36 - The DeFi Blockspace Cycle | Nic Carter

🚀 SUBSCRIBE TO NEWSLETTER: http://bankless.substack.com/ ✊ STARTING GUIDE BANKLESS: https://bit.ly/37Q17uI ❤️ JOIN PRIVATE DISCORD: https://bit.ly/2UVI10O 🎙️ SUBSCRIBE TO PODCAST: http://podcast.banklesshq.com/ 👕 BUY BANKLESS TEE: https://merch.banklesshq.com/ ----- GO BANKLESS WITH THESE SPONSOR TOOLS: 🌐 UNSTOPPABLE DOMAINS - HUMAN READABLE ETHEREUM & CRYPTO ADDRESSES https://bankless.cc/unstoppable 🌈 ZAPPER - ULTIMATE HUB FOR DEFI - ZAP INTO DEFI http://bankless.cc/zapper 💳 MONOLITH - GET THE HOLY GRAIL OF BANKLESS VISA CARDS https://bankless.cc/monolith 🤖YEARN - YIELD-SEEKING MONEY ROBOT THAT FARMS DEFI FOR YOU http://bankless.cc/yearn ------ 36 - The DeFi Blockspace Cycle | Nic Carter Nic Carter recently released an article titled "Public Blockchain Fee Cyclicality and Negative Feedback Loops"... ... simplified "transaction fees get higher, and that incentives people transact less, and then that lowers transaction fees and that incentives people to transact more" According to Nic, there's no equilibrium found upon public blockchains with inflexible block size; the demand to purchase blockspace will always be volatile, across all time frames. Another perspective: constraints on blockspace availability dramatically impacts the kind of usage that is feasible to happen on the base-layer blockchain. Transactors who are transacting large transactions will pay for higher fees! This severely impacts the markets that are supported by public blockchains! Constraints on block space are constraints on market participants! David, Ryan, and Nic go through Nic's process is disecting the data that created these conclusions. Nic gives his perspective as to the ultimate pattern that emerges from this data. David reads Nic's article aloud on the Bankless YouTube! Useful for listening to the episode! https://www.youtube.com/watch?v=RZ1X_3I5KrI&t=666s https://www.youtube.com/watch?v=RZ1X_3I5KrI&t=666s Actions & Resources: Read Nic’s articles Ethereum’s Fees Mean Choosing Between a World Computer and a Financial Network https://www.coindesk.com/ethereums-fees-mean-choosing-between-a-world-computer-and-a-financial-network Public Blockchain Fee Cyclicality and Negative Feedback Loops https://medium.com/@nic__carter/public-blockchain-fee-cyclicality-and-negative-feedback-loops-1620141a8a87 The Adaptive Markets Hypothesis Robert Low https://blogs.cfainstitute.org/investor/2017/12/18/the-adaptive-markets-hypothesis-a-financial-ecosystems-survival-guide/ https://www.alphasimplex.com/wp-content/uploads/2004/09/The-Adaptive-Markets-Hypothesis.pdf ------ Don't stop at the video! Subscribe to the Bankless newsletter program http://bankless.substack.com/ Visit the official Bankless website for resources http://banklesshq.com/ Follow Bankless on Twitter https://twitter.com/BanklessHQ Follow Ryan on Twitter https://twitter.com/ryansadams Follow David on Twitter https://twitter.com/TrustlessState Follow DeFi Dad on Twitter https://twitter.com/DeFi_Dad ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time we may add links in this channel to products we use. We may receive commission if you make a purchase through one of these links. We'll always disclose when this is the case.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:14Ryan Sean Adams?

  Welcome to Bankless, where we explore the frontier of internet money and internet finance. This is how to get started, how to get better, and how to front run the opportunity. This is Ryan Sean Adams. I'm here with David Hoffman, and we're here to help you become more bankless. David, how are you doing?

• 0:31David Hoffman?

  Feeling a little bit more educated about block space and fee markets after this podcast with Nic Carter. Nic Carter recently put out this article called "Public Blockchain Fee Cyclical and Negative Feedback Loops." And we kind of go into what the significance of what Nick discovered when he was researching for this piece. I thought it was a very interesting piece, and to the point where I actually read it on the Bankless YouTube. And so if you are the type of listener that likes to hear things, as you would be since you are hearing this podcast, I've read this article on the Bankless YouTube. And there's a lot of implications in there about what this means for DeFi, because DeFi specifically has a lot of implications for what Nick is talking about in this feedback loop. So in

• 1:16David Hoffman?

  addition to all of that, we get him on the Bankless podcast to go through some of these concepts with him together.

• 1:23Ryan Sean Adams?

  Yeah, I feel like we've never actually done a deep dive episode, David, on Ethereum block space, and particularly gas fees, like gas prices. Like, why do they rise? And why do they fall? I think a lot of folks who are going bankless experienced that this summer and have over the past few months. Like, you wake up, and sometimes gas price is, you know, 20 guay or 80 guay, and other times it's 500. And you're wondering why. And you actually feel the downstream implications of that. Like, you know, what transactions are you willing to do at a guay fee of 20? Might be completely different than the transactions you're unwilling to do, I suppose, at a guay fee of 500. And Nick provides some analysis,

• 2:07Ryan Sean Adams?

  I would say, of the cycles. Of this gas fee supply, like demand primarily and the implications of that demand. So if you've never really understood gas fee markets, why price goes up, price goes down, and how that's even related to the price of ETH, this is the perfect episode to level up on.

• 2:30David Hoffman?

  And I think we just had a very strong example of what Nick is talking about in this article in DeFi, where, you know, yield farming started with comp, things started to get a little bit crazy. And then urine came around and it got even crazier. And then yams came around and it got super crazy. And then it kind of just spiraled out of control. So one day we woke up and gas prices on Ethereum were three to 400 Gwei. And the ether price was pushing up into $500. And at that same time, with the gas fees so high, people stopped transacting. And the thing kind of all fell apart to where we are now with ether, you know, trying to hold its head above water, above 300.

• 3:10David Hoffman?

  And Nick contends that all of these things, the gas markets, the gas fees, the blockchain congestion and the ether price, along with DeFi, and how some of these protocols like Uniswap and Wiren depend on transactions in order to generate APY. And so that's, that's kind of why we brought him on to the episode today to have some holistic conversation between the link between DeFi economic activity, block space demand and block space fees.

• 3:38Ryan Sean Adams?

  So if you're ever wondering why gas price goes up, if it will ever fall again, what these cycles mean for the innovation of Ethereum? Will we have a, only a whale layer level one? Or will normal folks be able to transact in a, in a trustless way? This is a fantastic episode for all of that and we can't wait to bring it to you. But before we do, we want to tell you about our fantastic bankless sponsors.

• 4:06David Hoffman?

  One of the tools I've started to use recently is Zapper. For those of you that were a part of the 2017 bull market, it was characterized by just opening up Blockfolio and refreshing it over and over and over again. And also, anytime you ever made a trade, you would have to go into Blockfolio and manually input that trade information to make sure that your portfolio that you think that you have matches what you actually have. With Zapper, you don't have to do any of that anymore, because all you have to do with Zapper is input your Ethereum addresses, and then Zapper will give you a really elegant report as to where all your money is. So there will never, ever be any disconnect between the money that you think that you have and the money that Zapper reports to you. Zapper looks directly on-chain and gives you a nice portfolio summary

• 4:50David Hoffman?

  of all your assets and how many assets, and all of your debt, and all of your lending positions, all of your positions, all at once. So there's no more editing your portfolio, because Zapper just does it for you. One thing that I thought was really useful about Zapper was when I plugged my wallets in, I found that I had submitted liquidity to Uniswap forever ago, and without Zapper, I would have probably lost that forever, because Zapper knows where your money is better than you do. It's also the gateway to investing your money into this ever-expanding list of available DeFi platforms, like Curve, Balancer, Uniswap, Urn. In the Bankless Nation, there is this growing number of money Legos, and keeping track of them all is just super overwhelming, which is why you could just go to Zapper, and Zapper will solve the problem

• 5:35David Hoffman?

  of there just being too many money Legos to choose from. So check them out at zapper.fi, enter your Ethereum addresses, and check out your portfolio, and see if there's anything that you missed.

• 5:45Ryan Sean Adams?

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• 6:30Ryan Sean Adams?

  card. It's optimized for European listeners. They'll be coming to the US soon. And when you get that Visa card, the Monolith card, tweet about it when you do. I love seeing people unpackaging their beautiful Bankless Visa cards. It makes me realize that the revolution is here. Search Monolith in the App Store. All right, let's get to the episode with Nic Carter.

• 6:54Ryan Sean Adams?

