Show Notes for Kain Warwick Podcast

Last year, Synthetics pivoted towards the creation of synthetic assets and where/what they can be used for? Why do we need them?  The end goal is to give people the ability to have exposure to other asset classes while remaining on Ethereum.  There are a whole bunch of properties you have when you have an asset on Ethereum. If you can create a system where you can allow a range of different assets, you can create some really cool applications that take advantage of these price exposures through the power of Ethereum. That is the idea behind synthetics to give people this price exposure to any asset.  

The difference is if you have a digital asset back gold token, you can redeem it for the physical delivery asset from those tokens.  If in the future, all the commodities will have one to one tokens; what would be the benefits of working with a synthetic token? It comes down to cost and the infrastructure; do they need to be redeemable to something physical?  99% of people just want the price exposure to the synthetic asset without having to hold the underlying asset or have an intermediary or custodian hold the underlying asset. This is quite powerful. The permissionless nature of it means you do not have any custodial risk.

Synthetics give you price exposure without needing a custodian or accepting custodial risk.  What you want is people to be providing hedging through these risk pools.  You need to work out how you make dividend payments.  It can be done through synthetics.

Do you think it will remain a niche product in the crypto space? It depends on the trajectory of the Ethereum platform.  I think it is dependent on how the Ethereum network grows dependent on adoption.  I don’t think Synthetics will be the killer app on the network; you need a stall basis for the network effect of increasing adoption.  Maker might be the killer app for mass adoption.  We see a whole bunch of wallets built on Ethereum, and they allow all these things to be built on Ethereum. These wallets will provide access to these products build on Ethereum. Ethereum solved the volatility problem in the crypto markets.  The complexity increases as you go long but the benefits of creating those assets allows you to build or get price exposure over the longer term. This allows you to unlock the true abilities of Ethereum and build on it.

What are some of the coolest things you have seen people build on Synthetics? We see some interesting compositions in terms of liquidity provision. We incentivise a pool in UniSwap, which is one of the largest pools (25% of UniSwaps liquidity is in our pool); and that is designed to be an on-ramp into the Synthetics ecosystem. If you need to take ETH or assets on Ethereum and put them into Synthetics, people have taken this and built some interesting synthetic products into UniSwap. It can all be done in one click, which is really cool. We are starting to see some of the wallets are looking at implementing these different kinds of strategies, like DEX wallet, for example, where you can combine different assets to create these DeFi baskets.  These baskets of assets allow people to track prices.   There are also these exotic illiquid assets which allow you to track these pools of assets and assign value to them. This is the leading edge of creative asset creation.

One of the things I love about the Ethereum community is the creativity of the community and the composability of it.  Every day it is amazing. I think it will be the lasting ability of ETH to try things and create new projects in early stages.  You had a year and a half since the ICO to find a market fit for Synthetics. It has taken us a couple of years to find where the market is wanting us to go. You need to be able to move with the market.

What was the metric for those pivots? There were so many proposals and products we looked at. If we don’t pivot here, we will struggle to get adoption or users.  Coinbase’s on-ramp into Crypto creates liquidity to move money into USDC.  The tail risk we all live with and all these regulated stable coins have kill switches.  You are inviting someone into your house that could wreck everything, and we all need to be aware of this with USDC. Blacklisting is a very big risk you accept by using USDC or other stable coins with backdoors. Why do I need privacy is the same problem; these backdoor kill switches exist, and we have to be aware of these.

These on-ramps come with a trade-off, and the risk needs to be acknowledged because it exists.  We haven’t yet seen these back doors used, and I think it will be a wake-up call for people that the trade-offs are there but just hidden away from us.  PAXOS, GEMINI – all these stablecoins have these backdoor trade-offs that come with regulation.

The collateral that is backing synthetics now is Ether and USDC. Would you incorporate real-world assets into Synthetics? I hope not. I don’t want to create systemic risk by incorporating real-world assets into synthetics as I think it is not a good idea as it defeats the purpose of being permissionless.  As a project Synthetics would never say never; but the community might want to go there. Ideologically though I hope that Synthetics does not go down that path as I am not sure that the community wants this.   We want to stay as permissionless as possible.

