Unchained - PaperTrade Attracted $140M, Then Changed the Rules. Was It a Bait and Switch?

Starting point is 00:00:00 You sell a bunch of people on a rule set beforehand, a bunch of money comes in, and now you change everything after the fact. Like, it's not exactly a rug in the sense that crypto Twitter is like very used to seeing, right? Like an actual rug where they just take all your money and run. But they are kind of big in switching you with the rule set and the parameters around the protocol and the token beforehand and after. Hi, everyone. Welcome to Unchained. You're a no-hype resource for all things crypto. I'm your host, Laura Shin.

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Starting point is 00:01:22 million clients. Find out more at nexo.com. to bits and bibs yet, it's our weekly crypto and macro market show with Rom Alawalia, Austin Campbell, and Chris Birkins. Search bits and bips and subscribe. Today's guest is Jason Pagalottis, head of markets at Delphi Research. Welcome, Jason. Hey, Laura, thanks for having me. It's good to be back.

Starting point is 00:01:53 Last week, crypto's Twitter was a buzz with excitement about paper trade and it even flipped NASDAQ's daily notional traded volume on one day. this week it's a different story crypto twitter is very upset with paper trade before we dive into all the drama explain what it is and why people were initially so excited about it uh yeah i mean that's a pretty good summary right of of the of the last week and a half or so but uh paper trade i guess like the easiest way to think about it um probably i'll use like their words to be to be as fair as possible is it's like a fair launch so fully on chain exchange sort of which i'll get into uh launched on the hyper evm network which is essentially like the hyper liquid on chain portion of their

Starting point is 00:02:44 business right not the hyper core platform where perps and everything are and it essentially lets traders take these massive leverage trades but mostly gambles right up to 1,000. X leverage, right? Because if you're trading on a thousand X leverage, it's not really trading. It's mostly gambling. And it was siloed to Bitcoin and ETH positions. And when you take a trade on paper trade, you're not actually taking a trade against other traders. Your trade isn't going into an order book. You're not selling into somebody else who's buying. Like if you, if you place a sell order, I might be on the other side of that on hyperliquid and on buying, right? But on paper trade, the positions are taken against the house,

Starting point is 00:03:29 right, against the house single pool, which I believe they called kind of funnally is Mardingale or LP, right? So essentially when you place trades, you're placing trades against the house, the house takes the other side of it. And because of that, it essentially

Starting point is 00:03:45 allows there to be no funding rates, no fees essentially, no slippage and things like that. That Mardi Graselor LP pool that you're betting against or trading against, I should say started at $0 and it's funded when traders lose money. So their margin goes into that LP pool.

Starting point is 00:04:04 And then if you lose money, you then mint paper as kind of like this rebate token on the back end. So it's like at the beginning for every dollar of USDC loss trading on the platform, you would mint I think it was 100 paper at the time. And then obviously if you win, you don't mint any paper. So essentially, it's if you go on this platform and you're trading and you lose money, you get some kind of rebate back in the form of these paper tokens, which can then be staked on the platform for USDC yield generated from the trading activity on that platform as well. The easiest way to kind of think about it is if people who are watching have been around for a little bit, like if you think back to Rollbit, it's very similar to the Rollbit model. there's obviously some different things there but it's probably the easiest way to think about it

Starting point is 00:05:00 for a lot of people and it went on October 10th right that that was like their whole thing and I have like some issues with that but like it was like that if you think back to last year it was like that October 10th liquidation event where everybody got nuked right you had that finance weird thing going on and then you had the ADL across the board

Starting point is 00:05:17 everybody lost all their money everybody called it like that you know that liquidation day and then this paper trade protocol is like oh, you kind of have that narrative of like everybody got liquidated and now we're launching this thing where if you get liquidated, you at least get, you know, some kind of rebate back as well. So that's kind of like how it all started when it initially launched maybe like two weeks ago at this point, two and a half weeks ago. Yeah.

