Bitcoin: Only The Strong Survive

Hi and welcome to Stephan Livera podcast, a show about Bitcoin. So today I am in Nashville, and I'm here in town for Students for Liberty Free a Future Festival, which is the conference on this weekend, and just earlier tonight I was at Nashville Bitcoin Meetup with Matt Odell, and I, we were talking about Bitcoin privacy. and so for this episode, we're talking- Talking about Bitcoin, only the strong survive. So this was an excellent article written by Alan Farrington and Big Al. Now Alan couldn't join us for this episode, but Big Al was able to, and we talk about various critiques of crypto as opposed to Bitcoin, and we contrast some of the key things that you need to know around DeFi, not being decentralized and not being finance, as well as the, the problems of utility tokens and perhaps some of the dishonesty around TVL metrics, as well as the leverage. present in DeFi. The show is brought to you by Swan Bitcoin. Have you signed up with us yet? Swan allows you to accumulate Bitcoin with lump sum purchases or setting up your automatic recurring buy. Now, as I'm part of the team, I've been helping onboard various people into our service at Swan, and that includes high net worth investors, corporates and business entities, and essentially we're providing dedicated Bitcoin account experts who are available for one on one calls. So with the recent price action, we're seeing a lot of New customers come in and I'm spending a lot of my time actually helping those customers out in terms of handholding and guidance on the pathway, as well as giving them some tips on self-custody and security. So Swan is a great place to come and sign up or if you have friends who are interested to buy Bitcoin, send them over to us, send them to swanprivate dot com and they can complete the form to sign up. Lend at HodlHodl is a peer-to-peer Bitcoin backed lending platform where you can lend or borrow stablecoins globally and anonymously using Bitcoin as collateral. There's no KYC, so with Lend at HodlHodl, you no longer have to sell your Bitcoin to get short-term liquidity. You can borrow stablecoins against your Bitcoin and still control your collateral in escrow throughout the whole deal. You hold one key out of the three, while stablecoin owners can earn some extra interest. So there's a major security upgrade coming through with HodlHodl's lending platform. It'll Starting on the 11th of October, so sign up at lend dot hodl hodl dot com and be among the first users to try the great improvements. If you are looking for a Bitcoin hardware wallet, my favorite is the Coldcard over at coinkite dot com. Now, the Coldcard is a specialized device. It can be used in an airgapped way, meaning you plug that device into the wall, or you get a cold power and battery power your Coldcard, and then you get a micro SD card and use that to move the transaction data back and forth between the Coldcard. And your computer, and you would use a wallet such as Specter Desktop or Sparrow or Electrum to do these kinds of air-gapped transactions. The coldcard has all sorts of other security features like the ability to have a JuraS pin, a BrickMe pin, and you can also use the Address Explorer to verify your receive address. So what you're doing here is you're making sure that you truly control that receive address and that it hasn't been maliciously exploited and changed. So if you wanna get your coldcard, go TheCoinGuide dot com and use the code LIVERA to get a discount on your cold card. Onto the show.

Big Al, welcome to the show. Thank you for having me, Stefan. It's, it's a pleasure.

Yeah, so I really enjoyed this piece that you and Alan wrote recently, around what's going on in the Bitcoin and the crypto space, and it's called Only the Strong Survive. And so for listeners, Big Al or Al is under a pseudonym today, so we're not gonna go dive too deep into his background, but Maybe if you could tell us a little bit about your process of, you know, writing this article with Alan?

Yeah, yeah. So, you know, Alan and I have known each other for quite a number of years, and over the past year, we've, we've become closer, and we, we were always having back and forths and discussing what was going on in Bitcoin and as well as just broader, and especially with everything going on in DeFi, and I think both of us like to take a pretty open-minded approach. I certainly don't consider myself a maximalist, I don't think

Into what was going on in, quote unquote, decentralized finance today, we decided that we wanted to put our opinions on paper. From, and I believe we must have started this about five months ago, so it's been a quite, quite a journey writing all of this, but we wanted to be as thorough as possible. It actually at one point was seventy-two pages, so this is short. You got it down to like

forty-eight or something.

Exactly. This is actually the shortened version. And, you know, what we were really trying to do was put out our opinions. And we, the best feedback has been from people who helped edit it, who, you know, don't quite agree, but still appreciate the level of diligence that we, we tried to put in into expressing our, our feelings.

Yeah, okay. And so let's start with defining some terms because there's all these words people are throwing around, you know, crypto and DeFi and things like that. So how'd you-- How do we even define what crypto is? Because I mean, really, the, the hardcore answer I've heard is more like no- No, crypto means cryptography. Crypto is nothing, right? So, how would you-- Do you have a definition of that or how would you encapsulate what we're talking about here?

Yeah, I think that it isn't a hardcore definition from what we use or, or how I use it. I, I'm gonna give the market the benefit of if they wanna dub it crypto, what is going on, all these different, quote-unquote, blockchain-based applications that are maybe decentralized, maybe not, fine, we can dub them crypto. And what we're trying to do is,

just And all these other things versus maybe a Bitcoin and other chains that are perhaps actually touting and doing what they're touting. so we stayed with sort of the, the market version of, of what crypto was, because we thought that was what was best for the reader.

Right. And, it's, you know, definitions can move and change over time, and that seems to be what the world is going to, despite my protestations of Bitcoin not crypto. but anyway, also there's this term DeFi. So how do you- Define DeFi. What does it, what does DeFi mean to you, in the context of you, your, how you think about things and this paper?

