Liquid Staking: The Tail Wagging the $20B Dog – Gavin McDermott

my name is Gavin I work with idea of collab ventures see a few people I recognize out here yeah I want to talk to you guys a little bit about liquid staking or staking derivatives as they're kind of being talked about because as the I call it the billion dollar tail tail Waggin the twenty billion dollar dog because as the theorem starts to move towards more of a staking ecosystem I want to talk to you guys a little bit about kind of the incentives here and this is all about incentives and outcomes so we'll start with a quote show me the incentives and I'll show you the outcomes and this is by Charlie Munger if you guys know Charlie Munger he's Warren Buffett's right-hand man and literally this is I usually quote from a financial human on this because this is as much about financial engineering what we're getting into as it is about network engineering or systems engineering and that's something that we sometimes forget and so let's talk a little bit about the migration that's happening that sets the stage for we're going to talk about there are multiple asset migrations taking place right now so in the proof-of-work land let's say it's on any given day 240 billion dollar market but we're having right now is this migration into proof of stake we're not going to talk about the attributes of these two mechanisms but we are there's this kind of like movement over into this roughly now twenty four billion dollar market as new networks are launching a lot of them are proof mistake and so you see this kind of this movement taking place but migrations happen for a reason the reason they happen is because the first generation creators usually aren't able to and it's not their job to consider the higher-order effects the things downstream it's their job to get things working and then it's people kind of fill in later are the ones dealing with kind of the higher order of that so let's keep that in mind so defy it's a thing we're talking a lot about right defy is a higher order effect it's one of those things that a decade ago we weren't we didn't have any idea of this but it really took kind of a solidifying or at least a getting comfortable with the base behaviors on that bottom layer to make defy something that's kind of normalized and we're talking a lot about it here so defy being a high order effect kind of sets the stage so let's talk about the other asset migration that's kind of happening so there's that twenty billion dollar or twenty five billion dollar market on prove mistake right now and we've got roughly this kind of migration now happening into the D Phi and it's happening because people are now with with a couple of attributes they're wanting to do more with their money they're looking to get more yield out of things and so they're saying okay I'm in proof of stake and now I want my assets to do a little bit more for me and so this is the the great deal the great define migration it has begun and it's it's going to stick around because the fight like decentralized finance finance is it's a meme it's it's something that people grok because money is like the one of the oldest human-made incentive mechanisms that we've had and so it's a really simple thing I think people been talking about this all day it's a simple thing to understand so finance as a meme stick so it's no reason that people are starting to design around these attributes so so something like this is gonna stick around so my question is is it a little bit of the case of the tail wagging the dog because the surface area for defy it's something that people understand and so we understand the incentive mechanisms and financial markets have been around a long time but they're starting to influence the design of the lower layer protocols and change the incentives because even with proof of stake haven't been around we're still starting to understand how these security layers work and how the incentives work to align things so we don't collapse them I mean it's really really new but so is my question is it a case of the tail wagging the dog so in order to understand some of the risks that are actually present because when you start to look at staking derivatives it make sense on paper but let's kind of like walk through a little bit of defy to understand the the nuance risks that are actually pretty massive so what is defy about it's about markets markets everywhere so permissionless markets we all know them we know Eunice WAP it's about kind of being able to spin something up anywhere and you also get permissionless permissionless markets but also leverage future swaps and the audience back here hey like you get this ability to have markets anywhere and leverage positions anywhere that's a thing that's just gonna continue so markets it's also about composition things plugging in to one another we all know this it's like you have compound which works on top of maker which works with which works because of etherium so there's this composability aspect that is just kind of something that we're coming to demand from our assets they need to work together and defy is really starting to push this forward even more so and then most of all this is the phrase that everybody is like talking all about and second of all like just the aside anytime I hear like the word derivative used all the time like it makes me a little bit skeptical and I've heard it more in the last like common conversation last year than I have in a long time so little flags are going up anyways yield is the thing that everybody's talking about too because they want to make money on their money so it's like how can I get more yield and so they're just trying to take whatever ass that they have and extract every little ounce of yield from it and this is where it starts to get interesting and start to starts to play with the incentives a little bit different than we've ever seen in the last decade of these networks kind of evolving okay but at its core defy is about a new breed of financialization in financialization this introduces a ton of asymmetries and rich that are new on the asymmetric side it's all about asymmetric information and what we're doing is we're throwing application engineers into the deep end of the pool with seasoned financial engineers and there's a really big difference here seasoned financial engines like this there's a whole market in a whole there's decades of people locating things in tearing the earth apart to make light travel less of a distance in order to find some information asymmetry so you can extract it and so from that perspective in the dphi markets going across protocols we're already seeing like some examples within the last 24 hours you get to see that some of the holes that open up in this are the size of the state of California I mean it's huge so those are just like it's one set of asymmetries on the other side there's this like new class of