Episode 73 – Discussing DeFi Risks (Featuring Lily Francus)

DeFi and Cryptocurrency Risks and Rewards (Feat. Lily Francus) Crypto Critics' Corner

Today Bennett and Cas are joined by Lily Francus, director and quantitative research strategist at Moody's Analytics, who helps us understand the underlying risks, rewards, and caveats of participating in the decentralized financial industry. Follow Lily on Twitter @nope_its_lily or join her free Substack here https://nopeitslily.substack.com This episode was produced by Asher Hirsch and recorded on Thursday, April 28th, 2022.

In this episode Bennett Tomlin and Cas Piancey are joined by Lily Francus to discuss the risks of DeFi.

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This episode was produced and edited by Asher Hirsch.

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English Transcript:

00:00:05:06 - 00:00:28:14
Bennett Tomlin
Welcome back, everyone. I'm Bennett Tomlin, and right now I am not joined by my partner in crime, Cas Piancey., though he should be joining us shortly for this episode. He is down in Reno right now investigating a blockchain city and we are joined with a very special guest today, director of quantitative research at Moody's Analytics, Lily Francus. How are you, Lily?

00:00:28:22 - 00:00:36:04
Lily Francus
Hey, Barnett. Nice to be on. Finally, I know we've talked about this for a couple of months now, and, you know, I'm glad the schedules could work out.

00:00:36:18 - 00:00:55:22
Bennett Tomlin
We're very excited to have you on. So one of the pieces of work that you produced that I found especially interesting was along with several other cryptocurrency researchers, you produced a piece that began to create a framework for understanding lending risk in DeFi. Can you share what that framework sort of looks like?

00:00:56:03 - 00:01:21:08
Lily Francus
Yeah. So this is a piece that actually I wrote, you know, under the context. And as a lot of people actually know me from just my Twitter and, you know, my my work on options and other sources of understanding market structure. But this was something that we released actually in January with Moody's and the Gauntlet teams or Gauntlet is this, you know, crypto company run by Tarun.

00:01:21:08 - 00:01:45:15
Lily Francus
Chitra a friend of mine as well that essentially they work with these protocols to manage their risk and optimize for collateralization ratios and various tokens they accept or other crypto assets. So from this angle where we kind of looked at it from traditional corporate credit risk because, you know, at its face a lot of these defined lending protocols, yes, that's a new paradigm maybe.

00:01:46:07 - 00:02:12:18
Lily Francus
But essentially it does follow the same laws as traditional banking understanding. And you know, if you look at banking, you don't have to look much farther than Basel three regulations of making sure that certain types of basically collateral are accepted as well as reserve ratios. So while there is definitely some differences in crypto and I think a lot of it has to do with the volatility as well as the difficulty of moving money into crypto and out of the crypto ecosystem.

00:02:13:06 - 00:02:34:00
Lily Francus
Essentially, the principles are similar. So, you know, when we looked at creating this framework or at least, you know, this rough draft of a framework and hopefully it seemed to be an actual framework, essentially we kind of started from the ground floor here where, you know, we looked at what is the basic interaction of a lending protocol in DeFi.

00:02:34:05 - 00:02:55:10
Lily Francus
There's a lot of defined protocols that aren't you know, direct lending. You could argue that any kind of pooling structure is a pseudo lender at the very least. My favorite and kind of the case example here was MakerDAO because it does conform out of any kind of crypto DeFi protocol, the closest to our traditional understanding of what a lender is.

00:02:55:14 - 00:03:28:10
Lily Francus
That said, it's very interesting because, you know, one of the unique aspects of crypto is this idea that code is law. So fundamentally a protocol once it has been published on to the main that essentially cannot be changed other than in the constraints of what is allowed in its code. There are ways that a lot of these protocols can conduct governance, and that is part of their actual smart contracts that encoded, which should allow them some sort of flexibility as the macro environment changes usually negatively.

00:03:29:01 - 00:03:57:16
Lily Francus
That said, you don't have the risk like you do in traditional lending, where let's say I give you know, I'm an investor I give a company, my money company at its core is a black box. So realistically, you will never know the internal day to day management of the company. Of course, as an investor, especially a large one, you do have specific insight from meeting with the managerial team as well as reviewing their publications let's say, by the SEC.

00:03:58:06 - 00:04:21:04
Lily Francus
But, you know, you do not get that kind of transparency that you do see on the blockchain. At its core, a protocol cannot go away and abscond with your money theoretically if it's in the code. And this is kind of basically a critical point when we think about what credit risk looks like in crypto. Is basically that the code has to operate the way that it was intended.

00:04:21:16 - 00:04:49:02
Lily Francus
Whether or not you understand the code when you put your money into that is where the risk is. So we've seen a lot of famous hacks recently, you know, Ronin Bridge, for example, Beanstalk Finance. These arguably are not hacks in what we would consider the traditional sentence. In both cases, they were kind of social engineering. I would probably lean more to calling them hacks, but we did have some debate on Twitter.

00:04:49:15 - 00:05:19:01
Lily Francus
But I guess the TLDR here is that our understanding of credit risk on the blockchain has been transformed from depending on the credit worthiness of individuals or, you know, in more formal legal terms you could say on the company or the obligatory itself to worrying about code quality and the ability that it could lead to something unintended by both either the author, if you know who they are or at least personally in lending the money.

00:05:19:12 - 00:05:50:12
Lily Francus
So, you know, we kind of looked at this framework, you know, in the traditional DeFi framework right now, you mostly sit on these over collateralized models because fundamentally what I always say is that credit is the delta between your collateral and your loan value. So, you know, when you think of stuff like loan to value ratios, if we were to think about it in a normal world, where I was like, But I'm going to give you $100, but you need to give me $100 as collateral.