Absolutely. So Alan and I, and I, I'm gonna speak from as much I know you would have loved to be on and talk about this as well, but Alan and I definitely agree on this. We love the concept of decentralized finance. The idea that you're building an ecosystem that is more fair, accessible, has less middlemen in, in the financial world, which is notoriously has had middlemen throughout the ages. There are things There's also issues with how the monetary policy, is done in many countries, especially as what we're seeing today. so it's probably a good time to have written this paper. But from a concept, decentralized finance and building out the, building blocks of capital markets and financial markets in a more free, accessible, and open way for everyone is, is how we define decentralized finance. And we make this hopefully very clear is that we love decentralized finance, our concerns are about A lot of what we're seeing being called DeFi today, and is it actually living up to, to that beautiful definition? And, in a, yeah.

Yeah. And as, as we'll get into, I think some of the problems are, you know, it's not decentralized enough, and it's not finance, right? So it's like, it's, it's, unfortunate in that way. and so I think you were touching on this earlier in not being explicitly a Bitcoin Maxi, but that also comes up in this conversation because In the Bitcoin world and have lending and collateralized loans and so on as an example, and so are things unequivocally good merely because they are built on Bitcoin?

Absolutely not. If I start to see a lot of the shenanigans that we have seen on other chains and, you know, rehypothecated tokens, tokens that, that don't have a clear tie to real world value, tokens that, you know, say they earn yield, but yield requires a connection to a real monetary asset, a real productive asset, if, if I begin to see those come on Lightning or Layer 2, so Bitcoin or Layer 2 Lightning, I'll be the first one to write another one of these.

Yeah, and so I think that's an important point to make, and I think others have framed it similarly, like Elise Kalin has framed it more like being a sound technology maximalist as opposed to being doggedly or ideologically or like being an ideologue about only, Bitcoin, I suppose, is the, is probably the way people are framing it, right? Absolutely. So it's important then to talk about what the real breakthrough with Bitcoin was. And now I touched on this, actually, Guy Swann and I were talking about this in a recent episode as well about Why you should focus on Bitcoin and not get distracted, but I think it, it is worthwhile to talk through that, important breakthrough. So from your point of view, what, what is the breakthrough here? What is making Bitcoin distinct?

Yeah, you know, and without doxing myself, I guess, but I got into Bitcoin years back 'cause I was doing a lot of game theory research. And what got me into it was the beauty of creating a consensus mechanism and a, a permissionless settlement layer, but truly permissionless, truly open. And of course, you know, especially when you first learn about it, you think about the issues, well, it's, you know, it can't have the transaction throughput, et cetera, et cetera. But as you learn more, you know, the base layer I love using the analogy, it's like a good judicial system. No one really wants to deal with the judicial system, deal with the Supreme Court, but how you create any sort of economy or strong monetary value out of that has always for history been based off having a strong judicial system. And a judicial system is sort of like a settlement layer. When there are issues, it is secure. And so that really using proof of work, using cryptography, using, you know, "quote unquote" blockchain or time chain Shane, as we call it for most part, is-- those technologies by themselves are actually quite boring, quite old, and quite inefficient in a lot of ways. It's, it's, it's the combination and creating a beautiful consensus mechanism, and I would, I would probably attribute most of it to proof of work.

Yeah, absolutely. And I think it is an important point because this also comes up when someone is a new coiner and they're thinking, "Oh, but is Bitcoin the MySpace?" Right? And that's obviously anyone who's been in this space for any reasonable amount of time But essentially, it's, it's saying that these pieces existed in certain forms, but it was about the combination of them and certain tweaks, right? So proof of work, the difficulty adjustment that really took it, that edition of it combined, made this something valuable. And this idea that we can have a ledger that you don't have to trust, and we can all come to agreement on what is the true state of that ledger, who owns this coin and who owns that coin, we aren't in dispute about that.

Exactly. And that means- It needs to be bulletproof if we're gonna accomplish the goals and the dreams of what decentralized finance, as well as a lot of other things that are being built on this, hope to accomplish.

Yeah, yeah. And so then let's bring it to, I guess, some of the high level problems as we were touching on earlier. Some of the problems with so-called crypto is that it's not decentralized enough and not really finance. So do you wanna expand a little bit on those ideas there? Like, why is it not decentralized enough?

Yeah. I mean, there's, there's, there There and I, I'm gonna try to distill for the sake of a, of a helpful, helpful interview. I mean, one, in, in a lot of these different chains and a lot of these different projects, you, you simply do see key leaders, key figureheads, constant changes, to their base chains. Like, you know, it goes to simple quotes like, you know, if, if the government were to come after you, could you turn it off? And I think the answer for a lot of this is yes. If a couple of people showed up in your house with We'd like you to turn this off, it could be turned off. And that is, that is for one, the issue with, decentralization on, on some of those assets. And then, of course, with, with some of the extrapolations past the base layers that we see. And this is really where, you know, I don't wanna harp and attack too many of the base layers, but a lot of this talks about sort of what we're seeing in DeFi, which are these one-offs, which are essentially can be traced back to a handful of people who control what go

I see, yeah. And, it's, for anyone who's following the space, it seems that every week or every second week there's a big hack and it could be fifty million dollars or hundreds of millions of dollars worth of some token that has been, maybe there's been an exploit or it's been stolen by somebody and then they're trying to get it back and then you're seeing the shenanigans around the decentralized ecosystem saying, "Oh, please, please send the money back to us," right? And so it's, you know,

oh, yeah. Only the strong survive. The strong don't have to call the IRS when they, when they create an oopsy. But I don't wanna attack any specific project or anything like that. It's, that was just a really funny, I had a laugh when I saw that.

