What Is Low-Risk DeFi and Why It Will Win? Keynote by Marcin Kazmierczak - Co-founder, RedStone

Hey everyone. Uh I'm very glad to be back at stable summit. It's a conference I have been to a couple of times as a participant chatting with other D5 folks but also as a speaker. I'm Marson co-founder at Redstone and also right now Credora that we acquired uh two months back. I will be talking today about low-risk DeFi, what it is and why it matters for Ethereum, especially right now after so many years of this ecosystem being live.

So maybe let's start with a question to the audience. Who has seen that pause from Vitilik from 20th of September? Raise your hand if you have and keep your hand if you have read the whole piece. All right, I would say there's probably 10% of people uh that would read the whole um Vitalik claims that lowrisk DeFi can be for Ethereum what search was for Google. And after reading the article, I believe that's a pretty misleading uh tagline because if you hadn't read the article, you might wonder like why what's the connection between Ethereum and Google in that sense.

So the thing is Ethereum has uh very noble goals and wants to be the global compet. But it turns out there is this constant battle between solutions on Ethereum that generate revenue and have uh big financial gains and opportunities uh for example leverage sometimes maybe memecoins. So those are plenty many times short-lived but high revenue opportunities. And on the other side, you have social solutions, privacy, prediction markets, and long-term uh game solutions that bring a lot of value for the users at large, but maybe not necessarily that much of the revenue. So here, Vitilik claims that it's good to have one solution that generates a lot of traffic in terms of financial sense and revenue category.

And for Ethereum, it can be finally the low-risk DeFi with a goal of achieving global democratized access to payments and savings in valuable asset categories. So, we're talking about major currencies such as dollars of course, but also euro, yen, yuan, Argentinian peso, um, stocks, bonds, commodities, and so on and so forth, living on chain in a tokenized most likely manner. In finance and economy, I graduated quantitative economics at Warso. Uh there's a concept of cash cow which is a product that constantly generates revenue over a long period of time. It doesn't have to be tremendously revolutionary but it has to be uh long lived when it comes to the revenue.

And I would say here is what Vitalik means with low-risk DeFi. It doesn't have to be extremely innovatory as long as it keeps its purpose. And for Google search was just that. It was this one product that generated so much revenue for Google that they can they could create maps, they could create chromium, they could create so many other services that are apparently right now free and people could claim hey Google is actually bringing a lot of value in all those other aspects for our daily life. So the two main categories would be the basic function of payments and savings in low-risk DeFi and the other one is well understood tools like synthetic assets and fully collateralized lending and the ability to exchange between these assets.

So DEXIS someone could say all right but that was available in 2020 or 2021 why now is the big change? Well, for once, we have the change in regulatory environment. Right now, the blockchain based solutions are very much welcomed by many of the global economies, including the US, but also Europe is working on new regulation and Asia. And the innovation in DeFi has skyrocketed since 2021. Right now, we have liquid staking tokens, liquid restaking tokens, use bearing assets, higher monitoring tools.

Uh we also learned a bunch through past mistakes. And crypto does not have magic secret sauce source for sustainably creating much higher yields than stratfi. It's not that there's a magic wand and we create hey 12% for everyone with very low risk. But what crypto can offer is the secret source for having the economic opportunities that already exist globally h and permissionally accessible for everyone no matter which country you're in and no matter uh what kind of uh strategy you are interested in. And here we go into the credora aspect which in this low-risk DeFi movement that is not ideally defined because vitilik doesn't say hey aan compound is low-risisk defi and anything else is not low-risk defi it's a spectrum right so it's subjective way of assessing which strategies and which h categories you would put into that lowrisisk defi defy bucket and this is the problem of the users it's difficult to choose the right asset lending market and vault for your risk appetite.

Over the past years, we've seen proliferation of stable coins. We started with USDC, USDT die. Then we saw the uh emergence of ETNA on the USDY hash node USYC that was purchased by Circle and right now we have over 200 stable coins. So how a regular user can navigate that tokenized assets? Same.

We started with tables. We've gone through private credit, cash and carry and so on. Now we are tokenizing stocks, reinsurance, refactoring and many other well-known trati financial primitives. And in D5 volts it's the same. We started with a compound the two giants that have been around for a very long time.

Then we opened up with permissionless vaults on more forer and now we have over 500 vaults yield strategies with risk risk creators and fintech companies such as Stripe, Revolute, Robin Hood are going into that category and will be revolutionizing even further. So for regular user it's very hard to determine which strategy to choose and which one is adjusted to the risk appetite of a particular depositor. Therefore we created risk ratings with Credora where we take into consideration plenty of risk factors such as network risk, counterparty risk, smart contract risk, operational risk, oracle risk and we create a very simplified uh risk rating model. So in trfy it's something very well established. There are three major agencies over there.

S&P, Moody's and Fitch that are rating various assets and we took the traditional ratings scale that is very I would say granular for example BB B minus BB+ and so on and we made it simpler. So we kept it only from D to A+ so that for regular user it's easier to distinguish. And our thesis is that in crypto the differentiation between very stable and safe yield and the yolo products that promise you high yield and pinky promise they are low risk are extremely hard for regular user to distinguish because there is this concept of social proof. If someone put already $100 million into a specific strategy, okay, they had to have some proper risk assessment for that asset, right? So this is exactly what happened with stream finance.