00:05:50:21 - 00:06:28:22
Lily Francus
In that case, your LTV is one, but that's because you or I guess I'm the lender here, basically I have full faith that I can take the hundred dollars you just gave me and turn it into $100. So my risk effectively is zero. But in the crypto landscape, that's completely different because so there's two issues. One, not only is liquidity a lot lower than even traditional financial analogs you can I mean, even in the most liquid markets, which are like maybe CME Bitcoin futures or you know, maybe sometimes Binance, you know, it's just the level of liquidity is not there.

00:06:28:22 - 00:06:52:12
Lily Francus
We're talking about billions of dollars. We'll have a measurable market impact. Well, you know, good luck trying to make a measurable, measurable market impact on a normal day on the S&P. I mean, it's getting worse. And I do believe you have talked to Mike Green so, you know, I think that's one of his favorite points, that basically liquidity is diminished, at least visible liquidity even in the traditional equity markets.

00:06:52:22 - 00:07:20:05
Lily Francus
But in crypto, it's much worse. The second part is liquidity is fragmented. So because of the fragmentation across exchanges, yes, there is arbitrage that's going on, which does keep it line to line. But essentially moving size and crypto, especially at short notice, is much more difficult. And that's why most DeFi protocols, as is do depend on over collateralization to kind of hedge out their volatility risk and market impact risk.

00:07:20:05 - 00:07:55:19
Lily Francus
Does it work perfectly? No. Do they err on the side of caution? Yes. Is a capital efficient? Absolutely not. But looking at this, we kind of determined that the tilde is there's no real mechanism of credit risk. And if due to the fact that everything is over collateralized, the most salient risk on the short term is of course, smart contractors were Oracle risk Oracle being I'm sure your listeners already know this, but Oracle is being the source of true APIs that essentially connect with the blockchain and allow the smart contract to operate based on real world events.

00:07:56:01 - 00:08:18:14
Lily Francus
There's governance risk, which I think is long term probably the most impactful, in which case, how is the token governance properly? We've seen pretty famously this year with sushi as kind of a laggard and a pretty good case study, that governance eventually does have an impact, even in crypto. There's clearly currency valuation risk, which I've also written about in the risk free rates.

00:08:18:14 - 00:08:44:17
Lily Francus
And you know what that means under cover interest rate parity. And there's probably the most salient is regulatory risk. You know, this ecosystem, a lot of promise. I work pretty closely with individuals who are close to regulators but you know, a lot of these major institutional players will not touch crypto with a ten foot pole right now. You know, until there is sufficient clarity from regulators.

00:08:44:21 - 00:09:07:05
Lily Francus
Not only is it an issue for long term investment, but even for certain concepts like real world assets, or privacy coins or stable coins are all still fairly up in the air. You know, I will give credit to the Biden administration that they've been making an attempt here at least better than the European Central Bank. But, you know, it's still a risk factor.

00:09:07:05 - 00:09:14:15
Lily Francus
And, you know, I'm looking forward to doing a lot more work on this. But it's it's an exciting dangerous area, basically.

00:09:14:19 - 00:09:44:12
Bennett Tomlin
That was a fantastic summary. And I do have follow on questions. One of the reasons you suggested that the lending had to be over collateralized is because the liquidity is so fragmented and is so much less than in traditional finance. Whereas like when I think of decentralized finance lending, it seems challenging for me to figure out how outside of the potential liquidity issues, how to reasonably measure and extend loans based on trust.

00:09:44:21 - 00:09:52:05
Bennett Tomlin
Do you think that under collateralized loans or something we are ever going to see at a meaningful scale in the DeFi economy?

00:09:52:05 - 00:10:38:17
Lily Francus
So I think it's fundamentally a question of do you believe DeFi is the new paradigm that will take a significant amount of traditional financial transactions my optimist answer is yes. You know, I do think there are interesting especially cross-border implications of DEFI, and I think that fundamentally it is a fairly efficient way to gather capital. There have been lenders that have bridged this idea of collateralized or non collateralized loans like Goldfinch Finance, which essentially operates as a private debt market where you see that the actual lenders get their inflows via DeFi but they work with traditional KYC providers, trod fi basically in the local regions to kind of give out the loans.

00:10:39:03 - 00:11:05:06
Lily Francus
So there's two major issues here over collateralization and the ratio fundamentally depends on the question of when the market goes to shit, can I liquidate it and not incur a loss reasonably speaking, most protocols will operate some sort of reinsurance scheme where they will try to collect a reserve so that in turbulent times they can buttress against loss of collateral value.

00:11:05:15 - 00:11:33:03
Lily Francus
I mean you saw this pretty evidently in March of 2020 where you know MakerDAO had a massive cascade during the massive sell off of crypto like a 50% down in a couple of days and you know a lot of their collateral was liquidated for literally zero. So the issue of course is this reinsurance scheme largely at the current time depends on governance tokens themselves.

00:11:33:07 - 00:12:12:02
Lily Francus
And you know this is not too dissimilar from the idea of equity as a call option in traditional finance or the emergence structural model of credit risk. But at the same time, you know it's basically an IOU scheme on the protocols future operation. So it isn't it's a metastable equilibrium that would work for very short term pain. But fundamentally this equity cause, for instance, maker has a burn scheme that in good times that protocol surplus is used to conduct open market operations by MKR and it to a burn address in bad times.

00:12:12:02 - 00:12:51:11
Lily Francus
The protocol then uses that same operational scheme as a way to mint extra MKR so that they can cover protocol deficits the issue of course, is that depends on the marginal buyers stepping in and care. You know, just like any kind of equity or pseudo equity, you will observe that it's a very sensitive to market factor performance. I mean, crypto beta, I've something I've talked about on Twitter pretty heavily, but realistically speaking, you know, you see these incidences, I think a famous one was called ion finance where you have and this is kind of we can talk about stable coins too in that vein, but you have this scheme of you know, A and B

00:12:51:11 - 00:13:11:03
Lily Francus
token, where is a pseudo equity that acts as a volatility absorber? And this is what you see even with the different governance schemes. Basically and it works for short term acute pain, I think very well when you expect the market will bounce back. But fundamentally, it's just not the same as a true reinsurance pool.