Yeah. And so, I mean, now, I, I wanna be fair here as well, because Bitcoin has, is not unblemished, right? In the early days of Bitcoin, there was the buffer overflow, I think it was late 2010 or maybe 2011, and it was like eighty-four billion bitcoins got created

And although arguably that was because of that, there was like a, you know, this Berkeley DB thing that happened, and there was an inflation bug in twenty eighteen, but it wasn't exploited in Bitcoin. And there have been times in Bitcoin's past where people have, as an example, tried to say, "Oh, look, this mining pool is getting too big, we need to try to not point hash rate to this mining pool," and, you know, and I think in fairness, that, that mining pool, I can't remember the name, was it And I think they voluntarily lowered their hash rate. So, you know, I, I wanna be fair here. It's not that Bitcoin has had this perfectly unblemished record, but I think it is fair to say it might have started out centralized, obviously with Satoshi and Hal in the early days, and it has continually and progressively decentralized. And I think that is a fair statement. What do you think?

I completely agree. And, you know, in this, in this piece, what I hope comes across is that we're not dismissing all these things. I have, I have many, you know, Who are significantly smarter than I am, who have dedicated their, their professional careers to helping build out these other chains, and, and perhaps they will succeed, perhaps there will be something that changes and it becomes decentralized and it becomes what they say it is. This is really talking about, you know, right now what is going on and what is, is being said as decentralized finance, is so far away from what's actually happening in, in the background. And, you know, it's a classic thing in investing, you always have to get a little concerned when, when there's- One thing being publicly said, ideals being spouted, and then what's actually going on behind the back of the door is slightly different. But you're absolutely correct. We could-- you, you never wanna just fully dismiss other things. You never wanna say they can never get there. It's just, we're writing this piece as of the evidence that we have seen today.

Right. And so, yeah, fair to say this is based on your views, as of September twenty twenty-one and say the few months preceding to that, that's essentially, that's the time period that you were assessing and I think it's also fair to say that there are pressures and centralization pressures, and so for listeners, check out the earlier episode with Alex Berge, where we spoke about, for example, with Ethereum, that there is very arguably, a pressure towards centralization in the Ethereum ecosystem, because of the way of the interaction between staking, staking derivatives, exchange incentives, and so on, that might lead towards someday a lot of the power being Held and controlled by certain individuals and institutions who are ess- essentially choosing who are the validators, whereas in the Bitcoin world, it's saying, "No, it's proof of work, and that's how you tie the real world to, you know, the blockchain or the time chain, and in that way keep the system open in terms of who is able to be a validator." but do you have any thoughts or reflections to add there?

Yeah, I mean, I, I couldn't agree more with that. I, I believe from what I've seen is that there might actually be a push Centralization on, let's say something like Ethereum, I, I'm frightened of proof of stake for, for at least the, perhaps there are ways to solve it that doesn't make it just an oligarchy. But when I think about proof of stake, it, it goes against, then okay, especially as you said, it could centralize into certain institutions and they choose who the validators are. You're creating sort of the opposite of what we were hoping to. Proof of work, anyone can go online. I, I actually, help with a Bitcoin miner, and, you know, we're Not new to the game, but, you know, we're just some random people building large Bitcoin mines. And so, you know, everyone is allowed to participate, but if it becomes proof of stake and where all the assets are staked, that, that sounds-- starts to sound a lot like, a bit ola-- like a bit like an oligarchy, which I concern myself with. And maybe I'll be proven wrong, and-- but I, I'd certainly, I would need to be proven wrong for me to change my belief on that.

Yeah, I see. And it ultimately comes

Bitcoin node just on your laptop and you will be validating the entire supply of Bitcoin. You'll be validate-- you can validate every transaction that's ever occurred in Bitcoin, at least in terms of the main chain, and that's just simply more accessible than a lot of the altcoins are. So I think that's also a very important point to consider there for people.

Absolutely. I mean, being able to run nodes and being able to at least validate what is going on is incredibly important, and that needs to be accessible. It's simply, I think that's-- I, I do think that's a must, and, if other chains i-ignore that, you're, you're ignoring one of the core principles here. Yeah.

And I think perhaps that's-- because it's such a complicated space and that there are different moving parts, it's easy to confuse people by talking about, "Oh, look how much..." Transactions we can do or look at this metric that we can show, but they've made a trade-off in the background without telling you about that. So they've made some kind of trade-off that says, okay, we're, we're trading off the decentralization of this ecosystem, or we're trading off the ability for the everyman, the retail individual, the man walking on the street, to be able to run his own full node and fully participate and, fully validate as well. So I think that's an important point that, people, people who are new to this world might not Yeah. So I think over the last few years, the economics angle has also been quite important. I, I think it's a mix of economics and technical, but the important point to understand here is that there's always this tendency towards the most saleable, right? So if you're talking in the realm of something trying to be money, then that's an important consideration. But maybe this is one of the counterpoints we're starting to, it, it come here again, and it's not a new point, but this idea of, oh, fine, we're not even trying to be money. What And an altcoin that's trying to market itself, or the proponents of that altcoin marketing under that pretense.

