you have a liquidation, you have to reward the liquidator so that you don't have to depend on anyone and so that the incentives between all participants allow the lender to stay whole. Yes, the borrower gets wiped out, but they took the risk. So that's kind of their fault. The other aspect was, yes, for us, liquidity is same block. This is the other major difference change in perspective coming from traditional finance where presuries are liquid because they are T plus zero or T plus one. For us, instant, liquidity means the same block.

no money market fund to date has like absolute same block liquidity for now. We're hopefully going to be able to do something about this in the near future. Until then, there will be a fundamental inefficiency between moving between Sofer and DeFi because you don't have that transmissibility. And so from our perspective, actually Bitcoin and Ether over collateralized lending is more liquid, even than US treasuries in DeFi, just because of this. And then the, so that's really the biggest, if you do away with this methodological disagreement, you realize that actually Bitcoin and ETH, over collateralized lending in variable rate repo markets

like Morpho when they're isolated are very liquid and very safe. Historically, there are risks. So the biggest risk is if the price of Bitcoin and the price of ETH were to gap in the same block, more than the haircut, the lenders would experience the loss. For that to happen, the Oracle system would have to fail, or there would have to be an actual price, single block price drop of that magnitude. But the more that Bitcoin and ETH get adopted as an asset, as an institutional asset in ETFs, what have you,

the lower the volatility is and the less likely this outcome becomes. So from our perspective, this prime lending was very much, out of range from what Luca was arguing. Oh, great, Tom. Yeah, I know. Luca and Adrian both know a lot of more about the nuances there than I do. I would just point out that over collateralization is not a long-term solution in my mind to any sort of credit markets. So you could a higher level over as premium there as in when we move to at least something on poor or maybe even undercollateralized in the future.

Okay. Well, I did also want to ask, like when we were talking. about how Kelpdow didn't even start with lending. Like, how do you guys think about that aspect of it? Like, I guess Tom, in your equation, would that be sort of that initial, I forget what you called it in your equation, but would that be the initial risk or like, how do you guys even quantify that? Because, you know, just like, it almost feels like, you know, there's sort of the universe of

lending itself, which you should over time be able to come up with models for, especially, you know, as Adrian talked about, just like each of the specifics, like, you know, different types of vaults would have different equations, whatever. But then, yeah, when you end up in this situation where there can be something, yeah, that just sort of comes in another direction. Like, or is that something that is easily quantifiable? I don't really know. So, And this relates to the point you mentioned about more traditional risks that don't present themselves in traditional finance that do present themselves in DFI. I mean, there's no, there's minimal social layer. Like, yes, I could upload something on a USB device in my mortgage Stanley office and, you know, take it home and maybe it gets hacked or whatever.

But, you know, the instances of that are few and far between. I mean, there's a very clear attack vector on a social layer in DFI that needs to be priced and that presents itself in Kelptow. And then there's the, it's called it rehypification or exotic. asset risk that is a distinct and separate risk in most of traditional finance and usually contained in a certain sense. Maybe it wasn't in 2008, but large majority of the time it is, is not contained traditionally in defy, right? Adrieno was just saying he didn't really have exposure to this incident and still had some effects, knock on effects, because defy is so highly integrated, particularly with these exotic assets that have hundreds of millions of dollars, right?

You had people coming out at the woodwork saying that we've heard of kelp out, you know, whatever, $300 million, $200 million. So, you know, those two risks are distinctly different and something we should certainly assign another level of risk premium to. Then there are other things like, you know, staple coin depag risk that I accounted for. That is call it minor today, but USDA has,

USDC has deepagged in the past. Obviously, things like Tara Luna have materially deepagged. There are other risks there that are present that are not in traditional finance that we have to just add on to this risk-free rate. And then more broadly, as we kind of think about this baseline level of rate that we have today in DFI, is it a true rate? Is it a battle tested rate? And I would argue no. I mean, we're trying to disaggregate the little pieces on the edge. And, you know, folks will say, okay, but the market rate is the market rate. It doesn't really matter if you think it's 12 or 13 percent. It's actually seven or eight. To which I would say, okay, we have, you know, a few billion dollars trading against these amounts, you know, daily. turnover, right? You know, you guys, Adrian have what, two, three billion, something like that. I mean, total defy is like 20 billion. The battle festive rates in traditional finance trade trillions

