How to Fix DeFi with Dan Elitzer

We get back to basics on the show with Dan who answers some fundamental questions about DeFi and what it means to actually be a decentralized protocol. What are the threats to DeFi and how can we build a great decentralized future. ------ 📣 CONSENSYS | DILIGENCE FUZZING https://bankless.cc/diligence-fuzzing-pod ------ 🚀 Airdrop Alpha is waiting for you on Bankless.com https://bankless.cc/Alpha ------ BANKLESS SPONSOR TOOLS: 🐙KRAKEN | MOST-TRUSTED CRYPTO EXCHANGE https://k.xyz/bankless-pod-q2 🦊METAMASK LEARN | HELPFUL WEB3 RESOURCE https://bankless.cc/MetaMask ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum 👾STADER LABS | ETHX LIQUID STAKING https://bankless.cc/Stader 🗣️TOKU | CRYPTO EMPLOYMENT SOLUTION https://bankless.cc/Toku 🎮IMMUTABLE | GAMING ECOSYSTEM https://bankless.cc/Immutable 🛞MANTLE | MODULAR LAYER 2 NETWORK https://bankless.cc/Mantle ------ Topics Covered 0:00 Intro 3:34 Let's Talk About DeFi 8:09 Intro To Dan 10:51 What About DeFi is Broken? 15:05 Why is DeFi Vulnerable? 17:23 What is an Oracle? 20:12 What if Chainlink Goes Down? 27:08 What Does it Mean To Be DeFi? 33:17 What Apps Are Actually Decentralized? 41:15 How Dependancy Free Apps Emerge 45:36 Solving the Liquidity Issue 47:57 Bring Your Own Oracle 54:36 Is Orcale Free The Future? 59:35 Closing and Disclaimers ——— Resources: Dan Elitzer https://twitter.com/delitzer Why DeFi is Broken and How to Fix It, Pt 1: Oracle-Free Protocols https://www.nascent.xyz/idea/why-defi-is-broken-and-how-to-fix-it-pt-1-oracle-free-protocols Some of Dan’s favorites: Panoptic - https://twitter.com/Panoptic_xyz?ref_src=twsrc%5Egoogle%7Ctwcamp%5Eserp%7Ctwgr%5Eauthor Timeless - https://twitter.com/Timeless_Fi?ref_src=twsrc%5Egoogle%7Ctwcamp%5Eserp%7Ctwgr%5Eauthor Blend by Blur - https://twitter.com/blur_io?ref_src=twsrc%5Egoogle%7Ctwcamp%5Eserp%7Ctwgr%5Eauthor ----- 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 I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://www.bankless.com/disclosures

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

• 0:21Ryan Sean Adams?

  Bankless Nation, it's time for State of the Nation. The topic today, is DeFi broken? That's the question we raise. It's from a post that was written that caught our attention. Why DeFi is broken and how to fix it. Part one, Oracle free protocols. Huh, how is DeFi broken, David? And how do Oracle free protocols fix it? Actually, that's going to be the topic of the show.

• 0:46David Hoffman?

  Don't ask me.

• 0:46Ryan Sean Adams?

  So don't give me the answer. But why are we exploring this topic? Give us some context.

• 0:50David Hoffman?

  Yeah, the guest on today's show, a long time Bankless listeners will be completely familiar with, Dan Elitzer, who has written a number of articles that have, I think, all turned into Bankless episodes because he has the uncanny ability. He's got a great hit rate. So when Dan writes an article, I pay attention. He doesn't write too many. He conserves his bullets for that when he shoots one, it really means something. And he shot a bullet. And so we are going to go and explore why Dan thinks DeFi is broken and what DeFi needs in order to really not lose $3.8 billion like it did last bull market.

• 1:29Ryan Sean Adams?

  Oh, geez.

• 1:30David Hoffman?

  Yeah, yeah, 3.8. That was a number. So that's the topic of today's show. But before we get into the show, we got to talk about to our friends and sponsors at ConsenSys because they would like you to make sure that you know that you can get some fuzzing going on.

• 1:43Ryan Sean Adams?

  They also don't want you to lose $3.8 billion.

• 1:47David Hoffman?

  Similarly, on theme, they also don't want you to lose $3.8 billion. So if you have not fuzzed your contracts with ConsenSys' diligence fuzzing tool, there's a link in the show notes to go fuzz your contracts. I'm not going to explain what fuzzing is because I've already done that too many times and it's probably too cringe. But if you are a code developer and you would like your code to not get exploited or hacked or code developer.

• 2:11David Hoffman?

  We have some podcasters. Anyways, make sure that your code does not get exploited and doesn't lose 3.8 billion dollars. If you, if you ever do make a smart contract that hosts 3.8 billion dollars, congratulations. I hope you use consensus's diligence fuzzing tool to get to that point. There's a link in the show notes to get started with that.

• 2:30Ryan Sean Adams?

  Yeah. If you're not fuzzing, what are you doing? David, there's also, there's also another thing we, we have to mention. I think that's happening tomorrow, right? We have a, what is this? Dad's chat with dads?

• 2:41David Hoffman?

  Yeah, dads are chatting with dads. Bankless and Blockworks, two founders, two pairs of founders are gonna have a Twitter space together. So if you are interested in crypto native media, I would assume you are because you are listening to this. Me and Ryan are going to be talking to Jason and Yano from Blockworks. So we're bringing some questions for them. They're bringing some questions for us. We're just gonna chat about what it's like in the world of crypto native media. Because this last bear market has also rocked the world of crypto native media. So CoinDesk is under, yeah, yeah, there's lots to talk about. Yeah. Anyways, so that is talking, that's happening tomorrow. BYOB specifically tomorrow at 12:00 PM Eastern Time on Twitter. So if you're a Twitter person, that is what we are going to be doing at 12:00 PM Eastern tomorrow.

• 3:26David Hoffman?

  Today, if you are listening to this on the podcast feed.

