DeFi By Design EP#108: MEV, Restaking, & Rollups with Matt Cutler From BlockNative

Transcript

[Music] welcome to D5 by Design where we talk all things blockchain and cryptocurrency while striving to educate Empower and enrich what's going on guys welcome to episode 108 of the def5 by Design podcast our second rundown with Matt Cutler from block native going be talking about a lot of things that are happening in the ethereum world today um and some interesting Educational Concepts that I personally would like to learn more about and we've got just the right guy uh so what's up Rob how you doing GM GM doing well I just had some lunch so I am full and and ready to chat

I uh I won't take any more time before we introduce Matt uh who needs no introduction because he gave quite a a uh insightful one last time I think uh rattled off like seven or eight startups that were some ups and downs but ultimately we're we're here to stay so Matt welcome back to the podcast man uh you bet thanks for having me back great to see you Andy great to see you Robbie and excited to dive in awesome uh Andy do you want to kick it off I think there's some really interesting uh conversations that that we can we can get into and uh yeah go ahead first question yeah I think just what what was interesting is that we uh last time that we had this pod we were

defi slate and now we've uh jumped on the the scaling bandwagon um you know I would love to hear your thoughts as to if the if since the last pod we had maybe a year or two ago year and a half two years probably um yeah what how do you think the ecosystem is scaling from a from a TPS perspective and you know is this kind of the modular and rollup world that you were expecting from from that last pod I'm just curious well it in web 3 two years feels like a lifetime ago so it's like we live in a completely new reality that much is clear um I think that the There Was You Know Back Then There Were you know significant questions on what

was scalability going to look like and how we're going to get there I think the ethereum foundation provided a lot of clarity to have an L2 Centric uh uh scalability plan we've seen the rise of a couple of really major l2s you know largely with optimism and arbitrum but also you know matter lab ZK sync and now things like bass and and many more and and I think that the thesis is playing out pretty cleanly um you know there's still a ton of questions we're still very early in the cycle but uh net net I don't think there's any ambiguity around how ethereum is going to scale what it's going to look like what the tradeoffs are going to be and what I'm hearing out there is you know are are there going to

be a handful of rollups that matter are they going to be dozens or are there going to be thousands and most of the smartest people I know are are very much in the thousands or tens of thousands of camp and so uh it starts to get super interesting in terms of the diversity that's possible the um just the number of players and also the complexities that emerge from it um we always say like do you pay attention to where the food that you eat comes from you should because it's sort of What You're Made Of and then similarly do you pay attention to how the transactions you're doing actually get on chain and get confirmed because you should because ultimately um settlement really matters in in these in these systems and they particularly

matters as it relates to l2s and so uh the L2 settlement is complex because you have to settle first on the L2 and then on the underlying L1 and there's a ton of interesting questions surrounding that and then final point is ethereum itself is basically making significant upgrades to facilitate this with the next major hard Fork coming up probably end of the year beginning of next year called denb with uh EIP 4 844 Proto Dan sharting which is really targeted at making life easier and cheaper for rollups so um they're putting their money where their mouth is and and we're underway but there's still a lot of history to be written as I like to say yeah speaking of eips I think the last

time we spoke was around actually the merge I think it might have just been just after the merge perhaps but I know that you guys were super super excited about block building uh in this new proof of stake model um for those of you who are unfamiliar block building is like basically kind of what it sounds like the the process of building and creating blocks that uh are are finalized and settled on ethereum um obviously with proof of stake now that's what we have we have validators building blocks um in in the least technical way possible building blocks and posting transactions um and so I know that's what you guys were super focused on and you guys were making some some good

dough on that but what's going on now where's the where's the focus and kind of what have you guys been uh leaning into o over the last year so sure so actually quite a bit of change here for us recently so just over a year ago ethereum completed the merge it was on September 15 2022 um this was a transition from proof of work to proof of stake a brand new consensus mechanism but or brand new to ethereum I should say proven elsewhere um but along with the merge came a number of fairly significant upgrades to the network that that did not get quite as much attention because they're sort of less fundamental a little bit or a little bit harder to understand one of those upgrades was known as PBS or

