"Things Tend to Get Better. For Anyone Involved in Crypto, It's Obvious That This is 1,000x Better," 1kx's Lasse Clausen
Hello Defiers! In this week’s interview, I speak with Lasse Clausen, founding partner of 1kx, one of the most active venture funds in DeFi.
A typical VC question in the traditional tech space is it a 10x? Is it 10 times faster, better, cheaper? This concept has been dressed up very nicely as like, often with grand statements about making the world a better place, but really, Lasse says, VCs are subsidizing a market takeover. The real question they're asking is, can this become a national monopoly, where users are so locked in, that they have no choice but to use the product.
Lasse thinks crypto will crack this system open and that the paradigm shift is so big that there will be some networks that are really 1,000x improvement over the status quo. That's why his fund is called 1kx.
We talk about token-based business models, and how he prefers systems which aren't based in extracting value from users with fees, but rather on pushing the token itself to appreciate. In any case, Lasse believes token-based models are a huge improvement to the current system, as they provide a sort of membership into a digital cooperative, a way to participate in governance, and the potential to benefit as the platform gains in value. that's already better than free.
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Lasse Clausen: I was a software entrepreneur in Berlin and I was doing mobile internet startups and was or still am just a product nerd. And in 2012, I wanted to know what it's like to pay with a mobile phone. And at that time, the only way to do that was either in Japan and I think South Korea. Paypal didn't have an app yet and really, bitcoin was the only way to do that.
Bitcoins for Burgers
Berlin had the first place in the world to pay with bitcoin, the Room 77 Burger Bar started by this libertarian Texan. And so [being based in Berlin], I kind of had the fortune that it was relatively easy for me to try this out. And I came from sort of a product manager perspective. I wanted to really know what is the user experience of paying with a mobile phone and spend a couple of Bitcoin on a burger and fries. And so, what’s interesting also about this place is that it really was that early that there wasn't even a mobile wallet before and so people would come with a laptop and type the public key manually. So, really enthusiastic, very, very early Bitcoin people.
The first mobile bitcoin wallet in the world actually was built in Berlin. And it was great, you scanned the QR code, you punched in your pin , paid, bitcoin was fast and cheap as a payment back then. And I thought, oh, this is great, but I don't see them winning sort of mainstream adoption. And this is because something that we as entrepreneurs at those times, with apps with millions of users, really understood how difficult it is to get something in the hands of millions of users. Understand that maybe just another tap might be too difficult and too challenging and backing up the private keys and all these things was just something I didn't see happening.
“You scan the QR code, you punch in your pin paid, bitcoin was fast and cheap as a payment back then. And I thought, oh, this is great, but I don't see them winning sort of mainstream adoption.”
And on top of that, payment networks are even more difficult, because first, you need to convert like 80%-90% merchants. That for me, in Berlin, I wouldn’t bother downloading just another app just so I can pay. We actually had two projects in our portfolio that they're doing a terrific job at converting Starbucks and other companies to user payment network, but I didn't see the bitcoin core guys doing that, they were not going to wine and dine Starbucks. And I think we can still see that bitcoin itself is sort of struggling as a payment network.
Lasse Clausen. Image source: Twitter
And back then that was a narrative of bitcoin, that was peer-to-peer cash. And so, I thought it was great, but I didn't see it winning. And so, I kind of had this useless bitcoin on my phone left. At the end of 2013, I met Amir Taaki and heard about Ethereum from him.
And that really resonated with me, simply because of the fat protocol thesis. So, the idea is that in venture, you had to be really smart and be able to predict an individual application that will be successful. And I as an entrepreneur, I had really witnessed that nobody really can predict innovation and on average, VCs actually lose money.
And so, what resonated with me is that I don't even need to know what's going on to win on the application layer. If I invest in Ethereum and then decentralized insurance or maybe decentralized money or whatever it is, become successful on top of the Ethereum, then I will participate in the upside. So this is something that I learned: When you're young it's actually really nice to put yourself in a position where you can be pretty stupid and still be successful. And this seems like a very good way to do that.
“So this is something that I learned: When you're young it's actually really nice to put yourself in a position where you can be pretty stupid and still be successful. And this seems like a very good way to do that.”
CR: You just need to have the platform win and eventually, you're reading that one of the many different applications on top of this platform will become successful.