00:13:11:08 - 00:13:41:13
Bennett Tomlin
You mentioned the MakerDAO Black Thursday event back in March of 2020 and one of the complicating or extenuating factors in those liquidations was of course that the keeper contracts were not configured to adapt well to a congested chain in this high fee environment. So would that type of risk like the entities intended to bid up and collect this collateral to do these liquidations, is that like a part of smart contract risk when they're configured like that or how does that fit into the risk model?

00:13:41:21 - 00:14:09:02
Lily Francus
So we talk about it as one of the main factors is called cooperative risk. And you do see this with DeFi that certain or pretty much every protocol I know of depends on the action of arbitrageurs or at least some third party liquidators to essentially call certain functions or certain actions or the protocol needs for financial incentive. And the issue, of course, is that depends on a stable system.

00:14:09:02 - 00:14:38:16
Lily Francus
You know, in the Black Thursday, event, clearly the incentives and ability for Arbitrageurs and liquidators to operate was severely impaired. That said, you know, this is part of proper modeling and I believe part of what Gauntlet does. Essentially, you need to make sure that not only are you properly incentivizing that these activities occur in a sustainable way, but also that you minimize their importance or at least factor that into your calculation of risk.

00:14:39:05 - 00:15:21:19
Lily Francus
I mean, realistically, there's no perfect system here. I think that there's a lot of work basically that's going to be determined over the next year, especially as we slide into a more bear, muted market on understanding crypto risk better. I do think that, you know, my keyword that I flagged in cooperative versus sustainable because a lot of these protocols operate these essentially equity dilution schemes that would be the closest to an analog in traditional finance where they have some kind of arguably worthless governance token that may eventually collect dividends from the protocols operation.

00:15:22:05 - 00:15:55:08
Lily Francus
And they use it as a means to incentivize either liquidity providers or arbitrators or something like that. And the issue, of course, is in the beginning, because there's a speculative boom, it's very similar to what I've talked about with Tesla. and the idea of at the money equity offering is, you know, this idea of value X Neil, low speculative valued can turn into value in certain cases because fundamentally it creates a pool of capital which the management team can draw upon to actually build or acquire or generate some kind of sustainable business model.

00:15:55:08 - 00:16:27:06
Lily Francus
But by itself, it is not a sustainable business model. Clearly, because, you know, I think The Simpsons are the best. A couple of years ago, you know, you can print as much Monopoly money as you want, but it doesn't you don't you don't change the actual value of the money that's backing it. And I've actually written a post about this recently about crypto as this hot ball of money where essentially you have a lot of these protocols that they depend critically on their operation, on incentivizing based on arguably more and more worthless.

00:16:27:06 - 00:16:50:01
Lily Francus
You know, governance tokens. So the issue is it becomes extreme negative convexity because the value of the token goes down, the incentive goes down, which makes the protocol operate worse, which makes the protocol token go down more. And that is kind of the death knell. And I think a lot of insanely intelligent people are working on bettering the economics here.

00:16:50:10 - 00:17:10:17
Lily Francus
But fundamentally, you know, this is what you're going to see in a true bear market with a lot of these protocols because if your protocol sustainability only makes sense when the token price is either stable or going up while you have this continuous dilution model, then you're probably not going to be around in two years.

00:17:10:23 - 00:17:43:03
Bennett Tomlin
Yeah, and that's an incredibly common model. I mean, most tokens that are talking about staking are often doing basically you're capturing your proportional share of the inflation and not getting like diluted out. I remember when I looked at like Olympus though, that's what the entire thing was. They're minting more and more of the governance token, and if you stake, you make sure you control your portion of the market cap, which is one of the things you talked about in your series of articles on risk free rates and conceiving of a cryptocurrency risk free rate.

00:17:43:03 - 00:18:06:11
Bennett Tomlin
And the reason I chuckled when you were talking there is because one of the quotes I had pulled up in my notes from your articles was the way I personally view the current ecosystem in cryptocurrency is akin to a hot giant pool of money. And so I had also pulled that one out. Could you help introduce our listeners to the work you've done in laying out this path towards a cryptocurrency risk free rate?

00:18:06:11 - 00:18:33:13
Lily Francus
So yeah, I mean, again, I have purchases from very much a quantitative risk modeling perspective. You know, this is kind of similar to what we do at Moody's Analytics with traditional finance and kind of the cornerstones of quantitative risk modeling are you need to be able to calculate a theoretical price of risk in the market theoretically. You know, at least if you follow modern portfolio theory, every type of return over the risk free rate is fundamentally an efficient market.

00:18:33:13 - 00:18:55:02
Lily Francus
And there's a couple other assumptions here. So you know, please don't shoot me out in the comments is essentially that you're taking on excess risk. So there is you know, Markowitz, I believe, was one who did the efficient frontier model where basically, you know, there is an optimal way to construct a portfolio for a given level of assumed risk.

00:18:55:02 - 00:19:25:14
Lily Francus
And return. And what that means is that if we are thinking about either relative or even absolute risk in crypto terms, we can essentially assume two things. Right now, there is minimal economic value inside the crypto ecosystem. So basically endogenous value creation, there are some exceptions that I'm not going to mention. Basically where I do think these may be true economic value here, that will by itself be controversial.

00:19:25:14 - 00:19:56:10
Lily Francus
But if you look at economic versus speculative value, I think most people would argue, yes, you know, this is probably a fair point. So what is interesting about that is we could then extend that argument and say that any excess returns in crypto over the crypto risk free rate and we could say this on a blockchain level, for example, are due not to economic value creation, but to increase your risk of being taken again, this is going to change over time.