proposer Builder separation what this did was break apart the roles of proposing a new block to the network from building the block so building the block is the the act of basically deciding which transactions are going to get included and in what order by the way as part of that you also can decide which transactions get excluded and PBS basically introduced the opportunity to Outsource block building to a a a network of independent thirdparty providers um with the reason being building blocks that are valuable which is what validators want to do because they get rewards based on the more value that's in the block is actually pretty hard it's it's hard to build blocks you need a lot of network you need a lot of compute you need a lot of storage but really you need a lot of

relationships um you need relationships with actors known as Searchers who basically uh are the Trader like entities that extract me me is known as maximal extractable value and it's the value that you can um gain by by manipulating and altering ordering and so uh the the thesis was that block building is going to be a specialized skill that um would be problematic for independent stakers you know one of you guys of the staking rig in your in your house you know machine underneath your desk that's sort of doing all of this it's going to be hard for you to compete for value for Block value versus large staking pool operators like Lido or

rocket pool or others that have a a large amount of economic resource that they could devote to this problem so the idea was look if we create an Outsource Network then everybody has access to valuable blocks and then larger entities don't have to build this capability themselves and that's exactly what happened today on ethereum about 95% of all blocks are outsourced and the reason why they're outsourced is because they're about five times as valuable as a vanilla block or internally Source block so there's great economic incentives for to do so at the merge we were given what we had done historically we work very closely with sort of real-time mempool data and we have Global infrastructure for that and we evolved into being a block Builder so at

the merge we uh started building blocks on behalf of the network and we started um relaying blocks or intermediaries between the validators and the builders and we really excited about that because um there was a hypothesis that being a block Builder would be this really interesting opportunity economically well fast forward a year and just last week we announced that we're actually suspending our builder in our relay and the reason for that is those economics didn't really materialize in the way that we and I think many others sort of anticipated um namely that the there's not a lot of value in being a block Builder because there's so much more value in being a Searcher Trader and so

the profits in Block building go to what are known as vertically integrated Searcher Builders so we're a credibly neutral provider we're not a trading entity for a whole bunch of reasons we don't have a big stack of capital that we use to make Arbitrage bets on and but there are a bunch of actors out there who are and what they were doing because they want to make sure that their trades land is they just became Builders themselves and so it turned out that the market for Builders evolved in a different way than we anticipated in a way that's much more verticalized and therefore more centralized than I think um uh folks probably wanted um and today there's a handful of builders that really matter um and in depending on

external circumstances there might be only one Builder that matters which is not great for the health of the network if that Builder doesn't like you they can decide to not include your transactions or that Builder has a competitive strategy to to you so they have their trades versus servicing your trades that they they could censor the network or things like that it's not ideal um but that's sort of where we are uh we as block native are a you know a venture back startup we're trying to build a real business out of it and after a year we've learned a ton um but we've decided that you know it's just not sustainable for us long term um to either operate a relay which by the way have no economics associated with it or to be a builder instead what we're doing is we're focusing yet again and what we

find in the current system is end user transactions are effectively second class citizens um largely because these large training entities are always competing for the the best settlement the the most valuable position in block and we don't think that's great for the long-term health of the network and and we have a lot of ideas and a lot of capabilities that can actually help regular users via wallets um compete for optimal settlement and so we're choosing to focus on the the areas that we really think are are most interesting and most relevant which are really uh helping users have observability in what's going on helping users protect their transactions from adverse settlement and um helping them get get optimal settlement wherever possible so you know we're continuing to work really hard in

