Noah Litvin - Managing Demand & Incentivising Liquidity Provision for Decentralised Stablecoins

baby for the time being though we're going to bring up another protocol that you are hopefully all very familiar with um I'm assuming all of you here are like very experienced otherwise you probably wouldn't be here synthetics of course is a war horse in the space if you look at the top volume charts you always see synthetics atop and we're pleased to welcome Noah litvin Noah [Applause] hi um I'm Noah I'm a core contributor on synthetics and I'm going to talk through how I think about stable coins stablecoin scalability and um derivatives Unchained derivative scalability of all kinds um to start I got some good feedback from other core contributors on this uh maybe there's something in here that some of them disagree with I don't know but I don't mean to speak for all of synthetics uh completely just myself here um and for those of you aren't familiar with synthetics the project started in 2018 um as Haven it was a decentralized payment Network in the stablecoin project uh four years later it's evolved into a derivatives liquidity protocol uh the the core the central core mechanism is a CDP issuer uh similar to liquidy uh and then Market implementation smart contract uh derivatives markets implementations can plug into it for liquidity provisioning to issue derivatives of things other than dollars anything with a price feed on chain um so I've structured this talk which should be as accessible as possible it's my first time seeing some of the uh talks earlier so I think I'm going to be echoing a lot of the uh content you've seen already but I think it's good to work things up from Basics so um if the beginning is a little pedantic I apologize in advance uh okay cool so at a high level I think of this basically you just have two discrete uh categories of stable coins centralized and decentralized uh the way these are designed within them you could have a more or less centralized or decentralized design um and there's no value judgment here I use both kinds of stable coins they both have their place um but they do seem to be too too distinct uh approaches and designs um centralized stable coins fundamentally you have a trusted party that's holding dollars cash equivalents some sort of liquid asset of at least equal value to the to the total issuance um it's scalable it makes sense the issuers can operate with a sort of borrow short lend long uh Ponzi scheme that Banks use to uh to to to finance their operations um super scalable it's great I just find it less interesting than decentralized stable coins um so with decentralized stable coins we have this question of how do we how do we eliminate the trusted parties uh altogether that sort of the spirit of the whole thing um and so so the the challenge is how do we take crypto native assets that have a certain value um despite detractors saying that crypto has no value or objectively there is a value how do we how do we take that and convert it into um an asset with a stable price so uh the most popular design for this is to use a Smart contract to create a collateralized debt position uh so the smart contract receives uh collateral it relies on decentralized Oracle networks to determine what the value of that collateral is and then it issues a a fewer uh amount of a lesser amount of uh stable coins and so you have the value of the collateral over the value of the debt that gets you a collateralization ratio um so as we all know the value of crypto native collateral can change it can go up and down uh very quickly and a lot um and so what happens when the value increases uh everyone's happy right the uh C ratio increases from the borrower standpoint um you run a lesser risk of liquidation you might be able to borrow more uh from the network or the lender standpoint uh the system becomes healthier you have more collateral backing less debt yeah uh the collateral can also go down uh in this case everyone's a little less happy and the solution here is to have a liquidation ratio under which someone else so there are different ways to process liquidations but a simple way is when uh the threshold of a particular loan the C ratio drops below a liquidation threshold uh a liquidator can come in and basically buy up the collateral buy up the discounted collateral by paying off the debt of that position that's an incentive for the Liquidator um so long as the markets are efficient and there's enough liquidity in the market this can happen and keep the keep the Network healthy um so essentially the market cap of the stable coin decreases but the price is able to stay constant so what what happens though if the total value of all of the collateral backing the network drops below the total amount of all of the debt issued um then we have a problem we would expect the price to start dropping on the stable coin itself uh so this is a risk for both centralized and decentralized stable coins uh perhaps more so for centralized stable coins because they're expected to be collateralized around closer to one to one whereas with decentralized collateral you expect it to be over collateralized um and so this isn't theoretical right like usdc