Yeah. So there's a lot of thoughts there, and I'll try to condense them. A lot of, we've talked a lot about DeFi, right? And that is really what we're talking about, and much of the, much of what, quote unquote, finance is, one, you need a strong monetary asset at the base of any financial system. That is a, that is a fact of, of economics. But two is that much of this has to do with generated by these tokens. But if your token's one of two things, one, if it's simply just a utility token, the liquidity and the value that will come to it, simply isn't there. No one holds casino chips because they wanna hold casino chips, you use them and then you leave. You'd get an iTunes gift card, or at least back in my day when I gift those for birthdays, you get an iTunes gift card and you'd gift it. No one was using those as solid currencies. So let's say you're not that. Well, then you're, you become-- I hate to use the word 'cause I know there's a lot of regulatory pressures, and I don't always agree with the SEC and regulation. I'm not, I, especially in the industry I work, they're always a pain. But, no, I love you, SEC. Don't, don't listen to them. They, they, you know, you, if you are, then giving a token, you know, label it a governance token or whatnot, the only reason it would maintain value is that you have an expectation of future free cash flows and yields. And if you don

Yields, it's sort of a self-licking ice cream cone. You're not-- you're creating a token to yield more of that token, but without that ending connection, it's not true yield. That isn't what a yield is. that's, that's not a, yeah. Yeah.

So let me, let me paraphrase that and put that in, in another way. So we could think of it like, there's the world of investment, right? So you buy a stock, that's an ownership share in a company, and you will generally be receiving a stream of the productive, the profits from the productive enterprise of that company. Or you might own a property and you might be getting rental payments, because again, somebody's paying you to use the house or the apartment. Or you might have a bond and you're receiving coupon payments, interest payments, right? So that's in the world of investment, and then in the world of holding money, you-- we hold money because it reduces our fut- future uncertainty. And so Bitcoin doesn't necessarily have to be an investment in that sense. It's, it's more like savings. And so- If you're not in the trying to be money category like Bitcoin is, then it's kind of like why there needs to be a reason for people to hold it, and as you were saying, there's not really a reason to hold it other than to create more of that coin or there's kind of governance coins or governance incentives and things around these, so it just ends up being that there's not necessarily a good reason to hold these coins.

That is unfortunately, 'cause honestly, when I came in, I was like, "Oh, wait, decentralized finance is actually being built. This is awesome." And as you, as I've dug through the onion layers, and I'm sure there are people who are a lot sharper than me, but Alan and I've spent a lot of time digging through the layers here, and yes, unfortunately, it's not become clear to me why, why these tokens should, accrue long-term value outside of simply speculation, which we emphasize and it's very important to emphasize, speculation in of itself. Is not only not bad, it is actually good in a lot of regards. It funds some of the most innovative ideas. But speculation on speculation that it will continue to have value without a bridge back to a real world monetary asset, that is, you're misconstruing some other sort of speculative investments that have done very well, like venture capital and early tech and whatnot, to, to, to a space where it might not be deserved to be

applied. Yeah, I see. And I think The other point that you make in the article or the paper is this idea about coordinating security costs, because as we were saying earlier, proof of work gives that link between the physical world and the digital, and if you're now taking that away, well, what's, what's the security model? Could you elaborate on that?

Yeah, I mean, I think it's actually that, that simple to be honest. I think it, it really is. If, if you're taking away the link from the work, from true world electricity costs, which are real things, coordinating, you know, all the machinery, the energy, the electricity to validating the network, and instead you're just purchasing the asset and putting it in there, well, like you're, you're disassociating one of the core links from the real world and, and the value that should be put into, to the- The coin, and it, it, it, it takes once again another Lincoln, which, which leads us, and we write a lot of pages on this, on, you know, where are these yields coming from? Where is finally the connection in all of this? And we really, I, I have to emphasize again, we-- and I still take an open mind, I would love to be proven just completely wrong on this by someone who's so much smarter than me, but I just haven't heard it yet, I haven't seen it.

Yeah. So it, it seems that the yield

I'm, I'm a bit confi- like maybe, maybe the steel man, okay, so let me, let's try to steel man this for a second. So could it be that this platform enables some kind of thing that's only possible in this way, and in order to use this platform, you need this utility token? And is that the reason why you would hold this coin? Or, or is it, yeah, I mean, I, I, I'm trying to make this argument, but I just, I really can't even make it make sense in my own mind.

but What would the argument be?

Yeah, if, if I had to steal manor on argument, it would be, it would be exactly that, that, you know, you, there's something so valuable about using this network, but let's say there's some new internet protocol, quote unquote, suddenly we all started, stopped using Google Chrome or whatever browsers, and the only way you could do it is if you, you bought their, you know, made up token, and, and to use that internet you hold the token. And again, though, I'd go to the, the thing I probably have a better steel man to make an argument, 'cause that's intellectual honesty. But then I just say like, okay, when I was younger and wanted to buy a song on the iTunes store, I would, you know, get my iTunes gift card, but I would spend it. So you're not-- you, you, you fight for liquidity, and, and we, we go into a section about the fight for liquidity. So if you suddenly become a utility token and people and companies everywhere, you don't wanna-- that make, makes it essentially inventory, whether it's personal, Those inventories. So, hopefully that was a decent answer, but it, it is difficult with the stealer, and I struggle too sometimes.

