Recap: DeFi Week of Nov. 11 🦄

Hello defiers, hope you’re having a great weekend!

Summing up last week: This week 0x’s cofounder Will Warren dove into the upgrade to the platform and his vision for a tokenized future. Vance Spencer, co-founder of Framework Ventures, outlined his investment thesis for Synthetix. CoinMetrics found ERC20s are on fire, Opyn wants to build tokenized options, ENS names are going for $100,000s, and Ethereans basked in the afterglow of ETHWaterloo.


Balance Sheet as a Business Model for DeFi Platforms

Vance Spencer, co-founder of Framework Ventures, which led Synthetix’s recent $3.8 million round, dives into his investment thesis fro Synthetix and outline what’s next for the platform. Vance says both Synthetix’s and MakerDAO’s business models consist on monetizing their balance sheets. The difference between the platforms’ token economics will lead MakerDAO to become a digital central bank and Synthetix to become a decentralized BitMex. Vance lists the four steps the platform plans to take to get there. First up is Synthetix’s plans to incorporate non-SNX collateral, so users will be able to stake ETH to mint synthetic assets. 


"We Believe the World is Going to Become More and More Tokenized:" 0x's Will Warren

0x’s ZRX token holders approved a proposal to upgrade the 0x decentralized exchange protocol, whose relayers are among the top five dexes transacting the most volume. 0x co-founder Will Warren explains what the change will entail; how it tries to better answer the question “does your protocol really need a token?” and improve liquidity and prices for its users. He also talks about his larger vision for a future where millions of assets will be tokenized and traded on Ethereum. Before doing all of that, he lays down the basics of decentralized exchanges so that we can all be dex-perts.


  • Defying the Biggest Market in Traditional Finance: An options market has yet to develop in decentralized finance, even though they’d provide much needed investor protection against the high risk involved in transacting in this cutting edge market. This is what the team at Opyn wants to fix, but it’s doing it in a DeFi way, with options contracts minted as ERC20 tokens.

  • Tokens are Cool Again: Ethereum tokens are having a renaissance. Actually, more than that, there’s been no better time for Ethereum tokens, according to on-chain data found by CoinMetrics.

  • How to Profit From San Francisco’s Poop Problem: There’s now an ERC20 token on the Rinkeby testnet that tracks the frequency of poop sightings as reported by San Francisco's SF311. UMA cofounder Hart Lambur took developers Daniel Que and Tyson Battistella’s idea and issued the token using the platform’s synthetic token builder.

  • Synthetix is Now The Second Biggest DeFi Project: Total valued locked in synthetic assets platform Synthetix on Tuesday crossed $100 million, surpassing Compound Finance as the second DeFi platform with most value locked after MakerDAO, according to DeFi Pulse.

Monday: ETHWaterloo Edition

  • The first hackathon was in Waterloo in 2017 and there have been 14 different events –and a crypto boom and bust– since. Two years later, Ethereans are back where it all started The 65 projects submitted over the weekend brought total hackathon projects to more than 1,000. Unlike past events, there wasn’t such a big focus on DeFi, save notable exceptions. It was all about smart wallets, messaging and games.

💜Community Love💜

Thanking all the amazing defiers for the support and love this week (and always!)

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Balance Sheet as a Business Model for DeFi Platforms

Framework Ventures provides its thesis for investing in Synthetix.

Hello defiers and happy Friday! Synthetix, a platform to mint and trade synthetic assets, this week climbed the DeFi ranks to have the most value locked in dollar terms after MakerDAO. Its growth has been explosive, with value locked surging by 60x since February to over $100 million. Today Vance Spencer, co-founder of Framework Ventures, which led Synthetix’s recent $3.8 million round, will dive into his investment thesis and outline what’s next for the platform.

Vance says both Synthetix’s and MakerDAO’s business models consist on monetizing their balance sheets. The difference between the platforms’ token economics will lead MakerDAO to become a digital central bank and Synthetix to become a decentralized BitMex. Vance lists the four steps the platform plans to take to get there. First up is Synthetix’s plans to incorporate non-SNX collateral, so users will be able to stake ETH to mint synthetic assets. It’s an interesting read!

The Defiant is a near-daily newsletter with all the latest in decentralized finance, complete with interviews, a weekly recap, and occasional columns from those who are thinking deeply about the space (like today). There’s a new financial system being built. Don’t miss out.