  Bankless Nation, I want to welcome back Nic Carter, who is a frequent Bankless guest now. He is a crypto writer, of course, a venture capitalist at Castle Islands Ventures. His current Twitter bio states that he is that proof of reserves guy. We're going to talk a little bit about proof of reserves, hopefully, near the end. But Nick, how are you doing, sir? Welcome to Bankless.

• 7:18Speaker 02

  I'm doing great. Thanks for having me back on. Thank you for making me your most frequent Bitcoiner guest. I don't know if that's actually true, but I'm just going to assume that.

• 7:28Ryan Sean Adams?

  Well, last time we started with that power question of like, are you an Ethereum? And I think you kind of said yes-ish, right? So you belong in both camps.

• 7:36David Hoffman?

  You made us define our terms first.

• 7:38Speaker 02

  I prevaricated heavily on that question.

• 7:43Ryan Sean Adams?

  Well, as long as you haven't gone back on it. All right. So on that podcast, speaking of that podcast in June that we did, you talked a little bit about this, and this was a title of a recent article, but you predicted that Ethereum's or Ethereum writ large would have to choose whether Ethereum is going to be a world computer or a financial network. Were you right about that, do you think?

• 8:08Speaker 02

  Not to get all technical, but technically I didn't write that headline. So, you know, that's like the classic thing that happens when you have an editor.

• 8:17Ryan Sean Adams?

  What would the headline have been had Nic Carter wrote it?

• 8:21Speaker 02

  Um, you know, I can dig it up. I had like a great, great headline somewhere.

• 8:28Speaker 02

  I, I, it might take me a second to find it. I don't know if we want to do it. Uh, but yeah, I actually thought the, the like, my draft headline was great.

• 8:39Ryan Sean Adams?

  CoinDesk had, that was a good clickbait headline. I immediately clicked.

• 8:43Speaker 02

  But that was like the source of some like discontent among, you know, a few Ethereum's that read it. It's like, you know, like with the implication that you like have to choose, obviously, like, you know, Ethereum doesn't have to choose anything. It kind of just is. My draft headline, which I liked was resurgent fees are a stark reminder of the monetary primacy of blockchains, which I can understand that they didn't think that would like, like popular appeal.

• 9:11Ryan Sean Adams?

  Much more tempered though.

• 9:13Speaker 02

  Well, exactly. And, and it's like, it's like, you know, it's kind of neutral. And that's like my objective, like, you know, these are like the first couple of articles I've probably ever written about Ethereum. And my objective is to be fair, you know, like that's, I want to be seen as a neutral operator. I don't really have a strong agenda here. I just want to describe things.

• 9:31Ryan Sean Adams?

  Well, I for one, like both of us, uh, have really enjoyed that you're writing more about Ethereum. It's like, it's really great stuff. Like, thanks for adding to the, uh, to the, to the writing pool here. But like, what if we take that straw man that, uh, that was the title, world computer or financial network? Do you think Ethereum really has to choose one or the other? Are there elements of truth in that straw man headline?

• 9:54Speaker 02

  I would say so, yeah. And I never really knew what world computer meant, to be honest. So, uh, to me, it's like a kind of incoherent term, but like a hundred percent, I think blockchains optimize by their very nature to be, you know, financial networks and really to be like settlement style financial networks as opposed to payment networks. So like, a narrow breed, uh, of, of financial networks. But yeah, I, I am very strongly of the opinion that the financial use cases, just by sheer force of gravity tend to win out with time.

• 10:25Ryan Sean Adams?

  So I, I seem to remember this from reading the article. It was basically like, kind of written, um, partially to Ethereum's saying, hey, guys, there are trade offs here and you can't have it both ways. Is, is that sort of the premise of, of the article that you can't have scarce block space? And also have like non-financial, low economic density, uh, you know, transactions at the same time? Or what would you say the premise of that, that article was?

• 10:55Speaker 02

  Yeah, so that's exactly right. And I mean, it might be possible, I mean, it is possible to kind of like Merkelize data and, and you know, can you use a timestamp method to compress lots of data and then commit to it and publish a small digest of that data. So you can still kind of commit to arbitrary amounts of data. But if you want the really nice qualities, you know, the nice settlement and atomicity and kind of base layer qualities that you get with base layer transactions, you know, I think that's going to be challenging. So I'm, I generally tend to believe that to the extent that fee pressure exists and to the extent that block space is capped, which I think is prudent,

• 11:36Speaker 02

  of course, to cap block space, then you're going to just get this relentless optimization for the largest transactions, which are happiest to be fee bearing and are willing to outbid other transaction types.

• 11:50David Hoffman?

  Me and Ryan, before we started recording, we were also talking about how the, the world computer metaphor or analogy is just somewhat like nonsensical. And maybe, maybe it fit the times in 2015 when we didn't really know what Ethereum was, was going to be. But comparing a world computer versus a financial network doesn't really seem like a viable comparison in the first place. And, and I, I think you would agree with this statement, Nick, that like, any and every blockchain that is successful must become a monetary or financial based blockchain. There's no such thing as a blockchain for like social media or something like that because, because of the inherent scarcity of block space, because you can't have infinite block

• 12:32David Hoffman?

  space, because then you just turn into a database, because there's block, because there's block space scarcity, it therefore forces the convergence of all economic activity on that blockchain to be financial in nature. Would you agree with that take or would you amend it somehow?

• 12:49Speaker 02

  And I mean entirely, I mean, you're bidding against every other global user that wants access to the, to the ledger. And whomever is willing to pay the highest price, maybe they're super irrational and they really want to insert some arbitrary data. But most likely it's if they're willing to pay a high fee for inclusion, that's because they're making a large transaction. So the fee is proportionally very small part of the transaction. Like I sent a wire today. Wire cost me $35 to send, which is preposterous. Of course, I hate legacy finance. Let's go bankless, guys. But, you know, I was happy to pay 30.

• 13:28Speaker 02

  I was happy to pay 35 bucks for the wire because it was like a fair amount of money, you know, and I needed, you know, instant settlement and all those guarantees. So in that same vein, you know, someone who's making a $100 million tether transaction is willing to pay, you know, probably 500 bucks plus for inclusion in the next block and final settlement and so on. They're going to outbid someone deploying, you know, an Aragon DAO on chain, right? That's just financial gravity.

• 14:02David Hoffman?

  When we were in 2015, 2016, talking about like the world computer or, you know, ethers gas. Before we understood these things as we understood them today, what you're saying is that Ethereum was destined to be a financial network from, from day one, simply by nature of what it is.

• 14:20Speaker 02

  It was something that you probably could have predicted. Although in fairness, you know, back in 2015, we didn't even really understand the nature of Bitcoin that well. You know, a lot of Bitcoiners thought we would get these trustless side chains. And then we kind of figured out later on that you had to make all these additional assumptions about proof of work and, you know, a side chain operator is not misbehaving and, you know, we didn't really understand how lightning would, would play out and so on. So I guess to a certain degree, this whole thing is a process of experimentation, but, you know, I, I think a lot of Bitcoiners' early objection to Ethereum was,

• 14:58Speaker 02

  hey, like some of these promises are overcooked, especially in light of, of, you know, of the effects of the emergent effects of, of scarce block space.

• 15:09Ryan Sean Adams?

  Would you say the evolution from Bitcoin as like a payments rails or a payment vehicle to Bitcoin as a store of value reflects the same dynamic as well?

• 15:18Speaker 02

  Oh, yeah. I mean, that's a big issue with Bitcoin historically is that a lot of Bitcoiners kind of had misperceptions about what Bitcoin was suited for. And there are all these startups that got built with the assumption that P2P base layer transactions could scale up to a global audience. And that's why we had the block size war. So we're really all talking about the same thing here. This is a kind of recurring theme, you know, just conflicting visions of what these networks can be. And it's afflicted Bitcoin and now Ethereum's having reckoning with it, although it doesn't seem to be, you know, dividing the community as starkly like we saw with Bitcoin. But it's all the same concept. It's, hey, what are the constraints here? Where realistically should we draw the line? What are we trying

• 16:01Speaker 02

  to optimize for? And what's our kind of time preference? You know, do we want to unlock, you know, a marginal extra 50% of block space? Or do we just kind of bite the bullet and keep block space capped and then try and build a layered layered approach, which seems to me Ethereum is going for the ladder now instead of, you know, incrementally adding block space, which I think is probably a good call.

• 16:24Ryan Sean Adams?

  So there was this reckoning for the Bitcoin community in 2017 as it realized Bitcoin would not be a payment network. And like there were forks that that thought maybe maybe it would be. Yet what's interesting about Ethereum is that I, I feel like there are still large numbers of the Ethereum community that will still tell you, no, Ethereum is also meant for non-financial transactions. Like what, what would someone like Vitalik say about about your post?