• 3:29Ryan Sean Adams?

  Okay. So is DeFi broken is the question today. I really feel like, um,

• 3:35Ryan Sean Adams?

  man, it's been a while since we've done an entire podcast dedicated towards DeFi. And yet what's ironic here, David, is that's where we started.

• 3:43David Hoffman?

  That's why we're here. Yeah.

• 3:44Ryan Sean Adams?

  The reason Bankless started is because we were like, oh, you know, we're not, the industry isn't talking about DeFi enough, like the thing that actually makes us fully bankless. And yet I feel like while our protocols have experienced tremendous success and DeFi now has clear product market fit. There's something missing.

• 4:05David Hoffman?

  Right.

• 4:05Ryan Sean Adams?

  Like, we're, we're, we're, are we working on a new narrative? Everyone's talking about, okay, this is the next bull run. That'll kind of fix things. It still feels like we've got some things to build.

• 4:14David Hoffman?

  Right.

• 4:14Ryan Sean Adams?

  In deeper, in, in the stack here, at the, kind of the core primitive layer. So I think that's on, on deck for today. Yeah, why else are we talking about this? What's more context?

• 4:24David Hoffman?

  I, I think this episode will pull in some themes that we've been talking around on Bankless since day one. The protocol, when I was reading Dan, Dan's article, the protocol sync thesis came, came to mind. The other image that came to mind is, you know, that, um, that meme of like apes evolving into men. And then like, there's like, it's like the Darwin picture. There's like seven of them. But then there's the joke of like, the last one is like, wait, we've gone too far. Turn back. I feel like that's what DeFi has been for like the last like 18 months. Like we skipped a step. And I think that's what Dan is saying is like, wait a second. We've gone too far. We skipped a step. We have to go back.

• 4:55Ryan Sean Adams?

  Yep.

• 4:55David Hoffman?

  And we have to go back to prove, to progress forward. And so, uh, the words primitives are going to be said in this podcast. I'm going to bring up the protocol sync thesis, which we'll define later in the show. And, uh, risk dependencies and oracles. These are all going to be themes, uh, about why Dan thinks that perhaps we should kind of, kind of go back to the drawing board, at least in a couple of certain respects, just to be able to actually progress forward in the world of DeFi innovation. So that, that's the, the, uh, context I would leave Bankless listeners to.

• 5:26Ryan Sean Adams?

  I think the theme is back to the basics. This is, this is going to sound a little bit like a 2020, circa Bankless 2020 type of episode. We're talking about these fundamentals. Remember that? I can't wait to dive into this. Guys, we're going to get right to Dan in just a second. But before we do, we want to thank the sponsors that made this episode possible, including our number one recommended crypto exchange, Kraken. Go create an account.

• 5:47David Hoffman?

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• 6:30David Hoffman?

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• 7:14David Hoffman?

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• 7:59David Hoffman?

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• 8:12David Hoffman?

  Bankless Nation, I would love to introduce you to Dan Elitzer, a partner at Nascent, a VC firm that specializes in deep crypto-economic primitives. You may remember Dan as the guy who wrote, I don't know, about the threat of liquid staking derivatives, backed when he called them "the death of Ethereum", as in delegated ether. Now we call them LSDs. And that was three years. Before proof of sake was even a thing. Maybe you remember him from writing about superfluid collateral in 2019, which was a huge precursor to what became yield farming, which he also wrote about yield farming called aquapophonic yield farming in DeFi. I think in June of 2020, right before DeFi summer, and then also wrote uni-chain is inevitable,

• 8:52David Hoffman?

  is inevitable, a thesis on the inevitability of app chains. All of these things have more or less come true with varying degrees of success. I would say very strong degrees of success and all of them have also become bankless podcast episodes. And Dan has also recently released an episode, why an article, why DeFi is broken and how to fix it. And so here we have Dan on the show today. Dan, welcome back to the bankless for I think like the fourth or fifth time. It's good to have you back, my man.

• 9:19Speaker 02

  Yes, guys. Always great talking with you.

• 9:20Ryan Sean Adams?

  Thanks for helping us produce all that content.

• 9:25Ryan Sean Adams?

  I feel like you've earned a co-host status here or something.

• 9:28Speaker 02

  Hey, anytime. I'm always happy to chat.

• 9:32David Hoffman?

  On that note, like what, when you, how do you decide when you are going to write an article? Because you, you, like I said in the intro, you conserve, you don't, you don't, you know, it's not, you're not like Dan Ellis or every single week. You're not shooting your shot left and right. What does it take for Dan to actually put pen down on paper?

• 9:48Speaker 02

  Well, I am trying to, trying to ramp up the frequency here a little bit, which is one of the reasons why this was part one. I wanted to kind of publicly commit myself, but you know, you can't wait six months for a part two. But really, when I write, it tends to be because I'm seeing a trend and I'm seeing enough teams, enough people talking about similar themes. And then I try to pull it together and express it in a way where I have the great fortune to be exposed to a lot of really talented builders and be talking to them all the time. And so I see some things and some patterns a little bit before I think a lot of other people have the opportunity to. And so when I'm seeing these patterns emerging,

• 10:29Speaker 02

  I then try to take it and condense it and articulate it in a way that I think will help it click for more people, the way it started to click for me. And to be clear, I don't know where things are necessarily going, right? I'm not claiming that I, that I can see these things. I'm just seeing possible futures and trying to make the case for that future as clearly as I can, if I think it's a future that is, is worth considering, worth discussing.

• 10:55Ryan Sean Adams?

  Well, we definitely want to get into what that trend is. But first, can we just establish what the problem is? The trend is here to fix things, but does that imply that something is broken? What about the current state of crypto? What about the current state of DeFi is broken?