daily, literally trillions. So, you know, there are a number of reasons to be on chain that can compress these yields. So I would argue once you get institutional players who actually come in and net new capital, it's demanding a level of sort of light on each one of these individual risk premium that the rates would materially rate higher. Yeah. So actually, actually, actually, let's talk about that because I think that was like one of the main criticisms I saw to your piece. So for instance, Dan Robinson of Paradigm responded, quote, I agree that defy lenders seem to be underpricing risk. Most blue chip yields are lower than the risk-free rate you can earn from money market funds. Even for lenders who don't have access to treasury yields, it surprises

me that they take those risks to earn roughly three percent on stable coins. Then he said, but that doesn't mean rate should be higher. You have to take demand to. into account. I saw Bill Barheight had like some other ones which we can get to, but, you know, I just wondered like, you know, you didn't really seem to factor that demand bit into your equation. So how do you think about that? There's a real convenience yield for having assets on chain. And that could be if you're a crypto native fund or defy power user or whatever and you want the optionality to keep your money liquid on chain available for opportunities. communities, absolutely. There's a censorship-resistant angle, right? If you live in Iran or something

and you want access to stable coins or something, it's much more convenient to have that than try to find T-bill rate somewhere else. There's a real tax advantage for most people, right? There's a lot of profits that have been made on chain that folks are less likely to opt-bord depending on their tax jurisdiction. I mean, there are a number of individual reasons why you would structurally look for a yield on-chain that could satisfy some level of demand up and above the straight risk-free rate you had by moving it to your US bank account and pocket money market fund or something like that. So I think those are totally legitimate arguments, but they would actually make the actual assumed rate higher if we were to make all us equal.

Adrian, what about you? But that's why I think the, I think the universe of current defy users has a convenience yield aspect to it. But I don't think it's the whole universe of crypto-native users. I mean, one of the biggest use cases on Morpho is borrowing against Bitcoin for users within the exchange. None of these users are presumably in Iran. And lending to those same users on a D5 venue on base. Again, also none of these users are in Iran because the settlement layer is quicker, cheaper, more convenient and has the benefit of speed, finality, et cetera, and when those markets can clear and meet each other without the need for intermediation, I would press those margins higher. So an interesting benchmark that actually I didn't

pick up on and I don't think anyone else in the discourse picked up on was the simplest comparison you could make of how efficiently defy is pricing these yields is how does the rates compare or defy Bitcoin overcladale is lending to off-chain, you know, institutional Bitcoin over-cladurize lending. And there's a significant difference. And it's not because DeFi is on chain that it's special or there's a convenience yield that people are willing to sacrifice and not lend to a user in custody. But variable rate crypto for all its, you know, volatility and instant liquidation. so forth, is more liquid. Rather than being, this is one thing that I didn't pick up on when I was having a chat

with Luca actually, where he was suggesting, yes, there's supply and demand imbalance, and that could explain part of the difference. But actually something that people are discounting is that rather than there being a liquidity premium demanded for lending against over-collarized Bitcoin, there could well be a liquidity discount by virtue of the fact that these markets are so big and so liquid. that you can actually lend at 4% for 12 seconds and come out for hundreds of millions of dollars. And that's very difficult to replicate in traditional finance.

So that liquidity again has like that flip side where it can actually explain why the rate is so much closer to Sofer. So like if you can get Defi Coinbase Bitcoin borrow at four and a half percent or whatever, then the comparison is can you buy? from a market maker and what is that rate and it tends to be significantly higher because there's intermediation and margin extraction and rent extraction essentially and that's one thing that defy does well in compressing that layer away and that's our sort of view for the direction of travel of this space and that's how you

can get to more efficiency and in the future like yeah we're in the space because we we want to make finance open and transparent we really believe that that this is a better way of doing finance for all of its defaults and, you know, curiosities. Tom's, you know, lost given default rate. I think it was like one and a half or two percent. It's not that bad. Sorry. Compared to traditional finance.

It stacks up decently well as a whole. And it's not like traditional finances absent of infinite mint issues either. You know, I'm in Switzerland at the moment. We used to have two global G-SID banks. Now we have one because it was, it faced very much a similar, like the Archegos blow-up that destroyed Cadizuis was very much an infinite mint hack that the hedge fund manager had unlocked because he found that he could infinite mint his assets

by just not telling other people that he was doing it. And Cadizuizu's were the last to exit and, you know, other banks were quicker and facing our losses, but it's no different. And now Switzerland has one G-SID instead of two, you know, to potentially far more catastrophic or potentially far more catastrophic consequences and in a system that if it had been mediated on defy could have been resolved more transparently and perhaps quicker. Tom, I just noticed in the chat you wanted to talk about Stakehouse Financial's risk funnel? Yeah, sorry, I had asked the, the, but that was new. Yeah, because it was relating to an