Becoming an Investor
LC: And this wasn't the case before. With the internet, the way to do that was buying a lot of domain names. That was the only way that you could sort of index-ize internet of information. And with blockchains, the unique thing is protocols are investable and you can, again just broadly bet on the Internet of value or the Internet of money is going to be a thing and then invest in the protocols that are most likely going to get the most developer adoption.
And then I was sort of actively watching crypto evolve, because I knew about timing and was continuing doing mobile internet companies. And then end of 2016, we had another hype cycle starting to form and my CTO and cofounder, Christopher, we thought maybe it is time actually now that we as application developers can build on top of blockchain.
We realized that was a little bit early, but this is all the sort of when we kind of refreshed our understanding of the fat protocol thesis and more things which lead us to formulate our thesis, got us really, really excited about participating in the space no matter any way we can move forward. We saw the best way to do that at that point was by being an investor.
“And with blockchains, the unique thing is protocols are investable and you can, again just broadly bet on the Internet of value.”
CR: Hay you already invested in Ethereum before this point or bought ether?
LC: Just bought ether in the ICO, never touched the wallet until 2017.
CR: Oh, that's nice. So, at this point 2017, you decided to become a dedicated investor in this space and move on from building applications?
LC: Yes. And so, what we saw is that, I think, when you've been an entrepreneur, it is substantially easier to be helpful to other founders than when you haven't been. I just think being an entrepreneur is exceptionally difficult. It's really a pretty difficult life. And it seems kind of glamorous and exciting from the outside. But 95% of the moments of an entrepreneur are really difficult. And we had one VC that had backed us as entrepreneurs that gave us the sense that he's always got our back. And when you have these sleepless nights and some sort of existential anxiety about your company, I think it's extremely helpful and comforting to have the sense that there's at least some people out there they’re going to go through this with you no matter what.
“When you've been an entrepreneur, it is substantially easier to be helpful to other founders than when you haven't been.”
And so that was our inspiration. As investors, and also looking at the space, especially in 2017, the average quality of investors, it was what it was, but it wasn't fantastic. And so, we really saw a wide gap of investors and entrepreneurs themselves that understand technology, but then also understand this new paradigm. Because on top of that, what we saw back then is that a lot of very successful traditional VC funds had a really hard time wrapping their heads around this completely new paradigm.
CR: Let me stop you there. Is this when you founded 1kx or did 1kx come later or was this a different fund?
1KX Beginnings
LC: 1kx started in early 2018. We just invested the private ether windfalls and then had some folks in adjacent spaces reach out to us and proposing that we start a fund and that we take outside capital. Namely, Passport Capital was the one that persuaded us the most and helped us a lot with setting up the fund structure. I think at that time, there was still a lot of confusion about how you best structure these things. Is it a hedge fund? But it shouldn't be because you're not trading, you're investing.
On the other hand, you have something that you buy that is liquid immediately and most of all active network participation. ETH2, if you don't stake, you're going to get inflated by up to 50- 60% a year, so you can’t just keep as capital. And especially what we're seeing now is that, really one of the most important things for early stage DeFi protocols is that you actually provide liquidity, that you stake, that you contribute. And this is in a lot of jurisdictions, a VC fund has big problems, because the tax treatment is different for operational companies versus investment companies. So, they can be funds that only have an investment mandate and they can't be operationally active which sort of all these things are, and then they fall into different tax bracket. So, it's very difficult for them to actively participate.
CR: Oh, interesting. So, what kind of classification do you fall under?
LC: When you have a fund like ours with a very, very broad mandate that is particularly offshore, then you don't have this classification.
CR: We talked a little bit about this before and I love your reasoning. Tell me about the name 1kx, what's behind it?
1,000 Times Better
LC: A very typical VC question in sort of the traditional tech web to kind of space was, is it 10 times better, faster, cheaper, right? For a normal user that has an app that's working and they’ve used it for two years, for them to switch to something that is better, it really needs to be 10 times better. The question is it a 10x? And we actually think that the paradigm shift of crypto is so big that there will be some networks that are really 1,000x improvement over the status quo. And so, this is why the firm is called 1kx.
“… for [a normal user] to switch to something that is better, it really needs to be 10 times better. The question is, is it a 10x? Is it 10 times faster, better, cheaper? And we actually think that the paradigm shift of crypto is so big that there will be some networks that are really 1,000x improvement over the status quo. And so, this is why the firm is called 1kx.”
CR: That's such a kind of bullish point of view on crypto. I'd love to have you explain that further, are we already seeing that? Are some of the services provided by Ethereum or Ethereum dapps do you see them heading that way? Are they 1,000 times better already?