Balance sheet as a business model; a framework for understanding synthetic asset platforms

By Vance Spencer, Framework Ventures co-founder

The business model of both Synthetix and Maker is simple: monetizing a balance sheet. 

Maker allows users to post ETH collateral to a balance sheet and to mint a synthetic stablecoin (Dai) at a specified collateralization ratio. In return, users pay a fee which is distributed to MKR/DAI stakeholders via a buy/burn schema and the DSR. 

Synthetix builds a balance sheet in its native token through staking incentives, allows users to mint a broad spectrum of synthetic assets (sBTC, sETH, iMKR, etc.), and charges users fees to create and trade debt. These fees, along with protocol inflation, are passed back to Synthetix stakers, incentivizing them to keep their collateral posted. 

The business model of a synthetic asset platform, with a few tweaks, is largely that of a bank; build a balance sheets of user deposits, lend out capital for a rate of return, and distribute the proceeds back to stakeholders. 

The two meaningful differences between dominant synthetic asset platforms

1.  The spectrum of assets a network prices debt in determines the market size 

Maker is relatively simple, risk-averse and bank-like in this regard - it mints and prices debt in Dai, which tracks the USD. When a user opens a CDP, the user posts ETH collateral, and promises to repay the Dai that was borrowed. Because all protocol debt is issued in Dai and Maker has a robust liquidation process for CDPs, a user can be reasonably certain that the network won’t become undercollateralized. 

Synthetix is more complex, risk-on, and has a potential path to a different and much larger market than Maker. Currently, a user can mint or trade (reprice) debt with one of 24 different assets when staking the SNX token or utilizing Synthetix.Exchange. When a user mints $1 of sUSD (a USD stablecoin), the SNX-denominated collateral pool is responsible for backing $1 of sUSD. However, when a user trades (reprices) sUSD for a synth like sBTC, the network’s debt fluctuates as the price of sBTC changes. Network debt can fluctuate heavily, and as a result a greater degree of over-collateralization (+750%) is required to operate the network safely. Eventually, this ratio will drop as SNX gets more liquid, a liquidation process is implemented, and the network generally matures.

Being able to mint different types of synthetic debt drastically increases the addressable fee market for a synthetic asset protocol, yet also increases the extent to which it can become undercollateralized due to users repricing debt profitably. To solve for this, Synthetix will need to move towards having a balanced book of synthetic assets, by integrating different collateral types and utilizing open-interest based APR. 

2. Value accrual differences between liquidity vs. governance tokens

The differences between Maker and Synthetix token economics will lead to divergent outcomes for the two respective platforms. 

Maker currently builds its balance sheet with ETH, charges users fees to mint and maintain a Dai position, and distributes fees to MKR/Dai holders. The MKR token is used for governance of the network and as the lender of last resort if the network becomes undercollateralized. The value for MKR tokens accrues based on the amount of outstanding debt, and therefore stability fees, which determines the amount of MKR to be purchased and burned. To cover existing accrued stability fees, about 0.8% of MKR would need to be burned; 0.5% has been burned already. At a high level, MKR holders risk dilutive events as the lender of last resort and act as the governor of risk in the system. If MKR can scale its stablecoin protocol across multiple collateral types, it becomes a digital central bank.  

Synthetix’s balance sheet is built by incentivizing holders to stake the native token (SNX). As an SNX holder, you can stake SNX, which generates a debt position denominated in sUSD. If the debt position is over-collateralized (+750%), a staker is rewarded with weekly protocol inflation, as well as the fees generated by users minting and trading synthetic assets. Currently, inflation is intentionally high relative to the fees (10:1) cycling back to stakers, but this is changing as the trading and creation of synthetic assets scales. Exchange fees currently generate roughly a 10% APR on a SNX position.  

At a high level, SNX holders stake their tokens to provide the platform with liquidity, becoming a debtor counterparty to every trader and minter on the platform in a zero-sum game. If Synthetix can scale a balanced book, SNX becomes an infinite liquidity pool that can mint any asset with a reliable data feed against the collateral pool. In the near term, this looks like a decentralized version of Bitmex. 