the space we're continuing to focus on all the interesting challenges of me we're just applying our efforts in sort of a narrower area and we're excited to to do so in in conjunction with our wallet Partners so a lot of change out there um web 3 moves quickly and we have to move with it so that's that's the aot long answer to a short question but that's where we are yeah so it was mostly economical as far as the change goes you'd say yeah there were many factors that went into US deciding to make a change here clearly like the the dominant one was effectively our investors are financing the operations of the the network which which isn't great right like why are we spending investor dollars to make ethereum run

more smoothly um when we're actually providing you know value to all the various actors and to the network and network operations we sort of felt like it's a reasonable expectation that we'd be economically incentive to do so um that's not the case right now and so we basically said we have to find Opportunities where there are uh positive economics but there are other reasons as well um you know we're a us-based entity which makes us subject to um what's known as uh ofac sdn so the US Department of Treasury has a thing called the office of foreign assets control and they have uh this thing called the specially designated national list which basically if you're a US person it doesn't even matter where you're Incorporated but if you're a US citizen you can't touch that stuff the

the the rules are pretty strict it's $30 million per infraction and up to 30 years in jail and so you know that's something you really have to be careful of as a US entity and unfortunately just before the merge um the tornado cashmart contracts were listed as ofac sdn which basically meant for us we couldn't really build blocks that included those addresses because we'd be in violation of some pretty serious regulations in the US well there are members of the ethereum ecosystem who viewed that as as really problematic because that's censorship you're basically deciding who can get on Shan and who can't and so we wound up inadvertently sort of between a rock and a hard place um where on one hand we have us regulations we have to

comply with on the other hand we're trying to be ecosystem aligned and we're trying to square that Circle and and even after some pretty extensive conversations with ef cevs really found ourselves in a position we don't like to be in where where we really couldn't find a path forward that satisfied all the constraints and we really do try to be ecosystem aligned so it turns out to be cleaner for us to to not do these things I mean we were like 10% of the network uh in many circumstances and doesn't feel great to to say you know in order to live our values we're going to stop doing this for the network and we're going to contribute to centralization but that was sort of the position we were in as we look ahead we care about observability we care about things like everyone being able to see

what's really going on we're now a more credibly neutral player in that regard um because we're not building blocks and you know we don't have there's not any question as to do we provide different degrees of observability or transparency for our blocks or our transactions versus others so that's good and then finally you know we really do care about end user and end user sement I mean we we've been building an ethereum ecosystem for five years with the idea that we're building the foundation of the next economy and that next economy is going to be fundamentally better and uh more Equitable than the than the existing economy but when we have a a network which fundamentally biases towards Traders and for for Trader settlement at the expense of regular end

user it doesn't feel that Equitable it feels sort of like the existing system we have and maybe that's inevitable maybe there's no way to avoid that but we feel like we can do some things uh that are quite clever to actually help end users and sit on that side of the table and so that feels bit more values aligned to us so you know there are many reasons that went into us making this change the biggest one is we have to find economically viable things to do but that's not the only one by any means bare Market Vibes Rob what you got well when I first got into the space it was like you pay the highest gas you get the you get the best EX execution

but there is so many layers to it that it's no longer the case and maybe it never was the case um while while we enumerate like elements of this system I'm curious to like for my own edification of of like understanding some of some of these components in the ethereum machine um we hear a lot about sequencers now and back then it was a lot about about block builders so has has the model changed much or is this just kind of like a new term for the same old thing um that's a big question so so I think thinking and understanding here has evolved a huge amount so it's sort

of hard to dive into this without diving into me first so me I mentioned before maximal extractable VA value was minor extractable value with with the basic idea being Financial systems are fundamentally ordered systems meaning the sequence of transactions matter and it turns out whoever controls the final ordering can extract value from the system and and today me the market is measured in billions of dollars per year and it continues to grow so the idea is whoever whichever entity sits last in the ordering can extract billions of dollars by altering or selling the rights to specific ordering and and it's