00:19:56:10 - 00:20:14:15
Lily Francus
I do not believe every single source of yield in crypto is just due to risk. But, you know, we can clearly see that a lot of them are. I mean, you also see some things that are just completely unsustainable yields, which, you know, I won't name here as well, but we all know which stable coin protocol I'm talking about.

00:20:15:07 - 00:20:47:20
Lily Francus
Basically that's not necessarily being paid for. Is that because someone is essentially just subsidizing it, but it's clearly not sustainable and you know, even that team, they are very well aware that the long term rate will be a lot lower than it is right now. But given that you can't really start talking about quantitative risk in crypto without at least getting an idea of what the risk free rate is, I think that, you know, the first well actually for people is that if you follow traditional financial theory, there is only one risk for it in the world.

00:20:48:03 - 00:21:10:16
Lily Francus
If you have a completely open economy or sorry, a closed economy where there are no capital controls, logically speaking, that's a pretty simple prove by contradiction. There should be only one risk free rate. What you see in practice, of course, is that there is very severe capital controls between crypto and TradFi. It is very much non-trivial to get a dollar into crypto.

00:21:10:21 - 00:21:39:22
Lily Francus
And even if you're in crypto and I've talked to friends, a very large prop trading firms, it's even more difficult to get it into DeFi itself versus, you know, let's say laboring on a centralized exchange because the regulations are not there. The idea of custody is really difficult. So we would expect that there would be an endogenous risk free rate for a dollar that is present in DeFi that would probably be higher or at least different than a dollar outside of DeFi a dollar.

00:21:39:22 - 00:22:04:01
Lily Francus
In the real world, for example, you could argue that the difference in those risk free rates represents the difficulty and assumed risk of just being in DeFi because fundamentally there is a background risk if you're individual, there is also a risk if you're on a centralized exchange, which I've talked about significantly. But these are all in the context of themselves so a dollar that's already in DeFi.

00:22:04:15 - 00:22:28:20
Lily Francus
The risk free rate is the rate of return you can expect without assuming any extra risk. So we all have, you know, risk every single asset in the world has a risk. When we talk about the risk for in traditional finance, we largely assume U.S. Treasuries, and that's because we assume it's in U.S. dollars. But the thing is that for someone who let's say someone who wants Japanese yen, a treasury is clearly not risk free because of the exchange rate risk.

00:22:29:00 - 00:23:07:02
Lily Francus
Someone holding a U.S. dollar more or less arguably holds a no extra risk holding a treasury than holding the dollar itself. But that's only in the context of being in the dollars phase that we consider at the Treasury to be a risk free rate. So there, you know, you could use this line of logic to basically assume that each blockchain should also have its own endogenous risk free rate, where if I own an avalanche token of shocks, then basically the risk free rate would be some operation that I could do with my token that would not increase my risk over the risk already have owning a box.

00:23:07:05 - 00:23:35:07
Lily Francus
And because of that, you know, staking is pretty much the natural analog here. I think historically people have used the futures basis. Trade on exchanges is the risk free. But that has, you know, even papers have been written it runs fundamentally into problems because it relies not only on the implied exchange risk premium. So what the market views is the risk of holding a dollar on the crypto exchange, but it also is supply and demand effects.

00:23:35:12 - 00:23:50:07
Lily Francus
So it's very hard to, you know, basically separate it out while staying on the other hand, at least two networks that don't have sloshing, for example, you could argue, is the closest to a true risk free rate, at least inside of the currency space. Itself.

00:23:50:19 - 00:24:08:07
Bennett Tomlin
And then even in ecosystems where there are slashing, you expanded your definition for these currency specific risk free rates as like the staking yield minus the inflation, minus the overall risk of being slashed to still arrive at a risk free rate for ecosystems with the slashing from understanding that.

00:24:08:07 - 00:24:36:00
Lily Francus
Correctly, yes, that's interesting talks with some folks that I won't name them because they've been there running on paper. Who essentially argue against my proposal that or it's hard to say against but it's they argue that the true risk for it in DeFi either zero or negative. I need to philosophize on that a bit more. I think there's arguments that are problematic there because, you know essentially in an asset space itself a negative risk free rate

00:24:36:00 - 00:25:07:01
Lily Francus
The implication is that it's essentially a bubble. So you know, if you have a negative risk rate in the context of operating an atom or let's say I gave you an investment that the risk free rate is going to reduce your atom over time, the cosmos token then essentially. So there's there's two ways you could do this. One is that if there is a rate of negative here, then overall the market cap, assuming it stays the same, the price of atoms should go up relative to other currencies because essentially a burn inside the currency itself.

00:25:07:04 - 00:25:30:07
Lily Francus
The other way to view it is view that that actual total risk period is negative. So in the context of I hold Atom and invest it, but I'm looking in dollar space, then essentially it just becomes isomorphic to a bubble. So, you know, you would expect that future long term value would be zero and through backwards induction you can assume that the present value is also zero.

00:25:30:15 - 00:26:01:19
Lily Francus
So there are issues with that kind of reasoning and this is kind of goes into the field of rational bubbles and economics but fundamentally, my guess and I haven't done, you know, true analysis on this. Yes. Is that even if you use that line of seeking yield reasoning, the risk period is probably positive and it probably once you account for capital constraints, risk of sloshing exchange rates, if the markets are efficient, you would assume that the risk rate in crypto would be very similar to what the risk for it outside of crypto would be.

00:26:02:08 - 00:26:24:19
Bennett Tomlin
And so sorry, what I'm trying to work through is that there's a good chance after Ethereum goes through the merge and with EIP 1559 active, that Ethereum will be deflationary and so could you help me understand how the risk free rate interacts with that inflation term, especially when it goes negative?