• 16:53Speaker 02

  Yeah, but I was interesting. Vitalik answered my, my post, a series of tweets. I don't think I interact with Vitalik much. So I was kind of taken aback by that. But yeah, I mean, he told me that my interpretation of his words was kind of wrong in that he really did earnestly want to, you know, get the internet of money or whatever down back to cents for transactions. As opposed to dollars and fees for transactions and he still wanted to create super abundant quantities of block space. And that it was just a matter of waiting for ETH two and then maybe with rollups being kind of intermediate solution.

• 17:33Speaker 02

  But Vitalik seems to be defending his, his kind of original position on this, which is that, that, you know, there's like a teleology to blockchains, like transactions should be cheap in absolute terms. And so it, yeah, in contradiction to what I wrote in the post, I don't think he's actually evolved his stance that much. Seems like he still really does want to produce, you know, really cheap transactions and lots and lots of block space. Through these kind of different like R and D initiatives.

• 18:06Ryan Sean Adams?

  Why do you think he wants that?

• 18:08Speaker 02

  Well, it's a good question because, I mean, maybe it's like the unconstrained versus constrained vision kind of thing that, you know, Arjun wrote about in a blog post a while back, you know, he has this progressive streak to him, not in a political, not in a political sense, but you know, he has a vision about what blockchain should be for. There, the amount of inclusion that they can offer to people. And I guess I'm, I'm probably just, I would say more pragmatic, maybe, or more realistic. Not to, not to, you know, express a pejorative or anything, but I tend to, to believe in, in trying to optimize what we have and what we understand, what we kind of know.

• 18:52Speaker 02

  As opposed to, you know, putting all of our, our eggs in, in one basket of, of, you know, sharding maybe. Or relying on, you know, significant computer science breakthroughs to kind of take us to the promised land kind of thing. So I do think it's just like fundamentally a conflict of visions.

• 19:13David Hoffman?

  I would say that I think if you and Vitalik got in a room and fleshed out some terms and some parameters and some bounds as to what you guys are talking about, that you might come to more of an agreement than what we've, you know, what, you know, 280 characters on Twitter can can express. I would say that Vitalik, you know, couldn't disagree with, and I think I remember him talking about his agreement with a thesis that, you know, heavy valuable transactions push out lighter, less valuable ones. But what Vitalik sees is optionality with scaling and optionality with packaging of data into smaller and smaller packets where like, even though you're still transacting on the main chain, you are doing

• 19:54David Hoffman?

  that in kind of like you're on a highway, but you're on a bus with like 70 other people instead of you're on a car with just you, right? And so you get bundled up or and because of that, you know, you come off with some trade offs where instead of being dropped off at your home, you get dropped off at the bus stop and you have to walk the rest of the way or something, something trade offs like that where Vitalik kind of counts it as an L1 transaction, but there are still some other trade offs that as a result of the lack of density of said transaction, that this transaction has to therefore go through.

• 20:29Speaker 02

  Yeah, and I think that is, that's a view that I share. I mean, my view of scaling blockchains involves removing data that's registered to the main chain as opposed to producing more data that the block, that the main chain can offer. And, you know, so to that end, I think that we're pretty firmly in agreement there. You know, like, that's why I advocated for for batching, which is a very simple thing, but it has kind of the same effect. You know, putting lots of payments together in a single transaction, Bitcoin saves you a lot of that overhead. And that's why I'm still optimistic about side chains.

• 21:10Speaker 02

  I mean TBD, if I look at rollups, rollups kind of resemble side chains in some respects. But yeah, I think that's fundamentally how blockchains scale. They don't really scale arbitrarily by, you know, forcing more data through the network that obviously has really significant externalities.

• 21:29Ryan Sean Adams?

  What's kind of interesting to me is I feel like at some level, the Ethereum 2 roadmap has sort of evolved a bit more with like that notion in mind, Nick, and you might call it a Bitcoiner notion, that there is kind of one main chain for settlement. Even an ETH3 search post that Vitalik put out two weeks ago, a week and a half ago, maybe, it depends when listeners are listening to this, about the ETH2 roadmap, like almost an alternative, kind of an ETH 1.5, one and done. And basically, for folks that aren't familiar with ETH roadmap, what it kind of means is

• 22:07Ryan Sean Adams?

  less urgency on a full sharded ETH2 with like EVM capabilities and state execution. And maybe you just get basically proof of work, a proof of stake, a data availability layer, and you kind of scale in these rollups instead. And you keep almost like something similar to the ETH1 chain as a settlement chain, which has been an interesting evolution and feels a lot more like the Bitcoiner feel on this. Have you read that post or like, are you familiar with kind of the evolution of the ETH2 roadmap?

• 22:48Speaker 02

  I have, yeah. And I can't say I'm as familiar with it as you guys are. I kind of dip my toes into the ETH2 roadmap every six months or so to see what's going on. This time I finally wrote about Ethereum, so I figured that I had to actually learn about it a little bit better, so people wouldn't, you know, just immediately dismiss what I wrote by saying that I was an uneducated Bitcoiner, which like totally pisses me off so much. So I did my homework, you know? And I honestly, learning about rollups was very challenging. It was, there's a lot in there. There's kind of a lot to it. But it is very interesting to see this.

• 23:31Speaker 02

  And I often say this, I think Ethereum ideology is sort of Bitcoin ideology with a 24-month delay, not to be trite or kind of uncharitable, but you do notice these, you notice certain ideas which are popular in Bitcoin community, which then are manifested with Ethereum. So I would say You know, acknowledging that governance is extremely challenging and maybe on-chain governance isn't the best idea, that's something which Ethereum's in the last couple of years have adopted.

• 24:05Speaker 02

  You know, believing in the quality of fees as a really important stabilizer and a way to retain scarcity in kind of the units of the network. You know, believing in this layered model, you know, avoiding protocol-funded slush funds to pay, you know, finance developers, stuff like that.

• 24:32Speaker 02

  All these things are features which I've sort of, you know, Bitcoiners were sort of preaching for a while and then, you know, later on you see them manifest in Ethereum, which is either encouraging or perturbing. I don't know what the interpretation is, but I see Ethereum culture as like slightly downstream of Bitcoin culture, not to be like unfair about it. It's just like an observation.

• 24:55Ryan Sean Adams?

  I feel like there's maybe two points of pushback on that, which is, I largely agree with what you're saying with many of the points that you raised on sort of the convergence there. But one area of non-convergence has been Ethereum has always been steadfast on having some programmability and smart contracts on the base layer, which, you know, does not seem to be a Bitcoiner kind of notion, like that's always been rejected on from Bitcoiners. And another thing I think Ethereum's would say is, they might say like, it feels like Bitcoin has kind of given up on the vision of a peer-to-peer money at all. They're kind of scaling with crypto banks.

• 25:39Ryan Sean Adams?

  That would be almost like the bankless editorial criticism of Bitcoin, even though a bankless, we love Bitcoin as well. But it's basically like Ethereum has not given up on that scalability vision, hence pursuing technology like rollups and, you know, plasma and all of the various ways it has evolved, whereas Bitcoin just kind of has, feels like anyway, only one bullet in the chamber, which is lightning, and that hasn't quite taken off yet. Any reaction to that?

• 26:10Speaker 02

  Yeah, I think that's fair. I mean, Ethereum has always been less encumbered when it comes to vision. And Bitcoiners are very adamant about, you know, not including tokens on the network. You know, that's definitely Bitcoin. I say Bitcoin's interested in cultivating its own UTXO set and very little else. You know, so it's kind of discouraged the insertion of third-party tokens on the network. And then, of course, discouraged excessive complexity or expressivity at the base layer for kind of safety reasons. So yeah, Bitcoin optimizes for one thing, and Ethereum is much more aggressive in pursuing different value propositions. I think that's very fair, and that's the chief distinction between the two.

• 26:55Speaker 02

  On the Lightning front, I think this isn't acknowledged that much among Bitcoiners. Lightning was like a very convenient kind of, sorry, there's traffic outside. It was a very convenient sort of rhetorical stick to bash big blockers with as, you know, the token layered scaling system.