• 11:09Speaker 02

  Well, like you, I mean, I really got into this space with first Bitcoin, thinking of it in what was actually a DeFi context before the term DeFi even existed. But saying, hey, how do we actually make financial services available permissionlessly for the world? And I think we've made incredible progress with this experiment, but we've also had huge problems. And I think when you look at that headline number, you know, $3.8 billion being stolen in these hacks and these exploits just in 2022, right? Not even the full bull run, right? That was just last year. And that is just, I think, a couple orders of magnitude higher than an acceptable rate. If we really want this to be the future of the kind of global financial system.

• 11:55Speaker 02

  And we can't expect to be able to recommend to our friends, our relatives, entire countries and communities that they should be using DeFi when there is still this much money being stolen through vulnerabilities. And I think it is a tractable problem. I do think that teams need to do a better job taking high quality audits and security practices seriously. But I also think that just doing more of the same is not going to get us to that orders of magnitude improvement that we need to have in order to really be able to advocate normal kind of non-tech forward people like ourselves be using this and being comfortable putting their life savings into these systems.

• 12:39Ryan Sean Adams?

  So Dan, are you are you positing, though, that the big scalability, the big thing we're missing in DeFi? The big reason it's broken is hacks, stolen money, $3.8 billion? Is that the the the real reason that DeFi is kind of broken and not taking off, you know, as quickly as we might hope?

• 12:59Speaker 02

  I don't think it's the only reason. Certainly, I think there's a lot of other things we need to work on too. But I think that if we don't make meaningful improvement on the security front. It's never going to be able to be mainstream without improving security. And if we manage to improve on UX, improve on the way that we onboard people into the ecosystem, the way people manage recovery, the way they understand protocols and interact with them. If we don't, if we manage to fix all those other things without addressing security, we're actually doing a disservice to the world because that's just going to mean it's easier for more people to lose more money.

• 13:36David Hoffman?

  Yeah, the worst experience is like the one we got with SBF and FTX where it's like,

• 13:41Speaker 02

  Exactly.

• 13:42David Hoffman?

  The stream is so fast, but oops, doesn't have any of my money.

• 13:44Speaker 02

  Right. So it's not just about like smart contract vulnerabilities, right? It also is finding ways to better like self-police, hopefully within the industry around things like, you know, scams and bad, bad actors, both at the kind of company level, at the project level, at the like, you know, Twitter spam, Telegram spam and scams, WhatsApp scams, all these things. Like, we need to make progress. The number one thing holding back the industry is retail users in particular getting wrecked. Right? Because then people don't trust it. They don't want to, want to use these things.

• 14:23Speaker 02

  They, they get a bad impression. They get, it makes sense that regulators would want to come in and regulate when they're seeing retail users getting wrecked because that is their responsibility, right? As they see it is that they're supposed to help keep people safe. And if people are not safe, then they're going to feel like they need to step in, even if they really don't understand this thing and don't want to be touching it in the first place.

• 14:47David Hoffman?

  So that $3.8 billion number that you cited, you're not saying that is because of one specific part of DeFi. It is a global problem. There are many different types of hacks.

• 14:57Speaker 02

  Absolutely.

• 14:58David Hoffman?

  Perhaps that's why there's part two coming, maybe more parts after that. But let's focus in on what the content is around part one. What, what is broken about the current state of DeFi that is leaky in, in the capital? Like, why, why is DeFi vulnerable? And why does the current flavor of DeFi that we have not suitable to scale up to the masses?

• 15:19Speaker 02

  Yeah, so I think that the major problem here that, you know, oracles fit in the headline, but it's not fundamentally about oracles, right? It's about thinking with a layered approach to how protocols are being designed. One of the things that we've spent a lot of time focused on at Nason recently has been around security and really understanding the whole security process, the security stack, and working with both portfolio companies and looking at other code bases and understanding how hard it really is to go in and understand the surface area of a contract, all the things that could potentially go wrong with it.

• 15:59Speaker 02

  And so our view is that the right way to do this is to start with a primitive. And a primitive is a contract or set of contracts with zero external dependencies. And an oracle is a type of external dependency. Governance and upgradability are massive external dependencies. And so if you have to reason about all the possible values that could be changed or different ways in which external data can be brought onto chain in both an accurate and timely manner and how even if slight deviations in that accuracy or that timeliness

• 16:41Speaker 02

  can cause really bad consequences for the protocol, for users of the protocol, that the more we can strip that out at the lowest level, the better. And there are absolutely very good reasons to be using oracles, to have governance, to have forms of upgradability. But the point is, we want to be very explicit about the range of scenarios in which those come into play, when do those dependencies matter? And what can we have and reason about and allow to be used that does not have external dependencies?

• 17:17Ryan Sean Adams?

  So it's been a while since we've done an episode on oracles. And I think that we should kind of go back and reestablish how oracles are actually used in some of the most popular DeFi protocols today. So what is an oracle? Are we talking about a price oracle? What does it do? What are some of the popular DeFi applications that make use of this? And can you describe that in some more detail?

• 17:41Speaker 02

  I think the number one thing that oracles are used for today is around price oracles. Now, oracles are a very general tool overall, right? And I think that Chainlink in particular and a number of others have made great progress on being able to bring various types of data that is exogenous to blockchains, right? Take real world data, things that occur that can't be defined within Ethereum or other blockchains natively. And how do we import that data? How do we bring it on chain? And I think the, one of the ways that people have tried to get price data via an oracle on chain without pulling it in off-chain via Chainlink or something similar

• 18:25Speaker 02

  has been to use these kind of T WAPs, the time weighted average price, pulling it from Uniswap or other places. The problem is those have a very, very strong trade-off between how essentially accurate and timely the price is and how manipulable it is. Because T WAPs over a, say, 10-minute period, pretty easy to manipulate for a lot of assets. Over a 24-hour period, pretty hard to manipulate for most assets. But if you're trying to do, you know, perps with 50x leverage, you can't look back at the average price over a 24-hour period. You want it closer to that 10-minute window.