Yeah, yeah. Another way I've heard of it actually, my friend John from Sydney actually, I think he's framed it this way, and I'm not sure if he invented this or other people have, but it's this idea that, imagine you had a coin to pay your bank fees with, right? Bank fee coin. Who in their right mind is gonna prepay their bank fees? You would just buy the bank fee coin at the exact moment

You're not sitting there holding a cash balance of bank fee coin, right? No, you are not. So I think, and that, and that ties into that point you were making earlier, that everything fights for liquidity. And so in the world of money, you wanna hold the most saleable commodity, and that's, again, the Mengerian, Austrian story around money. So bring it to the utility tokens idea as well. Even in this whole notion of, okay, so in order to use this platform, you need this utility token, but again, you might still be at the risk then of Oh, you've made this platform with an unnecessary coin. let me just remake this platform without the coin and strip it out, right? So that's also a factor that you're just always going to be vulnerable to that.

Yeah, it's a beautiful point. You know, from what I do professionally, as I disclose, I'm not gonna disclose all, but I do work at an investment firm, a hedge fund here, and, as we've looked into the space, you know, what you see a stark difference with regards to the issuing of tokens, that the fact is most these tokens don't need to exist. There have been some brilliant economics done to try to create them and try to convince people to, to move them around. I believe probably the most famous example is Uniswap and Sushi Swap, right LPS and try to sort of get, get people off of Uniswaps. But what you notice in the Bitcoin ecosystem and what is being built, albeit a lot slower than the "move fast and break things" ecosystem, which is very admirable in its own right, except as we say, maybe a little dangerous. But when you speak to founders of these, these projects in, in layer two on Bitcoin, I don't think a single one of them has basically spoken about creating a token, 'cause they're like, "Well, we don't need one. It's not-- it, it's unnecessary, we are using the base monetary asset that people want.

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Yeah, absolutely. And I'm gonna be honest, when, when Alan and I were writing this, we found this to be one of the most difficult sections of the paper because we were playing around trying to rehypothecate assets on, on these platforms, and it gets quite funny. And I have to give a lot of credit, the CoinMetrics team Apothecation, I believe a month, month and a half ago, we, we stole, but we, we gave them credit, part of that report, in it. But, but what you're seeing essentially is that, you know, it's, it's being pitched as over collateralized, and in the first step, it is over collateralized. Most of these things, let's use the wrapped ETH example, you know, you put wrapped ETH on an original loan, and then you can take out a thousand of DAI, but you're allowed to then put the Pool as LPs. So we've got two thousand dollars put in right now, but then you also, can redeposit those again into another, into another loan of Dai. So suddenly when you-- and we did a bit of a graph of this, you've essentially turned, you know, two thousand dollars into five thousand five hundred dollars. So that's on like the total value locked and the rehypothecation of the assets that are going on, which, again, lending in and of itself isn't Bad. Lending is a very, very important part of any sort of financial ecosystem. It's, it just gets more dangerous when you start taking assets where I'm already concerned that they have actual any real value outside of speculative value, and then you start rehypothecating them on each other to market yourself as having all these volumes when truly it's, it's a lot of leverage, and that's- That's always a little, a little scary there.

Yeah. And so just walking that through, 'cause there's a lot of terminology there. So for listeners, if you're new, just walking that through, TVL means total value locked. And now one thing a lot of these altcoin proponents are doing is they're coming out saying, "Oh, see? Look how much TVL is in my altcoin DeFi protocol." And the reality, as you were just saying there, Al, is that a lot of that is actually rehypothecation. But the trick is, you have to

Or even different coins, such that the ecosystem is as a whole rehypothecating up on top of each other, because the superficial understanding of it would be that, oh, see, this particular loan, it must be two hundred percent collateralized or one hundred and fifty percent collateralized, and therefore we're safe if something were to happen. But as you point out, the reality is that people can take a certain amount of ETH, say, fifteen hundred dollars of ETH or whatever, and pyramid on top of each other and keep going into different assets in, in- to different platforms, such that they get new tokens and receive more governance tokens, and then use that to lend out on some other protocol, and before you know it, like one thousand dollars has become five thousand dollars.

You know, it's funny human nature, you know, we've

seen this in traditional finance, it's led to a lot of issues in traditional finance. The funny thing is, once you start going down this path, it's very tempting because if, if you do it right, or if you're the, the, let's call them middlemen, you're the people who are creating these It's very dangerous for the ecosystem overall. So, you know, when I say I love decentralized finance, I'm saying also

let's please not just repeat the same mistakes that we've done in the historically in traditional finance.

Right. And people like Caitlin Long, also a past guest on the show, has been very vocal about the problems of rehypothecation, both in terms of securities and in terms of money. And so she has been very vocal about that, and as many, many people are. And so it really does seem like some of these people are just recreating- The fiat system, but just in this quote-unquote crypto world, unfortunately.

Well, the, the beauty of it for them is they get to be the new bankers and the new Federal Reserve, which is always a nice place to be, 'cause you can make a nice chunk of change there.

Yeah. And so, I mean, I, I loved, there was this section, I just wanna read this section as well, it's related. You were saying, a given asset can be used as, quote-unquote, collateral in one protocol, contributing to a new asset being minted Reused, its collateralized end products reused, or its securitized governance rights reused, all again and again throughout multiple different protocols, right?

Exactly, exactly.

So then, I, I think the other question would be, what would it look like if there were to be a collapse in some of these DeFi coins or potentially the price of some of these DeFi altcoins?