earlier point to show that we had very much the same risk dimensions as Tom. We just ran into different places. Yeah. Okay. If it's not relevant to the point, we don't have to bring it up. Yeah. So this is on our docs page. We have another page which we update once a day. And it's very much, you know, it'll see, it'll look very familiar because it's very much like, what's the source of social risk to the asset, what's the technical risk, lindy risk, the market, the liquidity and so forth. And this is kind of, we don't come up with the risk premium per se, but it's how we underwrite an asset to qualify it as prime or high yield. Stakels, primary which is high yield. Okay. There was one other response to Tom's piece I wanted to talk about,

which was Bill Barheight. So he, you know, like the others felt like, the market was deciding what the, what the yield should be. Some of the things that he disputed were he thought that 10-year treasury was not the right risk-free base. He, again, felt you were double-counting some of the, you know, possible, you know, failing, possibilities. And then he also thought that you were. sort of like annualizing some of the what he called six weeks of panic into a permanent risk rate.

I don't know if you, you know, had any thoughts on on his response or, you know, if you wanted to, yeah, to. I'll do them quickly because I feel like I've been on a little bit here. So the risk free rate, that's fine if you want to use a sofa overnight rate, it makes sense. I think there's some, the 10 year yield capture some time value, some credit risk components that are not inherent. to the overnight rate that I think are actually present in a lot of defy. So I think it's very used to 10-year rate, rate, and that's the traditional risk for rate of finance.

So if you want to use so hurt, totally makes sense. You just got to take 50 to 65 basis points off my yield. Totally reasonable assumption there. I don't think I've double-counted anything. I think I outlined that. But I'm going to release the full detail on all of the different risk for me after that, because I did do a good enough job there. But I don't think I'm double-counting there.

If anything, I think I'm probably undercounting some of the other components that I mentioned. And then Sarah was the third point he brought up. Oh, he said he felt you were annualizing six weeks of panic into a permanent risk rate. Yeah. So I think I think that's short-sighted in that when you have an event or a month like we've had now, you have to materially change the risk profile. And I just think back to my Treadfi days or underwriting private credit. And I was like, okay, give me your history of what you've done for the last 10 to 15 years

of underwriting prior credit. Okay, you have a 99% rate of non-defaults, so 1% default rate. Okay, your recovery given default is about 95%. Fantastic. You've done that for like 10 or 15 years. Here's the mix of your loan composition. And then all of a sudden, you have something like Blue Owl happened where it's like, oh, shoot, you had most of these as software and SaaS-based loans and all of a sudden

the default rate ticks way up. You have to re-underwrite your models based on that. You can't just say, oh, that was, you know, we can't just go back to the old model because this thing happened. So you have to re-underwrite what the risk profile is. When you have $600 million of DeFi hacks in one month, you have to rewrite your models. Now, do you have to say, you know, the higher yield for this one particular month is completely what you should use going forward? No, but you have to assume that some level of that was actually real because it did happen and you have to price it into your models.

And this is a fundamental challenge across cryptos because our time series are so short for all assets, for all risk profiles, for volatility across the board, that every single negative data point just makes the default rates and sort of the overall risk profile that much higher for traditional investors who are looking at time series data over a number of years and decades. Yeah. I completely agree with Tom. Sorry to interrupt.

I completely agree with Tom on this, actually. Like for us, it's a reflection of, we would describe it as something like the cost of capital for going on chain spikes whenever these events take place. And for good reason, because it is nerve-wracking. And because these losses are very, very, public, very transparent and catastrophic and large. And yes, it would be unreasonable not to have a marginal lender re-underwrite their expectation

for the cost of capital for going in. Yeah. So one of your fundamental disagreement there. Yeah, I'm going to add like a few that Luca pointed out. Or sorry, sorry, this was, these were some of his explanations for why he felt that, for instance, morpho depositors weren't demanding more in terms of, you know, yield. Some of the hypotheses were depositor misperception, as in they didn't understand the risk they were taking.