• 19:07Speaker 02

  And so there's this inherent trade-off with doing stuff in this very robust on-chain way. And so Chainlink and other providers who are pulling things in off-chain really look to change how you approach that trade-off.

• 19:22Ryan Sean Adams?

  So we have the the slow oracles that are kind of on chain with with kind of the T op T WAP thing that you mentioned, which is this is something that that Uniswap and other protocols like it sort of brought the market, but we're still missing that that fast oracle to give us kind of up to the second, up to the minute types of prices. And so there's an external off chain dependency if you want prices like that. So what popular protocols are using, say, a chain link or some sort of off chain oracle in order to like actually do what they do? Is it a lot of them?

• 19:58Speaker 02

  Pretty much all of them, right? If you look at, you know, compound, A, any of these lending protocols today, any derivatives, protocols, all like synthetics and GMX and others like they're all using a form of price oracle. Most of them are using chain link.

• 20:17Ryan Sean Adams?

  Dan, if if chain link went down, how F would we be?

• 20:21Speaker 02

  Uh, be pretty bad, right? And I think, you know, a lot of folks commenting rightly pointed out like they're actually, it'd be hard pressed to come up with an example of an exploit where chain link did not function as advertised and where the the exploit was due to chain link. And I'm not at all claiming that there is. I think the problem is that we are now using chain link in such a way that if there is a problem with chain link, it creates a proper across all of DeFi on like basically every different blockchain or L2. It's not just Ethereum that would be affected here. And so I think that you know, again, they performed very well so far. And while, you know, there's always room for improvements.

• 21:05Speaker 02

  And I think chain link has done a great job improving over the years. I remember some of the early protocols used in chain link and there was a lot of kind of performance and reliability concerns back in the day that have largely been addressed, but this really is on a go forward basis, right? What I want, what I'm thinking about is, hey, the next bull run? What are the things that if we don't get ourselves on solid footing now that we're going to regret? Because when the bull runs happen, you guys know, right? Everything gets crazy. People are just like trying to like, you know, go to the moon as fast as possible. Or terrorism. Right. And so, yeah, so I, I, I think that that is the thing that we need to be doing during these quieter periods is like taking a step back and saying, hey,

• 21:48Speaker 02

  even if stuff has been working so far, what are the, what is the kind of like technical debt, um, right? Ecosystem debt that we can clean up? I would, I would put USDT as pretty high on that list as well as like just, hey, USDT has been fine so far. But there's a lot of reasons that people have been concerned for years and need to be concerned. And so like, let's, let's find these things, having a single Oracle or single Oracle network as the dependency for everything, having USDT as dependency for everything. How do we start, uh, really diversifying the, the risk here? Because that is what we're trying to build, right? Is a more robust financial system.

• 22:29Speaker 02

  And just because a bank isn't the single point of failure, doesn't mean that we don't want to find more ways that people can choose the trade offs, choose the risk models that they want. And again, no one's going to be choosing directly and piecing together every single piece of the stack, but having composable layers that people can choose service providers or other protocols that are piecing together the different dependencies uh, and creating the right end user product. I think that's the exciting thing here, right? The fact that we have these permissionless protocols underneath, especially primitives at, at the base layer, and that you can build whatever you want on top of it.

• 23:13Speaker 02

  I think that is what excites me.

• 23:16David Hoffman?

  And that's really the call to action that you're presenting in your article. This, we've been talking a lot about oracles and, and I just really want to double down on this is actually not an oracle conversation. It's deeper than the oracle.

• 23:27Speaker 02

  It's dependencies generally.

• 23:29David Hoffman?

  The dependencies generally, yes. Oracles being the biggest one, the biggest systemic issue that we might have as an external dependency. But it's the fact that we rely on external dependencies in the first place, which is the area of emphasis that, that you're bringing to the conversation. And you said this word, exogenous dependency, exogenous to the blockchain system, right? Something external needs to come into our DeFi apps in order to make them work. And that an exogenous dependency is also risk. And I think what you're trying to advocate for are not just the reduction, the elimination of exogenous dependencies, but also producing what we need, would otherwise need as like an external oracle,

• 24:12David Hoffman?

  but being able to produce it internally so that we can actually, it's like an inversion. Can you walk us through like this part of this conversation?

• 24:19Speaker 02

  Yeah, I think a lot of what we see now is like the kind of centralized exchange world and the things that exist outside of blockchains. Just they're much, much bigger than the on-chain kind of like ecosystem today. And we've been kind of catching up, right? As DeFi has grown, as, as usage of protocols has grown, that, that gap has shrunk. And eventually I, I, I hope and I believe we will hit this tipping point where the on-chain volume is actually higher than the off-chain volume, right?

• 24:57Speaker 02

  The activities that is happening in this kind of crypto native on-chain context will become the primary market, not the secondary market where we need to refer off-chain to data from the primary market. And we've already seen that with certain assets that have gotten very large before getting a listing on a centralized exchange. But there is still much deeper liquidity for them within DeFi. And that's awesome, but that's the exception. And I hope someday will be, the rule will be stuff is more liquid. The primary market is happening on-chain and then we don't have to pipe in information.

• 25:37Speaker 02

  From off chain as much, we can be more reliant on things that are wholly on chain. But to date, that's been a really bad idea to make that assumption because the primary market has been off chain. So let's design in a way where we can eventually transition to a more on-chain centric world, where the dependencies can be fully defined and are not subjecting to the very complicated process of bringing in data outside of a blockchain context and bringing it on-chain.

• 26:10Ryan Sean Adams?

  By the way, for people who are like, well, Dan will always have centralized exchanges and you're living in this fantasy crypto world. I remember when, back in 2019, people, this is Grandpa Ryan coming out. I remember when 2019, people said decentralized exchanges would never take off. And if you looked at the market share in 2019, so that's just four years ago, 0.06% of spot trade volume happened on decentralized exchanges. The other 99 point, like whatever percent was on centralized exchanges. You know where we are now? We're at 20%, all right?

