DeFi Needs Backup Plan | KBW2023

[Music] hi everyone uh my name is Jacob I'm a partner at superscript we're an early stage Crypton native fund based out of Singapore we invest mostly in infrastructure and Technology but enough about me today we're here to talk about Defi and we've got two Specialists on stage with us we've got Andre we've got Dan um I'm going to throw to you guys to introduce yourselves and maybe a little bit about the portfolio companies or the the companies that you work for uh thanks so much uh hi everyone I'm Andre I'm founder of opium protocol and uh that's decentralized derivatives on chain on ethereum chain I used to manage a hedge fund and I was in trade fine for most of my life and now I'm very excited to do defi uh hi everyone thanks for coming down uh my name is Dan Thompson I'm the CMO insurace which is the leading defi Insurance protocol which the sexiest protocol in defi at the moment um we provide onchain Insurance uh for smart contract uh risks stable coin dpeg risks custodian risks and Bridge transaction risks all right so let me set the scene before we jump into some of the questions right of where we are today with defi last year 2022 we had $3.8 billion of losses from Smart contract hacks exploits protocol prop s right and this year in 2023 it hasn't really slowed down either we've lost $700 million uh you know Oiler Finance was a is it's a very secure protocol that suffered a hack we saw the curve attack with 16 $69 million of liquidity drained so I'd love to hear from you guys what your thoughts are on the state of Defi and how sustainable it is uh for these protocols to operate in the this environment uh thanks for the good question I think uh defs uh at the very beginning and um to say simple what we need uh we need uh some complex instruments uh derivatives Insurance uh to make it more mature uh and a very uh easy example like um if you have a car uh you can protect it uh talking about hacks you can uh protect your car you can put all kind of alarm systems you can uh put uh anything you want there but it can be still stolen another approach is to buy an insurance uh and then uh you can sleep uh well and uh it's a financial solution for the problem uh and I can make much more examples but that's basically what uh we need in defy in order to be more mature we need different instruments to share the risk to transfer the risk and so on so insurance and derivatives are those instruments and uh we're working on it hard I hope to see it more awesome yeah I mean I think the 3.8 billion out of defi hacked last year and I think it's around 12 billion out of the wider crypto Market um hacked exploited stolen fished whatever it is you know you're talking about around about one 2% of the total I mean obviously defi tvl is right down right now so at the time it would be about 1% if you look at it about now it's probably up around like 4% uh of that total amount that's actually Stak into and locked into these protocols you know it's it's a huge amount and 3.8 billion in itself is a huge amount for people not to be investing more into this but I'm going to put a bit of a controversial Twist on that and say that these hacks as as Andre says it it's we are early and because of that you I think that it's a necessary part of this evolution of what we're doing so that we can all improve so that every Builder here everyone who's learning about the space everyone who's wanting to get into the space sees these mistakes sees these hackers getting involved and sees how they're taking the money hey maybe they go down that route maybe they say do you know what I fancy trying to steal 100 million myself who would if you could um but the reality is all it does is it forces every team who's in the space building for the right reasons to improve what they're doing to learn from it and make sure that that doesn't happen to them because at the end of the day the users are the ones who get hurt and that hurts everyone for the future people who get burnt on one particular protocol don't trust those Founders again and these Founders are really working hard we're all working hard to ensure that we're building something to make people's lives better for the future to reimagine finance to do a better job so yeah if if if these are happening and like I said they are a necessary evil in my view that we do improve and it does make everything better for the long run okay so that's all well and good we can accept hacks to some degree because if we don't have them we're not going to have great prod protols but how does that work for a protocol or a business like insurace because you're going to have a bunch of risks and you can't really cover all of them or maybe you can so could you maybe talk through some of the the risks that users will face in Defi and what you guys would be able to look after and what you can't sure so if crypto we all say crypto we're still early in crypto we're definitely early in defi we are super early when it comes to ensuring the risks that come with it so there are not you know even with insurance on a global scale in traditional Finance you can't cover everything there are Global catastrophe risks that only have something like 20% you know actually covered even though you take like natural disaster that happen all the time all the data from history and even then they're still not completely covered the same thing happens in crypto and defi a lot of the risks we just you know you look at and there isn't either sufficient data or the risk risks are too high so we look at things like um let's say slashing cover you know you've got a a few billion transactions and you can see how many times uh validators have been slashed so you are you can understand the