We actually recorded this episode a few weeks back, so we did not cover the recent bZx events.
Bitcoin is only good for speculation. When DeFi came along, I saw a real thing that companies and people could use. For Bitcoin to become a stable currency, it takes more than a fixed supply. I love the technology behind Bitcoin. I look at what people and businesses want to use money for payments or for transfers. The greatest achievement was to create trustless, decentralised stablecoins which we have in DAI. If you look at how banknotes were created, for example, US dollars, they were originally backed by gold and the promissory notes is backed by the physical gold. That is what we are doing in the DeFi space. This banknotes structure happens online via collateralised dollars in DAI.
This step has helped like in traditional finance. The notes can be traded, and you can peg it to something. DeFi has this step now. It is self-custody. That is the cool part. Now those notes are being used to buy cryptographic tokens in DAI or Aave. I think this is the huge awakening: the greatest innovation to create dollars out of nothing in DeFi. Stablecoins changed the space a lot. This enabled us to build financial products on top of these. I hope we can go beyond the one billion mark. I am amazed by the speed of development. Maker was 2017; Compound was 2018, bZx and so many others in 2019. TokenSets is amazing; a socially-built portfolio. There have been so many products built in the last year. The custody and management of the portfolio is done trustlessly in Tokensets.
Does the MakerDao contract need to start integrating real-world assets into it to reduce the volatility of it? I don’t know. I have been reading a lot of articles about this. There are so many levels of ideology, economics and narrative here which is what makes the question difficult. Ether used to be GAS, and now it is programmable money, and it has many functions. What is interesting is that we are still in the Ethereum community, ETH is decentralised money in many ways. There is no such thing as trustless; we are building a trustless system, but we are not there yet. Ethereum is a trustless currency in the Ethereum blockchain; you are always trusting the community and the prospects of the whole.
The next question is what kind of value you want to have and how that value is controlled? For example, like DAO, which controls custody of those assets. We have real-world assets, and somehow the governance of those assets is derived outside the community, and then we go back into the old system. The simple answer would be to leave SAI as Ethereum-only trustless money and then to make DAI, as they go forward would become multi-collateral and bring on other real-world assets. Ethereum, in a broad sense, is a liquidity aggregator. The next logical step is to create these NFT tokens that are representation of real-world assets. One of the things that gives me hope is that the Ethereum DeFi narrative is so strong; in the long term, it may never take place on Bitcoin due to their scripting language. It would not make sense to have a lending protocol on Bitcoin or NEOS as you can just bring your bitcoin onto Ethereum on a one to one basis.
WBTC is just one example. There will be a winner takes it all. I see it like format wars which you see in Hardware. One of the interesting things in the network effect in the DeFi space is the liquidity effect. Everything is based on smart contracts. Big banks are trading with each other on a daily basis. This permissionless narrative can just basically grow to a limitless extent. I think those protocols that have raised billions of dollars; it is still looking better for Ethereum. At the end of the day, the liquidity goes where it is most trustless and secure. You can’t have scalability when you sacrifice security.
Moving to proof of stake: will Aave’s smart contracts be broken when Ethereum moves to PoS? Our Flashloans where the loan is taken and repaid in the same Ethereum block. These are atomic transactions. With Sharding, this will affect different protocols. As long as DeFi exists in one shard, outside everything else running on Ethereum, then this should work. It really depends on how it will be architected. From what I see, it will not break DeFi.
What is your overall thoughts on 2020? Will it be the year of NFTs? There is a new service called rocket NFTs. It is a very interesting project.
Running a lending protocol, have you been thinking about NFT integration or how that would work? The idea of NFT is just to tag something. We have many different types of loans. Do you need an NFT? If the credit risk is similar, then you might not need an NFT. We are trying to bring liquidity to a particular loan or asset, and you need to package those NFTs into a particular category. Maybe you have a basket of NFTs which are covered by ERC-20s or shares of these; that can be valued on the secondary market. Maybe this is already there. TokenSets has already done this; you can definitely borrow against these because you know the value. In less liquid NFTs, you need a bigger basket of NFTs to create a loan to value ratio so you could tell how much to trade of the underlying asset. I would love to see ERC-20/ERC-71 combinations with baskets to bring liquidity into the NFT game.
Credit makes the world go-round. DeFi is going to have to solve the question of how to provide under-collateralised loan problem with more than one transaction. You guys have dealt with this problem with your Flashloans. This is the holy grail of establishing a credit money system on Ethereum and is it possible to do this trustlessly? Or is it always going to need an outside reference or third party system? This is something I have been thinking about for the past three years. The way the current credit system works is based on trust. DeFi is trustless on Ethereum and smart contracts. How do we add those credit-based trust into the system? Is there an underlying rating that can be based on trust? I think the under-collateralised problem is solvable. We need to make a decision at some point about whether or not this is part of the narrative.