00:26:25:04 - 00:27:06:08
Lily Francus
And I don't know the specifics technically when, you know, Ethereum's merge. I do think that the traditional paradigm we're seeking is right now is staking rewards or the risk free rate at his basic core is a combination of inflation rewards, which is what you mentioned with deflation as well as transaction costs. So the actual use of the network, you would argue that in most cases the long term is if you look to time as infinity, the aggregate value of the inflation reward is zero because one third, first of all, is very PVP in the sense that inflation rewards do not actually generate any true economic value.

00:27:06:08 - 00:27:31:03
Lily Francus
They just shift the balance of who owns the market cap of the currency itself. So if you have an inflation reward base taking model fundamentally, you know, any kind of value add is endogenous to those who stake at the expense of those who do not stake. You know, on the transaction model, clearly you could argue that is a sustainable yield and represents the demand for block space.

00:27:31:03 - 00:28:04:13
Lily Francus
So fundamentally, you know, the deflationary aspect here, I'm not exactly clear what's to tax in in deflation you know, currency where or we could just argue that it's taking without inflation reward. So in that case, you would see that the risk free rate would essentially just be the relative transaction volume or relative to induction of fees that are paid by the network at any given time, which of course it's a variable rate that's always positive, but it's not, you know, a fixed rate.

00:28:04:13 - 00:28:31:08
Lily Francus
So then you'll see the evolution and you're seeing this with like alchemy and a couple of other, I think, strips finance is another one where you're going to see an active futures market and this kind of very much starts to look like the overnight rate and repo rates and traditional finance because, you know, arguably the Treasury rate is, you know, it's the government is basically taking on debt which can be inflated away long term if the government is running a deficit.

00:28:31:17 - 00:29:03:08
Lily Francus
So you could say that's more acknowledges that bondholders you know, in the Treasury aspect of U.S. dollars are being paid in inflation rewards, at least when it's running a deficit. Otherwise you're depending on the actual economic surpluses gathered by the government. But in the transaction fee model, it's very much more similar to like the overnight rate and repos where you could start seeing futures contracts being traded on the markets, expectations of it, which would probably be a more real risk free rate.

00:29:03:22 - 00:29:23:22
Cas Piancey
Hey, I know I'm coming I know I'm coming in half way here, more than halfway here. Hi, Lily. But I did want to just and maybe you've gone over this already, but I did want to ask you hearing all this and hearing you talk about all the risk and hear about hearing about you talk about how this resembles traditional finance in so many ways.

00:29:24:05 - 00:29:43:15
Cas Piancey
I know you're more bullish on cryptocurrency in general than Bennett and I are, and I'm wondering if that's because you see it replicating the traditional finance system and moving closer and closer to what traditional finance does or if you think there's a lot of value out there that hasn't been actually realized yet.

00:29:43:19 - 00:30:24:06
Lily Francus
I think that's a pretty good analogy. You know, I do think I'm actually more bullish and feel more safe, you know, being in the crypto space because there as I said on Twitter multiple times, there's nothing new under the sun. So, you know, a lot of this stuff, you and what I just talked about in traditional finance, the analogy is the free is spread basically between the three month LIBOR and, you know, the expiration of the overnight index rate where you see that these analogies like the variable staking rate accounting for sloshing risk and these futures contracts that can essentially trade on it, which would be very much similar to a three month LIBOR rate.

00:30:24:06 - 00:30:47:01
Lily Francus
You get an additional not LIBOR anymore, but when LIBOR was still around that, basically you see them in traditional markets. So I do think that, you know, there's two ways to look at that. One you could say is, look, well, you know, it's replicating traditional finance. So it's maturing as a market and there's unique parts of crypto which are strictly better than we have in traditional finance.

00:30:47:01 - 00:31:08:22
Lily Francus
I think that, like I said, international settlement is a big one. I mean, if you know, financial history there was a famous case with Herstatt Bank and FX settlement and my need to look at the specifics because it's been a while, but essentially two banks in order to settle and the counterparty went out of business literally this was the 26th of June in 1924.

00:31:09:09 - 00:31:31:07
Lily Francus
Herstatt's license was drawn by German regulators the end of the Banking Day and some other banks worldwide had undertaken foreign exchange production with her short and already paid Deutsche Mark to the bank during that day. Believing they'd receive U.S. dollars from her own account. But because of the time of settlement, by the time they were, you know, expected to get the money back.

00:31:31:07 - 00:31:53:07
Lily Francus
But they didn't exist anymore. So you basically in crypto that's clearly not an issue, although you could argue that the downside of that is, first of all, you know, basically self custody is a big problem, especially for richer people. But second of all, you can argue that you don't need a permissionless blockchain. You could also use a permissioned one like what if we put swift on the blockchain?

00:31:53:18 - 00:32:08:08
Lily Francus
And I would say, yeah, you know, basically. So obviously a permissionless is more of a technological curio in that case rather than something that's uniquely an innovation of crypto versus a permission blockchain.

00:32:08:10 - 00:32:11:18
Cas Piancey
What would be the benefit of putting swift on the blockchain?

00:32:12:00 - 00:32:36:15
Lily Francus
Well, I mean, Swift is a messaging system, so you probably wouldn't want to put Swift. It was more an example. It would be more like, I don't know, we could have like the Fed now that it's basically a new payment rail that's being added next year by the Fed, that will kind of supersede the ACH system of that early 1970s and what that does it going to provide much smoother and much, you know, less costly transactions.

00:32:37:00 - 00:33:03:11
Lily Francus
So you could say, well, why don't we build a FedNow on the blockchain and the argument is, you know blockchain is basically like get because I'm a software engineer, you know it isn't by itself necessarily most efficient system but it does have nice properties when you aren't sure about the liveness and consistency of records. And for something like the Fed now it's the U.S. government so like they rule by fiat.