Like when people were seeing others generating 20% yield and the product already had for example 120 million of deposits, everyone was like, "Hey, I'm missing out. I'm missing out on a beautiful opportunity that is considered already by the market like a very low risk." So this is where Credora comes and says, "Oh, we cannot rate right now stream because it blew up already." But we did some back testing and most likely you would have gotten a C or maybe even C lower than C rating. So there would be already a signal for regular user that this category is actually very high risk.

So the ratings are the bridge gap between institutional investors and cryptonatives because the crypton natives can still look at crypto Twitter of people like warning or informing hey this product can be potentially higher risk. But if you want to appeal to the global audience to people that don't understand at all the difference between LST LRT and how the yield brings chercoins are constructed this is where we have to go. So with the methodology we look mainly into three buckets first. We look into the asset h we quantify the likelihood of default and potential loss if the default happens. We then look into the markets.

So the markets are constructed from assets. It can be just two asset like deposit and uh borrow assets for example but it can be plenty of asset in a single market and we quantify the probability of significance loss. So if something bad happens what is the probability of this actually hitting that particular market and then you have vaults for example morpho that are constructed from either one market or plenty of markets depending on the vault creator how they want to allocate their money. And we aggregate exposure to underlying uh lending market ratings and assets to talk about the specific inputs. For example, in the market characteristics, we look at uh loan to value ratios uh of specific markets.

Uh oracle characterization allocation distribution. So if there is a market how actively it's utilized. So for example, if a market has 10% utilization, so only 10% of available assets is borrowed, it's probably a different scenario than when there's already 80% borrowed and there's not that much left. What is the rebalance profile of the participants in the market? So have they in the past h added uh to their collateral when their health factor was depreciating.

So if there an active allocator that manages the position or just took a position and then waits until it's going to get liquidated or not. Collateral uh asset rating so looking at specific things that are into the uh market itself. Returns distribution. So we model return distribution considering volatility on the market. And then poor per liquidity data which assess available market depth.

So how much you can sell of an asset given a specific slippage. So to give you a particular example like deep dive into one of those categories when you talk about oracles because as Redstone we are one of the leading oracles we know that market category very well. There are various types depending if the asset has the dynamic oracle which is many times called market oracle. So how people trade an asset or it has an exchange rate oracle. So there is a contract where you can deposit or withdraw asset or mint and burn.

We look at the exchange rate between the deposit and the receivable asset. And there can be also hard-coded oracle. So you say, "Hey yolo, uh let's just say in the market vault that uh price feed for a specific asset is just worth $1, no matter what the market says and it's going to be like this." That was one of the big problems with stream finance. some of the vault uh vaults were hardcoded with one.

We did chat with a stream team and we were advising them hey guys maybe it's not the wisest strategy to follow but right now it's spilled milk and u learnings from the hand hand side looking at the market methodology we look at collateral asset and probability of default for the rating uh price per simulation I think this uh chart shows it pretty nicely so what is the current available liquidity obtained from the slippage curve so imagine If there is a liquidation of for example $10 million of position with rap Bitcoin, what would be the slippage given the available liquidity on various uh decentralized exchanges, right? Because that's where usually the asset is being sold right away. Um I try to go back but I can't. Okay, so I'll just move forward then. Um we also utilize Monte Carlo uh simulations to look into the uh liquidation steps because if some asset is going to hit a liquidation threshold, it doesn't mean that asset will continue just to plummet or go up depending whether it's a long or short position.

It can be like different paths for the asset to move forward. Uh [snorts] so we do those kind of assumptions and then uh the final rating and the probability of significant loss is the accumulation of of the all of those inputs and then as I was mentioning a vault usually consists of couple of markets that have assets in there. So there is asset there's a market and there's a vault. So the rate the final rating for the vault so the final product for example if you deposit on a stakehouse USDC market on Morpho is going to be the conjunction of the underlying markets in which the assets is are being deposited. So what you're going to see in the next couple of days when you go on Morpho and the regular earn uh front end you're going to see a yield that is projected for example 5% and an A+ rating next to it another vault giving you 10% with a B rating another vault 15% with C rating and then as a user you can decide whether you want to allocate into something that can be considered a low risk D5 which is this A+ rating with lower yield or you want to be a bit more aggressive and allocate towards um higher risk but also higher return uh allocation opportunity from Vitalik point of view the low-risk uh assets.

So the ones that are going to be rated A and A plus are the assets that should be distributed also across the globe. So when Revolute, Robin Hood will be offering one-click deposits for their users that have zero knowledge about crypto specifics, they should be offered the assets that are already with the highest standard and quality. And this is where Credora wants to play a big role and as mentioned it's already live on uh Morpho. It's coming to Spark. We have it confirmed and uh working on the methodology already and it's coming to Uler.

So our goal is to rate 90 to 95% of whole DeFi in the next couple of months so that users can simply take more informative decisions. Thanks a lot and as Redstone and Cordora we are both hiring because the demand for the ratings aspect is tremendous. Uh if you have any questions happy to stay later and now we'll move to a panel. Thank you. [applause]