• 26:54Ryan Sean Adams?

  Decentralized exchanges are now up to 20% four years later. Basically, nothing. I'm still impressed, David, all right? And by the way, much higher post, guess what? SPF, FTX, all that whole mess. So this kind of thing can happen. And it gets to the core of actually what we mean when we say DeFi. Because remember that guy Alex Mashinsky was saying, I got some DeFi for you. Come on over to Celsius, I'll give you some DeFi. And it wasn't really DeFi. If you go to kind of the most extreme version of what DeFi is on the fully decentralized

• 27:34Ryan Sean Adams?

  side of the spectrum, it would be something that doesn't have any external off-chain dependency, no exogenous type of data source. And so something like Ether, the asset, is very on-chain, right? It has no external dependency. That is a very much economic bandwidth DeFi. Probably the closest protocol we've seen, and I don't know if you'd agree with this, but that's hit kind of mainstream, is something like Uniswap, which really has like, it has its own oracle. It doesn't, doesn't require some sort of

• 28:08Speaker 02

  It doesn't really need, I mean, yeah, it produces like a two watt that you can use other places, but like it fundamentally doesn't need an oracle. It is people just trading, right?

• 28:17Ryan Sean Adams?

  Right. It produces an oracle. It does not ingest an oracle. Yeah. The more off-chain sort of dependencies you inject, the less DeFi something becomes until you're kind of like all the way to Alex Machinsky, I suppose. So what we're talking about is getting back to the core of like DeFi by trying to like reduce. I feel like we've become complacent somewhat a little bit in that we're like, ah, oracles work and these, you know, governance dependencies, whatever. I mean, we're just kind of papering over some things and you're, what you're saying is, hey, let's, while we're sober now, because we're sober, it's 2023, no one's, no one's drunk on the hype of whatever bull market. Let's shore this up. Let's make sure we get this right. I think that's what you're saying here.

• 28:59Speaker 02

  Right. And I think it's, it's a, it's an idea about having choices along the spectrum, right? Like if you look at Celsius, you look at FTX, like, right, they were, they were just like scamming, basically. But if you think about what is the kind of future state look like, it is not an incredibly purist, everybody is doing everything fully on-chain with zero external dependencies. But I think Andreas Antonopoulos had a, had a great bit that he did, you know, years ago, where he talked about what is the benefit of having up kind of permissionless systems and permission systems? How do they coexist? And his point

• 29:41Speaker 02

  was you can build a permissioned system on top of a permissionless system.

• 29:48Speaker 02

  You fundamentally cannot build a permissionless system on top of a permissioned system. And so I think for DeFi, similarly, what we're talking about here is let's actually start with this incredibly low attack surface, zero external dependency, low level primitive. And then you can build things on top that have dependencies and you can choose which dependencies. And if you want to go all the way to something that, you know, is a fully centralized custodial KYC service that is built on top of that, you can, and that can still be built on top of the same

• 30:30Speaker 02

  base level primitive, but people can choose kind of like what, what is their points along that spectrum? What services do they want to trust while still actually concentrating all of the liquidity, all of the economic exchange at the base layer can be happening in this very secure, shared market.

• 30:50David Hoffman?

  But Dan, building DeFi apps like that is hard.

• 30:54Speaker 02

  It is hard. It's so hard, right? And that's what we haven't seen a lot of it. And so we've been cutting corners, but I think also, you know, this might be a, another controversial point. I think, you know, AMMs, automated market makers, you know, that Uniswap really helped popularize have been a real leap forward and have allowed DeFi to get to where it is today. And we tried the pure kind of like order book style peer-to-peer exchanges for both trading and for lending markets prior to that. None of them worked. AMMs were what allowed it to break through. They improved usability, given the constraints of what kind of like low user base, small user base, and just like low throughput, high cost doing

• 31:37Speaker 02

  stuff on chain early on. AMMs were great. I think we're actually going to circle back. We're actually going to end up like the, the ultimate efficient end state is we're going to have things that are much, much closer to order books than to AMMs as they exist today. And I think uni V3 was a big step in that direction with concentrated liquidity being effectively a gas efficient on-chain order book. And we're, we're going to see more shifting in that direction. So we're,

• 32:06Speaker 02

  It's hard to do certain things. We've kind of got to look at how things are going to evolve over time. And so a lot of the things about layering and thinking about what is possible with these isolated markets, what is possible for going this pure no dependency version of DeFi. That wasn't possible previously. It was tried in various forms, but it wasn't really possible. Now I think we've evolved to the state where we have enough users, we have enough liquidity. We can be more thoughtful about building the architecture that is actually long-term and robust. Because we've gone through an initial bootstrapping period to get there.

• 32:47Speaker 02

  So this isn't necessarily, some ideas are probably just like bad and wrong. Other ideas, the timing is off and then you think that it just means that this architecture is wrong. This idea is wrong. It was wrong for the time, but now we can do it with advantages that didn't exist before. And it is, I think the people who are trying to do those things weren't wrong. That those were the right ways directionally to build up a decentralized financial system. That the timing was just off.

• 33:21David Hoffman?

  So Dan, how many DeFi apps check this box as a very deep primitive that has no external dependencies? We got Uniswap. How many apps after that?

• 33:34Speaker 02

  Yeah, it's, it's pretty, pretty slim pickings in terms of like what's, what's live today. I think there are a few that have hopped out. I think it was Panoptic. May have called out for like oracle free options that they may have actually originated the term of kind of like oracle free protocols. There's, there's others, I think, is it Timeless or others that have been doing this in various forms? I think finding the right. Way to not completely mess up UX and actually keep the liquidity there, keep the UX up to par is tough.