00:33:03:12 - 00:33:27:00
Lily Francus
So there's very minimal benefit in those cases making it a blockchain sort of versus a traditional database system. But, you know, going more to the downside of cryptos replicating, you know, traditional finance. You could also argue that the pessimistic cases, well, so why do we need crypto? And like I said, you know, I'm more of an optimist by nature.

00:33:27:00 - 00:33:54:14
Lily Francus
I do think that some of the innovations we're seeing and the speed of it is pretty incredible. You know, you could have said the same argument about the Internet. It's like, why do we need e-commerce when we can go to the store? Or Why do we need email when we have letters? At the end of the day, you know, I'm sure in the next five to ten years, assuming crypto still around, we're going to see more and more innovations that are very much crypto native and we're going to wonder how things were done pre crypto.

00:33:54:22 - 00:34:34:12
Bennett Tomlin
So yes, like why do you need crypto there? And generally the reason I have to reflexively respond is because you're trying to build these censorship resistant systems, right? And that's for me often what the foundational innovation of cryptocurrency and these systems are is the ability to do things in a censorship resistant way. And so that's always been my difficulty with understanding the utility or appeal of permissioned or private blockchains, because when you have an entity or a group of entities who can all agree to set up this thing and do this thing, I struggled to understand what the marginal benefit of adding a blockchain to that situation is.

00:34:34:20 - 00:35:01:22
Lily Francus
Why haven't we seen it? You know, I basically the granddaughter of two Holocaust survivors, you know, they basically they they lived in Romania. My grandmother her land were stolen. You know, they had oil land. So I would be much wealthier, you know, if that were to didn't happen or my family would they eventually fled communist Romania to go to Israel basically.

00:35:01:22 - 00:35:29:00
Lily Francus
And back in the 1960s. And you know, what we saw even under these authoritarian regimes is you couldn't if they let you live, you just count your blessings and they don't you don't leave with anything. You leave at night, you pack your bags you they steal everything you own. So we have to be mindful that of course we are the children of Pax Americana where the world is by most metrics over the last 50 years gotten better.

00:35:29:04 - 00:35:53:20
Lily Francus
But I could see, you know, even from the comfort of my high rise in Oakland that, you know, there is a place in this world for storing value outside of the purview of government system. Government is very much like a protocol in the sense that clearly there's more flexibility in how government operates. And we have a system in the US that we can amend.

00:35:54:01 - 00:36:26:03
Lily Francus
It's difficult, but it does rely on the social consensus and more into social norms that is more fragile than most of us want to admit. I mean, we've seen the rise of populism in the West since, you know, the late 20 time period we saw recently with basically the Ukraine war or the Russian invasion of Ukraine. Peace is fragile and you know, I think that in normal times there is minimal benefit to this idea of a completely censorship resistant monitoring system.

00:36:26:03 - 00:37:00:22
Lily Francus
And, you know, execution. If you have a smart contract layer, there is minimal benefit over what we currently have. Now, in a lot of cases, it's strictly was basically tax reasons. It's slower, it's more expensive. But, you know, in bad times when our judicial system is you go against us. And that's kind of the cycle of human history I could see it, you know, I mean, I think that Web three has a lot to go before it becomes usable to a normal person, before it becomes something that would actually be competitive with most of our applications we know and love on the Internet.

00:37:01:09 - 00:37:18:08
Lily Francus
But yeah, I mean, this is not I don't I don't even own enough crypto to show it to you guys. It's just realistic. We should just look at the error of history. There is room for money that is usually custody and is not under the purview of the government.

00:37:19:01 - 00:37:51:13
Cas Piancey
I don't think either of us disagree on that. I think that I think that we've both stated at least unequivocally that we think like non-governmental money, like Bitcoin is a very cool idea that I think Bennett is more bullish on like smart contracts than even I am. I think I think we acknowledge those use cases. I think what Bennett was saying before is that introducing blockchain to concepts that don't need them, you know, like I look at the Fed or the, the way that the US monetary system works and when people go, Oh, but you could do it on the blockchain.

00:37:51:13 - 00:37:56:01
Cas Piancey
And I go, Why would they want to do that? I don't understand why they would want to do that.

00:37:56:07 - 00:38:24:02
Bennett Tomlin
Yeah, yeah. So just to add on my point I was trying to make is that the value I do see is in the censorship resistance is in the times where it is outside of the purview of these centralized entities where there isn't like a list of people agreeing to coordinate on a single blockchain and where it is this globally distributed network, the part that I've always struggled with is the private and permissioned blockchains, because it doesn't seem particularly useful technologically to me in those instances.

00:38:24:06 - 00:38:50:11
Lily Francus
Well, I think I mean, putting on my software engineer hat the major benefit of because this goes into consensus protocols and you know, I think the fundamental basis for permissioned blockchain is really the same as any kind of distributed database system where you are concerned about live nodes, you're concerned about corruption, you know, it's arguable that a permission blockchain really is just a distributed database.

00:38:50:11 - 00:39:08:01
Lily Francus
So maybe it is an idea of nomenclature, but fundamentally cryptographic hashing of database records has long preceded the current web theory stuff. So whether we call it permissioned blockchains or you know, geo distributed databases, I think it's really the same technology there.

00:39:08:21 - 00:39:19:22
Bennett Tomlin
Recently you tweeted about how in five to seven years you would like to run for office. How serious were you being and how tongue in cheek was that comment?

00:39:20:03 - 00:39:41:04
Lily Francus
It's interesting. I mean, you know, I've always considered it I think part of it when I was younger is that, you know, I don't consider myself very charismatic or easy to talk with people, you know, which is kind of a necessity especially in American politics. I've gotten older. I realized that I'm not as bad as I thought, you know, I don't know.