• 27:16Speaker 02

  I was never convinced that Lightning would be a panacea or a salvation for Bitcoin, or that even it would be the predominant popular scaling method employed in the future for Bitcoin. And there's going to be some disillusionment, I would predict, you know, that if Lightning continues to not really take off in the coming years, people will say, well, you know, it's a red herring. You know, you guys falsely advertise Lightning as the panacea here. And to a certain degree, I think it was it was wrong to over-index on Lightning rhetorically as a way to ward off the big blockers. The correct approach should have just been to say, look, we don't know exactly what, you know, layered scaling solution is,

• 28:00Speaker 02

  but we do know that constraints are the mother of all creativity. And eventually we'll develop some, you know, good layered like systems, and Lightning will be one of them, but it's probably not suited for all second layer, you know, models. Unfortunately, I think there's going to be some, you know, like a slight realization that, you know, clearly Lightning's not going to take Bitcoin to the promised land. Again, I mean, I could be wrong on that, but it's always the issue of managing expectations when it comes to blockchains. You never want to oversolve future.

• 28:38David Hoffman?

  Alright guys, we're gonna get into the details of Nic's article, as well as how it creates a cyclical market cycle in the DeFi ecosystem. But first, we're going to talk about some of the sponsors that make this show possible. Y-EARN is DeFi's first self-building project on Ethereum, focused on producing products for those who are interested in earning yield in DeFi. Y-EARN's various products are all built to suit each individual investor's preferred level of risk, from various vault strategies that leverage DeFi tokens, to the safer Earn system which relies on stablecoins. Vaults are aggressive yield-farming robots, each with a unique strategy that is designed to maximize the yield of the deposited asset.

• 29:21David Hoffman?

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• 30:06David Hoffman?

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• 31:45Ryan Sean Adams?

  We talked a bit about the CoinDesk article, "World Computer or Financial Network", and I felt like the article that you more recently released on fee cyclicality was almost a follow-up to that, in a way. At least it was certainly a continuation or related to that original article because you got into explaining actual data and what we're seeing in the fee markets today. And you started with this really cool metaphor, like a governor and throttle metaphor. Can you talk about that metaphor and get into the article a bit?

• 32:21Speaker 02

  Yeah, so basically I wanted to explain visually what a negative feedback loop was. People talk about positive feedback loops all the time and talk about reflexivity. And I wanted to instill the visual of a negative feedback loop. So basically, this was a widget attached to steam engines that basically made them work. It made them, it gave them moderation, made them more stable. And effectively, it was a spinning valve that would take rotation from a steam engine, like a rotational input. And as it rotated, these ball bearings through centrifugal force were pushed upwards, which itself was connected to a valve which would...

• 33:06Speaker 02

  Choke off the flow of steam to the engine. So basically, the faster they spun, the more they would regulate the flow. So it's a negative feedback loop. And this basically allowed steam engines not to overheat and explode. And it made things like the textile industry, you know, basically function. So that was the baseline metaphor. And the point I make in the article is that fees are similar to that. Fees regulate the usage of blockchains. But maybe unlike the governor on a steam engine, they do it in kind of a less predictable way, maybe slightly more chaotic way.

• 33:47David Hoffman?

  So the through line that I'm seeing in this article, your first article in CoinDesk, and what we've been talking about so far in this podcast, is you are on this quest to find evidence of economic density or transaction density, where we started talking about how all blockchains that would work would ultimately become financial blockchains because of the inherent scarcity of block space. And in this, in this particular article, you go on a little bit of a quest to actually find evidence for the thesis behind economic density of a transaction. So when you were looking for that evidence, what did you find?

• 34:28Speaker 02

  More generally, I was looking for evidence that capped block space causes interesting emergent phenomena to result. And one of those is economic density. But the other ones is, the other features are, you know, strange oscillations and transaction count. But yeah, I mean, I found a number of things. I mean, my most startling discovery probably was the fact that as fees rose dramatically in kind of late August and early September, the number

• 35:06Speaker 02

  of smaller transactions on both Tether, on ERC20 Tether and Ether itself dropped off a cliff. So smaller transactors just stopped transacting. And then the other thing that was really interesting that I found was a really tight correlation between fees and Ethereum terms, and then the median transaction size of Ethereum and other tokens like Tether as well. So clearly, there's some interesting Threshold in people's minds where they're willing to pay X percent of the value of a transaction in fees. And as fees climb, the transactions they're willing to pay necessarily

• 35:47Speaker 02

  get larger. And maybe they defer those smaller transactions, or they just choose to only make larger transactions. And I don't know what the percentage is, and I'm sure it differs for lots of people. But I don't know, if it were up to me, I would probably mentally peg it at 2% or something. But the point is, as fees rise, as the stakes rise of transacting on-chain, people will come less willing to make small transactions than they opt for bigger ones. Or alternatively, again, I need to collect more data on this, it could just be the composition of transactors changes, you know, that certain people that are predisposed to making smaller transactions just cease their activity altogether, and it's only the larger transactors that are left.

• 36:30David Hoffman?

  And this isn't the only time that you had seen this behavior. This is the first time that you had seen this behavior on Ethereum. Talk about what you saw back when you looked at the data back in 2017 for Bitcoin.

• 36:41Speaker 02

  Well, I didn't look at it with this much specificity on Bitcoin. Those are things that I specifically sought out those data points in the Ethereum context. What I did see in 2017 was this relationship between transaction count and fees in Bitcoin. We saw this cycle repeat six times in 2017. You're probably going to want to look at the article to visualize it here. But basically, as transactions rise, they drag up fees. Once you hit that capped block space ceiling, and then the fees themselves actually moderate the transactional intensity. So the fees are then a disincentive to transact. And so then you have this kind of attenuation, or you have a decline in the transactional intensity.

• 37:26Speaker 02

  And then as the blocks empty out again, people realize, hey, there's lots of interesting opportunities to transact cheaply on-chain. They start transacting again, and then the fees rise again. And so you have this cycle that, you know, from peak to peak, the cycle lasts about 60 days on average, or at least it did for Bitcoin. And there's always a latency between the peak for transactions and the peak for fees. The fees always follow the transactional peak. So it's just a fascinating relationship, which I didn't see pointed out much in 2017. I pointed out at the time, it's just a curiosity. And then when fees started to really take off on Ethereum, I thought to myself, hey, maybe this is going to happen again.

• 38:10Speaker 02

  And maybe there'll be some interesting effects on Ethereum because Ethereum's liquidity is much more kind of on-chain than Bitcoin's liquidity was in 2017.

• 38:20David Hoffman?

  Yeah, that's kind of why we wanted to get you onto the podcast because, you know, the integration of smart contracts and native financial activity changes up this cycle. And so just to reiterate the cycle super clearly, the cycle begins at one part in the loop. You know, we'll just start with there's, there's some amount of block space demand. And as demand increases, the overall transaction count increases or transactions increase, therefore there's more demand. And when this happens, the fees go up, right? And when the fees go up, the smaller players are incentivized to transact less.

• 39:00David Hoffman?

  And in your article, you called this, you know, it turns out that transactors on Ethereum are very sensitive to fees. And so people that are sending some amount of value don't want to pay above a certain ratio of that value in fees. And transactors are very sensitive to that. Therefore, when fees go up, these people who are sensitive to this stop transacting. And then the transactions decline and then the block space starts to empty out and the fees decline. And then once the fees decline, there's incentive to purchase that block space again, because the block space is therefore cheap.

• 39:36David Hoffman?

  But what you alluded to in your article is that when DeFi, there is so much native economic activity that is possible that it changes the game. And you specifically talked about how Ethereum has so much Ether liquidity on-chain. Whereas in Bitcoin in 2017, Bitcoin price discovery is found in centralized exchanges where there isn't actual transactions on the main blockchain. So in your view, how does the, the fact that liquidity for Ether, the native token and other tokens on Ethereum, because it exists on-chain in DeFi, how does that change up the cycle?

• 40:15Speaker 02

  Yeah, so this is really the key. I don't know if I want to say finding, but. This is probably the most important takeaway, I think, is that in a network like Ethereum, which itself is like an enormous DEX, you know, you could probably describe Ethereum as a big clearinghouse for value between various tokens and Ether itself, you know, with Ether acting as that liability-free kind of reserve collateral, you know, it's the base pair for everything else. And since so much liquidity is on-chain, I mean, we have Uniswap flipping Coinbase in terms of volumes, so much liquidity is on-chain, all of these transactions require on-chain settlements, you know, that effectively means

• 40:57Speaker 02

  that the fee break is more, is more of an effect, it has a more pronounced effect on liquidity and volume than, than the fee break did for Bitcoin at exchanges in 2017. The reason for that is to buy Bitcoin on an exchange, you have to send them a wire or an ACH deposit, you can buy Bitcoin, you can sell Bitcoin on the exchange, you know, none of that actually requires cashing out to the chain itself, you could just perform that whole process with kind of traditional banking infrastructure. And that was just the nature of the liquidity environment in Bitcoin in 2017. Now, to participate in

• 41:38Speaker 02

  DeFi, which was, you know, really the big attraction this year, you know, a lot of that was, you know, DeFi native, you couldn't really, you know, yield farm through an exchange, you'd have to actually instrumentalize that on-chain. And my hypothesis or kind of presumption here is that as fees rise, you're massively raising the barrier to entry for these putative DeFi users. And they're willing to tolerate some amount of fees because the opportunities were good, of course, and, you know, there was literally free money floating around at some points with some of these airdrops and kind of similar opportunities. But at

• 42:18Speaker 02

  a certain threshold in fees, those smaller kind of DeFi transactors got priced out and their bankroll just didn't justify paying, you know, a $10, $20, $50 fee to, you know, make a trade on Uniswap or something. And it priced out everyone with a bankroll maybe, you know, below $10,000 or $50,000. I don't have the exact numbers, you know, obviously it depends on where the fees are, but certainly. There are some smaller users that got priced out. And the point isn't to say, you know, this is unfair or anything. I'm not taking like the Roger Ver perspective where fees are like this hideous evil thing. I think fees are great. Yeah, no, I'm 100% in favor of, uh, you know, fee intensity.