risk and there is more data in the last few years of slashing than there has been in the last two decades of uh of cyber security because it's all on chain it's all there and it's all easy to see wow okay so that that to me is a really interesting factoid because uh when I look at defi I think it's a brand new world right so I think that a lot of the data is hard to get but what we're seeing is that the onchain Paradigm means that you have more data points to be able to price risk essentially yeah so then it just comes down to extracting that that those data points being able to validate them and then building those and arguably traditional Insurance models around that newly available data and to actually that allows us to you know work out the price and the capacity for those particular risks that we're looking at got it now now Andre how do we use derivatives to protect against Risk insurance is one plank I guess of a defense mechanism but how does it work for derivatives I think it's absolutely the same the difference is that derivatives are uh more uh underlying instrument it's like goinging on assembler uh because insurance companies they do use derivatives uh in order to hch and derivatives a very flexible instrument uh that dis advant Vantage for retail that it's very difficult to use but uh under every Insurance there is derivatives for sure and the cool thing about derivatives and uh pricing uh that derivatives are priced normally they priced on the market so it's Supply demand and if uh they are mispriced then there are bench of hedge funds uh who going to take advantage of it and uh put the price down up or down uh to the fair value uh but more or less uh derivatives are like insurance so CDs contract it is insurance but uh it's very difficult to trade CDs contract for the normal uh person because uh it is sophisticated uh so I would say that uh it's very likely what we do is just different layer layer of obstruction got it and you know I think you said it yourself it doesn't really it doesn't come naturally to retail users to be able to hop on a protocol uh play around with derivatives uh even Insurance sometimes doesn't seem all that intuitive for people to to to buy for def protocols so how are you guys going about educating people and ensuring that you onboard people to use these products to have a backup plan for their defi activities uh from our side yeah we try and integrate as much as possible so if we were to integrate with opium it might be an add-on that when someone's trading and they're locking Capital into the into the protocol they might actually then have an option to uh add the insurance on top uh one great example of this we've done recently is for our our new bridge transaction cover so we've just partnered with light leafi who operate a bridge aggregator across the space and so if you actually go to their native Bridge jumper. exchange uh as you go through a bridging transaction which does make a lot of people nervous especially people who are new to the space and have heard about a lot of the risks that are associated with Di and and bridging in particular you you know you now have this option to mitigate that risk completely by having an ad on for insurance very similar to adding an opting in for flight insurance so I'm guessing a lot of people have flown here for this week so you know just as easy as adding flight Insurance you can now add uh Bridge transaction cover by using jumper.

Exchange or any of the Lei Affiliated Bridges and I do think we need uh more uh let's say regulation or at least risk disclosures because uh everybody is doing something but it's very difficult to understand what is the risk behind it and defi is complex so the more complex the instrument become the more disclosures they need and um we see some projects are doing uh self uh assessment of risk uh they do some uh standards which they follow but we don't see it as indust in Industry level I think this is uh everybody hates uh regulation uh everybody hates to speak about regulation but I actually do like simple reasonable regulation so U the problem with regulation is uh everything is over regulated in traditional Finance you have hundreds of regulator but but some very simple some very basic regulation does make sense I think if only there was a a standard that we could all abide to that says this risk assessment has been done to a good enough standard and here's the score well at least the at least the standard how you disclose and what you disclose yeah completely agree yeah I mean if we if we had more standardized data then we could probably run more exal models and and have more uh deeper and better Insurance products covering different risks but maybe let's dive down into the risks that people face right let's go in a little bit more detail we've got smart contract risk we've got Market volatility risk uh when people trade we have the team rugging right and leaving a project risk around that what does insur race or maybe even any other insurance protocol cover right now because as you said it's really early right so what what could you price and cover so at the moment we' we're covering like smart contract risk stable coin deegs Bridge transactions um slashing risks you've got a few new upcoming different types of risks that are tagged tied onto real world assets but there are lots that we still can't cover you're right rugging risks uh Market volatility which can be hedged with derivatives um but rugging risk is a one that is is in demand but there's not much that people can do about it same with things like custodian risks especially after ft FTX last year people people are a lot more wary of where they where they where and how they store their crypto got it and