Structural Shift
LC: We had this conviction very, very early on, because we're very intimately involved in Silicon Valley-style venture building and company building. And it's been dressed up very nicely as like, we want to make the world a better place . But really, the playbook is that you subsidize a market takeover with venture capital funding and you get to a natural monopoly or very, very strong technology lock in/technology dependence.
And this is very specifically, very surgically, is how you design the dynamics of these VCs companies. Can this become a national monopoly? And when you get to that stage, can you then pretty much —extortion is a strong word, but when you're in a position, is that you have a large number of people that are completely dependent on you and you can basically dictate prices in any way you want. And you can become this sort of benevolent, network to this really almost predatory, sort of extractor value out of an ecosystem.
CR: And is that what we're seeing, like with Google, Facebook, Apple?
LC: Exactly. I would make a point there. For example, at this point, there is no publisher that voluntarily gives Facebook anything. At this point, it's just pure dependence. We cannot get around Facebook. We have to do it. I think, this is with Google having 90% search market share is very, very obvious. Then you can see that now, Google is starting to push their own products.
Ultimately, the dynamic is company versus customers or suppliers. It's just how it will end up. The really, really big innovation in crypto is, yes, it's technology, but it's a structural shift, that you can now create token networks or the software networks that have the best worlds of being open source, but also have the sort of economic/capitalist incentives that for individual upside that attracts talents, that attracts entrepreneurs, but really gives you the design space to create a network and to create incentive structures that are more circular that keep the value among all the participants versus the typical company is, a board, a couple of founders and then passive capital that is extracting all the value out of the network via dividends or profit margins and dividends.
What we like here is that you can actually redistribute that value that’s accruing entirely to every participant. And so, in theory, these very, very powerful network effects that Silicon Valley companies also have of the first few years, because they're reinvesting everything they have into the network, you can actually now continue this in theory forever and in a very virtuous cycle. We do actually think that we might see some of these networks become bigger than any traditional company ever before.
“What we like here is that you can actually redistribute value that’s accruing entirely to every participant.”
CR: That's so interesting. I'd love to get more specific on this view. How exactly are these token crypto networks different from, for example, Google distributing shares among employees and just any user being able to own a piece of Google through its shares? Is that not kind of people being able to own a token in a network? Like, what's the specific difference that crypto is creating?
Shares vs Tokens
LC: I think there's definitely been some thought around it. Airbnb was saying, can we give the host some shares, basically become the members of the network. I think, there's a lot of friction around that. There's been some sort of, I would say, maybe benevolent attempts, but it hasn't really happened.
So, we specifically and we don't even see it necessarily, ideologically even. We just see that for certain things, it's going to be really hard for a typical company to compete with these networks. And so, there are really specific reasons. The first one is that token models they’re better than free versus a company where you pay every time you use it and the amount is really surgically designed to be as much as possible in favor of the company.
“For certain things, it's going to be really hard for a typical company to compete with these networks. And so, there are really specific reasons. The first one is that token models they’re better than free.”
Whereas here, you have a work / utility token. So when I have the token, it's almost for free to use the network. I might pay some gas fees, but the original reason the gas fees is actually prevent spam. It wasn't there to enrich anyone. On top of that, those gas fees are straight one to one passed on the miners. They’re not pass to, let's say, Ethereum Foundation or Vitalik in the middle.
At the same time, you are a member of this digital cooperative, you have the token. That's your membership token that might actually rise in value. So now, that's already better than free. On top of that, I think there's interesting experiments now with governance, where you get to actually have some sense of sovereignty over the network and very, very important positions. So, I would say that this model is already, is much better than free. And so, this is sort of Amazon's, your margin is my opportunity, really take into the absolute structural maximum. So that's the first advantage.
“You are a member of this digital cooperative, you have the token, which might actually rise in value. So now, that's already better than free. On top of that, I think there's interesting experiments now with governance, where you get to actually have some sense of sovereignty over the network.”
The second one is if you're a platform that requires a lot of innovation and experimentation on top, it's really impossible to compete with the sheer number of experiments as a permission system. So, I'm Apple, I want to be king and gatekeeper to my platform. Every app that goes through has to be reviewed for five days, there's a lot of friction. And on top of that, I have this incentive to monetize that access.