risks that on the surface you don't really see them because because things are technically interoperable right the attributes of defy that we just talked about make everything look interoperable because it's what we've demanded in order to grab some yield but it introduces a bunch of risks let's talk through some of those because risks change the nature of the of the of the incentives and the outcomes but in order to describe what these risks are this is where it gets kind of fun there's we're gonna talk about it in terms of delivery so in finance there's this concept of delivery we'll describe what it is but we're gonna use this term because I think it's kind of appropriate right because in finance everything has like multiple meanings and those like slight tweaks like meaningfully changed the the incentives anyways all right delivery so let's say we're gonna talk about physical delivery first so in physical delivery if you and I are like trading corn let's let's say that at the end of the day I'm selling and you're buying at the end of the day the corn actually trades hands there's physical delivery at the end of that but what that does in terms of the incentive is it means that both you and I care immensely about the health of that corn we care about the health of the underlying asset it's a thing we both care about right and so if my corn is full of maggots or let's just say it was just just a crap crowd right then but the entire market suffers the entire market actually cares about the corne um then let's talk about paper delivery now paper delivery is kind of the more financialized concept of delivery where honestly you and i are just kind of like we could we trade positions on top of the corn now and so agnostic of wherever the corn is the corn could be in a dumpster on fire and you and I could be trading positions on top of it and we could still make money in net profits at the end of the day but in the end it's like and if that market collapses we can move on with a with a whole lot less with a lot less friction for us for trading paper on top but anyways the difference between paper delivery and physical delivery is pretty is pretty large especially when you consider the incentives to take care of the health of the underlying so now what the hell does delivery have to do with staking this is what so vanilla staking is we have it today is pretty similar to and physical delivery in the assets right you have this like base layer protocol and then you have basically the staking mechanism over on here and so on the left it's like you can imagine you have this everything is kind of bundled together in this like relatively naive world you have the mechanisms of network adoption network security yield and speculation all those all those things that people care about are actually bundled in that circle on the left and your layer one and then over on the right in there like Staker you have this you have this mechanism that is meant to encourage network security as well as participation in various like network activities governance voting things like that and then as like as an added bonus like as just kind of this like secondary thing you get some yield by way of staking maybe you don't get diluted out of your position it's either way it's kind of this Manute thing and so yeah you get this kind of like thing where it's all bundled together and that's the state of the primary mechanisms however when you start to introduce staking derivatives you introduce this next hop you introduce this derivative layer which starts to bring these which starts to create this next layer and incentives where in this case you don't necessarily it's it's a little bit more like paper delivery derivatives in this case they seek yield for yield sake so kind as we were talking about you and I could be trading these derivatives these staking derivatives and you know regardless of you know depending upon the liquidity and the availability of the market we can make a lot of money agnostic of the health of the underlying network so you know the corner the network can be on fire but the there's plenty to money to be made to be in the near term when you're actually just trading in the derivative space so that's kind of the comparison so in this world the the emerging world of likes taking derivatives or liquid staking you had adoption security and yield on the left but let's just assume a couple of a couple of trends continue in terms of there's a shitload of liquidity there is sorry there's there's a lot of liquidity there are right there's a there's a lot of liquidity there is uh there's the ability to open leveraged positions anywhere kind of permissionless lee and some of these let's just assume these all continue because i think they're going to and so then you have this this market was kind of the underlying market for security and adoption all these things on the left but now you have this market that is purely yield seeking on the right where you can actually just take positions on these derivatives and anyways when we're talking about information asymmetry and people who are really good at extracting that just to make one trade all it takes is one trade in order to undermine a certain a certain network so these are these are windows and gaps that are going to be growing in terms of their availability to be to be used so anyways all of this right like at the core like financialization pro tip in finance there's this idea of like the risk-free rate right the risk-free rate is like this base level of return that you can get on any asset that you hold for as effectively no risk that's in itself but like the risk-free rates just that concept but anyways if you just take right I see somebody laughing at that but the idea is like if you're seeking yield literally you're seeking risk so yield seeking and risk seeking are literally the same thing and when you're talking about securing the network and network security and seeking risk those things are are not necessarily diametrically opposed but there is a very clear tension in those two concepts and it's a common so anyways that's just a thing that if you're building a service order any of things and you're considering trying to eat more yield out of a derivative or out of an asset these are things to be considered because we're having in the very early stage of this and most people are not talking about them vast majority of blog posts and things to read are just kind of missing that anyways so what's gonna happen to the underlying networks I don't have a clue I really don't know where this goes I know that kind of these trends are gonna continue in this direction but surely if we're like actually taking on all this risk we should be getting compensated for it I mean if you're gonna see keeled you're seeking it for a reason so we're taking on risk in order to you know get some reward out the other side but this is kind of the like what just because