so it sounds like you cover smart contract risk bridging risks but in so far as markets go up markets go down maybe derivatives are better suited for that yeah derivatives are definitely much more focused on the market risk so you can hedge different Market risks um and uh create risks at the same time funny enough um we were just talking about it um we had insurance project uh for product for smart contracts few years ago it was like CDs contract um uh on um smart contract risk and we did offer it to uh Auditors we contacted uh I think most of major Auditors and saying hey guys you are making an audit of smart contract does it make sense that you sell insurance so you under the right uh because that will um show some credibility that you put some skin on the game so yes uh we audited uh but but we also put some money um as a skin on the game everybody said no and that was funny this is just uh an example about the maturity of the industry how industry ready for this isn't that crazy the auditor's role is to ensure or give a guarantee that a smart contract has been looked over that the code works that there's not going to be any bugs but they didn't want to put their money where their mouth was yeah we were surprised as well do you know I've I've got a good one for that it's because I think um and and I know the hacking guys are here I don't know if they're actually they are here so I probably got this stat wrong but it's something like I don't know it was like 40% of people after an audit don't then upgrade their contracts or something ridiculously high so even though they get the audits the amount of teams that don't then make the suggested improvements or at least all of them is is ridiculously high for what You' think it would be so that maybe that contributes to why they don't want to actually underwrite the risks got it so I'm a little curve ball question here right uh we always hear about the hottest Trends in web 3 uh whether that's you know AI or um some new restating thing or liquid derivatives but if we go back to AI how do you think AI may or may not make what you guys do better easier or maybe even more difficult well that's a very good question uh I think the AI uh can be nice to have to uh and um I don't believe yet something going to be built on AI because it's uh it can analyze information it's a language model it's pretty cool right now yes yes yes but if we uh put some money on it if we trust uh money based on the result um I personally don't see it yet I don't know what do you think uh personally I'm a massive fan of AI and everything and anything AI right now um our team still will oversee what we're using AI for and how we can actually learn to improve what we do but we have some some big bottlenecks our our risk assessments to list any new protocol take three to four weeks so by having AI help us to do our own mini audits of code to help it uh build out the better data models to which helps with products so from across the board even on just marketing side right marketing enabling us to communicate things and complex issues in a in an easier way or a different way through AI is one thing our product team are using AI to help with the calculations and just sheer data analysis uh from these different products that we have and we have the data there but instead of having our team having to Crunch the data and our head of product having to oversee it well he still is overseeing it obviously but having the AI run the data side by side at the moment and we will get there when it does get to a point where maybe the AI can do it all automatically but even just for our risk assessments helping it's like having someone another pair of eyes look over the the code for us when we're doing a risk assessment but you're speaking about uh using EI for yourself so the risk is on you if EI uh doesn't deliver then it's your problem it's not a client's problem right sure I I don't think it's going to be like ever that uh you make a product uh and AI going to decide something uh for the risk that user takes because if something goes wrong then um users have a big problem I think there can be AI enabled from both sides the users could use AI to verify the verify the risk assessment pretty quickly um you know they can we can actually you know there are plenty of people building risk assessment tools already using AI so it just I think it just enables the whole Space to better improve what they're putting out there as well as that sort of safety standard we we're talking about earlier so if AI helps to alleviate some of the Manpower that would have taken before if it's set up in the right way then you know we should all be all for it it's a completely different discussion but it's very interesting because if you uh if AI can help you to um assess the risk uh probably it can help you to uh go around and make uh something which optically looks like good risk but it's not so I mean um simply speaking um AI can also hack the system right if one AI is protecting the system another AI can uh hack the system and make it look very nicely optically yeah of course there's always going to be bad acts in the space and maybe they leverage a AI for their own their own Mal intent and sure that's going to be an ongoing Battle of good and bad and it has been in the financial world for forever so I don't think there's an end Victor but as my earlier point was I think that the Bad actors do help us to build a better you know a better world for the good actors and actually relatively speaking the Bad actors in the space when when you really do boil it down is it's is actually such a small percentage of what the wealth generated has been in in the space I mean it's why we're all here it's why we're