So people who pay professional ad space, etc. that doesn't compete in the number of experiments that are running on Ethereum. Granted from everything, the good to the bad. But I can be an extremely talented developer anywhere in the world with an internet connection and I can build something pon top of Ethereum and I don't need to negotiate, I don't go through preview. And most of all, I can create something really, really crazy that an editor and an app server will just not understand and would say no, probably.
This is the second advantage that these networks have is that in terms of innovation, permissionless innovation really wins, not because they're better or anything, it's just that the number of experiments that happen is just so much greater and innovation is a numbers game. The more experiments happen, the more likely you really going to almost maybe by accident discover something that is truly unique new use case. For example, in the App Store, every 10,000 apps, one of them is successful. So, it's just probability you need a lot of experiments.
“… permissionless innovation really wins, not because they're better or anything, it's just that the number of experiments that happen is just so much greater and innovation is a numbers game.”
And then the third one is that private companies or public companies are going to have a really hard time competing with is trust. So, if you want to build a very, very large network, you need buy-in from users, suppliers, regulators, media, people on the street, pretty much everyone. And trust in business has really steadily been declining over the last decades. People don't trust companies anymore. If you compare that to the 50-60s, were Ford, were these large corporations were these benevolent overlords and people were super excited and proud to work for, I think it's really started, especially with 2008 that faith in business itself really were shook and started declining.
And so, we just see that these open, permissionless, ownerless networks that belong to nobody and because of that to everyone. They actually have a much better time at harnessing trust on a large, large scale from the bottom up. I think the counter example is you can see Facebook and how immediately regulators very aggressively step in against that. That's not really blockchain. It's actually corporate kind of it's a company coin. And people don't trust companies anymore.
CR: Maybe the current environment we're living in now will accelerate that. People are trusting the system even less after what we've seen with COVID and Black Lives Matter and, you know, kind of whole uprising against police brutality, all of that, I think, people have become more aware of how broken some institutions are.
LC: Absolutely. And this is sort of the part of our thesis actually, is that the cost of trust is massive. It's around 35% of GDP. 35% of the economy is just to establish trust. That's auditors, doesn't even work with Wire Card. It's law enforcement, it's judges and all these things. And so, blockchains are inherently good at reducing that cost of trust almost down to zero, because it's also open source trust system and they're trustable and for the reasons that I explained before.
“Blockchains are inherently good at reducing that cost of trust almost down to zero.”
On top of that, that market for trust is actually up for grabs, because it's not just trust in business that is declining, trust in the US government is at historic low, it’s never been as low as now. Trust in every other institution as well, NGOs, media, NGOs or health organization, etc. So, it's really in line with what you're saying. And COVID actually massively accelerated this trend, that the faith in most institutions that we have globally is really broken. And our thesis is that we invest in that mega trend and that we think that some of these crypto networks are actually able to pick up that market for trust.
CR: These mega corporations ruling the internet now, they were built on top of this open distributed protocol which is the internet, but they were built as closed centralized for-profit businesses, because otherwise, it's not sustainable to build a social media company or to build a search engine. I mean, you need kind of incentives for people to stay building there, for the company to make money and for it to work, basically. That's why they're closed, centralized companies. And what the big disruption with blockchain networks is that the token itself provides that incentive and allows these services to be open and permissionless.
But I think there's still a question mark on how good these token-based business models really are. I guess it's too early to tell whether these applications or services can run in the long term with these token-based business model. I'd like to get your thoughts on that. What are some of the good token-based business models that you're seeing? Which do you think will be successful in the long term?
Token-Based Business Models
LC: Yes. But I think it's a very important point. Another way of looking at it is that we might not have definitive data yet on it saying yes, this is going to work for 100 years. On the other hand, we have over 100 years of data on the counter-argument, which is companies and where it leads to. That might help.
“… we might not have definitive data yet on it saying yes, this is going to work for 100 years. On the other hand, we have over 100 years of data on the counter-argument, which is companies and where it leads to.”
On top of that, you are seeing, I think the most sustainable or the most long term one is probably Ethereum. Where you had a distribution of 9% for the team, 9% for the foundation, the rest was sort of sold to the community. And that has been going for over five years now. And I think the Ethereum Foundation at the peak had like 90 years of runway. I think they also sold pretty well at almost a peak. And so, I think you have some early indicators that this token incentive model can be sustainable.
On the other side, what I also think some things to consider is that these networks or these protocols, they're not supposed to be like companies and for founders to fulfill their visions of self-actualization and be in power for like 100 years and run this empire. For networks the idea is that actually they’re protocols and after a while, they are owned by the communities, by users, by suppliers, etc. You don't want to build an empire and try to stay relevant for 100 years.
