The Power of Open Financial Primitives by Nadav Hollander

check-check hello hi everybody so first of all I just want to thank Louise for giving a fantastic talk this is it's a bit hard to follow that and I want to thank them for their efforts and just really leading the way in terms of reminding projects in the space that we are trying to build a decentralized future we are trying to build public goods that are that are governed by communities in general and I really think that Aragon's setting a fantastic standard and really really being a vanguard for this so my name is Nadav I am the founder and CEO of Dharma labs which is building Dharma protocol and this talk is called Dharma and the power of open financial primitives so first of all just as a quick poll of the audience could you just raise your hand if you've heard of Dharma before and what we're doing okay fantastic I love seeing that number of hands go up every time so for those of you who have not heard Dharma is a protocol for borrowing and lending tokens in quick summary we've been live on the etherium maintenance since May of 2018 something around 150 K and peer-to-peer loans have been issued with Dharma so far and three awesome businesses have been built on Dharma that are on maintenance owned this talk we're gonna cover first of all why did we build this like what's the point of this whole thing number two how it works so I'm gonna try to give you guys kind of a high-level overview of it and then finally number three how to get started so if you're a hacker here and you're looking to build a project we've got a whole suite of developer tools and starter kits that you can use to get up and running right away building adapt so why do we build this so I'm gonna talk a little bit about debt and I'm gonna make a claim that the world economy runs on debt now debt has a very kind of negative loaded connotation to it you know we think about things like student debt or our credit card debt but I'm gonna make an argument that it's actually kind of a very double-edged sword in a sense the houses that we sleep in are funded by mortgages the cars that we drive in are funded by auto loans the businesses that employ us stock inventory using debt the infrastructure we build is funded often by municipal bonds the education we receive is funded by student loans and even the states that govern us rely on debt fundraising in order to kind of keep their day-to-day operations going so it seems like so many parts of our lives are funded by debt and the kind of machinery that operates in the background to enable this system to work is what we refer to as the world's debt capital markets this is basically like the system in which different debt agreements are issued and traded and this happens a lot so if you kind of look at at the far left here we have the total market cap of crypto I think it's actually kind of funny I give this I've given this talk a couple times already and every time I think that I need to update the total crypto market cap but then the market just turns and goes back to that 200 billion dollar number so you guys gotta like stop giving me talks cuz it's just like a bad luck thing the and then we have the total equities market cap over here which is around 65 trillion clearly us in the crypto community have a long ways to go to catch up but when the right we have this huge figure which is the global debt market cap right like this encompasses all the world's mortgages all the world's sovereign debt etc and it hovers it around like two and a half times the size of the world's total equities market cap however debt capital markets have several serious flaws so first of all they're really inefficient and in several respects so if you think about what a debt agreement is it's basically just like a legal document right it's essentially a legal document that a borrower and lender sign that says I promise to pay you back X amount of dollars and if I don't then you know why default conditions are going to happen and you're gonna do some bad things to me but the problem is with legal contra is that I'm sure this resonates with you guys they're very messy and non-deterministic unlike smart contracts right and when you have these kind of textual legal contracts and something goes wrong and the happy case doesn't happen then you need to bring in lawyers to essentially adjudicate the situation and those lawyers tend to extract rent from the process the other problem is that essentially when you if you want to be able to have a debt agreement that is tradable in some capacity so that there's a secondary market for it that essentially somebody needs to keep track of who owns that agreement at any given time so that if a borrower makes a repayment funds are properly routed to the to the actual owner these entities in the financial system are known as paying agents and similarly they kind of sit in the middle and extract rent from the process and then finally we have these guys called escrow agents so the vast majority of the world's debt is in some way collateralized or secured which means that the borrower has to put up some some asset and essentially if they do not pay back their loan then that asset is going to get seized and the problem with the traditional financial system is that you essentially need to have some sort of trusted third-party custody that asset if you want the agreement to be like quote-unquote secured and these are known as escrow agents and similarly the extract rent and so you have all these different parties who are sitting in the middle extracting rent from that transaction and at the end of the day the person that's paying for that rent is you guys it's the borrower's and the lenders it's the end users of this system and so that translates to more expensive debt agreements so the second kind of big category of flaws within debt capital markets is just a notorious a notorious proclivity towards opaqueness essentially so this is a diagram of what's called a CDO or a collateralized debt obligation these are incredibly complex financial instruments that I'm not going to give a talk on right now but they are kind of notoriously known for precipitating the 2000 financial crisis and one of the big issues with them is that it's not like there's anything inherently wrong with taking loans and bundling them together and creating sort of derivative credit instruments it's just that these things were like insanely obtuse and difficult to analyze so much so that only rating agencies really had the ability to peer into them and there is all sorts of incentives issues around whether these ratings agencies actually had an incentive to rate them correctly and then you know two or three steps after that you end up with a financial crisis and so essentially debt markets are hugely lacking in transparency but finally and most importantly I would argue that debt markets lack universal accessibility and I'm gonna point out a few interesting data points with respect to this so first of all many of you have probably