• 34:14Speaker 02

  And so, but I'm seeing this kind of wave of folks coming, both ones that we've invested in nascent, ones that we haven't invested in, like the two mentioned previously. I think that there's this trend coming and we're going to see how it plays out. I think it has potential to be a lot more robust and that if we are thoughtful, if we've got teams like Oasis, like DeFi Saver and others who are building on top of some of these. You know, that's going to be very helpful to maintain a consistent UX on a solider base. And I think that there are many, many more services and protocols that will build on top of these if they can get the initial traction going.

• 34:55Speaker 02

  Such that the average DeFi user today will see equal UX while having essentially a more robust stack that has been built up to support that.

• 35:07David Hoffman?

  So Uniswap is one, but we'll talk about how all the other major DeFi apps that have TVL do not check this box. So we got Ave, we got Compound, we got Maker Dow, which I think the next like synthetics, I think all have external Oracle. And so I think what really you're saying is like, hey.

• 35:29Speaker 02

  Anything with lending, derivatives, all of this stuff is using external price oracles. Yeah.

• 35:33David Hoffman?

  Basically, if you're not using Uniswap, you're probably using an external dependency. And an external dependency is just a fancy way of saying bank, I'll say. If you really want to generalize what a bank is, it's like somebody that can control your funds in ways that you don't agree with. And so very generalized.

• 35:53Speaker 02

  Yes, yes and no. I think the custody distinction is really important, right? Because a lot of these things, they don't custody of your funds. They could in theory be upgraded in a way that is like, ends up resulting in them taking custody or being very custody like in these things. So I think that's, that is an important distinction, but the fact that there could be these like really bad upgrades that could happen. Means that like, man, we've got our hope that the governance systems are robust. And I don't think there's anybody who's been deeply involved in governance for any of these DeFi protocols. That has like, their view is like, oh yeah, governance works great. I love it. I feel totally comfortable with it.

• 36:31David Hoffman?

  Right, okay, so maybe to be less hyperbolic, not a bank, but trust. Like, these things aren't a bank, but you do have to trust them to not turn into a bank if the wrong governance proposal went through. And this goes right back to the roots of what Ryan and I got into DeFi in the first place, right? It's like, hey, what about bankless finance? What about trustless finance? Like, my Twitter name is called Trustless State. And so I think what you're saying is like, hey, all of these DeFi apps beyond Uniswap haven't been trustless, and so we need to get back to our trustless roots. Dan, I know you've got a number of protocols. I want to pick your brain out to understand how these things are actually built. And if we're going to do lending without an oracle, how does that even work? And how this is kind of like inverting the model as we know

• 37:17David Hoffman?

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• 41:08David Hoffman?

  Bankers Station, we are back with Dan exploring this world of primitives. God, I used to love saying that word. We haven't said that word in a while. Dan, with all of our DeFi apps that we want to become primitives, is there a pattern for how oracle-free or dependency-free DeFi apps emerge? Like, how does one actually remove an oracle? Or is there an underlying pattern that we can understand here?

• 41:30Speaker 02

  Yeah, so on the trading side, like, pretty well established, right? We've seen the AMM model, X, Y, K, and then all the variations on it. On the lending side, it's admittedly a bit more complicated. And so usually what we're seeing with, you know, with AVE, with Compound, with these other pooled lending models, is you're relying on an oracle saying like, "Hey, what is the price of Ether right now?" And being able to say, "Hey, we've got these kind of universal collateral factors." Basically, how much can you borrow against a given set of collateral? And how much, at what point do you then start getting liquidated, right? When you move to an oracle-free context, what you generally have is the lender.

• 42:15Speaker 02

  So let's say I want to lend USDC, and I'm willing to have Ether as collateral against it. I can choose essentially what is the amount of USDC that I will lend against 1 ETH or against 0.5 ETH or against 100 ETH, whatever it is. I can choose that ratio, and I'm implying the collateral rate that I'm comfortable with based on what I see as the current price of Ether. Now, if the price moves, that does not automatically get updated, right? And so I would need to, if I don't want to see a liquidation occur

• 42:57Speaker 02

  as both a borrower or a lender who wants to lend, say, a new ratio based on the current market price of ETH, I would need to then update the terms of either the current loan or of a future loan to reflect that. And so some of these different protocols will address how that liquidation process works and how both lenders and borrowers initially express their preference in the market. But at the core, that is what's happening, is you have a quote asset and a collateral asset. And you're agreeing, like, what are the kind of ratios between these assets that both lender and borrower are comfortable with?

• 43:39David Hoffman?

  So instead of depending on one external oracle, you just are the oracle. You're you are just the one that inputs the desired ratio. And that's how you remove the oracle. Simply put?

• 43:52Speaker 02

  Yeah, and I think we're seeing that, you know, with with NFTs in particular, right? Where it's been harder to have that kind of like off chain price. It's like, OK, here's an NFT as collateral. Like, what are you willing to lend against it? How much you want to lend against it? And generally, the platforms are defining it based on the price. But you could, you know, choose what price you're comfortable with. Maybe this is a floor asset, in which case it's easy. If it's not a floor NFT, then it's going to be a lot more subjective, what you consider the price to be and what what you're comfortable. And so this is just saying, hey, we're not going to say we're just trusting. We're all agreeing to trust this person saying the price. It's like, no, no, you come in, you choose what you are comfortable with using as the price, either based on your own information or whatever other service you want to trust

• 44:35Speaker 02

  to provide accurate price data for your, you know, kind of risk profile references.

• 44:41David Hoffman?

  So in the history of DeFi, I remember there was, in the very early days, there was peer to peer lending. And I think that's what AVE was pre in very early days.

• 44:53Speaker 02

  Eclend, yeah.

• 44:54Ryan Sean Adams?

  Eclend, oh, my God. Before they pivoted.

• 44:57David Hoffman?

  Yeah, yeah, they pivoted from peer to peer, where two people set the terms. Also, we had Dharma, we talked about that in the in the commercial break, we had, which was peer to peer, like two, like each side of the market would individually find each other and they would come to an individual agreement. And these peer to peer finance, peer to peer DeFi, just got absolutely smoked by peer to contract.