Vision(s) for the future of Synthetix

In the next 12 months, we expect Synthetix.Exchange to evolve into a decentralized version of BitMex, with multiple collateral types, a liquidation engine, and a SNX-denominated balance sheet to backstop trades. The market for synthetic assets is both a large and immediately addressable. In traditional finance, the derivatives market is estimated to be 10x the size of global GDP annually. In crypto, we are seeing similar dynamics play out with the success of BitMex and its perpetual swaps dwarfing corresponding spot markets. Our belief is that a non-custodial, decentralized, infinite liquidity version of BitMex would achieve product-market fit at scale.    

Longer term, the business model for Synthetix might look a lot like franchising liquidity to generate additional fees. In this world, new exchanges, prediction markets, or other front ends pop up overnight, buying liquidity from Synthetix’s balance sheet, and competing on user experience to differentiate. A lot of the fundamental assumptions in the space surrounding liquidity, and the pecking order of business models, could change as a result. All of a sudden, a project wouldn’t need to aggregate users in order to aggregate liquidity. 

How does Synthetix get there

Synthetix Core’s experience, work ethic and commitment to the community make them one of the most high-output teams in the blockchain space - they are absolutely incredible. Two years ago, Synthetix was called Havven, and focused solely on building a balance sheet to support a synthetic stablecoin. Nine months ago, Synthetix changed its name, token economics and broadened its synthetic asset mandate to monetize its balance sheet. The team is deeply committed to a test-and-iterate methodology for product and protocol development, taking direct feedback from the community and using rough consensus as a governance model to implement changes. 

Looking forward, the path to Synthetix becoming decentralized BitMex is clear: the protocol must reach feature parity with professional derivatives exchanges, while becoming truly decentralized in order to differentiate in their go-to-market strategy. As a liquid, feature-complete and decentralized version of BitMex, Synthetix will leverage an absence of centralized custody, personally identifiable information, and jurisdiction gating to compete for trading fees. As a community, decentralization enables the open source collaboration that builds a strong community and massively accelerates the flywheel of improvements. 

To get to feature parity, there are four main initiatives already underway that need to be completed: 

1. Non-SNXCollateral Options: The process of buying SNX, staking, and then trading is cumbersome for most. Many traders would prefer to use assets like ETH or tBTC as collateral to enter the system. An added benefit of multiple additional collateral types is that this builds short exposure into the system, balancing a mostly-long order book. The Synthetix team is working on implementing ETH as a collateral type before EoY, while still accruing value to the SNX stakers. 

2. Liquidation Process: The 750% collateralization level for SNX stakers limits the amount of synthetic assets that can be traded, and is due to the illiquidity of SNX and the lack of a liquidiation process for undercollateralized positions. To safely operate the protocol at scale, a liquidation process that has been designed will need to be implemented. 

3. Robust Price Feeds: Currently Synthetix’s price oracles are operated in a centralized way that allows traders to front run price changes, and also leaves the price feeds vulnerable to attack. To solve this, the team is working to integrate Chainlink as a decentralized oracle provider, and a unique order management system to prevent front running.

4. Professional Trading Tools: The interface design, order types and speed of execution on Synthetix Exchange is not up to the standards of centralized exchange offerings. The team is redesigning the exchange, integrating more order types, and is exploring Layer-2 solutions to speed up transaction throughput.

To become truly decentralized the development, management and ownership of the network must continue to shift to the community. This process will be gradual and take time, but doing so builds a strong community, mitigates regulatory risk, enables Synthetix to move quickly, and solidifies its decentralized value proposition. 

Sizing the prize

The opportunity for Synthetix as a decentralized BitMex is massive and straightforward to value using a DCF model. Because the token is utilized to build a balance sheet and represents a pro-rata claim on network fees, the value of Synthetix tokens grows proportionally to the volume traded on Synthetix Exchange. In Q3 2019, exchange volume was $298M, with September being the highest month to date with $252M in volume. This is tiny (1000x smaller) in comparison to both Binance and BitMex, which did $112Bn in spot and $320Bn in XBTUSD volume. Small shifts in volume from Binance/BitMex would represent huge gains for Synthetix.