00:39:41:10 - 00:40:17:17
Lily Francus
I don't have any specific aspirations electorally right now. I do want to make the world a better place. I also love to communicate with people. I mean, that's why I kind of blew up on Twitter was essentially because here's this like mid-twenties girl talking about option theory in a way that normal people can kind of understand. So I do think that missing from American politics, especially where, you know, even mentioned this today with the GDP figures, you know, you have all of these moderately dishonest takes about current events that can be construed according to whatever narrative people are trying to create.

00:40:18:07 - 00:40:42:09
Lily Francus
The GDP today came in negative. I understand it was partly due to a trade deficit. You could argue till the cows come home, you know, government spending. But unless you have those same kind of reservations, when I was positive, that's just called being disingenuous. And I think that I have gotten more and more cynical, especially about political stuff as well as somewhat about the media over the past year.

00:40:42:17 - 00:41:07:19
Lily Francus
You know, and I'm I am a liberal progressive. I voted for first Warren and then Biden, I never honestly voted Republican in my life. So I'm saying this as a Democrat, although that's clearly my political views and not my employer by any means. But it's just disappointing to see that at this point either. And both sides are essentially ignoring the true problem.

00:41:07:20 - 00:41:30:04
Lily Francus
We have climate change. If you ever want to be depressed, go read about sustainable finance. I was doing research on COP 26 and I'm like, Jesus Christ, I think we're going to die. Because if globally we cannot even commit $10 billion properly a year to sustainable finance across the globe, we've given way more in tax cuts in the US and this is our planet, guys.

00:41:30:04 - 00:41:57:16
Lily Francus
Like, I'm not basically saying that we need to, you know, switch from all of our oil tomorrow and destroy the economy. But we have severe income inequality, we have climate change we have social issues, severe social issues and partisanship we have basically denialism growing and people my age and even zoomers and it's like someone like I just it doesn't need to be me.

00:41:57:16 - 00:42:14:01
Lily Francus
I just want someone who can basically sit down and be like, yeah, she's kind of screwed up, guys. I don't have all the answers right now, but at least I want you to know that I will fight for you guys. I'm not here to take cheap political shots. I'm not here to promise you the moon for stuff that we cannot afford.

00:42:14:01 - 00:42:24:03
Lily Francus
And that's not even, you know, economically, socially possible. But I want to explain what's going on, and I want to know that you have representation in office, and that's what I want to see.

00:42:24:12 - 00:42:27:14
Bennett Tomlin
With a platform like that. You've got my support. Yes. Well.

00:42:28:05 - 00:42:34:10
Cas Piancey
I mean, I would never I would never, ever run for office. I think that's cool that you're considering it. Really.

00:42:34:18 - 00:42:38:04
Bennett Tomlin
It's because you're a felon, Cas.

00:42:38:09 - 00:42:40:18
Cas Piancey
And it's because I'm a felon.

00:42:40:18 - 00:43:02:19
Lily Francus
I know you. I was going to say for me, it's if I do it, it's years away. I'm not. I'm 26 year old. I would like to do some. I mean, look, maybe we have people like Madison Cawthorn and whatever, and Lauren Boebert who it's like, well, I guess the bar lowered enough that I can actually fit under it at this point, but I still would like to do something before I actually go into office.

00:43:03:18 - 00:43:18:23
Cas Piancey
Yeah. I mean, I guess where I'm coming from, what I was going to say is that right now I'm in Reno and I've been having an opportunity to chat with actually like a lot of politicians and like it is not it's a thankless job. It's a hard job. I'm glad that someone like you would want to do it.

00:43:18:23 - 00:43:55:09
Cas Piancey
But I also it seems like it's easy to go into it thinking like, well, everyone else does a really bad job. I'm sure I could do better, but I've yet to see that properly play out. Like even on a local political level. I look at the mayor of Los Angeles or I look at any number of local politicians and stuff, and particularly from a financial perspective, I think being so entrenched in finance, you can look at the stuff in the issues and the consistent and constant waste of money and go, Oh my God, there's a million different things, better things that you could be doing with this.

00:43:55:18 - 00:44:01:06
Cas Piancey
But I wonder, like there there must be a reason that nobody is changing the system.

00:44:01:15 - 00:44:26:16
Lily Francus
Yeah. I mean, fundamentally, it goes back to my point about look, it's about trying hard to effectively communicate to the public. It's about basically making others understand that you are there to help and awareness of the current issues. That isn't just distorted sound bites. If you ask me when I was, I don't know, ten years old, I would have told you I could terraform Mars I could build a time machine.

00:44:26:16 - 00:44:44:11
Lily Francus
It's safe. I think as you grow up, what you focus on narrows and you get more worldly and a lot ways more cynical. But if I was actually to go into politics, I wouldn't go from the idea that I'm going to change the entire system. It's more I just want to make the world a little bit less crap.

00:44:44:14 - 00:45:16:18
Lily Francus
Like, that's literally it. And it's not to say that I'm personally uniquely qualified. I might be less qualified than other people, and in which case I would love to support them. But it's really just we need a group of politicians. And I'm not saying that all politicians are like this, but we just need people who seem to care and who want to communicate and inform the public versus partizans versus cheap, basically interpretations versus worrying about your own next run an office, that's literally it.

00:45:16:18 - 00:45:23:16
Lily Francus
And it's like, I think maybe this is my own naivete, but I think a lot of people would just resonate with that at this point.

00:45:24:06 - 00:45:48:17
Cas Piancey
Do you find yourself like kind of as an outsider with the liberal perspectives that you have and the idea? And I think that and you're probably on the same page in that I do believe in government. So there's certainly a lot of people in cryptocurrency that seem to fully not believe in it. At all. And I'm wondering if, you know, we're talking about self custody, we're talking about decentralized finance.