Survivorship bias, because some of the losses only hit specific vaults, bull market masking, token subsidies. There's one other one that I really thought was interesting. He called it regulatory arbitrage. He talked about how basically the Clarity Act, since the... it's likely going to forbid stable coin issuers from passing long yield. He said that that results in a total pass through risk transfer onto depositors, which I thought was really interesting. If there's any Congress people who are listening to that, I hope you paid attention to his

point there. Okay, so I think we kind of covered like why it is that maybe the market is actually at a lower rate than some people think. But I did also want to then just go to RWA's because this is something, you know, that we're seeing like there's an uptick and interest here. But Luca called this out and we have another show, Bits and Beps, where some people have also been calling this out. Basically, you know, with RWA's being used as collateral, Luke is saying that when there's volatility in the price there, it's not observable because that's only updated, you know, like quarterly or whatever the cadence is. And then basically like the Oracle updates, but the collateral price can be out of sync. You know, one is just updating a lot

faster than the other. And then he also talked about how liquidation just can't be immediate in that kind of situation. It can even involve like a legal process. It takes months or, you know, whatever. So, you know, he's very bearish on non-crypto-native collateralized lending, and I was curious to hear your opinion on that. Depends on the collateral. If you're looking at, like, private market or real estate stuff that is marked quarterly and is very long process, involves legality to actually liquidate as real trouble. And I think that's a legitimate argument from the folks who may not like in Congress, why you want to put this stuff in your 401Ks. I mean, long-term investment vehicle, but if you ever needed to take a loan against it or try to liquidate

in some circumstances, it is not something that you're going to unwind pretty quickly. Now, if it's gold or oil or something you can easily trade or hedge, I would disagree. I think those are very well established and very easily the right collateral against. Yeah, echo Tom completely. It depends. And, you know, there are some, you know, assets that are not easily fungible, not easily easily measurable, update their price twice a year. They make for very difficult matches with on-chain variable rate repo with instant liquidations. It's a very dangerous mix.

There's usually a substantial duration mismatch that you can only patch at best. It doesn't mean that you can't eventually do something like on-chain receivables financing, as long as, for example, the entire chain is running on stable coins, because then presumably the secondary market for these individual receivables is much more liquid. You could update your models more frequently than once a month. You could do this every time there was a trade or swap or whatever. But yeah, something like gold, tokenized gold works fine.

In tokenized stocks, they're still sort of the weekend bridge, which is a question mark for variable rate repo because on-chain repo on variable rate works throughout the weekend. but obviously the stock markets don't. So there is a more pronounced gap risk there. It's not impossible. And there is a substantial margin that could be disintermediated with defy infrastructure, provided it's coming back to sort of the earlier points that I was trying to make more aligned with an equalized philosophy of make things more like Uniswold, make them harder, make them more difficult and stupider with.

less governance so that they can just do fewer things better. And that's actually the value proposition of defy. Okay. So last question. So one of the responses to Tom's post was from Michael Igorov of Curve. And he said, so this is what it's saying. If you supplied in random stable coins blindly to a random protocol on defy blindly, your break-even risk-adjusted rate is 12.55%. And then if you start being selective, these risk premiums go lower. So, you know, this is sort of where we've been trending in this conversation. You know, there's sort of like the broad brush stroke way of, you know, defining this. But then when you dig down into the details, you know, it could be like specific vaults, specific types of collateral, like, you know, whatever it is.

So how do you think about that? Like what, you know, which protocols or types of protocols or like, you know, ways. that, you know, defy lending can be structured that, like, how, you know, what are some of the ones that you think about as ratcheting the risk up or down? And then, like, how would you tweak your equations or models to account for that? Until a few months ago, I would have said blendiness is a clear one, but then you have something like balancer and he just kind of goes out the window, right? Like, you know, you would think that we have some level of assurance that these risk profiles are reducing, but in fact, they're increasing with AI. So I think it's really important

for folks to critique what I said and look at more and more risk premium and then individually try to assign some level of risk. So if you're working with Stakehouse, I'm very sure a lot of the risk premium I associated with are materially lower than I set for the broader market because they're curating for you. And I think in the short term, that's probably the answer, is to look at curated bolts with clear collateral backers that have a track record in history. And unfortunately, I know a lot of people in Defi won't like to hear this, but we're effectively having a bailout fund for this recent hack and socializing some of the losses on the other end. And we're sort of stepping into this permissionless financial system. And you can argue that's what curators are doing

as well by self-selecting these assets. So I think it's more of like the progressive decentralization route that folks would say, you know, I think we're, you know, Tom, aren't we here after this many years? I'd say probably not because, you know, you've seen a lot of these hacks and people want to sure since they're getting their money back. There's, there's an issue. So I think it's more like defy on guardrails for the time being until we can effectively really reduce a lot of the risk profile across the board here. That's what the, to me, that's what the, Defi is guardrails. So properly designed,

defy is nothing but a set of guard rails. You know, Uniswap and Morpho, Blue, like the singleton smart contract, don't do anything except constrain what the users can do with it. That's kind of their strength. That's really where the future of the ecosystem lies in our view. And, you know, I want to make finance open and transparent.