• 45:20Ryan Sean Adams?

  Yeah, it failed. Stani had to pivot towards AVE, which is peer to contract, as you said.

• 45:25David Hoffman?

  And so this is what Uniswap is. This is what AVE is. This is what Maker Dow is. It's like, instead of having to match make between individuals, just you just go to the contract and the contract is the aggregator between all the marketplaces. And so what I heard you say is something much more closer to the peer to peer world, where two individual people come together and have to come up with terms and then they can make an agreement. And that's how we get rid of the oracle. But then we introduce a problem of liquidity. How do you have, do you have any thoughts on this?

• 45:58Speaker 02

  Yeah, so there are multiple ways to get there, right? And so in the case of Aja, right, which is, which is doing this, I would say they're using a uni V3 style model where you have ticks based on the collateral ratios. And as a lender, you deposit into specific ticks. And so just like uni V3, where you have these non-fungible LP positions, where different people are LPing across different ranges. But as a trader, you can come in and trade across all of them.

• 46:33Speaker 02

  The same thing happens within Aja, where lenders come in and again, they'll lend, say, USDC in certain ticks against ETH. But then if you want to come post ETH as collateral and borrow, you can access liquidity from multiple suppliers across a variety of ticks. And so I think that's how you can make it. What's one of the ways that you can make it work is we can still use this kind of like peer to pool model, peer to contract model, and just make the kind of supply side non-fungible and make it a little bit, I'd say, more intensive. But that, that's also natural, right? If you look at any of these peer-to-peer marketplaces, even outside of crypto,

• 47:15Speaker 02

  what typically happens is you see one side of the market getting professionalized very, very quickly. And then you have retail on the other side because that's just the efficient way to do it. And that's ultimately, everybody benefits as long as you do have an open marketplace. Because you make it, I would say, high barriers to entry and requirements essentially on one side, just in terms of just how sophisticated you have to be, while allowing people on the other side to need to be less sophisticated. But as long as there is a competitive market that is operated in a fair manner, then they can't be taken advantage of.

• 47:54Ryan Sean Adams?

  Is, is one way of saying this, though, Dan, that? Rather than removing the oracle, it's kind of like bring your own oracle. Maybe, maybe, maybe there's a synonym here. Maybe we're saying one of the same thing. Cause now that I, I look back at kind of Uniswap V3, right? Or any of the versions of Uniswap, basically, you know, we might say that's an oracleless. No oracle protocol, oracleless, oracleless protocol. But actually, you kind of have to bring your own oracle, don't, don't you? Also, you get kind of like owned and I'm not saying a specific oracle, but you have to kind of know at what price point you're going to like LP. You have to kind of set your ranges yourself. You have to sort of bring some sort of source of knowledge, whether you call it an oracle or not.

• 48:39Ryan Sean Adams?

  So maybe that was already bring your own oracle and that's what you're, what you're saying. We could do the same with lending and borrowing. Am I understanding this? Like, how would you, how would you articulate this?

• 48:49Speaker 02

  Yeah, more, more or less. And I think the same way that we've seen as uni V3, you know, has made it harder to LP. That there have been a number of different services and protocols that have popped up to make it easy for retail users to LP for certain types of pools in certain ways. Because they're, they're kind of monitoring and bringing in this external information for you. But if you wanted to go and use it raw yourself, you can. But there's essentially a lot of,

• 49:22Speaker 02

  even if we don't call them options, effectively people are offering forms of options when they're LPing, either in, you know, DEXs or in lending protocols. And here it's just being made more explicit where there is essentially embedded options in a lot of the LP activity that's happening in these, you know, oracle free versions of lending protocols. And, and also various, if you want to get to like oracle free derivatives, absolutely, that's a big piece of this is you're, you're effectively embedding options, but in such a way that you don't have to like go deep on options pricing in theory to be able to use these protocols in various ways.

• 50:05Speaker 02

  But you, you probably do for at least one side of the market, want to outsource your LPing to somebody who has that level of knowledge, whether it's an individual, whether it's a centralized service, whether it's a decentralized protocol, any of that is possible.

• 50:22Ryan Sean Adams?

  And the advantage of this design is if a chain link oracle goes dark, like the entire protocol doesn't just kind of disintegrate, which could be the case with many oracle designed protocols today. Like really bad things happen if the price feed kind of stops.

• 50:44Speaker 02

  Those are erratic.

• 50:45Ryan Sean Adams?

  Those are erratic.

• 50:47Speaker 02

  Yes, well, absolutely. And to be clear, that hasn't really happened. And also, if you think about it, let's say that, you know, 95% of people are relying on then chain link via services built on top of the Oracle Free Protocol. That doesn't necessarily like help overall, except that, right? Except that the way these protocols were then designed is saying, okay, we're actually effectively embedding puts in the liquidity provision piece of this. And so you're saying, hey, worst case, if this can't be liquidated in an efficient manner, I will accept this collateral at this ratio in return.

• 51:31Speaker 02

  And so therefore you have already said like, hey, worst case scenario, Oracle's down, whatever happens, here is essentially the arbitrated outcome that will take place as opposed to saying like, oh, man, now look, this, this pool is insolvent. The protocol is insolvent. Everyone's like beating it to the exits. We've got all these problems. It's keeping risk much more isolated and more clearly defining what happens in extreme market dislocation situations. And I think that is very powerful because we've seen time and again where the like manipulation of, you know, price feeds for certain assets,

• 52:13Speaker 02

  whether on-chain or off-chain, or, you know, or exploits or other things. Protocols will end up in a state where like the DAO is like, well, what do we do? And try to figure out like, what is the right way to handle it? Because different people have different expectations and there's not like necessarily a clear way that this is supposed to be resolved. Because by definition, when these things happen, they, they were unexpected. And then we, we, governance will deal with it. And I think it's better if we say, okay, look, you were coming and you were getting the rewards. There's risks and they're very clear upfront. And yes, we can use external tools, other things to help manage those.