heard this figure before there are over two billion adults in the world who are either unbanked or underbanked but a lot of them are rapidly coming online through commodity smartphones the problem is is that it's not like if you're in a village in India you can go on to Lending Club calm and take out a loan from the United States or say go on to a Chinese peer-to-peer lending site and lend your money out in their capital markets and the reason for this is that while HTTP has no concept of borders ie you can go and load up all these web pages our financial system very much does so if debt capital markets are lacking and efficiency in transparency and Universal accessibility how can we build something better naturally we believe block chains are the missing piece of this puzzle block chains give us the tools that we need to build credit markets that are much more efficient much more transparent and much more universally accessible so starting with efficiency you can use block chains to essentially create loans that are in early peer-to-peer and are entirely administered by a smart contract so there doesn't need to be a paying agent there doesn't need to be a lawyer who adjudicates what happens when the collateral needs to be seized and there doesn't need to be any sort of escrow agent number two they're just radically transparent by default so right now if you go on to loan scam do you can see all the loans that have ever been issued via Dharma and you can see like you know the default status of all of them you can see kind of what risk they were underwritten at how much they were over collateralized etc all this stuff is entirely visible so you have this kind of root-level transparency and then finally universal accessibility this is a really exciting part these these tools are effectively accessible by anyone anywhere with an internet connection which is a really exciting prospect so how does all this stuff work so at a high level I like to think of Dharma as kind of being this financial middleware layer that sits between the etherium blockchain and end-user applications that are basically storefronts for lending so you know applications that let people borrow or applications that let people lend their money out or earn interest on their money and I'm going to break this down into three easy steps and the first one is essentially we need to define the terms of a debt in some capacity so the way that we do that in Dharma is using something that we call a terms contract basically what a terms contract is is kind of this template that defines a sort of type of loan agreement and that template is is literally just like a smart contract that adheres to a certain solidity interface and what's cool about this is that essentially if it implements the methods in that interface then you kind of have all the information that you need in order to programmatically query it and figure out what the terms of this debt are like ie how much is expected to be repaid at which time and what happens if the person defaults so I really like to think of a terms contract as basically being like a loan template that's deployed onto the theory blockchain and if you want to essentially take out a loan you say like I'm going to use this loan template with X Y Z parameters filled in so that's great but now you've got to actually express that intent somehow so that's somebody can find you and fill that loan so this is where the concept of a debt order comes in so basically what a debt order is is a signed message that indicates that you as a borrower want to take out some loan according to the terms defined in a terms contract so this is kind of an abridged version of what a debt debt order looks like but essentially you see that the person requests their desired principle they point to certain terms contracts address and then they list out the parameters that kind of fill in the blanks there so if you imagine like the terms contract parameters would essentially be what go into all the blanks right there so we've expressed our intent now what do you do so here's what you can do with a debt order if you already have some sort of counterparty or you already have somebody that's willing to lend you money so suppose we have Alice and Bob the canonical example Alice has a hundred eath bob has a hundred died so alice is gonna send her sign debt order over to Bob Bob is gonna evaluate it he's gonna check out the terms contract he's gonna check out the parameters he's gonna get this idea of kind of how good of an investment this might be and then he decides like okay I want to actually fill this debt order I actually want to lend money for an interest rate to Alice so he's gonna submit that debt order to the Dharma smart contracts and what the Dharma smart contracts are gonna do is that they're gonna take a hundred die from from Bob and they're gonna transfer them over to Alice they're then gonna go and take a hundred eath over from Alice custody as collateral and then issue Bob a debt token and what a debt token is is basically a non fungible token representing Bob's rights to receive repayments in this loan at any time in the future and what's nice about this is that this token is like any other 7:21 right it's tradable it's repackaged a bowl programmable etc and so essentially you kind of solve this this paying agent issue because now if you want to trade your loan in a secondary market there doesn't need to be any party that keeps track of who owns that loan now the quote-unquote paying agent is the Dharma smart contracts that kind of keep track of all this stuff but unfortunately not everybody has like a friend that they just know who is like willing to lend them a hundred died right and so you need to essentially find a counterparty to actually fill that order that's the whole point of debt markets is that you need to essentially match both sides so we introduced kind of two categories of what we'd call keepers in the protocol that are essentially financially incentivized actors that enable this sort of order matching or the sort of market matching and the first one is what we'd call real ayres and so I'm sure many of you here are familiar with the 0x protocol this is almost entirely the exact same concept so basically relays are are some sort of entity that hosts a public order book that where people can go and post their debt orders and if anybody comes along and decides to fill that order then the relayer is going to earn some sort of pre-specified fee and these relays can also optionally share liquidity with one another so essentially you you effectively have this network of actors that are financially incentivized to host debt orders that can share the liquidity amongst themselves that when a borrower wants to go and take out a loan they can broadcast their loan to all the different real layers and a creditor can come in to one of those real layers and potentially fill that loan so this is an example of a real layer today it's called block board I do believe Italia is somewhere here in the