Starting point is 00:05:42 And to my mind, you know, when you said it's sort of like gambling, like even the fact that when you trade on it, you're trading against the house. like that's you know it is from so so in their docs or like in in like posts that they've had like they've they've like in their model like this isn't my words they've likened their model to like those early bucket shop models back in the you know late 1800s and early 1900s where people would essentially be able to go to these like storefronts or whatever and place bets about an asset but not necessarily trading the underlying asset in the bucket shop would take the other side of that trade. It's a very, very similar model. It's been around for hundreds of years.

Starting point is 00:06:26 Just now we can do it on a computer. Okay. And so explain also this bit about, so there's no slippage or fees as far as I understand. Correct. So explain like what happens when you lose, what happens when you win? Like, how does it all work on the back end? Okay. So going back to the roll bit example. When you win paper trade copies the roll bits, uh, like asymmetric fee on winning trades, right? So essentially, if you win, you don't get the full 100% of the win. You get like 88 or 90 or 90 something percent of, of the win from there. Um, and if you lose, you obviously lose your money, your margin, but, uh, when you lose, the amount of money you lose goes to minting paper, which you then get back as like that rebate token, right? And then theoretically people would go on this platform.

Starting point is 00:07:23 They'd be like, oh, well, like if I, you know, lose a bunch of money early on because based on the way that the, you know, the curve of minting worked at the start up until there was like about $2 million of losses, the amount that you got, the amount of paper you got for per dollar loss was higher. Right. So like the incentive was to be earlier to lose your money. So you had got a higher amount of paper. And so when you lose, right, obviously that's what funds the the Mardi Grasler LP, which pays out to the profitable traders, right? And if the LP is out of money, it enters into this queue where like you can't actually get your profits until other people lose enough money to then start paying out the queue again. And so that's kind of like how it works. It's like a, yeah, it's just like one hand pays the other back and forth, back and forth. forth back and forth. And then there's like a haircut in the middle on fees. And because you're trading against the house, that's why you can have no slippage, no fees, right? Because a perpetual future, you actually have a funding rate, which is what kind of keep, it's the mechanism that

Starting point is 00:08:30 keeps a perpetual future in line with the underlying market. That doesn't exist here. And so that's why you can have these no fees, no slippage, 1,000x leverage, because none of these orders are actually hitting the market. When you place an order on paper trade, you're not actually moving, like, if you go buy $10 million of Bitcoin, you might move the market a couple basis points or whatever, right, depending on how liquid it is at the time. If you go buy $10 million of Bitcoin on paper trade, that market or that order never hits the actual market. So it doesn't actually have any market impact, which is why you have all these features, you could say, that are enticing for traders. Yeah. I mean, again, it's like,

Starting point is 00:09:13 I'm not trying to disparage it, but again, it gives me the casino vibes because it's like you have these poker chips. Yeah. It is a casino. So it's like play money. Yeah. I don't think it's disparaging to it's what it is. I think anybody who's being honest would be like 500 X trading isn't trading. It's gambling. Right. Like Bitcoin can move 10 basis points for any reason no matter what. Like you're not forecasting 10 basis point moves. And if you use a thousand X leverage, that's how much. Bitcoin needs to move for you to get liquidated. So yeah. Yeah. And another part of the billing was that because you, when you lose, you get paper. It's like you own a part of the house or something like that. Correct. So it's sort of kind of like this decentralized like Dow model being applies to a casino.

Starting point is 00:10:06 Yeah. Yeah. Yeah. It's a way to think about it. Yeah. That's what it's what it was, you know, branded as, at least initially. But then maybe we get into this, right? Like last week they had a different announcement where they kind of changed a lot of things retroactively.

Starting point is 00:10:23 Well, okay. So, but let's set it up. Yeah. So let's describe what paper was initially supposed to represent and like how it worked and, you know, those. Yeah. So, yeah, like I said, when it launched, you just pre-deposit money. crypto Twitter, I think, deposited or pre-deposited 140 million USDC, so not a small amount of money into the platform to start trading as soon as it went live. It went live on October 10th.