• 43:03Speaker 02

  I think it gives you tons of discretion and choice as a protocol architect, right? The fees are an asset, you know, that's the chain's own revenue. And you can sort of instrumentalize that in a variety of ways. And that's exactly what Ethereum is planning on doing. So the fees are great, but they also have some potentially adverse consequences in terms of pricing out some of those users of those kind of native on-chain DeFi platforms. And, uh, you know, the conclusions you draw from that are up to you. You could say, well, this is why we need, uh, you know, these super scalable ETH killers. Or you could say, well, that's just going to be the nature of Ethereum for now.

• 43:46Speaker 02

  I mean, the conclusions are kind of up to you to draw, but I really just wanted to point out this phenomenon and also encourage people to do more research on it.

• 43:55Ryan Sean Adams?

  I think that the phenomenon that you mentioned, like bankless listeners and people who are using DeFi systems and going on the bankless journey, as we call it, like, we feel that, right? Dave and I probably have, you know, 100 or more examples of this. Yeah, just, just a few that come to mind. Had a, had a, someone in the bankless community going bankless with a small amount of money. So depositing some funds into an Argent wallet, not a lot, you know, maybe $300, something in that range. But then when gas fees go up, it makes absolutely no sense to withdraw those funds, right? Because maybe you're paying a $50 fee. Or to do anything in DeFi, like take out a loan starts to require a lot of money for a, uh,

• 44:40Ryan Sean Adams?

  you know, a small transaction, a small capital transaction. You know, David, I remember you have an example of doing some DeFi farming at one point and just realizing, oh my God, that my farming proceeds aren't actually paying for my gas fees. So this whole thing doesn't make sense. I should just stop farming.

• 44:59David Hoffman?

  Curve man.

• 45:00Ryan Sean Adams?

  Yeah.

• 45:01David Hoffman?

  Too expensive.

• 45:03Ryan Sean Adams?

  Right?

• 45:03Speaker 02

  So it's like the DeFi equivalent of the Minsky moment.

• 45:06Ryan Sean Adams?

  Yeah, exactly. And so like we have, we have tons of examples of, of this and it's particularly interesting. And I think, um, It's unexpected for some DeFi users who haven't seen one of these cycles play out. When they have some small amount of funds and on-chain and in liquidity pools, that sort of thing. And they're not expecting a sudden rise in fees, right? So they almost get a little bit trapped on-chain, I might say. Because then it doesn't make sense to pull those, pull those fees out. And this happens to a lesser extent on Bitcoin. Because on Bitcoin, you might have like wallets, let's say, with, with trace amounts of Bitcoin that,

• 45:49Ryan Sean Adams?

  you know, the, the fees to move the Bitcoin from one wallet to another, it's not worth it. It costs more than the value that's inside the wallet. So you get this trace, this trace Bitcoin in all of these wallets. But on Ethereum, because it's a, a much more, I guess, robust and interactive financial system. A mini DEX, a mini financial system, a mini, you know, stock market in a way. It, it does have some downstream effects that, that users see and aren't necessarily ready for. And it also has effects on applications. So, applications that, that plan to develop on Ethereum with a certain, you know,

• 46:28Ryan Sean Adams?

  gas fee, I guess, parameter assumption, they have to re-architect to, to plan for a higher gas fee world. So that's kind of what you're talking about, right, Nick?

• 46:41Speaker 02

  Yeah, and I'm not, you know, trying to inject much normativity or kind of prescriptive findings into the discussion. I just wanted to point out that, you know, this thing that you feel intuitively is heavy users of the DeFi system. First of all, I wanted to kind of quantify that and try and find evidence for it. And then second of all, say, yeah, there might have to be rethinking around which applications and kind of usage modes are possible, at least in the near term. You know, barring any dramatic changes in terms of sharding or, you know, new super abundant forms of black space. There might have to be a bit of a reckoning in terms of what is considered economically viable

• 47:26Speaker 02

  in terms of a transaction type on Ethereum. Now, of course, fees have declined since then. And, you know, a lot more things are possible once again. But my guess is that we do have another cycle like this. And so people will be better prepared for it now. You know, they've been through it once. But you know, what does Ethereum look like if it is characterized by these cycles? You know, does that challenge your assumptions about the system?

• 47:56David Hoffman?

  Nick, in your, in your article, you talk about the link between the brakes on the system because fees are too high and the price of Ether. And I actually didn't totally understand that connection. So I'm hoping you can reiterate it here.

• 48:10Speaker 02

  Yeah. So this is like maybe the most speculative part of the article. But if you look at the fees on Ethereum and then the actual local top for both Ether and a bunch of kind of DeFi assets. Obviously, the value of a, of a DeFi pseudo equity token is a function of the kind of summed discounted cash flows that end users expect to accrue to, you know, the, the DEX or the marketplace. And so effectively, there, the value of that token is a function of the volume and the liquidity that, you know, end users expect to flow through the exchange or the, you know, interest rate swap product and so on.

• 48:55Speaker 02

  But with Ether, the, the value of Ether is to a significant extent a function of the usage of Ether as this collateral asset for DeFi and the reservation demand for Ether and kind of the induced scarcity that DeFi brings to Ether itself. That's all pretty long-winded, but my mental model has Ether's value being at least partially indexed to DeFi. That's why we saw it eventually being dragged upwards by DeFi this year. And so the, basically the hypothesis here is that the fees act as a brake on usage of some of these DEXs, kind of.

• 49:37Speaker 02

  Collapses volumes, not, you know, not by, you know, catastrophic amount. I mean, volumes is still pretty high across the board. They've definitely declined since kind of early September. But they're still higher than they were in, you know, early August, for instance. If you look at the DEX volumes.

• 49:54Ryan Sean Adams?

  And Nick, when you were talking about volumes, were you talking, you know, nominal dollar value of volumes? Or are we talking transaction volumes?

• 50:02Speaker 02

  Oh, yeah, volumes in dollar terms. They've come down since that fee peak. That was also the peak for early September was the peak in the Ether unit price and for a lot of those DeFi assets, which is less surprising. But I do think that in this case, there might be a connection between the fee intensity and the price of Ether. I know that's maybe a bit more tenuous. But I see, I'd have to kind of do a little bit more work on this, but my intuition is that some of the Ether backstopping these systems in the same way that it was kind of scooped up when DeFi, you know, really exploded.

• 50:47Speaker 02

  To a certain extent, it was disgorged when interest in these systems waned a little bit as the fees kind of took away some of the enthusiasm. So it's kind of like, if you guys remember the ICO kind of induced scarcity effect in 2017, where you needed ETH to participate in ICOs. And that was really accretive to the price of ETH on the way up and then catastrophic on the way down as a lot of these ICOs paid salaries and divested that ETH subsequently. You see a similar, kind of related version of that same phenomenon where ETH is, you know, a lot of ETH supply is taken off the market to be employed as collateral or to be the base pair in DeFi.

• 51:32Speaker 02

  And then maybe as some of the interest in DeFi wanes a little bit, the ETH appears back on the market. You have this fresh supply and that puts pressure on the price of ETH. So that's basically the hypothesis. But again, it's, you know, it's always very hard to kind of evaluate, you know, the drivers of the price.

• 51:50David Hoffman?

  I definitely agree that that hypothesis is there. However, if I were to add something to your article that I think you missed is that a lot of these DeFi protocols and these DeFi tokens that have valuations themselves are valuable because a transaction in their respective system is revenue for that respective system's protocol and therefore the token, right? And this is specifically true for Uniswap, but also for Wyvern and, you know, a few other other farms and Yams themselves, even though a transaction with a Yam doesn't add much to the market cap of Yams, economic activity around Yams adds money into the Yam

• 52:35David Hoffman?