I think for what you guys are doing, you need to leverage real-world assets to increase liquidity, and I don’t think the market knows how to price this systemic risk into the system currently.  Synthetics are crystal clear about the risks of operating on top of Ethereum; but it depends on what the markets want. What will be generated through your protocol for portfolio building or something else will depend on what people what to use it for.

One of the challenges once you start down this path of incorporated permissioned assets, it is hard to wind that back or split that out. You almost need to make an assumption and take that leap. On the one hand, I hope they are right and that it works. But I am concerned like others in Ethereum that we lose this permissionless stablecoin to these permissioned assets.

You mentioned the bZx exploit that happened recently. Does composability leverage risk by building on top of each other?  Every system has vulnerabilities. Is there large systemic risk being built into DeFi through this product layer process?  People trying to steal other people’s money is a historical problem. I think what changes the narrative for DeFi is that we have not been as concerned about; the big difference is that people have always tried to extract money, people will do it. These people are KYC, and you know where their office is. There is a legal system you can fall back on that. In DeFi, we do not have that legal system to fall back on.  As privacy options become more widespread, this problem will only get worse due to the ability to extract value and zero recall to get the money back. If the person does a great job of cloaking their identity, then you cannot find the person or trace the wallet back to them.  You don’t have the same level of open warfare you have with DeFi.   I think it is a much harder problem to prevent attacks in DeFi and the attack vector is much bigger.  We need to be aware as consumers that we are in uncharted territory, and if things go wrong, there is no way to wind things back.  I think the challenges are much much greater in DeFi than in the centralised system when trying to provide security.   Off-ramp liquidity is the only thing guarding the value in Synthetics through draining the pool. The terrifying thing is that our large honeypot of a pool has not been drained yet in eight months, but there will be bugs in the system that we haven’t yet found. It does not mean we are bug-free or safe. It is a very hard thing to do; it takes a paranoid mindset to crystalise your focus on whether we are doing everything we can to protect our users and our platform. There is always a trade-off, and you start questioning your models and assumptions to make sure we are doing what we can to make it more robust against attacks.

What do you think of Flashloans? Anything that can happen in Ethereum will happen in Ethereum.  I guess on some level Flashloans will crash protocols and weed out platforms that are not robust or have weak points or bugs. In 2017, we were working under the assumption that getting a large pool of ETH was virtually impossible; now in 2020, anyone can pool up an anonymous pool of ETH through DeFi.  This will definitely happen now, and we need to be ready for this.  Ultimately it is a good thing, but it will be brutal.

We have talked about becoming a permissionless Bitmex, a system that allows you to leverage trading and the reality is, that as good as Ether is as collateral for trading, there is a lot more bitcoin out there. It would be foolish for us not to do this. We need to choose an implementation of a bitcoin bridge that is permissionless. If you introduce a permissioned system, it introduces systemic risk into the system, regulatory capture and other attack vectors become much more likely.  I would rather have a Crypto incentivised bridge rather than a custodian bridge-like BitGo. They are very different approaches to the same problem. It is not something that I would like to add into Synthetics.  I think people are working on it and it will happen.  Would it only be Bitcoin or would you incorporate other altcoins? Probably not. We would not incorporate other altcoins as collateral into Synthetics, to be honest.  

We have got a model for this; there is an enormous precedent for this; for example, there is XRP transitioning to ERC20 and Tether moving to an ERC20 token.   I am a bitcoin fan, but I don’t see how transferring a permissionless ERC20 tokenised version of BTC is not going to be a better thing or a better user experience on Ethereum than just using Bitcoin. If I was a Bitcoin maximalist, I would be worried or shouting at the screen.

I think this is a reality that will play out this way. If you own Bitcoin and you want to access RSK, if you want to use it as a payment system; you have to get bridged into other networks like Lightning Network. These are all done natively on Ethereum; with a couple clicks without a Layer 2 solution.  Because of the number of developers on Ethereum working right now and the amazing dApps, it ports liquidity over, and it opens up things that do not exist on Layer 1 or Layer 2 solutions on Bitcoin.  I think there will be a value gains for Ethereum over the next decade.  

I didn’t get the value proposition of Bitcoin in the beginning.  It was a couple of years before I got the potential of Bitcoin; it was not a eureka moment for me.