And then me having, not from the inside, but from the outside, as a startup founder, been involved with larger corporations. I think, few things I find more sad than these companies that know that they're going under and they're just desperately trying to stay relevant and you have these strategy meetings about how we need to reinvent ourselves. I think nature also has these cycles where things come, they were big and then they die off and create a space for new things. So, I would also say that, it might also be okay, that some of these protocols, they're not determined to have three founders and primacy for the next 50 years.
CR: But still, you need that incentive to work, right? You need that token to appreciate somehow. So, how do you get there?
LC: Yes. I think it is very, very simple. You have a scarce asset or you have an asset with sort of a predicted supply. Even if it applies for the next 10-20 years, you have a limited supply. And now, how do you have more demand than you have available free float kind of tokens. I think we've learned and this is what's great about the space, everybody is learning together very quickly.
I think really in 2017, there were a lot of people that really think Taco Coin was going to be a thing. If I want to buy tacos, I have to pay a Taco Coin and the market for tacos is $30 billion every year, then Taco Coin’s market cap should be $30 billion. Obviously, in hindsight, you see how confused that was.
If you just have a token that is essentially money and has a high velocity, which by the way, Bitcoin, Ethereum actually still are this, Ethereum will change, but Bitcoin still is that. It's just a way to pay the miner and then the miner sells it, because he needs electricity. He needs to cover the cost of electricity. So, it's actually pretty terrible token model.
Bitcoin has it as well, but it kind of reinvented itself as like a hodl meme thing. It's like, you hold it for the next 20 years. But the idea is that you have more demand for the core utility of the network.
The idea, is not just investors who are buying, this is actually people and other smart contracts that have demand for that functionality of the network, therefore, they buy the token and you have several tactics or dynamics to actually take a lot of supply off the market. And proof of stake is a very simple one where you're taking a large part of the tokens off the market and you're staking them. And so, instead of people spending money on mining rigs and electricity, people spend money directly and lock that up as collateral.
I think that's the simplest form is staking is essentially, you just lock up a lot of supply for the token. Now, most proof of stake chains in the more recent and might be Ethereum killers haven't really found anyone that's buying their token for the demand yet, so are they haven't figured out yet. In theory, this is the idea that you try to restrict supply.
Distracted Capital
The more recent investors in the space that have business background or finance background, they are starting to get excited about these cash flow models, where the protocol extracts some fees and then you can value it in a more traditional sense.
And I'm ambivalent about that, because again, you don't want a small number of token holders to get into that same dynamic as with companies before where you sort of becoming this distracted capital. You're just holding tokens, you haven't done anything, you're not participating in a network. But because there's maybe a fee and then a buy and burn or something, you just get rewarded simply for being capital that is passive.
CR: Is that what's going on you think with Maker?
LC: Yeah, Maker has this model as well. I think some of the DeFi projects as well, I think there's not fees in there yet. But I think some of the people that are buying the token yet, the governance token are sort of hoping that governance tokens will allow them to vote in some fees and then they’re back to the discounted cash flow models.
CR: That's basically Compound’s token right now?
LC: Yes, in theory. Nobody knows that there will be fees voted in. But I think, a lot of excitement around that is around that projection.
CR: To you that could go into a slippery slope of going to the same model as like traditional corporations?
LC: Potentially. So, I would say it's not a given that we all need to go down the cash flow models. I think, you could potentially go down that route. And I think, especially in this space, it just invites forking. Forking isn't as easy as it sounds. There is some sort of switching costs for an ecosystem, maybe an integration center that used to. But if you're just adding fees it's against your core incentive of a user. If I'm a user, I prefer to pay no fees, it's really that simple. And so that's why I would say, we maybe have some healthy skepticism around these kind of models, these fee models, whereas simply for the sake that we're seeing a lot of excitement around it.
“I would say it's not a given that we all need to go down the cash flow models. I think, you could potentially go down that route. And I think, especially in this space, it just invites forking.”
CR: To you, instead of having a platform that can add fees and generate demand for the token with that expectation that the token will be a way to access those fees, to you, you think a better business model would be one that, for example, incentivizes staking that token and then have use on the platform increased demand for the token and that will push up the value of the token and therefore flow to investors that way rather than fees?
LC: Yeah, I would say.
CR: I want to ask you about your focus on Ethereum itself. Because I've seen your thoughts on this before. And interested to know what you think about Ethereum versus Ethereum killers. Isn't it kind of safer for an investor to diversify on different smart contract platforms? Or why are you like 100% Ethereum focused?