  Treasury, right? And so what we kind of saw with this DeFi yield farming mania is that a lot of these protocols learned to produce a treasury, which is what the excitement came about from. And especially with Uniswap and Wyvern, a transaction through these systems added fee or took fees and added it to the protocol's treasury, right? And so you slap on this cyclicality nature due to the this kind of like two market, two month long business cycle in Ethereum and DeFi, and you slap on these protocols that are also generating revenue from transactions themselves in addition to the fees being paid to the L1 blockchain. And you have this secondary secondary system that is kind of replicative

• 53:20David Hoffman?

  of the the primary system. And so we've seen APY from Urn or APY from providing liquidity to Uniswap track the returns or those returns track economic activity on Ethereum. And so when fees get too high and the smaller transactors get washed out, the APYs for these protocols reduce. And that's kind of the APYs for these protocols are why we saw so much capital and new people and new excitement flood into DeFi in the last few months was because like Urn was offering 50% APY because everyone Was using urine and same thing with Uniswap like if you you wanted to add liquidity into Uniswap

• 54:05David Hoffman?

  because the you know the banana farm was incentivizing liquidity to go there and therefore more people would trade bananas and and then the fees would get added to the Uniswap pool and the APY for Uniswap would go up uh but then but then fees then we hit like 400 Gwei and everyone like you are you are saying with this this article everyone stopped transacting and kind of like how you were just talking about with the 2017 ICO mania it's a little bit of a game of musical chairs right like the only reason why the APY is there is because everyone else is trying to access the APY and in order to access the APY you have to make the transactions and so it all kind of ended up falling apart and I think that's one of the most interesting

• 54:47David Hoffman?

  things about this article and what's recent in in the DeFi ecosystem is that uh so much of DeFi right now depends on economic activity and what your article is showing is there's going to be this natural break that happens every so often that's going to dampen uh economic activity on DeFi.

• 55:06Speaker 02

  Yeah, I think that's very astute and you're pointing out the pro cyclical features that uh you know, a lot of us noticed I I didn't really have the time to to kind of write a full analysis of that there's a few other kind of uh sources of reflexivity that I noticed in DeFi um but I think people are attuned to that now um I guess you know there's some potential good news though, right? I mean, and maybe we'll get to this, but if you believe that um you're you know, the efficiency, the economic density of transactions is going to vastly increase with some of these uh technical innovations around the corner, then maybe Ethereum isn't doomed to

• 55:46Speaker 02

  suffer these pretty vicious business cycles, maybe the that that cycle can be attenuated. So that's that that's going to be the really interesting thing that I'm going to be looking out for.

• 55:56David Hoffman?

  I definitely see rollups has a reservoir of economic activity that you know, as the L1 gets congested, like people can can flock to uh rollups uh and I think we'll we'll talk about that later, but but Nick, in your article, you uh use this analogy, uh this poker analogy that kind of uh put different characters of different poker skills around the table and I'm hoping you could uh go through that analogy here because I think it relates pretty strongly to what I was just talking about with the the returns on DeFi.

• 56:27Speaker 02

  Yeah, very much so. And the analogy is basically a layperson version of Andrew Lowe's adaptive market hypothesis, which if you haven't read that paper, and there's actually a whole book about it, strongly recommend. It very much informs the way that I think about markets, which is to say that market participants are heterogeneous. You know, they're very different. And in DeFi, I think this is very much the case. You have, you know, you have really elite players, and then you have some less sophisticated kind of retail punters that are involved. And it's kind of the same where to poker player in a casino, you might have,

• 57:07Speaker 02

  you know, amateurs that just want to hit the felt and grinders or semi pros or professionals. And if you're a professional, you want to select the loosest table with the most fish, essentially, you know, with with the most amateur players. And if those amateur players lose all their money, then it's kind of less lucrative to sit there as a sophisticated player. And the point here is that if you think about fees as the rake, the rake being the kind of the fee that the casino operator charges, although this isn't exactly how rakes work. So just bear with me with the tortured analogy. If you massively hike the rake, then players with smaller bankrolls, it's not worth it for them to participate in the

• 57:52Speaker 02

  game. And then the pros and semi pros and grinders are left playing against each other. And it's kind of less lucrative overall. And that's actually what happened in online poker

• 58:03Speaker 02

  as as it got kind of banned in the US and people had to move offshore and it became more challenging. And a lot of those retail users had lost their bankrolls. And I guess their wife or girlfriend told them they couldn't play online poker anymore. The game got more competitive. And there was basically less alpha to be found. So kind of the same thing in D5, you know, you've got these, these funds that are quite sophisticated, they're active in market.

• 58:31Speaker 02

  If if the retail users leave or defer transactions because fees get pretty high all of a sudden, now it's kind of the semi pros and the pros playing against each other. And that's kind of more challenging. And there's less easy sources of return. And again, this is a little bit more speculative. I don't have a ton of data to back this up. I just wanted to build intuition as to why, why the loss of of retail or call it uninformed flow or unsophisticated flow might actually be pretty destructive to the kind of liquidity environment and make it less attractive to participate in general.

• 59:11David Hoffman?

  So yeah, in the DeFi space, we saw, you know, a ton of new people come in, you know, install MetaMask, make their first purchase on Uniswap, but they weren't doing it with, you know, they didn't come in with $50,000 probably. They probably came in with a few hundred, maybe a thousand, maybe a couple of thousand, something relatively smallish. And, you know, because they heard about some DeFi token that was going to moon and they wanted to go to Uniswap to purchase it. And but then we have like these, you know, very, very,

• 59:42David Hoffman?

  we have these very experienced, you know, firms, these very experienced whales that have been in DeFi, have been in Ethereum for years now, who are, you know, crypto native and have all their wealth in crypto. And they just have the advantage, right? And so as soon as gas goes up to, you know, 300 Gwei, the people that just came in to make a quick buck with a couple hundred dollars on Uniswap just get priced out. And the only people remaining are just the DeFi whales.

• 1:00:10Ryan Sean Adams?

  Nick, you made it another, I guess, a fallout from the article or some speculation. And this relates to something that Kyle Simoni talked about called DeFi's invisible asymptote. So is there some kind of an invisible asymptote here, kind of a a ceiling that DeFi can't get through due to scalability on the base layer?

• 1:00:36Speaker 02

  Yeah, and I wish I'd, and a couple of people pointed this out to me, and I feel like maybe I should have referenced this in the article. But the truth is, I hadn't seen that one before I wrote this. But I guess I'm, so Kyle's view is, you know, to the extent I understand is that, well, this is why, this is evidence for creating a new base layer blockchain with a lot more capacity and then building DeFi there. So the reaction to this so-called asymptote is probably where me and Kyle differ. I'm probably of the opinion that that constraint is the mother of creativity. And if it weren't for the constraint, we would never learn or we wouldn't be incentivized to build

• 1:01:17Speaker 02

  efficient systems that try and increase density. And increasing transactional density is the whole game here, in my opinion, as far as I'm concerned. That's the challenge. That's what rollups seek to address. That's what sidechains would address. That's what any deferred settlement system or subledgers, you know? And if you look how the traditional payments infrastructure works, it kind of works like that. You know, you have ledgers nested within each other and layered on top of each other. You don't have everything settling to the same exact ledger or database. You've got layers and layers and layers. And that's how I expected to go with public blockchains.

• 1:02:00Speaker 02

  The base layer probably does resemble a settlement layer. And then you have these, you have deferred settlements or batch settlements. And to me, that's the kind of rollup idea. Now, the question is, can you reconcile that layered model with the really nice qualities of DeFi? That's really the big, critical question, in my opinion. Or do you need final settlement for each transaction? Kind of immediate final settlement, base layer style, final settlement for DeFi to work? And I don't know. That's, that's the question I would pose to the Ethereum's.

• 1:02:39Speaker 02

  Can you roll upify a DeFi contract and have it feel the same from a UX perspective as the default way that they work today? And if that's not possible, I don't think that's the end for DeFi, though. I just mean, I just think what it entails or implies is that the average transaction size will just be structurally pretty high and it just won't be as suited for retail usage. But Ethereum can always produce more block space, for instance. But yeah, I think, let's say there is an invisible awesome to it. I don't think that dooms defi, I just think it means that you're, you know, it's more suited for kind of larger style transactions.

• 1:03:21Ryan Sean Adams?