depeged in March when they announced that 3.3 billion dollars were stuck in Silicon Valley Bank that was experiencing a good old-fashioned Bank Run um so another risk here is that a lack of demand could leave the peg uh uh tracking below a dollar but for decentralized stable coins generally we see the problem go the other way with supply and demand so the peg can break up as well right so uh historically liquidity is traded above Peg and if a stable coin starts trading above Peg even at like a dollar in a cent or a dollar two cents um that that's effectively like a one or two percent fee trading into the stable coin so I think to a lay person it's like oh it's just a penny it's not a big deal but with financial products you're often competing on bips so um even a dollar one a dollar two would be a problem [Music] um so how does this happen uh basically people might not want to uh take out a loan to acquire the stable coin they might just want to buy it uh and it's just like any other asset due to supply and demand if there's too much demand relative to the supply the price goes up right and so when we're talking about stablecoin scalability like that's the most like distilled fundamental way that I think about the problem it's like how do we we either need to reduce the demand or increase the supply somehow so um again just being really trying to boil this down to Basics it seems like there are two things we can think about here how do we increase the value of the collateral right in the under this model that's always going to be an upper limit on the amount of stable coins that can be issued um we need that buffer for liquidations to kick in um and uh again like decentralized collateral tends to be highly volatile in price so so that that sets a pretty um hard cap on how much we're going to be able to scale this thing um so we can think about how could we increase this and I think there's sort of two uh main ways we can we can go into this one is um we can basically engineer it well it's really just one one one approach here is like how do we get access to more decentralized collateral foreign asset um across different chains through through better engineering so uh I have something like tbtc in mind here I don't know too much about their implementation um but it makes sense that you could have some sort of proof-of-stake network um connecting uh collateral from different chains and also synthetics teleporters which I'll get into in a second um and we can also think about how to make the supply go up and really this is um to me this is thinking more about how can we increase the supply without introducing commensurate risk to the protocol because obviously you could always just decrease the requirements for the for the C ratios but then um the the whole system gets riskier uh and so like I have synthetics wrappers in mind with this so we can get into that yeah so uh in relation to synthetics specifically um as I mentioned before it's a fully fledged derivatives liquidity protocol uh so there there is the the core issuance mechanism to generate a stable coin out of decentralized collateral um similar to other projects we've discussed uh but the system also allows liquidity providers uh to extend credit to markets for effectively Market making uh to to exchange the stable coin into other assets uh relying on decentralized Oracle networks to determine the price but these Market implement the the um the interface for markets that integrate with synthetics is abstract so uh there can be spot markets there can be Perpetual Futures markets or other um exotic derivatives it's anything so uh as I mentioned before uh cross chain uh stablecoin teleportation uh is an example of how we could potentially access a greater base of collateral um for for a single stable coin and so fundamentally what this involves is you you uh burn uh X number of stable coins on one chain you send a cross chain message to another um chain and then you issue an equivalent value on that chain and what this means is basically the stable coins are fungible across deployments or uh the the debt sort of uh issued or minted on one chain can be used to repay loans issued on a different chain so now all of the collateral all of the all the collateral native to these different chains uh can all be used to collateralize the same set of of stable coins um and especially as ethereum's uh scaling roadmap is uh horizontal across multiple chains that's a solution that that's a problem that we'll need to solve from an engineering standpoint uh one way or another um cool another uh tool in synthetics Arsenal for scaling is uh the wrappers uh this has sort of evolved into something I think that's similar to uh psms and other protocols uh but in synthetics V3 we've introduced this uh Auto rebalancing SKU fee so um a synthetic spot Market issuing Seth could accept and wrap um one native eth and then issue an equivalent amount of synthetic youth uh in in a single transaction uh and so um if if there's a floating supply of like a thousand eth and there's a sorry if there's a floating supply of like a thousand synthetic eth and we've wrapped a thousand native eth then the protocol effectively has zero exposure to the