Starting point is 00:10:54 And then it had like a really good week, right? Like a lot of people were using the platform, lots of paper was being minted. Trader losses, you know, mounted. I think I have the number here somewhere, but I think it was at this point, $57 million have been paid to paper holders via staking your paper after you've lost your money. And so for the first week or so, it was kind of functioning as fully intended, right? Like it launched, everybody's placing these massive trades, everybody's trying to get into that. Like I mentioned, that first tranche of losses where the rewards for your liquidation were higher.

Starting point is 00:11:39 And everything kind of was working as intended. Obviously, there's a whole, like, infra aspect with launching on HyperEBM, which kind of made the launch a little bit tricky up front. You had these cues to close positions because Hyper EVM isn't exactly a super high throughput chain. It doesn't have enough, you know, capacity to kind of support all of this speculative, A shift, not high frequency in the sense that you would think about it in terms of market making, but higher frequency type of trading activities, right? If you're trading of 1,000 X leverage position, like, you might want to close that trade 30 seconds later. But if you try to close your trade and there's a bunch of other people ahead of you in the queue to close trades because the actual

Starting point is 00:12:27 underlying infrastructure can't support all of these things happening at the same time, you're going to have a bad time, right? Like, by time you're the queue, gets to your order, you could have already been liquidated. And you're like, oh, well, damn, like, it's no way to trade. So, like, you had that little hitch go off. And then you had another thing going off on the first day, which is probably a bit of a bigger issue. And the main reason for the announcement that we'll talk about is that when you have something like this, there's always going to be an incentive for somebody to try to game the market or use the rules that you put in place to profit, right? We see it all the time in anything, right?

Starting point is 00:13:07 And so when you have these really big positions allowed on, for example, paper trade, you can then go on to an actual exchange, right? So paper trade derives its prices or takes the midpoint from Hyperliquid's actual price feed. So its market prices are based off of what Hyperliquids trading prices are, and Hyperliquid is an actual open order book. So if you have enough size where you can go into the hyperliquid market and push around Bitcoin or ETH, even on small amounts like sub 1%, even for short periods of time, you can theoretically push paper trades price feed. And then because everybody's trading on these massive amounts of leverage, it doesn't take much to, you know, kind of wipe out traders in one direction or the other. And so you actually saw that happening on the ETH perp pair on paper trade and hyperliquid the day of launch.

Starting point is 00:14:05 You had somebody putting in these, you know, 10, 15, $20 million market orders pushing the price around. And the team realized this. It's also, it's a risk they actually, you know, highlighted in their docs ahead of time. Unfortunately, most people don't read anything anymore. And so the team actually had to kind of go in and manually like lock the positions on paper trade. so he couldn't kind of, you know, I don't want to use the word exploit because it's not really an exploit. It's somebody just using the mechanics of the market in the way that it is. Other people might disagree.

Starting point is 00:14:36 But they realized this was happening and kind of went in and kind of locked his paper trade position so they couldn't close them. And then kind of got in contact with them and came to some kind of agreement. But it does show there's an open attack vector here. and that's something that people should be aware of or aware of for sure. Yeah. So in a moment, we'll talk a little bit more about what happened next, but first we'll take a quick word from the sponsors to make this show possible. What if your crypto could do more than just sit in your wallet? Nexto is a digital assets wealth platform where you can generate daily interest on your crypto

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Starting point is 00:15:48 Back to my conversation with Jason. So if they had identified in the documents that this was a possibility, why do you think they allowed paper to be, or said that it was on the roadmap for paper to be transferable? What happened to that trader? I saw people speculating that, like, this person was going to be blocked from cashing out. That's what happened.

Starting point is 00:16:12 The team did lock and lock those positions once they realized what was happening. And I believe they probably got in contact. I don't exactly know what the resolution was. I'm pretty sure the team handled it with the person and like on the side. But yeah, they went in and manually blocked those positions from being closed on paper trade, which then forces the guy because if you can't close on paper trade, then clearly it's not profitable, which forces him to go, you know, stop doing it on the hyperliquid side of thing. So, yeah, they manually block the position.