Ethereum as Cornerstone
LC: The first thing we saw in 2017 already was that you've had a lot of ICOs, thinking that okay, we're going to build this and then they got to it and they realize, wow, there are some very central tooling that doesn't even exist yet. Then they say, okay, we're going to build it. We just raised $20 million, whatever, we'll just build it open source for the community.
There's just a lot of like tooling and infrastructure that needs to be built on top of these protocols before it becomes accessible for a very good set of developers. And I think this is easy to underestimate when you're not very technical in background. And on top of that, we are co-organizers of ETHBerlin. I think we've been to almost every Ethereum hackathon since they started and so, we really saw this incredible and very unique kind of developer community develop on top of Ethereum and unlike really few others.
And this is, again, coming back to sort of VC landscape, what I was saying at the very beginning. In tech too, you need to be able to predict what individual application was going to win in consumer or enterprise adoption. And I think everybody is bad at this, so likely we're going to be even worse at this.
What we were pretty good at or are good at understanding is what developers are excited about. And this is again, coming to the innovation part. Do a lot of experiments happen on top of a platform. And it was kind of pretty easy to see that Ethereum was really the one very early on. And it attracted a very specific type of engineer. They come in all shapes and sizes, they’re from anywhere, we kind of bring them in MIT and they're mainly intrinsically driven and motivated. They get really excited and pay out of their own pocket, tons of money to fly to Singapore, participate in a hackathon, sleeping on the floor, like all these sacrifices.
When you see something like that versus you know EOS is paying some enterprise developer to pretend that they're hacking on something over a weekend, it was obvious. You're going to run out of money eventually. But Ethereum had the opposite. It actually had people paying out of their own pocket just to participate in that.
“When you see something like that versus you know EOS is paying some enterprise developer to pretend that they're hacking on something over a weekend, it was obvious. You're going to run out of money eventually. But Ethereum had the opposite. It actually had people paying out of their own pocket just to participate in that.”
And so, it was really nice to see how this sort of evolved. And I think for us, a very, very important moment was instant Instadapp, because it meant the arrival of the UI layer. Early on, it’s all protocols. If at the end of the day, no entrepreneurs come in that are good at building UIs that allow you to interact with these protocols we’re dead. And so, this was a very, very great moment for us to see this team, I think are participating in ETHSingapore. The beautiful UI to interact with was sort of landing on Ethereum.
Anyways, and so we've seen this kind of Ethereum take the lead. We've taken very few Layer 1 investments outside of Ethereum. And I could see how these Ethereum killers how that narrative was attractive. It was simple. So, a lot of times, very simple investment narratives, they really worked surprisingly well.
Ethereum was worth at the time was like $22 billion or something at the peak. Ethereum does 15 transactions per second and some people were complaining that their CryptoKitties were clogging up the networks. So now, CryptoKitties should have never been on Ethereum. If I send something that's worth 50 cents, I don't really need a blockchain for that. So, blockchains are really for high-value transactions that need to be with absolute security and guarantee.
Anyway, so then come these people with academic credentials, saying look, Ethereum is worth $20 billion and does 15 transactions per second. We can do 1,500 transactions per second, hence, we should be worth more like 100 times more. So, that really worked. And for a lot of investors, I think the more recent ones that came in, it didn't really make sense to us that much, because, again, we understand that once you have a developer ecosystem, it's extremely sticky. Once you have tooling infrastructure, it's extremely hard to port that over. In Ethereum, yeah, you just copy it, EVM compatible, whatever, but it's just not the reality.
“We understand that once you have a developer ecosystem, it's extremely sticky. Once you have tooling infrastructure, it's extremely hard to port that over. In Ethereum, yeah, you just copy it, EBM compatible, whatever, but it's just not the reality.”
CR: And of those applications on projects building on Ethereum, which are exciting to you? Especially considering what you mentioned before that you prefer a model that doesn't add on fees and is not looking for this more like traditional cash flow model, so, considering that like, yeah, which applications fit this trend that you're looking for?
First Investment in DeFi
LC: Now it's kind of obvious that I think the space or the sector where the most product-market fit is DeFi. We started investing in DeFi over a year ago. It was mainly because it fit very nicely within our token network thesis. And I guess, we would say as former real-world software entrepreneurs, application entrepreneurs, we're very realistic about something getting usage from whatever segment of users. And I think, DeFi is great, because you have around 20,000 people and around $2 billion that you can, as a developer, as an entrepreneur, this is your first market you can tap into.