  It seems like, and I'm going to grossly oversimplify, I think, but like, there are almost three schools of thought on this, right? As to where, where the transactions ultimately go. So everyone who's been priced out of settlement on a main chain like Bitcoin or Ethereum, well, where do their transactions go? And if I'm understanding something like Kyle's take is that, of course, they go to a new blockchain that maybe I own a portion of, but a new blockchain with, that has solved the scalability issues and is much faster than Ethereum and has very high transactions per second. Right? So that's one school of thought that the transactions move to a better layer one with higher transactions per second.

• 1:04:05Ryan Sean Adams?

  The Bitcoin school of thought, in the absence of something like a lightning or some way to scale with base chain security, is those transactions might move to a side chain or to crypto banks, essentially, to exchanges that then settle, use Bitcoin as a settlement layer on chain. I think Ethereum's hope is sort of this third school of thought that, again, you know, constraints are sort of the mother of invention here, that rollups will be that, that scalability layer. So that essentially, technology like rollups and state channels and, and plasma, but, but mostly rollups seem to be coming to the forefront,

• 1:04:46Ryan Sean Adams?

  will be a, a way to use these transactions and scale these transactions with the settlement guarantees of the base layer and thereby still preserve this idea of a decentralized, bankless, you know, transaction layer. I think that's kind of Vitalik's hope, right? That, that that will happen. What's your take on those three schools of thought? Do you, do you agree with, with the way I laid that out there?

• 1:05:13Speaker 02

  Yeah, I think that's a very fair characterization. Obviously Bitcoin is or heterogeneous as are Ethereum's. But so yeah, I'm still holding out hope that Bitcoin is able to scale in a more trustless way. Obviously, I'm trying to persuade exchanges to reduce the amount of trust that we have to put in them, kind of a variety of methods we can talk about. But also it would be great if we could continue with this kind of increasing economic density on Bitcoin as well. So I haven't fully given up hope that we can scale trustlessly with Bitcoin too.

• 1:05:57Speaker 02

  But yeah, I think your characterization is pretty complete.

• 1:06:00David Hoffman?

  In effort of keeping L1 security but having scale, you started your article off with the metaphor of the governor, right? Where there are these weighted balls and the energy from the steam engine spin the balls around. And as the balls spin slower, the valve closes and as it spins faster, the valve opens. And this finds natural equilibrium with how to govern the steam engine, right? And you're connecting this to the cyclicality of fees on a blockchain where fees go up, people stop transacting, then when people stop transacting, fees go down, and then people start transacting again. But there's a number of L2 solutions, which I think can act as reservoirs of this energy,

• 1:06:45David Hoffman?

  right? And so the balls on the governor, they're weighted, but they're still relatively small. And so an alternative model of a governor exists called a flywheel, where a flywheel picks up the energy of the system persistently when the energy is created. And then when the energy dissipates, you can tap into the energy supplied to the flywheel in order to keep the energy in the system moving forward. And this is how hybrid vehicles work, right? So when you're driving your Prius and you hit on the brakes, the energy gets captured from that braking and gets put into the battery. And then when you later, when the red light turns green, you put your foot back on the Gas and the energy in the battery goes into the engine to move the car forward.

• 1:07:27David Hoffman?

  And so as Ethereum is generating this economic activity, it also generates its own brakes. But with rollups, rollups can act as this L2 reservoir of more transactions, right? And so as, as the block space in the L1 becomes more and more in demand and pushes out smaller transactions, well, they can go and run to optimism and optimistic rollups where there is basically infinite block space because, because of how rollups work and how optimism works. And they can get on to the optimism chain and transact on the L2 and kind of wait for the tide to go back out.

• 1:08:06David Hoffman?

  Right? And, and I think an optimistic centric view of Ethereum has this natural flywheel effect where the energy boils on the Ethereum main chain and it pushes energy into the optimistic rollups. And as the main chain releases its energy, the activity back from the rollups goes back into the Ethereum main chain. Is that, is that kind of how you see rollups as a system? Or do you kind of just see it as a scaling solution?

• 1:08:32Speaker 02

  No, I think that's, that's very well put. And from my, my kind of investigation into rollups, I had a similar conclusion. I think that, I don't know if it's going to be Ezekiel rollups or optimistic rollups that are more popular, but I do see them as a reservoir for those on-chain transactions, the extent the chain is congested. I think the really salient question is, what is the nature of a transaction on a rollup? Specifically, what are the settlement assurances of a rollupized transaction as opposed to base layer transaction? And how easy is it to, you know, make those transactions kind of interoperate with, with other related systems?

• 1:09:16Speaker 02

  Do they have the same composability guarantees? That's kind of the number one question I have.

• 1:09:22Speaker 02

  You know, what, what are the prospects for rollupizing, you know, wholesale DeFi contracts and making them communicate, you know, clearly and efficiently? But yeah, I mean, certainly the vision of rollups seems pretty compelling to me. I guess the question is how it interacts with DeFi in practice.

• 1:09:42David Hoffman?

  I do know that the ETH online event that is currently going on right now, that there are a number of teams trying to figure out how to find workarounds for the withdraw period, making rollups, you know, a step in the right direction when it comes to having, you know, similar capabilities and assurances and guarantees as the L1 blockchain. But you're totally right. It is uncharted waters that is currently in research phase right now.

• 1:10:08Speaker 02

  Yeah, that was kind of my conclusion from looking at optimistic rollups specifically. ZK rollups are a little more black boxy to me and I haven't really understood them completely. But with OR, it seemed to me like I wouldn't consider an OR transaction final until that, you know, unhappy case period had elapsed, even though most transactions won't have to, you know, you'll have the happy case where there's no conflict or anything. So to me, that like seems slightly different from, you know, your standard Ethereum transaction, which maybe settles, you know, in a few blocks.

• 1:10:43Ryan Sean Adams?

  I agree. It's kind of like it's pseudo, it's pseudo settled until then. Can we, can we talk about something else? So some people listening to this, to this podcast are like, hey, like, what's the deal with expanding block space to just handle this, right? Some chains have done that. How are other chains handling this problem? So it seems like Bitcoin and Ethereum are similar in that they've said, look, there are constraints on the amount of block space that we have in a given time period. But other chains talk about, you know, free, free gas, like no gas transactions, or super high transactions per second where the gas is cheap.

• 1:11:26Ryan Sean Adams?

  And, you know, many of these are labeled Ethereum killers and that sort of thing. But do you have any thoughts on or a critique of other chains that are advertising low or zero gas fees?

• 1:11:38Speaker 02

  Yeah, I mean, frankly, no other chains have meaningful levels of usage such that we can evaluate their claims empirically. You know, so plenty of other chains made, you know, gas or block space effectively free. And so they kind of subsidized block space and made trade offs on validation. And then they had a lot of transactions, but it wasn't really economically relevant. If you actually look at the composition of these transactions, it's kind of like junk data being inserted. So we haven't really seen any of these other alternatives tested in the wild. But yeah, my, my stance on this is, is pretty consistent.

• 1:12:20Speaker 02

  I, I think metering resources, using fees as that, that kind of gating function and keeping block space scarce really is the way to go here. And I think in the long term, you're going to have great returns from maximizing economic density of transactions as opposed to just naively trying to increase block space and making validation really costly. Which to me, you get back at the same, same traditional financial system where you have a handful of super nodes that control everything. And that doesn't really seem very new or interesting to me.

• 1:12:57Ryan Sean Adams?

  Yeah. So why is it important for anyone to be able to run a node?

• 1:13:03Speaker 02

  Well, we're getting to like, you know, the, you know, the, the philosophical fundament of blockchains here. And I guess it probably depends on your perspective, but I think the whole point of these systems is that you can participate in them without too much trust required. And you can audit the supply of these assets and you can verify that an inbound payment is genuine. You know, you can reduce the cost of counterfeiting very low or the cost of detecting counterfeiting. So to me, the blockchains are all about, first of all, they're monetary in nature. And then they're all about verification, verification that a transaction is valid.

• 1:13:46Speaker 02

  And if you can't do this as an individual, then you're probably going to get taken advantage of at some point. And if we want to render the hierarchy flat, I think we have to make nodes cheap or at least reasonably cheap to operate. So that's kind of my stance, always has been. You know, like, people give Ethereum shit for the cost of running a node, but I've certainly seen much pricier nodes out there, which are virtually impossible to run even on, you know, really high-end enterprise infrastructure.

• 1:14:17Ryan Sean Adams?

  So Nick, this has been awesome to understand your thoughts on kind of economic density and how those articles came together. Well, we've got you. We want to do some, get some of your quick takes in like a lightning round, or as David and I sometimes call it, the roll-up round. So the first is this, there are now almost over, actually over a billion tokenized Bitcoin on Ethereum right now. So it's like 1% of Bitcoin's supply. What does that mean? Is that bullish for Bitcoin, Ethereum, both? What's your take?