Starting point is 00:16:47 So like when you say something's like fully on chain, it doesn't actually, It's not like fully decentralized, right? Like it's still a multi-sig. They still have full control over whatever goes on. So I'm not sure that was ever, you know, anything anybody really cared about with respect to this specific protocol. But like it's something worth, you know, highlighting too. Yeah, yeah. I think I saw the defiance said it's a 203 multi-sig.

Starting point is 00:17:09 And, and, you know, like it was, yeah, like a two-part operation, as you said. He was pushing down the price of ETH on hyperliquid. and then because that's the Oracle on paper trade, then he was profiting from a short there. So, all right. So now let's get into the meat of the controversy. Yeah. Because on Monday, I guess, so this was actually like roughly a week after those events.

Starting point is 00:17:36 So maybe it took them a while to figure out how to resolve this. But they started a controversy when they announced that they no longer had plans to make the paper token transferable, at least for now. after, as we mentioned, the roadmap explicitly outlining that as one of the later phases, they explained, quote, if we were to make the token transferable at this point, we are confident we would quickly enter a state too dangerous to allow any material exposure to be taken on paper trade. And as an example, they said, if our bankroll is $10 million, an attack costing $15 million manipulating the price of Bitcoin or ether is not viable.

Starting point is 00:18:14 You simply lose money. If, however, you are able to put on, 10 million of paper short side exposure. Suddenly an attack costing 50 million is very viable indeed. So do you feel like what they did here was justified? There were a lot of reactions to this. I've gone back and forth on this personally. Number one, they're right.

Starting point is 00:18:41 That is what will happen. It's not a matter of if that will 100% happen. if the token is made transferable because anybody can whip up a perp market and then boom, you have all the ingredients you need for this to come true and we've already seen the first part of it happen the day of launch. So to think that this wouldn't happen

Starting point is 00:19:01 if given the opportunity is just naive. So they're right in their analysis of the situation. The question is, did they know this ahead of time? And if they did know it ahead of time, why were they talking about making the token transferable? after some time when clearly by doing so, it either opens up the protocol to existential attack vector risk or because there are solutions, right? Like you can cap the pool size, right?

Starting point is 00:19:33 You can maybe add caps on leverage. You can maybe do like certain things to really like mitigate a lot of the math here. but in doing so you kind of take away all the reasons in which somebody would use paper trade to begin with, right? Like you're going on paper trade to use a thousand X leverage. You're not going on paper trade to trade Bitcoin with 3x leverage the way you would on hyperliquid, right? Like it's it's it's it's clearly there to solve like that DGen, roll bit, casino, gambling, quick hitter type activity. And by adding in those caps, adding in those restrictions, adding in those parameters and safety things,

Starting point is 00:20:20 it kind of takes away from the whole point, in my opinion. And so you're in this really weird spot, right? You kind of made a promise in a sense, or you at least sold that, like, everybody was under the impression when they predeposited their money into this protocol, that these paper tokens would be transferable at some time. And now it seems pretty clear that they're not going to be transferable for a while, if not ever. Because I don't know how you can actually, like how you actually solve this risk.

Starting point is 00:20:56 Maybe it's obviously somebody smarter than me on, you know, perps and stuff might have a solution here. But at the end of the day, they can't control perp markets. And if the pool is at risk and you don't really like at the end of the 10, A $15 million Bitcoin trade isn't that big, right? Like, it's not something that like only one or two people could pull off. It's something that lots and lots and lots of people can do. And the incentive is there if the pool gets big enough, which it probably will. And then it's just like a really weird thing.

Starting point is 00:21:33 And it's just like a people are saying it's like, oh, good communication. I'm like, I disagree because like they were, they were clearly aware of the attack vector. It's in their docs, right? the Oracle price risk. And if they were aware of that, and these guys are really smart, like Blur and Jez, they're not dumb guys.

Starting point is 00:21:52 They're really, really smart dudes. And so, like, if they were aware of that, they were probably also aware of the second order implication of that, i.e., the perps aspect, if you have a native token that has a pert market on it and what that means. And so it seems just like a, it's what they have to do if they want the protocol.