Now, before my mom does a few taps on her phone and deposit something into, I don't know, Compound or AAVE, I think that still a little bit out even though I think they’re doing a great job. And a really good example is Nexus Mutual. That was our first investment into DeFi.
It was also and I think generally, we like to invest in a way that we don't even have to be that smart to be successful. And so, Nexus Mutual was a bit of an index investment. No matter what wins, Compound, AAVE, etc., part of that value in these protocols is going to be of Nexus Mutual.
“We like to invest in a way that we don't even have to be that smart to be successful. And so, Nexus Mutual was a bit of an index investment. No matter what wins, Compound, AAVE, etc., part of that value in these protocols is going to be of Nexus Mutual. ”
If the total value locked up in Ethereum and DeFi grows, so do the contracts sold on Nexus Mutual. And yeah, Nexus Mutual has a token model, there's no fees in there. There's that sort of token holders take and sort of extract out of the system. You have stakers, they get part of the cover. When people buy insurance, 20-50% go to the stakers. So, people who've absolved the risk and sort of identified those contracts as insurable, but also taking risks in case things go wrong and the rest basically goes to the capital. And so, you really have this and entire value of this network really close to the token holders and the participants.
CR: You're right. I mean, if Ethereum and DeFi continues to grow as it has, you want more insurance, you'll have more demand to protect yourself.
LC: Yeah. You can see this, I think it's one of the strongest product-market fits in the entire space. It's constantly sold out. Insurance mutual at the beginning is it needs to be diversified. So, you probably need around 25 different products that people buy equal amounts of cover for and then you can buy a lot of cover. Aave, Compound, Balancer, I think Curve, they’re constantly sold out, so people are constantly trying to buy more insurance than what is available. So, I think that’s a very bullish signal.
CR: What other big investment in DeFi have you made?
Uncollateralized Loans in DeFi
LC: Another one that we're very excited about is Opyn, which is basically options. Another one is Future Swap which is also extremely exciting. So, I think one of the biggest money centers in crypto are really leverage trading in futures exchanges. I think then honestly a terrible tax on the entire ecosystem. They are unregulated, I'm not a proponent of regulation, but it's basically, nobody knows what's going on in the hood, BitMEX goes off at the worst of times, more or less convenient for them or not.
Other futures exchanges were the operators trading their own book, they’re insider trading, I mean, absolute red flags everywhere else. And so, I think, there's demand from a global audience that loves to do this. And at least again, we think if we can create an open-source, transparent token network where all of this value accrues to everyone who participates versus someone below in a shark tank then I think that's good for the ecosystem. I think that FuturesSwap is very exciting. Another project is the Union. So that's an attempt at under collateralized lending.
“We think if we can create an open-source, transparent token network where all of this value accrues to everyone who participates versus someone below in a shark tank then I think that's good for the ecosystem.”
CR: I don’t know much about Union.
LC: It's really interesting. It's something very new. At this point, we're all over- collateralized. And the criticism with that, is that really, it just benefits people who already have a lot of assets that they can sort of put up as bond. And generally, the tendency in the world is that you have few people with a lot of money and a lot of people who need capital and they have access to that credit and we haven't really been able to map that on the blockchain yet.
The way that Union does it is that you essentially have an underwriter ecosystem; people that, could be your friends, are vouching for you. It hasn't been on the mainnet yet. When I entered the Union, for that, you receive Union token. And then let's say I vouch for you for a certain amount of money and you have two other friends who do that as well, then you can completely under-collateralized for that money.
And that seems like very limited to our friends and we're vouching for each other. But it's really also imagined someone that just analyzes Ethereum addresses and says, because you're incentivized when, if you borrow money after I vouch for you, that Union inflation reward that I get, it actually multiplies. So, I'm incentivized to vouch for people that will also take the loan and pay back.
I could also see folks just analyzing Ethereum address system, that patterns that would repay and then maybe you send them a non transferable NFT or token and then should that address in the future ever apply for Union, I will automatically vouch for. It would have membership communities that have NFT tokens as part of the membership and you can say, hey, everyone who has this NFT in their wallet, I will underwrite that as well.