in in a very very nice setting in soul to you know have this have this conference and be able to talk at well maybe rather than AI being the main solution for insurance or for derivatives you could just use it in a more simpler setting so it doesn't have to decide something for the customers but we touched on how education is really tough because these concepts are difficult so imagine even having the right inputs or outputs that go into a llm so someone could say okay how do I hedge this risk and and you know an llm could come up with an answer either using your protocols or or other insurance protocols right that's exactly the usage I think that's that's exactly going to be the usage because it's so sophisticated nowadays and uh unboarding client obstruction uh a lot of lot uh other problems can be solved by I that's for sure got it uh is your fund investing in something like this no no but thank you for giving me the idea so uh yeah that you you never know where you get inspiration from I suppose so that's Fant fantastic all right so it sounds like we're still very early uh we're still early TM as everyone always says defi still has a lot of problems that it needs to solve but what's a positive thing that you guys are looking forward to in let's call it the next 12 to 24 months as we march on um plenty I think that there's there's still a lot to be looking forward to there's some great teams building the space uh personally I was really enjoying a lot of the game fight talks earlier I think someone was mentioning about how it's uh it's still that early stage of adoption and getting there but I've uh ever since game fire sort of came along a couple of years ago you know I've been massively behind the idea of like owning your own assets and I know that's not sorry I know we're getting away from defi how did that happen uh no in defi like we're we're actually about to and this is a career blockchain week exclusive for you guys uh we're actually about to launch this this concept of risk fire which actually allow ows people to invest into the underwriting of different risks in the same way that insurance companies make their money in the traditional world this will this this risky concept basically allows people to not only get their standard yield but fully protected with some standardized risk assessments on different yield strategies whether that's low medium or high risk as well as taking opportunities from the money making behind those that actual uh risk uh underwriting business so that's something that we're super excited about the next 6 months let alone 1224 yeah that's actually uh I share this and the think that every return has a risk so people uh not not everybody understand that for every return you have a risk and the higher return normally the higher the risk you have uh but we all have different views on risks we all have different P perspection perspective on risk um and risk truning so it's a very uh good and strong um instrument which will make defi uh just much more mature uh personally I'm also very excited about uh derivatives because uh of course I'm biased I do derivatives but look first of all it was spot Market centralized sport market like coinbase and then uh Unis swap uh took big part of it because it's faster more secure more flexible so on so on now we have the same situation with derivatives uh there is uh roughly one player theit uh who takes centralized market and uh it has grown enough it's it's quite big already and it's time now for decentralized derivatives like Unis swap for derivatives so that's my biggest um expectation uh but I I do think about regulation uh risk uh uh disclosures uh user uh education uh account obstruction as well because that's needed for everyone not uh for thei but for all the blockchain well yeah I think when you you look at the traditional markets spot is literally a tiny spot on the map where you compare it to the volume that derivatives do right and so if you take that Concept in the real world and apply it to defi then there's actually quite a lot to look forward to in terms of the potential growth of derivatives in in crypto and web 3 yeah so that's that's another idea uh where to invest wow I'm getting more ideas on where to invest and yeah that's fantastic how do you on board the next I don't know million users for derivatives in defi uh actually not sure that uh retail users going to use derivatives because uh derivatives is much uh it's it's the biggest Market in the world so uh derivative Market Global derivative market right now is probably 10 20 times bigger than uh the world GDP uh but how many of us do trade derivatives uh only professionals right right however everybody uh has exposure to derivative if you have bank account if you have insurance if you have mortgage you do have derivatives without knowing it so I think it's going to be kind of the same I don't think it's going to be um a challenge to bring 1 million users uh but uh it's a challenge to bring 1 million professional market makers companies so on who will use derivatives and end user they will have exposure to derivative Market uh through uh guys like you so through through Insurance because everybody understand insurance so I can go and buy insurance which is HED by derivatives but uh I do think derivatives is a little bit more professional product and uh we see a lot of um retail going into it but it's not going to be massive sorry this is where we get a bit away from our main topic but um do you do you see many other many new strategies that are sort of defy exclusive relative to traditional Finance when it comes to derivatives absolutely absolutely so basically uh everybody can run a hedge fund right now so it used to be like the privilege