00:45:48:17 - 00:46:04:19
Cas Piancey
We're talking about people, you know, largely being responsible for their own financials. But then simultaneously, we're here talking about, you know, a desire to make government better and to be able to help people through governance doesn't that feel a bit contradictory?

00:46:04:19 - 00:46:36:09
Lily Francus
Almost, does it? I'll give you an analogy here in the free markets, we believe competition is good fundamentally. I mean, that is one of you know, there's obviously in terms of the consumer, you have consumer protections, which is fiat. It's by the government itself that essentially regulates businesses. But at its core, you know, we do believe in the necessity for competition in order to provide more pricing power to the buyer rather than the seller, you know, especially for critical services.

00:46:36:12 - 00:47:00:07
Lily Francus
You know, in some cases we prevent natural oligopolies or natural monopolies. But in general, we do view competition as a good thing, at least in economics and finance. So would it be so bad to have these systems that do act as competition to the government, or would it potentially give the government more urgency to act in the better interests of people?

00:47:00:14 - 00:47:05:16
Lily Francus
And I don't have an answer to that, but I do think that it is something worth considering.

00:47:06:08 - 00:47:10:01
Bennett Tomlin
I don't have any more questions. Do you have any any remaining guess?

00:47:10:08 - 00:47:28:11
Cas Piancey
I guess I would just like to know, Lily, I assume you like not only work with people directly all the time who are involved in cryptocurrency, but I mean, you obviously you trade it, you like it, you enjoy it. Do you try to bring people into the system? Do you try to get people to understand it the way you see it as well?

00:47:28:17 - 00:47:41:18
Cas Piancey
Or do you think that there's a lot of speculation and garbage and are you more prone to like warn people about the issues or try to lead them in to DeFI and stuff or both?

00:47:42:01 - 00:48:05:02
Lily Francus
I think it's yeah, it's essentially both in the sense that, you know, and I'll give you an example. I sold it to other people I've talked to. I think warning about the risks and informing people is part of trying to make this a real thing. You know, I think fundamentally what you're what you observed is that if you have no risk and no leashes, eventually it's all going to crash down.

00:48:05:02 - 00:48:31:15
Lily Francus
People are going to hurt. That's how it gets this, right? That's how you see the end of DeFi And if DeFi, crypto has a future, then people need to be informed. People need to trust it. People need to want to interact with it. And right now that with the current state, I probably on Twitter, I probably have equal lists that, say, crypto critic or crypto hater or something as crypto like enjoy or like I talk about it from a systematic basis.

00:48:31:15 - 00:48:55:13
Lily Francus
I do think crypto I'm crypto optimistic, let's put it that way, where I think that if you care about this space and if you do see it as something other than just a quick cash grab, then it is your job to build these systems and risk monitoring that will make sure that people can use that and that the era of, you know, these wildcat bangs and super device comes to an end.

00:48:55:15 - 00:49:18:15
Cas Piancey
And sorry, just a quick follow up. Do you expect to see that sometime in the next few years? I would assume then that you this this kind of like Ronin Network hack followed by like, you know, a month after Wormhole or whatever, like where you're having $100 million hacks every month or every week, you think that that is a right now thing and hopefully is going to be coming to an end soon.

00:49:18:18 - 00:49:39:21
Lily Francus
I do hope. I mean, the thing is, you know, it's kind of part and parcel with the idea that we expect further adoption because I think that if you do not build these risk monitoring systems, you will not see further adoption, you may see further retail adoption, but at the end of the day, someone is going to measure risk someone is going to act on risk.

00:49:39:21 - 00:49:47:04
Lily Francus
And I think most people would agree that they would like to see the industry self-regulate before the regulators do it for them.

00:49:47:07 - 00:50:04:11
Cas Piancey
Yeah, self-regulation has been a concept for a pretty long time in crypto, and I have really yet to see it play out in a positive way, other than, I will say, that Zach has been a force to reckon with on Twitter and he has exposed a lot of garbage and he's gotten a lot of support for doing so.

00:50:04:18 - 00:50:27:18
Cas Piancey
So I'm glad about that. But I will say that he himself knows that like he can't stop them from just creating a pseudonym and jumping right back in and starting some new scam project. I also think that like the popularity of cryptocurrency and all of this money flowing in, this what do you call it, a hot pile of cash that that drives bad actors to want to pursue that money as well.

00:50:27:18 - 00:50:48:11
Cas Piancey
I mean, North Korea hacking the Ronin network, they did that because there was so much to be had. And this is the best and easiest way for them to evade sanctions now for them to acquire illicit funds. Like it's easier than trying to rob banks, which is what they were doing before, like in 2016 or 2014 they were robbing the Bangladeshi central bank.

00:50:48:11 - 00:50:56:16
Cas Piancey
Right. But now they're finding it easier to rob a bunch of cryptocurrency proponents and projects than to try to rob the Fed repeatedly.

00:50:56:19 - 00:51:17:19
Lily Francus
Yeah, but I think that it's fundamentally with this idea that crypto is just like it's basically speed running the history of finance. So I think, you know, even that in a bizarre way should give you some sort of optimism where in the sense that yes, we're, we're basically at the point where maybe we're at the wild west where people actually could probing.

00:51:17:19 - 00:51:37:22
Lily Francus
So I don't think most people actually physically rob banks anymore. Most of their cash is not even stored on site but yeah, I mean, it's really this is going to be the do or die moment where crypto needs to decide is it going to be a speculative casino forever. Or are we going to shape up and start protecting consumers?

00:51:38:16 - 00:51:41:19
Lily Francus
Are we going to comply with regulations and are we going to take risk seriously?

00:51:42:02 - 00:51:45:01
Cas Piancey
Perfect. Great. Thank you, Lily That was that. Was awesome.

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