Where do we fit in

Our view is that crypto-native investing isn’t a spectator sport, and that most venture firms are hamstrung by existing LP agreements, too much AUM, and a traditional equity investing mindset. Our style is venture investing, in tokens or equity, with a focus on active participation that pushes the network forward. We commit capital to build liquidity on synthetic asset pairs, we actively stake SNX to build the collateral pool, we write Synthetix Improvement Proposals (SIPS) to fix issues as we see them, we build products on top of the network, and most importantly, we help the Synthetix Core team. 

If you are building something interesting in the crypto space and want a partner, please reach out. 

Special thanks to Kain, Jordan and Justin from Synthetix for helping flesh out these thoughts.

"We Believe the World is Going to Become More and More Tokenized:" 0x's Will Warren

Hello defiers! 0x’s ZRX token holders yesterday approved a proposal to upgrade the 0x decentralized exchange protocol, whose relayers are among the top five dexes transacting the most volume. Sharing an interview with 0x co-founder Will Warren, who explains what the change will entail; how it tries to better answer the question “does your protocol really need a token?” and improve liquidity and prices for its users. He also talks about his larger vision for a future where millions of assets will be tokenized and traded on Ethereum. Before doing all of that, he lays down the basics of decentralized exchanges so that we can all be dex-perts :)

I edited the interview for length and clarity and bolded by favorite quotes. Subscribers get the full version.

Camila Russo: Before we get into the latest with 0x, it would be great if you could give me an overview on how the different decentralized exchanges work. I’d like to really understand how the different pieces fit together.

Will Warren: There are many different ways that decentralized exchanges have been designed on Ethereum. The first dex that was ever created was OasisDEX. Maker created their own dex because in order for Dai to be useful, there has to be markets for it. OasisDex took all the functionality of a traditional centralized exchange and put it into a smart contract on Ethereum. The order book, the list of offers to buy and sell different assets, was stored within a smart contract.

The problem with this approach is that interacting with Ethereum is expensive. Every single time you want to place an order on the order book or cancel that order or modify the price, you have to create an Ethereum transaction, and it's costly. And so basically the takeaway from it was that it's really inefficient.

Then there’s a class of decentralized exchanges called automated market makers, and this is Uniswap and Bancor, and there are a few other projects too. Basically, you get a smart contract and you put in two different types of assets into that smart contract. So say you want to trade ether for Dai. You get this big pool of ether and this big pool of Dai, you put them in that smart contract and then that smart contract will look at the ratio of those two different assets and it will offer a price that you can buy and sell at. So if the the ratio changes and maybe there's more ether and less Dai, the price of Dai becomes more expensive.

It's very elegant because it's simple and has a smart contract taking care of a lot of the things that traditionally an exchange or a market maker would. But the downside is that due to its simplicity, you can't really support large markets. And you can't have large trades because if you try and buy or sell too much of an asset, you're going to rock the price up or rock the price down. And so you're kind of limited in how much can be traded by the size of the pools of assets in the smart contract.

I kind of view them as like more of a toy honestly. And I don't mean that in a condescending way. I just mean that they're really cool gadgets, but they're not necessarily designed for really robust exchange markets.

CR: But the problem with the order book model is that while it does allow for maybe more sophisticated trading, it's more expensive to have everything on chain, and I imagine slower too, right?

WW: It's way more expensive and you're right, it is slower.

CR: Which type of exchange is more susceptible to front runners?

WW: Front running is relevant for on-chain order books. It's relevant for automated market makers, and it's also relevant for certain types of off-chain order books too, which is what 0x is focused on.

CR: So what 0x is doing unlike on chain order books and liquidity pools, is that you have an off chain order book model. Can you explain what, how that works?

WW: So it's good to note that on 0x you don't have to have an order book at all. The way that most people use 0x is through an order book, but 0x is actually like a message format. It's a way for people to settle trades. The important part here is that you're only interacting with the Ethereum blockchain when a trade is occurring. But if you're not actually moving value, then the blockchain isn't being used. And so the way 0x works is it's an off-chain order relay. On-chain order book orders are living in a smart contract, but in 0x these orders are pieces of data that have the assets you want to trade and the price and how long you're willing to do that trade.

It's just a chunk of data that lived off-chain. And then you cryptographically sign it with your private key and it's still off chain. Then you can share that order with anyone in a private way. But if you don't know your counterparty, then you'll probably use an order book. And so the analogy I use for off-chain order books is a check. You can write a check and it gives someone the right to pull money out of your bank account if someone cashes it. But they could just keep the check and not cash it and nothing would happen. In this case the bank is the blockchain and the check is the order. The order isn't on the blockchain until it gets cashed out at the bank.