In theory, the loan needs to make sure the cash flows are coming in to pay the loan. Look at R-DAI. You can borrow against the cash flow and sell the collateral to clear the loan. Money is created from thin air. Someone is paying interest on what we all have in our accounts. The other person who sells the asset gets the principal, and my dad is the person paying the loan and the interest rate. You have to figure out more cashflow creating assets. Maybe the inclusion of real-world assets will allow this to be built in the future.
DeFi has the smartest people working in it, and they are working on very cool stuff. It will be very interesting to see when the whole space scales; when we get people with economics background, how all this composability will play out? It will be interesting to see how institutions will react. If you can get a 9% yield on your cash here; this will appeal to institutional investors, they will want to get involved. Protocols like Compound have the collateral composition there. These protocols have high yields now, but in the future, they will settle down and become more like money markets or fixed income products in the future with reduced risk. They will be more like derivatives. There are different layers of systemic risk and economic liquidity risk associated with these products, and there will be yields for everyone. It will be interesting to see how these different portfolios will evolve and the different entities that will come like hedge funds and hopefully in ten years time, pension funds.
At Aave, we have fixed-rate, fixed-term lending. Did you see this project called ROW at ETH Denver? It is like Uniswaps for interest rates. It is amazing how fast all the financial infra-structure gets ported over once you have the ability to build all this stuff. One project creates the innovation, and then another project builds on it. What we need is more developers in the space, and we need to better audit the security of smart contracts. You always see this constant innovation.
What is the thing about the developer community in Ethereum that makes it so innovative? The people are pushing forward collaboration and open-source ethos in the network. There were so many projects that tried to build value into the system proprietarily, not in line with the community value; this did not work. The open-source building on each other ethos of the community creates innovation, and this creates the network effects growth we are seeing.
We did our token generation event at the end of 2017. Our main net was launched in May 2017. We had an MVP out before our fundraising. Looking back now from 2020, would you still follow the same path for your project and fundraising etc.? In my background, I did software development in my teens and then decided to go to law school instead. I was inspired by Ethereum in 2016 and the concept of immutable transactions. I grew up in Helsinki in Finland. There was not the availability of capital here as there is in other places like New York or California. It allowed me a student from a small Nordic town to innovate and fundraise in the same way as other people in bigger places. This democratisation of finance was a good thing. There are now VCs who are taking stakes in tokens in these protocols to allow them to benefit from the network effect.
Did you know a lot of Ethereum developers then or did the fundraise help you meet people in the space? Our project helped us get more involved in the community. I would say that in the beginning, I did not have such a connection but now in the DeFi space we brainstorm and work with other projects to develop the space. I have seen the space and seen the growth. I have always been more interested in what is being build on Ethereum because it is way more interesting.
Does the DeFi space and the creation of this trustless money break us away from the surveillance capitalism we have created? What sort of advancements are needed to break away from this? Governments, central banks and companies that are designing monetary systems so they can track and monitor their citizens for law enforcement, taxes, for all surveillance purposes.
If you look at why we are creating this trustless technology, blockchain has always cost more money than centralised systems. If you don’t achieve this freedom from control of your financial life/your financial path, then we are not utilising this technology to its fullest. If we are not using DeFi in the best way but rather are using it in the same way we have used financial systems previously, then this would be very sad.
To achieve this aim, there are so many steps in-between. There needs to be privacy as Ethereum is public blockchain. There are several projects working on privacy and innovation now. There is a need for understanding and consensus in the space as to what we want aim for this goal. Sometimes it feels like people see DeFi as Wall Street 2.0; but if you want to create Wall Street 2.0, then you are just getting expensive interactions especially if you add boundaries and jurisdictions, liquidity pools, KYC, retail investor regulation, etc.
Blockchain technology could solve so many of these issues including custodial and jurisdiction issues; and if we don’t utilise it fully, then we vacuumed all that capital into the space and don’t deliver any benefit for humanity, then that would be sad.
People look at every transaction recorded, and they see transparency and openness; what I see is a great data source for people to come along and try to identify wallets/transactions/identities. Decentralised protocols you can scan every transaction to see what they are doing; in terms of centralised systems, you are trusting what they are saying. This is exactly what we are trying to get away from in building trustless money. DLT is there to verify the data is true. This is why it is a great tool.
Has anyone built on Aave yet? We have had some interesting things built on us during recent hackathons in SanFrancisco’s blockchain event. Arbitrage Down wanted to utilise FlashLoans to build their arbitrage products and easier transactions. Refinancing is being built on Flashloans as well. Every time there is a yield transaction for every transaction where Flashloans are used. Composability benefits protocols and projects building for the whole community as well as users of Aave.
What are you working on in 2020? At Aave, we are working on governance. So we want to ensure the open-source protocol we have governance and that we give away our power to the community. When you are building important things, you have to have something that has least control in concentration and decentralise that as much as possible. We are focusing on governance and improving our protocol. We are having additional rounds of security audits to make sure we have the securest protocol around in terms of smart contracts. It has only been 4 weeks since the launch of Aave. There is an Aave watch site made by the community. We are encouraging more developers to build on the Flashloan feature. They allow you to borrow capital without using collateral.