Starting point is 00:22:14 call to survive, but it's also a bad, like, I don't, there's no sugarcoat. It's a bad look, right? Like you, you sell a bunch of people on a rule set beforehand, a bunch of money comes in, and now you change everything after the fact. Like, it's not exactly a rug in the sense that crypto Twitter is like very used to seeing, right, like an actual rug where they just take all your money and run. But they are kind of big in switching you with the, with the, you know, the rule set and the parameters around the protocol and the token beforehand and after. Yeah, I think also what makes it so much worse is the fact that in order to earn paper, you had to lose money.

Starting point is 00:22:56 So people were literally trying to lose. Because like I'm not going to try to lose money. It never made sense to me. I was like, why would I? I'm going to go golf instead. Like a lot of people, yeah, a lot of people were on there trying to lose money to, to earn this token. I had a bunch of group chats where friends were. like, what's the optimal strategy to lose money fast?

Starting point is 00:23:17 I'm like, what are you talking about? Yeah, yeah. And that money literally went into the bankroll. So it's their money now. Yeah, it's, it is what it is. So I think that's why, like, like, I feel like, yeah, I mean, I think people would have been mad no matter what, but the fact that people were on there literally trying to lose money to earn this other token that they thought was going to.

Starting point is 00:23:44 that they could then sell to make back their money. Yeah. Yeah. Yeah. You got, you got a, yeah, it's not a, I wouldn't, I would hate to be in this position right now. But fortunately, I'm not. Yes. Yes.

Starting point is 00:23:58 Well, so people are tweeting today that like paper trade is over basically. Ryan D. Crypto or Ryan to crypto, I don't know how to say this person's name, tweeted paper trade staking revenue today. 84.5K. With two hours left. Yesterday was 1.28 million. Sunday was 2.1 million. 93% drop in a day. And then Alex.hl, the hyperliquid account, tweeted,

Starting point is 00:24:28 yeah, I think it's completely over. Volume was purely from speculators, farming paper, hoping it becomes transferable instead of 1,000x leverage finding PMF. And yeah, I just saw a whole one of tweets saying it was over. Do you agree? Like, do you think there's anything they could do to revive it? they're funny takes.

Starting point is 00:24:47 They're not horribly wrong, I don't think. It's tough. It's really tough, right? Because this, like, what you now see is what the organic usage of people who want this type of thing is versus the activity that was there to potentially farm a token to then sell. Because if you can no longer sell this token, there's no reason to go farm the protocol anymore. So what you're left with is that that big gap. is like the farmers are now mostly moving their money away because they're like,

Starting point is 00:25:19 oh, I'm not going to lose my money and stake my paper and get some, some yield on that maybe, right? Like it might take, I don't know what the payback rate is at this point to, you know, make up your losses if you were to lose like $10,000 today on it or whatever, but it's not great. And so, yeah, like,

Starting point is 00:25:37 it's tough. It's going to be very, very, very tough. I'm not going to say it's over, but it's going to be extremely tough. And on top of that, right, like they change the mint curve too. So like each dollar lost now mince a fixed share of supply at that moment in time.

Starting point is 00:25:59 So you don't ever actually know what you're, what you're getting until that moment in time. And so I think like the math is essentially like 0.1 supply per like one million. dollars lost is like the math or whatever um and i could be off on that so don't you know nobody take that and make a decision based off that but uh yeah it's just like a lot of things have changed from pre launched to today and that changes the whole decision making matrix of everybody involved everything has changed so like yeah like you you could make the protocol today is different than it was when it launched everything is different about it besides

Starting point is 00:26:41 it's like the 1000X aspect, but like the tokenomics, the payback, the yield, the pool, everything, right? It's the promises about transferability. It's all different and it all makes everybody needs to kind of redo their calculus a bit. If this is a place where they think, you know, the capital is well placed and being used efficiently or if the opportunity cost of keeping your capital here is way too high, which is kind of where I've landed. I mean, I was never going to, but I'm definitely not going. And it's not like I'm not like trying to be mean or, you know, trying to shit on them or anything. Like it's an experiment. Clearly some things that were wrong. I think maybe communication probably could have been better up front.