So it's, it's a tougher question, and, and just for background for the audience and for yourself, Alan and I had- discussed actually just walking through an example or a historical one, but we felt like it was too hypothetical because again, to give the ecosystem credit, during times of major distress, there has been new capital flow in. But, but the way it would look and the way that is, is a very classic example of almost a bank run, to be honest. It, it would almost look like that. So if, you know, ETH started collapsing or Curve price started collapsing, there would be collateral calls. The collateral calls will close out other collateral calls on different protocols, which would then- Either require the users to re-stake, but if the users didn't have new money to throw into the system, they couldn't. So that's a fall in that collateral as well, and that starts to cascade through the ecosystem until all this pseudo-leverage has sort of been washed out of it. And that doesn't mean that these things collapse to zero, but it does mean a very nasty way down in collateral calls and things that b-become forced liquidations through all of these, because again, this is all algorithmically done. So once the collateral isn't there, it's a forced liquidation. And a forced liquidation then means an open market sale of, of some of the assets. And so what you do is a, is a sort of classic sort of, debt collapse or is probably a better word, or, or, or, you know, viewers can, view it as a, as a bank run, as people try to get their money out and, it's, it would just, it would require essentially some sort of a difference. But it, it, it's a very good question. It's something that we didn't want to give some historical example, Crashes that are due to this, there has been new capital to backstop it.

Yeah, and it's also important to note that it might look like it's all okay in the first few years because you might be able to bail it out with progressively injecting more and more capital from investors who are maybe swallowed, they've taken the Kool-Aid and they believe in this altcoin DeFi and so they're happy to just keep plowing money in because they're getting cheap credit from the Fed anyway and they're just plowing it in, but they might reach a point where the size of that The old coin defi market has just become too large to actually get bailed out effectively by new capital injections. And so what might have been okay when it was smaller, as it grows, it's just, it's not gonna-- they, they won't be able to save it next time. And, and as to when that point comes, we don't know, but it's, it's an important point to appreciate.

The larger the cookie gets, the worse the crash will be, and I'm not just saying this about crypto or defi, you can say it about actually almost any market equities and debt, you know, and, and, and really it's a, it's a dangerous situation to, to start to play around with, but you're absolutely correct, no one knows when it's actually gonna happen.

Yeah. I mean, they-- Yeah, and you never know how much money the central banks of the world are just gonna keep printing up, or the governments of the world are gonna just keep printing up for their stimulus and for their various spending packages, and then all that money sloshing around, and maybe people just keep going, but it has to stop at some point, and so we'll just have to-- A-and I, I guess I can understand as well for some people who are new and thinking they're looking at their friends who are gambling and hitting three X and four X, and here they are

Where it is, that can weigh on their mind, and there's a competitive pressure and desire there, and that, that may be also what forces or pushes people and pulls them in to this, shitcoin casino basically.

F-FOMO, FOMO is a very real thing, and also when it comes to institutional asset managers, and a lot of the people who, if you look at who actually owns these and the percentages, like most of these DeFi products are like bulk owned by like a handful of firms. The, the incentives are for AUM, it's an AUM Scared of the, the carousel going around. The incentives from not only retail FOMO, but from institutional is to, is to keep the, the games going for as long as possible.

Yeah. And on that, I'm curious as well as probably you would have looked into this as part of your research, do you know the split in terms of the actual retail number of people using these DeFi coins versus the amount of, let's say, professional money managers, funds, and those kinds of people who are involved?

I, I've looked into it, but I don't have I don't have the best answer to, to be honest. I think the number that are actually using it, especially when you're, if you're doing on a volume weighted basis, is going to skew very heavily to the large institutions and as an ownership basis, I mean, that's obvious, it skews very heavily, but I don't have a great answer for you.

Yeah, sure, sure. And I guess it does, because, and it seems like that seems to me like common knowledge, and yet, depending on who you're listening to or who you're seeing, it's, it's To what we were saying, this idea that any-anyone in the world can lend and borrow and send, but then the reality is it's mostly like big firms and high net worth investors and fund managers, professional level money managers, who are actually using this thing as opposed to the everyman on the street who is getting a loan for whatever he needs in his real life.

Exactly. I mean, the professional money managers are able to, they have the infrastructure and the time to be able to execute the arbitrage that keep coming up, 'cause there's new token launches, new yield liquidity pools, all of that stuff that come up all the time. They're the ones who, and that's what they're using it for. They're using tokens to trade other tokens to gain yield in other tokens. I'm gonna be interested to see what their exit strategy is on how to monetize this into a real monetary asset, 'cause at some point the cows will come home, and I Those large institutions get out of it, we'll see.

Yeah, and so in terms of those large institutions, what, what you say are their main advantages, is it around having high skilled individuals who know the nuances and the ins and outs of the ecosystem, or is it maybe better access to cheap credit, or is it better access in terms of information on, on what's going on? Do you have any thoughts on that?

Yes, I, I do, and I'm, I'm gonna be careful and, and subtle on this one. I, I believe it's access This information. One point I joke about, which I'm happy to say on here, is that what I see in this ecosystem, you know, knowing a lot of them, being friends with a lot of them, if I pulled what goes on on a daily basis in DeFi at my job, I would be in handcuffs by the end of the business day. So that's, that is my, I, I, it's, look, if it's not regulated, that's fine, you know, you're, you're not breaking, but it's, it's, I

There before I, yeah, yeah, totally. yeah, don't, only say as much as you're comfortable to say. But it seems like a lot of-- There's this whole cottage industry, right? Because you've got like exchanges who kind of have an incentive to, you know, promote this stuff 'cause they want the trading fees. you've got, you know, all kinds of different people, all with their own incentive to get involved in their own way, whether that's you're involved in the influencing and the marketing of it and you're getting paid out to do You, you know, have found some other role as a technical expert to help find these opportunities, let's say, and arbitrage and things. So it's, it's a very weird ecosystem, and it just seems to me like the everyman, the retail individual, just has no idea what they're up against.