it looks good on paper panin pun intended Wow what if the benefits that we're actually getting are kind of illusory and I think they are at this point in the game unless we start to change things so in theory all their doing these things to have assets work together so we can do things with them so in theory all these staking derivatives are fungible but in practice right now they're not and take this as a really naive example so we have a simple case of like which derivative is riskier and this doesn't even involve malicious activity right let's say the the circular derivative issue or that the staking service on the left let's say that previously there was like some network issue and they're like just super super redundant in their architecture and so and there were some pickups in the network and stay spun up a secondary node and they double signed a transaction they weren't even being bad actors right but anyways they have some history of slashing and so that's that's the game on the right hand side another service has never been slashed either way they're both staking services and people are staking with them so the derivatives being issued from both of those services should not be priced the same the risk of both of those is different right they have and across the entire like landscape of staking services you have these nuances and how they operate and so they're not all fungible basically you put fungible things in and then counter-intuitively get these non fungible things out which again we're doing this all to be able to pool liquidity in the first place so it's just kind of a thing we're not able to price this effectively right now like entire companies and protocols are gonna need to be built in order just to price this stuff effectively so we can use it how we want to none of that really happens there's one there's there's a anyways we'll keep going so in theory again you get more liquidity but in practice right now you get these aggregation issues you get silo with liquidity because of the nests the nature of the derivatives that are being issued again you don't really think about that but that's that's how this happens these things aren't necessarily one-to-one apples to apples and so again you get more counterintuitive more counterintuitive things and then markets as usual let's just let's say that like all that stuff pulls together let's say that like the pricing and the risk and stuff is all figured out and then you have markets as usual well again this is kind of a another BS thing in practice you get these like staking idiosyncrasies right let's just like say you have markets built on top of these derivatives which you're gonna have and what happens to like a massive position if suddenly there's the underlying staking or the validating services slashed like what just happens to those positions that are like there so anyways there's a there's a slew of issues in terms of just open market positions and what happens with these derivatives in practice anyhow and then as an added bonus because I work at I do we could talk about some of the UX issues you just get a boatload of weird usability things out the other side that nobody is talking about we're gonna take I'm gonna pick on compound sorry but and not because of they do a great job but I'm just gonna pick on the design as a thing right so the notion of having C tokens and these things right this works in a single unified context right you just wrap it with a C and so you know what you've got but suddenly we're gonna step into this world with derivatives and all sorts of assets that are the asset but they're just the derivative of the asset and they have different properties so as you start to get these different protocols issuing these different things that are all very similar but very different the wallets the interaction points all need to reflect the nature of the asset that people are holding if we actually want to like evolve the space to be known for something more than a piss-poor user experience which we kind of all know it is right now and so that's kind of one of the issues that we've got to figure out we need actually this is kind of a call we need a very simple unified design language for how to represent these types of new assets right because every wallet is doing it in their own idiosyncratic way and it's just not going to work people are already confused enough about what they hold and so as we get into more derivative territory this is not going to clear itself up anyways so that's kind of like these are all very real issues that that are just to emerge from staking so anyways the big issue we have a ton of a ton of hidden and unpriced risk that is going to emerge and it's going to emerge and it's it's almost like it's gonna have to emerge because just this pull of and the meme of decentralized finance is so sticky so well understood and so simple but it's gonna continue to pull people in because it just works and so this is the big issue but the bigger issue is that we're fooling ourselves into the fact that we're not going to repeat history just because transparency we think that we're protected because of the very properties of these of these ecosystems that we all kind of tout and talk about if you take the previous kind of any actually most financial issues were most people at the end of those like crises that kind of clamor for wow we just need more more more transparency it was the fact that the data was opaque and we didn't know how those CDOs were bundled at least most people didn't we didn't know how that was bundled so you know if we just knew what the composition of those things were would and we would have known it was so risky and none of this would have happened anyways what I'm what I'm saying is that literally we have the all the information available it's all transparent and we're reconstructing the same paths to the same outcomes potentially so it's not the mere fact of the presence of these things that protects us it's our ability to actually use them but because humans like to repeat history and we love to do it for whatever maybe our hindsight is just 20/20 but our foresight and ability to be present is just that leads us to these things so anyways transparency it's it's a thing but it also doesn't protect us so my point is yeah build build the out of things I like I like work at the place of prototyping word is just a it's the thing people do to explore and uncover and understand you've got to get hands-on with things and you got to you've got to do it all but my nudge is just that learn from history understand the nature of the risks that were actually opening up I mean the last 24 hours have been really interesting if you've been checking some of the cross contract calls and may symmetries that were that were poked at but my nudges just don't create a theory ins first like big short moment in the process because you could anyways Thanks [Applause] [Music] you