and you need to work like 20 years and I was dreaming for 15 years of my career to work in hedge fund and I was leading on hedge fund uh but nowadays uh you just need to be educated go new strategies and uh strategies can be very simple Market making uh providing liquidity um to Unis swap or something like that providing liquidity not in a uh Market neutral way but directional way that's another strategy so basically you define the risk and uh there is a strategy for it which you can uh do yourself without any uh custody without any intermediary also not paying huge uh amount of profits to those intermediat that that's amazing I guess I'll be down the the VC brunch tomorrow raising for my new hedge fund that's going to be Define native Jacob you coming in yeah you know um let's have a chat let's have a chat or maybe you're a little bit too late but uh who knows well maybe there's a there's a combination of your products right I mean if you think about everyone talks about diversifying that portfolio well what about diversifying your defense mechanisms uh I think there's a place for both products I think there's there's definitely yeah of course there is I mean if we the combined option would be you know the the risk strategies that be employed in in traditional derivatives uh markets plus those added added risks of defi so like smart contract risk possibly stable coin dep pegging risk when they're actually deposited into the protocol itself um among amongst some others but this just this actually ties into what we're trying to build with this whole new risk narrative in terms of taking these protocols that are leaders in their indust in in within their niches within Defi and making sure that the risk assessments are done properly on them and public as as we're talking about before and then being able to make sure they're secure with things like uh insurance or certain bug bounties or certain assurances that the end user at the end of the day will not get hurt by using the protocol outside of their own mistakes no insurance covering that one I don't think anyone's going to cover that one anytime soon what do you think going to be uh the most popular biggest or most sexy product uh Insurance product in few years time um in a few years time I mean hopefully there's bull market again and then the yields all come back up and suddenly the cost of insurance becomes a lot lower which makes it all a lot more appealing again so you know our our previous example was and our biggest product and and payout ever was on us last year but that was when people could stake uh stake their us into Tera into L into anchor on terror get their 20% 19% 20% come to us for 2 and a half% plus a US stable coin dpeg risk of 1 and a half% and so they're still netting 16% completely safely which in today's market sounds unbelievable and I think more people should have realized that it was unbelievable back then but here we are uh which led us to end up paying out 12 million to users it's a great use case for us and it was by far our biggest product uh and it was a great way to show that defi Insurance can and does work um and I think that will come back again and I think as the data improves and as our models improve that cost of insurance will go down which will allow us even during a bare Market to cover uh cover those risks but even now there are protocols that are still yielding quite highly I mean we're still super popular with things like uh GMX and Perpetual you know High yielding protocols right now so yeah it's it's still there it's just market conditions and also just get getting that right product fit is super important yeah and coming back to your also previous question uh the biggest advantage of Defy is composability actually not uh people people not always think about it but that's a perfect example how you can reuse uh or take few risks uh at the same time on the same capital and uh that's definitely advantage that's definitely the way that our protocols can work together and what do you say that you add one eeld on top of another uh that's actually amazing because that brings diversification and better sharp ratio so sharp ratio is risk return ratio so it improves dramatically once you have this composability once you combine um different uncorrelated risk in one basket and uh that was perfect example yeah so I mean use might lose a percentage Point here or there maybe two uh but at the end of the day if you're completely mitigating those risks of using the protocol then you know that that comes down to your own risk tolerance but we're seeing more sophisticated investors are the ones who are picking up on the insurance risk and and understanding that that is an important part of what they're doing and actually understanding that the risk is there and if they and usually they're managing someone else's money right so that's usually where they have to be extra careful amazing well that's the promise of web 3 infrastructure right composability uh having Solutions like this that could potentially be built on top of one another or in tandem with one another so there you have it guys uh when you consider defi think about insurance think about derivatives they might not be top of mind they might not be immediately sexy but when you combine the both of them they really are I would really super sexy there go absolutely super sexy well it's not the most exciting thing because uh people normally excited by 100 1 million uh% APR and uh you know how uh that's going to end up but uh thinking about risk uh is very important in the long run definitely well thank you guys I would love for you to give a big Applause to Andre and Dan for the time today thank you thank you so much thank [Applause] [Music] you