audience the the CEO but block port is the first real layer that went up on Dharma protocol and you can see that it effectively looks a lot like in exchange right it's basically a bulletin board for people to post debt orders on there and then for different creditors to come in and fund those debt orders now that's all well and good and that works pretty well when you're dealing with like heavily collateralized assets where you don't really need to like trust the counterparty but what if there's no collateral right what if we're dealing with an unsecured loan and so essentially for this we introduced the concept of an underwriter and effectively what an underwriter does in Dharma protocol is that it's some sort of trusted known entity think like ie a coin base or a credit rating agency or you know some sort of upstart company that starts to do this and essentially what this underwriter does is that they originate the debt order so you know I'm a borrower I go to underwriters website and I tell them I want to take out a loan they determine and negotiate the actual terms of the debt and then they cryptographically commit to their perceived likelihood of how how likely it is that the borrower is to default on that loan and so essentially what that means is that you have this kind of flow where Alice instead goes first to the underwriter the underwriter judges her credit worthiness through whatever means he sees fit right he can pull a credit score on her in the real world or maybe he's got some like fancy cryptographic magic where he you know looks over all of her history on the on the theory and blockchain and determines credit worthiness that way these the mechanisms by which the underwriter chooses to actually assess the risk aren't explicitly defined in the protocol the point is is that good underwriters ought to be able to get more business because essentially their performance will be seen on chain as being better and so now that the underwriter is gone and basically said like I believe that this loan has an X percent chance of defaulting they can pass that loan off to a bunch of real layers and when that loan gets filled then similarly the underwriter is going to earn some sort of fee so how do you get started if you want to build something on Dharma this weekend so we have a whole bunch of libraries and tools and starter kits that you can use to really get up and running unless the five minutes the first kind of big component of that is Dharma Jas essentially we wanted to create a system in which all the complexity of using solidity smart contracts is kind of abstracted away from you and you can basically use the same sort of commodity web dev tools that you're familiar with we have a very thorough developer portal portal that you can go to to find guides about how Dharma works in excruciating detail all sorts of tutorials all sorts of ideas for things that you can build a fake use api references etc we have this awesome thing called the real lair kit that we came out with a couple weeks ago where essentially you can clone this repo style it however you'd like and essentially spin up a real layer of your own in like five minutes and so we think this is an awesome place to start if you want to build something on top of Dharma so what can you build this weekend so first of all there's a lot of room for more real layers in Dharma protocol that service essentially different types of debt right so so right now the the majority of loans that we're seeing in Dharma are largely for speculative purposes its people like borrowing tie the shorts something or to leverage something but it would be really interesting to see for instance real layers that focus more on security tokens or real layers that are focused on seven twenty ones or something that is like not necessarily what we're seeing in the market right now and speaking of seven twenty ones there's this really interesting concept that we've been waiting to kind of see implemented in that we've actually been building a lot of tools for that we called collateralized collectibles we're essentially like I'm sure we're all familiar with things like crypto kitties and the many different incarnation of of NF T's that have emerged since then and we're familiar with the fact that these things can become incredibly valuable and so what's kind of interesting about an NF T is that if you think in the far future of what NF T's will be used to represent it'll probably be used to represent things like houses or like titles for different lands right because that's kind of inherently a non fungible good and what you can usually do something like say a house is put it up for collateral and take out a loan against it right that's that's what's known as a mortgage and so there's this really interesting concept that you can actually implement today using Dharma where you can create effectively crypto Kitty mortgages right or take any sort of NFT put it up for collateral and be able to like essentially take out some dye against it so that you have some liquid cash that you can use and so if anybody is interested in building this out we've actually created like a whole set of like miniature tutorials that aren't like publicly visible on our site in site right now so if you guys are interested in building this come talk to me afterwards and would be happy to support you in that process another idea that we're really excited about is just general structured financial instruments right so I talked earlier about this notion of a CDO where you take a bunch of debts and bundle them together and tranche out the cash flows in special ways and so what's really exciting about using Dharma debt instruments is that you can use a smart contract to package these things up instead of like you know 10 million dollars worth of legal fees and an entity in like the Cayman Islands to actually store all the cash flows and it's just infinitely cheaper to actually administer these things when you have a smart contract doing it so we're really excited about this idea of structured financial instruments and then finally we're really excited about the idea of Dharma explorers so essentially the ability to interfaces that let people look at the current volume and the protocol and analyze it in different capacities and kind of slice and dice the data in order to figure out like you know whatever it is that they're trying to look for so finally in conclusion the open financial system is very much in the infrastructure building phase right now but I feel incredibly optimistic about how fast things are going in that if you look at this this picture pretty much is the vast majority of projects on here like didn't exist a year ago and many of them are already I've on the etherion maintenance and being used and all these different primitives are being combined together in order to create fantastically novel financial services and applications many of which never even existed in the real world and I think that's really exciting so let's build a financial system together yes