• 1:14:52Speaker 02

  Mutually beneficial. I think it's good for both chains. It's good for Bitcoin, gives people a different way to engage with Bitcoin. You know, I might question, you know, the trust guarantees of that peg and, you know, the trustlessness and so on. But leaving that aside, I think it's, it, you know, is a interesting way to potentially transact with Bitcoin in context that you couldn't before. So I think it's good from that perspective. From Ethereum's perspective, you know, one problem I noticed with DeFi is kind of a lack of high-quality collateral to use in the system. It seems like people are trying to insert Bitcoin now because it's got, you know, fairly nice volatility

• 1:15:37Speaker 02

  characteristics, maybe compared with some of the newer, more incipient tokens that exist there. So it makes for fairly good collateral, too. So I think it's, it's good for both systems.

• 1:15:48David Hoffman?

  Recently, BitGo instituted proof of reserves. But then on Twitter, Nick, you said that this isn't that big of a deal. A, why should we care about proof of reserves? And why does B, BitGo's implementation of it matter less?

• 1:16:02Speaker 02

  To me, proof reserves means something fairly specific, which is if you are a depositor and you have a custodial relationship with a deposit-taking institution, you want to be able to verify that they, A, have assets corresponding to your liabilities, the IOU that they owe you, and B, that your liability is included in that kind of attestation. So you want them to prove your assets, and then you want them to prove that they specifically have a claim, or that you specifically have a claim on those assets. So that's just like a pedantic point, that's what proof reserve means to me. Maybe it's gonna get this more general, you know, definition.

• 1:16:47Speaker 02

  To me, the Bitcoin situation is like you're comparing an on-chain, you're just comparing one blockchain to another, you're comparing the supply of some UTXOs on Bitcoin to supply of tokens on Ethereum that are a claim on those UTXOs. I wouldn't necessarily call that a proof of reserve, that doesn't mean it's not important, it just means that it's kind of a different process. Maybe you do need an intermediary there to obscure the specific UTXOs where Bitcoin is custoding the coins, I don't know the specifics there, I haven't really looked into it. I think it's elegant and good that all you have to do to ensure the trustlessness of

• 1:17:29Speaker 02

  that system is just compare some Bitcoin balances to a token balance on Ethereum. It just seems like a different process than like the classic proof of reserve that I have in mind, which is more applicable to deposit-taking institutions.

• 1:17:45Ryan Sean Adams?

  Are proof of reserves and smart contracts with transparency on-chain basically converging? Are they kind of the same thing, they accomplishing the same purpose?

• 1:17:57Speaker 02

  Your classic proof reserves unfortunately tend to require a third party at a station, like an auditor, basically. And there's almost no way around that because you have to account for the full liabilities of the exchange. And you have to kind of make sure they're not cheating. So a proof reserve in like the classic sense is not a fully trustless or kind of crypto economic operation. Whereas if you know, you're comparing balances on chain or you're auditing the collateral quality for Maker, for instance, and all of that is on chain. That's kind of innate, like anything that's crypto native is going to be easier to audit because that's the whole point of blockchains. Now that said,

• 1:18:40Speaker 02

  there's always going to be these dependencies on outside systems, which is where these kind of attestations or proofs of reserve come in. Like, for instance, for Maker, if you wanted to audit the collateral quality, you'd actually want to drill down and audit the dollars in the bank accounts back in USDC, for instance. And that's when now you have a dependency on an accounting firm or, you know, this outside attestation. So it's kind of hard to get away from that fully. You know, like, I think that's, that's maybe like one critique some people would have of like DeFi is that it has reinserted dependencies on these like not fully trustless systems, like in the case of Maker, for instance.

• 1:19:23Speaker 02

  Whereas, you know, you get these really nice like risk management and auditability qualities if you are dealing solely with like crypto native collateral.

• 1:19:34David Hoffman?

  Will Ethereum 2.0 be delivered as advertised?

• 1:19:38Speaker 02

  Will something named Ethereum 2.0 be delivered? Almost certainly. I don't know.

• 1:19:45David Hoffman?

  As currently advertised in its current specification.

• 1:19:49Speaker 02

  I mean, just based on history, my guess is that the specification changes again. But granted, I don't really know too much about it. So I'm not very well placed to opine on that.

• 1:20:00David Hoffman?

  Last one for you, Nick. So the current, I guess, dip that we've seen so far Bitcoin ETH, kind of a price stall. What's your prediction? Does that continue? Or is this kind of a dip moment in 2020s? Yeah, 2021 is going to be great.

• 1:20:16Speaker 02

  The weird thing is that the, you know, crypto investors seem to be looking to macro factors and they seem to be looking what the dollar index is doing and the likelihood of Congress, you know, passing additional stimulus, which is funny that we have these like dependencies on these outside things. So we're kind of like a very small ship floating on a very large and chaotic macroeconomic sea. So like the endogenous crypto factors maybe don't matter as much. So to a certain extent, it's like catalyst driven. It's like who wins the election, how aggressive, you know, is the Senate in terms of like injecting new dollars into the US economy, which is weird to think about. But, you know, generally speaking, I think, you know, the the large caps are in a good position.

• 1:21:02Speaker 02

  I would say ETH is probably more exposed to, you know, the the little crypto native economy, it's cultivated on its own chain, although that's already experienced significant deleveraging. So maybe it's it's going through that process right now. But yeah, I it is weird that it's like we're looking at crypto as a bet on negative real rates and like to what extent, how deeply negative are they going to be? But yeah, obviously I have a positive view on it.

• 1:21:33David Hoffman?

  So recently Square just announced that they put $50 million of Bitcoin into its reserve, making it the second publicly traded company to own Bitcoin. Is but also Square is run by Jack Dorsey, who, you know, might, we might as well just call him a Bitcoin maximalist. Is this a big deal or is this not a big deal?

• 1:21:53Speaker 02

  It's not a big deal in terms of price impact, like one marginal $50 million buy doesn't move the needle that much these days, which is pretty astonishing when you think about it, but. It's a big deal in terms of signaling, it kind of normalizes Bitcoin as this balance sheet asset. It's not what I would do if I was running a publicly traded company, to be frank with you, but clearly he wants to send a message to his peers, basically, and send a message about his commitment to Bitcoin. So from a signaling perspective, I would say it's pretty interesting.

• 1:22:26Ryan Sean Adams?

  Nick, thank you so much. It's been an absolute pleasure to have you on to talk about these concepts related to economic density, explaining your work, explaining your articles, everything else. So glad that you are writing about both Bitcoin and Ethereum these days. David and I have got to come up with an episode title, but you know, something that captures some attention. How about this one? Nic Carter says Ethereum is only for whales. How will that do?

• 1:22:53Speaker 02

  I see. I don't know if I said that.

• 1:22:56Ryan Sean Adams?

  We won't do that.

• 1:22:59Ryan Sean Adams?

  We will be very measured in the way we

• 1:23:03Speaker 02

  Bitcoin Ethereum, you know, I mean, obviously I have like my opinions about stuff, but

• 1:23:09Ryan Sean Adams?

  Of course.

• 1:23:10David Hoffman?

  You do. You do a good job with it.

• 1:23:11Ryan Sean Adams?

  Yeah, just kidding. You do a great job and it's always fun to have you on, Nic Carter. Thank you for coming in front of the Bankless Nation once again today. We really appreciate it.

• 1:23:20Speaker 02

  Thanks, guys. My pleasure once again.

• 1:23:22Ryan Sean Adams?

  All right, guys. Actions and resources, two follow-up articles that we will include in the show notes. One is Nick's CoinDesk article about the World Computer and the Financial Network that he did not name, but is great reading material. The second is the article that we talked about for the majority of our time with Nick about fee cyclical ity in Ethereum and also with Bitcoin. We'll also include a link in the show notes to the Adaptive Markets Hypothesis paper that Nick mentioned from Robert Lowe. So make sure you dig into that as well. Finally, we need some more five-star reviews from you on Apple iTunes. David, we're doing well, but we need a few more, right?

• 1:24:04David Hoffman?

  We are going to get the Bankless Podcast to the top of the iTunes charts as DeFi grows, but in order for us to get that done is we need those five-star reviews. So if you could go to wherever you listen to podcasts and give us those five-star reviews, so we can grow the Bankless Nation, we would really appreciate it.

• 1:24:23Ryan Sean Adams?

  All right, guys, risks and disclaimers, of course. Bitcoin is risky, ETH is risky, crypto in general is risky. You could lose what you put in. None of this was financial advice, but we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the Bankless journey. Thanks a lot.