• 52:53Speaker 02

  But fundamentally, you need to know what you're getting into and you can choose different risks than I choose or than David chooses. And so we can all still be interacting in the same market with our different risk preferences. And still have pooled liquidity. And I think that is what is super exciting about these protocols is that ability to not massively fragment liquidity, but still allow individual expressions of the risks and dependencies that you're willing to accept.

• 53:24Ryan Sean Adams?

  No, this is very cool. I mean, this is a very clean wind down. And another word that comes to mind to describe this is kind of resilience. So these protocols would have sort of a self-healing type of nature. So one oracle goes down like Janling or something. Well, guess what? The market is very incented to put another oracle solution in place. So, you know, market participants can kind of bring their own oracle and the kind of the protocol self heals. We've seen something similar with Ethereum and it's multi-client architecture, right? Where we had that, you know, finalization event where Ethereum wasn't finalizing a few weeks back. And it was because there was an issue with, with two of the clients, it turned out.

• 54:05Ryan Sean Adams?

  But good thing we had a third, good thing we had a fourth and the network kind of continued to march on. And this also, when you were talking, reminds me of like, this is all about maintaining fair, orderly and efficient markets. Right? It's like orderly and efficient markets. By the way, that, that is the mission of the SEC. So I'm sure Gary Gensler and, and team would be a fan of this, or at least they would if they operated on, on first principles. But I guess like a higher layer of, of, or a lower layer of, of kind of primitive that other protocols, other things can build on. And I guess we would have kind of an app layer, maybe a DeFi saver or something like this, helping individual retail users kind of manage their, their positions across these.

• 54:48Ryan Sean Adams?

  So do you think in terms of broad categories, we talked about decentralized exchanges and we've seen oracle lists, decentralized exchanges. Do you think we, the future really for lending and borrowing on, in DeFi is oracleless lending and borrowing? Can we like take that entire category and make it oracleless? Are there other categories beyond lending and borrowing?

• 55:11Speaker 02

  Yes, I think we can, whether we will is very much an open question, right? I think it is absolutely possible, but to David's point, like it's hard, right? Like Eric, I think maybe your point, Ryan, it's like it's harder than what we were, what we have been doing. It requires rebuilding some of the things that we've already been built. And can we do that fast enough? Can, can, do people care enough to do it? I hope so, but I don't know. We might see that just like there's no demand for this in the market and then people don't do it.

• 55:50Speaker 02

  And that will, you know, that's a choice that kind of like we as an industry have made, that individual users have made. But, you know, I want to at least draw out this potential future path that I think would be more robust. And again, I've seen a bunch of teams that are already starting down this path. And so I want to help shine a light and bring more awareness to that. And hopefully encourage more teams to think about this path if it wasn't already something that they had in their head.

• 56:18David Hoffman?

  Well, I think if we're thinking if with an adversarial mindset, which we should be thinking in an adversarial mindset. If it can be exploited, if it can be hacked, if something can go wrong, it will go wrong at some point in time. And so I think we should all be concerned when like 50% of the TVL is one oracle, erratic oracle away from getting liquidated. So like, I think perhaps we should assume that that is going to happen. And I think really the question is, just like how on-chain Dex volume is up post FTX? Do we win, do we want to get our on-chain borrowing and lending up into oracle-free protocols? Before or after there's a major oracle exploit?

• 57:02David Hoffman?

  I think is the big question, but either way it's going there. It's just a matter of time. Dan, you.

• 57:07Speaker 02

  And to be clear, this is not the only thing that we need to do to fix DeFi security, I think.

• 57:12David Hoffman?

  This is just part one.

• 57:13Speaker 02

  So there, and there's a lot of other ideas I'm sure that other people have, and I want to get the conversation going, but. I'm going to be touching on topics like, how do we actually introduce circuit breakers in a way that maintains permissionlessness and composability while presenting, you know, hundreds of millions of dollars from just like disappearing in one transaction? How do we actually get to what I'm calling generalized multi-party Sentinel contracts, basically permissionlessly delegate in a non-custodial way to multiple parties to help protect protocols and individual users? And then also really thinking a lot more about bounties and how we can have significantly

• 57:53Speaker 02

  larger bounties that scale with the value of risk and create the incentives to better secure the ecosystem. So these are just a few ideas that I'm looking forward to writing about and to discussing with people. And I know there's a lot of other people that are starting to think more about security, but I started here because I think this idea of a layered approach while allowing for unified markets actually underpins a lot of those other ideas as well.

• 58:19David Hoffman?

  Well, Dan, thank you for coming on and walking us through this conversation. You even mentioned a handful of projects and teams, but overall, who are the leaders in this space of oracle-free, dependency-free protocols? If people are curious, they go and poke around and learn a little bit more. What are some standout projects in your mind?

• 58:37Speaker 02

  Well, I mentioned a couple earlier that were very early in terms like Panoptic and Timeless. The, I would say Blur's Blend is a great example of this now that has become very popular. There's a bunch of others that are coming up soon, you know, a number of which we're invested in at nascent. So those, some of these are Aja, Ethereum Credit Guild, Metastreet, which does kind of NFT-based lending with their automated tranche makers, doing some very cool stuff. So there's a number of folks that are coming in this space and I'm very excited to see them all be in market and see how it plays out in real life.

• 59:16Ryan Sean Adams?

  Well, awesome. We'll end it there. Dan, this has been great. Always game to make DeFi a bit more decentralized, I should say. We got to work on that now, right? Now it's the time. So hopefully some of these teams and projects are coming to market soon. And we appreciate you sharing all this with the Bankless Nation. Thank you. Well, thanks for having me on for the discussion. Risky disclaimers. Got to remind you, of course, none of this has been financial advice. It never is on Bankless. ETH, DeFi, all this stuff is kind of risky. You could lose what you put in, 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.