I don't want to be underwriting food tokens for the rest of my life, you know, like the point of this is, like, I do want to eventually have a meaningful impact. We're starting to get there. You know, rent minimization, disintermediation. These are real benefits that are occurring now to users of defy, but they lean on the things that are being constrained more. a bad outcome in my view would be guardrail meaning the law has to come in and step in and say defy is only defy if it comes from this region of France

the best outcome is like you know the best outcome is something like you have small primitives you have uniswap you have morpho they're extremely constraining they provide for a set of rules that can't be broken because they're run on a decentralized net that can't be censored and then on top of that people will do what they may but at a minimum the base level is

really really hard the bad outcome is something like yeah like a kelp exploit or drift which is where you have like these mixes of in tech mixed with defy with all of the vulnerabilities that that ensues obviously that's much more risky and much more difficult to price

yeah steakhouse the champion of defy I think is a great slogan for you guys but yeah we're really you know, this whole castle will burn down and we will still be inside saying people will be the last out of the door. I think we probably need, we agree on a lot here. I think we probably need different definitions for these things, like, you know, kind of like we're trying to write

the definition of MEV again, because it doesn't really make sense in its current context. The way you say it, like, if you say defy more broadly, I guess it's like saying credit. But what you really mean is like, okay, you have treasuries, investment grade, and then high yield, and then just like random crap on the side here. And it's all blended together right now. But really, we need to segment these things and borrowers should look at it in that light. Because, you know, when you have the, you know, CEO of CalPERS coming out and saying, like, we can't touch Defi because it has all these crazy risks, it's like they're obviously not referring to you guys or these curated yields. They're referring to the complex more broadly.

So, yeah, as we continue to grow, I think it's just more nuanced we've got to add in the conversation. Yeah, yeah. Like, like, honestly, I envision a future where, you know, I mean, it's just such a basic thing to say. but the transparency of it all is really going to actually make this financial system stronger, in my opinion, than the traditional financial system. So, yeah, like people will be able to see kind of, like, more clearly what the risks are. But, yeah, we need more, like, experience with it all to even calculate it. Well, to give you a – in one of the big themes of the 2008 credit crisis and the Global Finance Corps – And the beginning of the global financial crisis was defined by a complete evacuation of trust in the system where nobody dared face any other counterparty because they had no idea what they were exposed to and to what degree.

And one of the main liquidity outflows was just people pulling into their idle markets. Could you use the defy-vote term? Like all of these banks pulling into idle markets and waiting to see who was going to die. whereas even in the heat of the contagion around Ave and Kelp and all this, I mean, all things considered, it has resolved, it has been able to resolve reasonably quickly given the size and prominence of this exploit relative to the size of its space. Like, you know, Archegos exploded clay swes over months and Nodi

still probably don't know what the exposure was. But even in the case where you had a question about specific issuer and their exposure to AVE, you can, oh, well, let me just check. And I think that goes a very, very long way in restoring trust and the system and bringing it back into bonds. Absent of the, you know, Defy United and all this, which is great as well. Yeah, actually, but just hearing what you said, it made me realize that the way things are headed, we will likely end up with more privacy in defy. So then would the system rely more like on ZK proofs to, for people to have comfort or like,

yeah, how do you feel like that part's going to work? I don't know the first thing about ZK proofs. Like I would qualify it as is it, am I depending on a social guarantee or am I depending on a crypto guarantee? Like if it's something that's hard and I can check it by myself with my own node and so forth, then I have reasonable assurances that that's there because I don't have to worry and do the calculations of whether Ethereum is censoring me.

I don't. Like, that's kind of a point. If I have to depend on a social guarantee, then that looks far more like a fintech or a trap-fi product than it does like a crypto product. And that will require significantly higher. Like, for the love of God, I hope collateral issuers are not going to start privacy shielding

their asset reserves. Like, if anything, I felt we were going in the opposite, After, if somebody wants to shield their stable coin transfers between their friends, then okay. All right, well, we'll have to see how that all goes. You guys, this has been great. We're a little bit over time, but thank you both so much for doing the show. Thanks, Lowe. Thanks, Tom.

Thanks, Adri. And for those of you who watch, thanks for joining us, and we will be back next week. Catch you later, everyone. Thank you.