Will Warren, 0x co-founder and CEO

CR: And that piece of data, or the check in the analogy, where does it actually live? Does it live on a 0x server or where specifically?

WW: So that's the important piece is that the 0x protocol doesn't say that there is a specific place or server where that order has to live. The protocol only cares that you're following the format as defined and that eventually if it is sent to the Ethereum blockchain so that a trade will occur. You don't need to have a server. I can just create an order right now on MetaMask and I could just send it to you over this video chat and then you could go and submit it and fill it. But if I don't know a counterparty, then you need a server to host the order, and this introduces the concept of relayers. Relayers are basically companies that have a database and a server. And what they do is they allow people to come and share their orders with them and they take those orders and arrange them into the form of an order book and display them.

CR: So there are relayers that work specifically with 0x orders, with people who want to trade using the 0x protocol. Are they just like independent companies?

WW: They're just independent companies and they can charge fees because they're the ones hosting the server. They only accept specific orders that meet their needs and in their case their need is a fee. So they'll say you can send in your order and I'll host it, but your order has to pay me a fee, otherwise I'm not going to accept it.

CR: And I guess what's interesting there is because you can allow competition between relayers, fees should tend to not be as high, right?

WW: Yeah, that's right. And there are a bunch of different types of relayers and actually it isn't just as simple as they host a server with orders inside of it. There are different ways to have the market work as well. Some relayers charge zero fees right now because they're just focused on getting users. Some of them charge a percentage of the trade. It really varies and it also varies depending upon what kind of markets that they're supporting.

Radar Relay focuses on supporting liquid ERC20 tokens. It really looks just like a traditional, centralized exchange. Another type of relayer works the same way underneath the surface, but trades digital collectibles, like cards and Cheese Wizards and stuff like that. You create these orders off chain, they host them in their server and then someone else can go to the website and find your order there.

CR: So there's these off-chain order books and then what happens? A trade is executed, then that goes on the Ethereum blockchain?

WW: Yeah, exactly. So the relayer isn't doing anything. They're just hosting the orders. The trader is actually going and picking that cryptographically signed order off of the website and sending it to MetaMask and telling it to send this order to the 0x smart contract. So the 0x smart contracts, all they are able to do is accept these orders that are sent to it, process the orders, make sure that all of the conditions that need to be satisfied for a trade to occur are satisfied. And then it will move the assets between the different parties on either side of the trade.

CR: Okay, and for a trade to be made, you still need to wait for that transaction to be confirmed on Ethereum.

WW: Yeah. So it isn't like a centralized exchange where it's instant, it takes 30 seconds or so.

CR: And so what have you learned so far about this system? What are some of the pros and cons that you're seeing versus the other ones?

WW: I'd say that because it's off chain it is more efficient and it can support more liquid markets than automated market makers. But because it uses this architecture, it isn't as like simple and intuitive for people. Uniswap is much easier for people to develop with and trade because it's either buy or sell and that's it. On 0x you actually have to get these orders from somewhere and it's either a counterparty directly or it's from one of these relayers and then you have to send that order to the 0x smart contract. And so it's a little bit more work to integrate 0x.

CR: And it also supports more liquidity and maybe more functionality?

WW: Yeah, it definitely supports more functionality. So 0x supports all of the popular token standards today; ERC20, 721, and then this kind of second-generation token standard called ERC1155. Most dexes today only support ERC20. We think that there are going to be all sorts of different types of assets that people want to trade and we want to make sure everyone can trade them.

0x also supports significantly better prices, with a lot less slippage, than Kyber or Uniswap because of its architecture.

CR: How does this immediate new update fit in into that? Like what are your trying to achieve with it?

WW: Yeah, so there are a few different main points here. The first one is that we completely redesigned the token economics. So the first thing to note there is there is a token associated with the protocol. A lot of people see a token associated with 0x and they're like, come on, does that really need to exist? That's definitely a fair question, but the answer is actually yes, it really does have to exist. The problem that we're solving for with the token, I think now with this new update we'll finally be able to address it in a much better way than we have been to date.

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