I couldn't agree more. I think you actually articulated better than I even could.

Yeah. And one other point I really wanted to get your thoughts on. So in the paper, you talk about, okay, so it's like a quote, right? It's- So it was almost like Ether is allegedly the right to run decentralized computing, right? But at the sam- you had a really interesting point about how that's more like an operating expense than, an equity or like something that should be floating around as a, and a, as an actual price. could you explain what you were getting at with that?

Yeah, yeah, that one, that one was certainly a nuanced point, and, Alan and I had a back and forth on that one. but it's, the, essentially is that, you know, it, it, Idea of, you know, okay, you need the ether to run the computing, that's, that's actually okay with me, but it creates the system of, you know, then all this other shenanigans that might be going on on top of ether become based on the operating expense of ether itself, and there's this mismatch of, incentives that takes place due to that, where if that gets more expensive and transaction fees go up, it's like, unlike in, let's say, with Bitcoin and proof of work, it actually makes the chain more secure, that's a good thing, That's making you bulletproof, that's wonderful. Here it is, well, that's actually a bad thing, you're passing it on into all the users of the decentralized finance, and, you know, of course, they're gonna be scaling solutions, and I'm, you know, I'm excited to see in Maondor what, what ETH2 scaling can accomplish. There's probably some brilliant things people will do. But it's, it, I think that point boiled down as simply as possible, 'cause it was a very nuanced point, even Alan and I had a lot of discussions

This, this system where, okay, it's a, it's a, a way to pay for it, so it's an operating expense, but then there's this mismatch in if it goes up in value, the operating expenses go up for everyone trying to build on you, which is supposedly a bad thing, so you wanna lower it, but why should that be a bad thing when it comes to the security of a, of a, of a network? So, so that was really the, I think that, that encompasses most that point, but, yeah.

Yeah. So essentially, put in other words, it's almost like the "quote unquote" success of the system can put almost put the system at cross purposes from a security perspective, and that it might then become less secure as the price runs up. And so it's a really weird thing there. And it also, there's like a really weird sense in which it just seems like a weird incentive, right? So as an example, and I think you made this analogy, it's this idea that, let's say you, you had a bank that has its office and its electricity bill, but it- It indexes that ratio to the price that it charges to the customers in terms of like their electricity or their rent, when they-- I mean, they should just be more like, they should just be charging their fee, whether that's a percentage fee or an upfront fee or whatever, but it's like trying to involve the customers to have a share in the like electricity cost of the bank, right? It's like a sort of loose analogy, right?

Yeah, yeah, I think that was the best analogy that, you know, maybe someone will come up with a much better analogy than us, but that We could come up with. So yes, yeah.

Yeah. And so it comes down to this point that, as you say, it's like the altcoin token is trying to double as computational credit And a security incentive, and then potentially, those are the ones really at peril, right?

Yes, very much so. I mean, that's-- I don't see how those two can exist in cohesion.

Yeah. Whereas I think comparing back to Bitcoin, it's much more of an explicit, "This token is trying to be money. You, you hold it, you save it, you spend it if you need to, and over time, the security of the network is coming from all the miners who are trying to mine new Bitcoin and they wanna receive transaction fees." And that's, it's a very honest and, I guess the word people say is incentive aligned or incentive compatible system in that way, whereas when you compare it to altcoins, it's, not really the case.

Exactly, A lot of, you know, getting past Ether, again, a lot of brilliant people work on it, you all have to give credit where credits due, but, you know, with, with Bitcoin also, and Ether isn't this, but a lot of the other coins, there's no promise of a yield. It's a floating point value. It's, it's what the community and what is built off it chooses is the value. It's incredibly fair, and I like that for my base layer. And we could talk about what I'd like for the layer twos, 'cause I

system on the Lightning ecosystem that absolutely doesn't mean tokens, but it does mean I like my base layer secure and boring like a judicial system. But what you do on top of that, there should be an entrepreneurial attitude of, of movement.

Yeah, I love that point about having the base layer secure and, and I mean, even in the, in the example of the Lightning Network, it is arguably like a, a court in a sense, right? That the two channel partners are trying to close their channel and the blockchain is essentially the one that's deciding who's getting what. In terms of how many Sats are going to each side of that channel. So, I mean, it's not like a full on, you know, everything code is law or whatever, but it is just a, in a restricted way, it's deciding who gets what in that sense. And so, it, it really is like that in the, in, especially in the examples of Lightning and other layer two protocols like that. So, I guess let me put it this way then, what would have to change for your view on altcoins to improve on, on this kind of idea of crypto and De

Okay.

I think that one is, we, we talk about this in, in the section why we might be wrong, 'cause you really do try to be intellectually honest here. I think one is that if there is an ability for, for different projects, I'm not sure if DeFi can ever get there, but there's certainly other chain, other projects that connect to real world value, things that people value as humans, whether it's, you know, you see some gaming stuff coming up now, some, audio, music stuff coming up now, if that can Translate to value to an end customer, then okay, I still don't quite see why you need a token, why not just use your base layer asset ETH? But that's a different story, we've discussed that enough for the interview. I also think that, you know, sometimes- I don't believe this, but it can always be true. Things like what we saw with the internet, it doesn't always turn out as perfectly as you'd like it to be, and maybe the average, person, average user is willing to sort of give up and give away the fact of, you know, this is truly decentralized and whatnot for, you know, these developers and the huge developer ecosystem on these other chains creating projects that, that again, create value. With DeFi, the, the problem and the promises is that there is just- It's such a disconnect for me, is that if, especially with DeFi, I mean, again, you need real world yields. Like, if, let's say if we can have lumber companies utilizing DeFi, like, like, you know, you buy wood to build your new patio, right? And it's, it's somehow on these DeFi protocols, then I will look at that. But, we, we go through a couple points on why I might be wrong, but again, until we get that connection where it isn't just tokens being created, rehypothecated, And you gain more yield on other tokens you trade, that's, I, I, I, I struggle to see where, where that will end up accruing long-term value. Short-term, you can make a boatload of money, and good for, good for them.