price of eth so um by if if the if this is off balance we can we can use fees to incentivize and disincentivize people to buy and sell the synthetic asset uh which relieves the protocol of um uh of that price exposure uh and this to me is more more along the lines of the um sort of how do we scale the amount of issued debt in a way that reduces that doesn't increase the risk of the of the protocol uh because we're losing price exposure um another strategy here uh is um with uh Perpetual Futures markets uh and this I think this came up a little earlier uh where um in synthetics V3 uh the Perpetual Futures markets that we currently have on testnet that are under development you'll be able to margin positions with spot assets so if you open up a 1x short um on Ethan the Perpetual Futures market and you margin it with a 1x with a with an equivalent value of uh synthetic spot eth then um you you have a you have effectively a a delta neutral asset that could be used to um issue stable coins against um either whether it's synthetics or a different uh a different protocol that that asset becomes scalable um and so uh or that that asset will allow us to increase scalability because you have a more stable asset uh and the amount we can issue there sort of becomes a function of the amount of open interest on the perps markets um and with all of this stuff I always go back to like there's no uh no free lunch so like where where is this coming from and uh effectively the there's a funding rate in the Perpetual Futures markets that incentivizes arbitragers to uh effectively like take up the other side of the trade to keep the markets balanced so like zooming out a couple steps basically um arbitragers are are sort of using open interest from other exchange venues to balance out the markets um on chain uh and then that that sort of becomes the the trick or whatever of um sort of where where the additional value is coming from to be able to create more delta neutral assets on chain while keeping the synthetic system uh decentralized cool okay so where am I going with all of this uh one way to one way to focus this in is to share a tweet that I don't really agree with um I think they're obviously going to be scaling limitations but I don't think we need to pick only two of these right I mean the trilemmas come up I think in both talks before me um there are definitely limitations but I think we still have a long way to go with better engineering to scale better with what we have available to us um you know uh centralized stable coins are always going to be more scalable than decentralized stable coins uh like liquidies market cap value USD market cap can't be greater than the market cap of eth uh usdc's market cap has been an order of magnitude greater than each in the past um but again I still think there's still a lot of progress we can make here and also over time crypto native assets uh are going to increase in value as the demand for stable coins and more people are doing things on chain it makes sense to me that crypto native assets will also scale in value um sort of creating a flywheel allowing scalability to to increase over time so um yeah like the the wrapped bases straight thing with the uh with the perps market I think it's super clever I wouldn't have come up with that on my own maybe there are other clever things we can do with more exotic types of uh derivatives markets um I don't know it still it feels to me like we're still early but um yeah I just closed by saying I think that the D5 Community should uh sort of focus efforts on coming up with more things along these lines rather than coming up with more elaborate uh Fiat back centralized stablecoin designs thanks [Applause] yep thanks um thanks for raising the delta neutral topic again do you actually see across the market the developments indexes and the perps and specifically in verbs burps because for this delta neutral strategy to be effective inverse verbs across the board so I know that I believe in V3 which is to be rolled out you'll have the inverse verbs already think so but have you seen this like developments on other protocols and other dexos you think this Market is going to grow what's your take on that because it's like key for scalability of this project obviously for the delta neutral webs yeah I mean my understanding of other attempts at this have been limited by the maturity and success of decentralized on-chain purpose markets so synthetics is also building those so basically like if we're running into scalability issues uh on the on the stablecoin front because there's something wrong with the perps markets or we can do better with the purpose markets like that that effort's also underway questions questions doesn't sound like it all right well thank you very much [Applause] and right now okay all right everyone everyone uh just a quick announcement of what's going on upstairs there's a crypto past Workshop going on where they're going to be talking about mic a the digital currency regulations and EU compliance so please please check that out um if you want to stay down here of course uh we promised at stablecoin Summits big brains and I don't think we've disappointed yet but if you'd like to