Basically, any data that you have off chain, it could be a bank, so bank could also tap into that. I think exchanges maybe, there are exchanges that have KYC data on folks and maybe some other transaction history and they think, for whatever reasons, they’re credit worthy, they can also underwrite them. So, it's very general purpose, leaving it all up to an underwriting ecosystem. And I think that's very exciting new step for DeFi to take
CR: Yeah, it is exciting. Yeah, I'm looking forward to seeing that play out. I think it is a kind of big missing piece in DeFito have uncollateralized loans, for sure. Because right now, it's kind of mainly for a playground for whales, which I think is okay in like the very early days, but we'll have to eventually move on.
LC: I think actually, it's been most markets actually have started out in the luxury segment sort of in the upper market segment for wealthier people and then have been made more accessible for the broader population. So, I'm not criticizing DeFi because it's just for whales. No, actually, it's an amazing experimentation space. And if you really think about it, it's fantastic that we have. So, when we were entrepreneurs and mobile apps, it was really, really hard to get like the first 5,000-10,000 users that really cared about this. And even when they’re broke, they would go through the effort of giving feedback. And most users, not only was something breaks, they just delete the app and that's it. They don't say a single thing. You just lost them and you never know why.
And in DeFi what's amazing, we have this large number of early adopters that is extremely keen and very risk tolerant. Imagine how much money people put into something just to try it out and then if it breaks, they will definitely let you know. Even if they complain, but that's a good thing. The problem is when people, they're upset, but they don't even say anything. And so, I think, this is a really special area of community that we have at this moment. And I have big confidence that projects like Union and many more will further make the market way more accessible to a much larger sort of population.
“And in DeFi what's amazing, we have this large number of early adopters that is extremely keen and very risk tolerant”
CR: I think it's a great point. DeFi builders are benefiting so much from having an outspoken and really active hardcore community of users at this point. Because everyone is really vocal about what's wrong and what's right. And I think because of the tokens, you create these highly engaged groups of people that are active and discuss on Twitter and do everything from creating memes to writing up long threads. It is a really special community.
To wrap up, I always like to finish with the big picture views on DeFi and crypto. I'd love to hear your thoughts on where DeFi is going in the long term. It might seem a little bit simplistic to ask this, but I still like to get this out there on whether you think DeFi will end up replacing traditional finance, because it is 1,000 times better or will it end up complementing it or I don't know a third option?
Replacing the Incumbents
LC: I think it will eventually completely replace it. I think it might take a long time. Something we're very realistic about is regulatory capture. And sort of, especially in the West. I would almost say, corruption in the US almost got institutionalized. It was that money is free speech and corporations are humans and you can lobby unlimited amounts of money to politicians.
And so, the anti-trust authorities in the US are completely toothless now and I think large corporations have completely captured the US political landscape. So, I really don't underestimate this. At this point, they're still distracted or still think bitcoin is stupid, and they just say bitcoin is stupid and they're missing everything else.
“A full scale regulatory attack on DeFi is, I don't think it's very likely, but something to kind of consider.”
But ultimately, I think over the long term we come from periods where you had a king and he would just come and take your horses and your wife and that's it, you couldn't do anything. And bit by bit over time, we've become more democratic, we have more access, more opportunity for everyone else. The world is slowly, but surely becoming fairer bit by bit. It’s made three steps forward, two steps back. It's not always linear, but I think we generally have this trend.
And I think if you look at all the shenanigans that are basically happening with regulatory capture, if you look at these recent bailouts now, how much money was again given to corporations with almost no oversight inside, so I think, over the long run, things do tend to get better. And this is very obvious. I think, for everyone who's been involved with crypto, it's very obvious to see how this is really up to 1,000 times better. It really is.
“Over the long run, things do tend to get better. And this is very obvious, for everyone who's been involved with crypto, it's very obvious to see how this is really up to 1,000 times better. It really is.”
And I think maybe it's a generational thing. I think, for someone who's grown up with crypto, it's going to be really hard to have any understanding for this typical bank kind of terms and conditions of a loan or credit card statements where there's 20 pages of fine print that is literally printed in the tiniest font possible so that in your computer you don't read it. I mean, right when you grow up in a world where that is not normal, you just absolutely won't understand it anymore and you will have zero tolerance for it. So, I think it might be in the worst case really, you need millennials and kind of Zoomers to be in the driving force. But yeah, no way you're going to put up with this.
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The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money.
About the editor: Camila Russo, is a financial journalist writing a book on Ethereum with Harper Collins. (Pre-order The Infinite Machine here). She was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. She has extensively covered crypto and finance, and is now diving into DeFi, the intersection of the two.