Yeah, I think you put it well there. And I think it's maybe one way to summarize it is there needs to be some kind of link back to productive, production, productive capital. And so maybe that's one way to think of it. And look, as an example, I recall like I've been in the Bitcoin world I recall there was a site called BTC Jam, and this was like a, you know, earlier days kind of lending out Bitcoin to get interest on it, and people would say, "Hey, this is why I want this loan, 'cause I wanna do Bitcoin mining or whatever," and it was, you know, you were gonna earn some money back in Bitcoin, alright? And that was-- I think later that site got shut down and, you know, so on. But you would need to see real productive use of that money, and as you were saying, whether it's lumberjacks or, you There. And so I wonder then, do you have any thoughts on the future of Bitcoin and DeFi specifically? Like, a, a, as an example, now one of my sponsors is Hoddle Hoddle, they've got this idea that you can collateralize and you can borrow against your Bitcoin and borrow stablecoins against your Bitcoin. So that's one example. Maybe in the future, if we were to start to see more people using that as a way of funding their business ideas, maybe that would be something more aligned with what we would call Bitcoin DeFi.

Yes, I, I absolutely agree. I think one of the key distinctions is that, you know, Bitcoin is intentionally trying to be a monetary asset, a monetary-- it's a floating point asset, doesn't have a yardstick to the real world, has a yardstick to the usages of it. I will have to look deeper, it's actually one of my to-do list, as you know, in this space, there's always a million things to do. But, I think that you can see a future where lending in of itself isn't a bad thing, and borrowing isn

A lot of evidence to show that strong, financial capital markets and the ability to lend and loan and, and raise debt is, one of the best things that, can show whether or not a society will be, productive and, affluent. so it, it, again, I think that I, I've, I've looked a little in Hoddle Hoddle, I'm looking a little at Sovereign just to learn about them. These, I'm excited about what they can do, and I just look, I'm gonna take the Tokens are rehypothecated and whatnot. But if you keep the base layer, you keep it strong, and you, you have a very clear, you know, you can create a monetary asset off of a strong judicial system, and that goes through countries and everything. And that is, that is why I continue to believe that most of the beautiful things or really cool things that might be a little scary, on ETH or other, chains will port over to Bitcoin, 'cause they will come to the realization that having a strong mon- Monetary base is critical for any economy to flourish, and at the end of the day, we want this to be an economy.

Of course. And maybe one other point just to add to that might be that, look, the world is undergoing Bitcoinization and eventually it will culminate in hyper-Bitcoinization, right? The world is-- That's at least, that's my view on where, where we're going. It could also be that until then, the best, most productive use is for people to just buy Bitcoin and hold it, and then only once we've reached a point closer to full For people to actually start investing that Bitcoin into other ventures, like business ventures, because at that point we would anticipate the purchasing power growth of Bitcoin to have-- start to taper down, right? So if you look historically, right now it's probably like a hundred and forty percent per year or some ridiculous number, right? Obviously that will have to taper down over time. It can't just sustain that forever, and maybe once it kind of-- call it five percent per year or something in that range, then at that point you might have more productive businesses and more of a reason to have a- Lending and debt market, but denominated in Bitcoin using Bitcoin DeFi to fund productive capital. What do you think?

I, I think you're absolutely right. I think we've, you know, everyone overestimates what they can do in two years and underestimates what they can do in ten years, and I think that we will get there sooner than people think, maybe in a ten year basis, but, you're absolutely right. I couldn't agree more. Bitcoin will not continue as you get hyperbitcoinized, I hope that we do create an economy that is perhaps more fair and There's a lot of, a lot of issues that we see in our current monetary system, which exacerbate a lot of both political and social issues. But that's a little outside the scope of this paper, and we could probably nerd out about that for a whole other hour. So,

sure, sure. so Al, do you have any closing thoughts or any, any final points that you wanted to make for the listeners?

No, I, I think, I think for the listeners, and once again, I really appreciate you having me on, and I, I really wish Al was able to,

You know, for all the readers and the people, if you actually read through it, look, both of us are always happy to be proven wrong. I've been wrong time and time again, and I, it really is, this piece was meant to just put out our opinions. We tried to be as thorough and thoughtful as possible, so if anyone listening to this or anyone who's read it wants to reach out, I don't check Twitter very often. I have a, you know, a fake profile I've used for basically nothing, but please do, please do reach out to me, and I, Allen and I have, have missed things. So that's, that's really all I have to say on a closing comment.

Fantastic. Well, thanks very much for joining me and, I really enjoyed chatting with you.

Thank you, Stefan. Me too.

Make sure you share this episode with your family and friends so they will learn about what's going on with Bitcoin as contrasted with crypto. Get the show notes at stephanalivera.com/three-one-one and I'll see you in the citadels.