Starting point is 00:27:26 To be fair, they literally put the risk in the dock ahead of time. You can't be more transparent than that. It's also not really their fault. Nobody reads. At the end of the day, they did change things too. so there is some blame to go around for everybody. Yeah. I mean, I know at Delphi you guys work a lot on tokenomics.

Starting point is 00:27:48 So I was wondering if, and I know like this whole thing about like mercenaries versus missionaries in crypto has been just a problem for forever. I don't like, like do you feel like there's some way to resolve this or do you feel like this will always exist? It's like, you know, I just remember back in the day after kind of like Bitcoin and Ethereum, people were like, oh, like, you can use the token of bootstrap and blah, blah, blah. But now it's like, it just doesn't work.

Starting point is 00:28:17 Am I, like, what is your kind of philosophical? So I guess it depends. I'm not a super big token expert compared to some of the guys at Delphi who like that is their, you know, expertise. Like I actually had this question on our hive mind show yesterday with Jan and Jose who are a lot more in like the tokenautil, a lot better at tokenomics than myself. And I was like, I asked them,

Starting point is 00:28:40 about paper trade. I'm like, can they like fix this? Like, is there anything that you see? And they weren't sure, but it was, you know, definitely something worth looking into because if you can fix it, it's probably, you know, something cool to do there. But like, yeah, like it's, it's tough. And tokenomics are not easy. There's a lot of stakeholders. There's, um, a lot of times people mistake the token for the product that has been the case in crypto for since I've been here for the most part. Maybe it's not mistaken. Maybe everybody's just pretending that, you know, or lying to themselves or whatever. But like, yeah, like if your token is the product, a lot of times, it can't work. But there are cases of tokens like working. Like hyperliquid is a

Starting point is 00:29:24 great example of it. Right. Like it's a recent one. But like hyperliquid would be successful without a token. It was successful before the token launched. And so what it comes down to is you just need to have a good business. Like, think, like, think of it like as like, just like, remove the word token and just pretend it's equity, right? Like, you just, like, for equity to be worth something, it needs to be tied to a business that produces value in some way. And so companies use equity all the time in the same way that crypto teams use tokens.

Starting point is 00:30:06 When you go join a company, like oftentimes, like, oftentimes, give you like, you know, RSOs, like restricted stock options that you can then, you know, exercise, invest at a later day that maybe a discount or something, right? Like, it's the same thing here in tokens. It's just that those things are tied to actual businesses that make money and have PMF and have customers and retention and durability. And a lot of times, the tokens that we attach to things, it's just like a speculative Ponzi or like something that hasn't demonstrated demand. and it's mostly just a narrative or whatever, right? Like a lot of that has been what crypto is.

Starting point is 00:30:43 And I think thankfully, we're making a lot of really good steps in the right directions. Like metadata has, you know, it's launch pad where they kind of like vet things a little bit more. You have like real businesses and you had cases on metadata where it didn't work out, but they returned money to the people who they raised from, which is I would consider a successful thing. Right. Like no, not every business venture will succeed. Most fail. But just be honest about it.

Starting point is 00:31:12 And if you realize you're going to fail, don't go milking the treasury for five, six years and taking a salary, return the money to investors. Like, like an ethical person would. I don't know. Like, I think like it's not rocket science. It's just make a business that's profitable, that's valuable and produces value. And a token will be valuable in that case, assuming you're not rugging the token from all values. But yeah. Yeah, it's not rocket science,

Starting point is 00:31:39 and yet it is somewhat challenging. Anyway, Jason, this has been a great explainer on a whole debacle. Thank you so much for coming on Unchained. Thanks for having me again. It's always a lot of fun. And thanks to everyone who joined this live stream. We will catch you next week. Bye now. Nothing you hear on Unchained is investment advice. This show is for informational and entertainment purposes only. And my guest and I may hold assets discussed on the show. For more disclosures, visit Unchainedcripto.com.

Unchained - PaperTrade Attracted $140M, Then Changed the Rules. Was It a Bait and Switch?

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