it's pretty simple when you get down to it imagine there's an oracle update so chain link updates their Oracle and the Oracle shows that the price of eth has dropped a whole bunch as a result of the price of eth dropping a whole bunch there's a whole bunch of collateralized debt positions and maker and a and elsewhere that suddenly are under collateralized and available for liquidation and whoever goes in and basically handles that liquidation is going to make a bunch of money right the issue is there's probably only one person who's going to do it and so how do you become the one person to win uh all those liquidations and let's use a hypothetical example where there's $100,000 of liquidations available but there's certainly examples

where there's millions or tens of millions even hundreds of millions of dollars at stake well in the old way of doing things you might do things like spam the network with a whole bunch of transactions trying to get your transaction immediately behind the Oracle update right because basically want to do is the Oracle update makes the uh the collateralized debt positions available for liquidation and then immediately behind that right you uh you're the entity that wins it right but just imagine all of these trading Bots competing fiercely for $100,000 opportunity how much do you spend to capture $100,000 you spend a lot right and in the old way of doing things

everybody suffered these were known as pgaas or priority gas auctions and this is those circumstances for those of us who are around there where you had these crazy spikes in gas fees or all of a sudden it would cost thousands of dollars to get a transaction on chain and it might be because just a handful of bots were going at war at war with each other in the public mol going after these opport opportunities and everybody else suffered but at the same time well resource actors were sort of like hey this sucks you know what if I just bribed the minor what if I just paid the minor 50 Grand and I said hey I'll pay a 50 Grand if you put my transaction right here and there is evidence of that kind of thing happening that sophisticated mining operations were cutting back room deals

so that large trading operations could get preferential ordering not great Along Comes This entity called flash Bots uh they build a system to basically move all of this offchain but basically make it uh open and permissionless so now anyone could participate in uh this activity of bidding for um for preferred placement and and this how you do this is you do what are you submit what are called bundles and so what you basically do is you grab that Oracle update out of the mempool public M poool you put your transaction behind it you submit it with a bid and you say if you put these two transactions in exactly this order on chain here's what I'll pay for it so

it's a $100,000 opportunity I'm a Trader I say I'll pay 10 bucks to make a 100 Grand but Andy's a Trader too he says well I'll pay 50 bucks to make 100 Grand Robbie's a TR he'll pay 100 bucks to make 100 Grand and it goes around as you might imagine and it bids up pretty quickly to almost $100,000 to make a $100,000 and all of these systems are happening at every block uh in real time all the time this used to be called Meb gu in the proof of work dayss under uh PBS sorry under under proof of stake of PBS today this is known as Meb boost and all these various actors sort of participate to try to uh win these ordering opportunities and to secure nft

drops to uh capture sexex Arbitrage or ar between centralized and decentralized exchanges to front run and sandwich and other folks now in the world of ethereum L1 um the ordering is determined by the system called PBS well with the L2 they are generally sequencers right and so sequencers take transactions they various sort of sequencer architectures and I'm no expert about this stuff but they basic basically get um uh a transaction submitted to them and they order them in some sort of first received basis or some sort of gas price bases but again now you have the same problem where you're going to have some sort of opportunity you're going to have some ordering preference you're going to

have actors who want to take advantage of that because they can make a gain well what do they do well if the fees are very low they just Spam the network and we've seen you know ample evidence of that of transaction spam hitting these l2s as you know Bots try try to compete for opportunities you also have things like collocation which is there is uh there is a a time element to all of this meaning how soon can I detect that this there's an opportunity and how quick can I respond and it turns out that things like the speed of light begins to matter because based on where the sequencer is based on where your training bot is based on the number of network Hops and the distance you might

spend a couple hundred millisecond trying to figure out what's going on and getting your bids in while someone else says oh I have a a deal with the sequencer operator I happen to know that they're located in Edinburgh happen to know which data center they're in so I put my trading operation inside the same data center in fact I bribe one of the people at the data center to put my trading operation on the same network segment maybe even on the same rack right because that way I'm closer to the sequencer and I can pick up this information faster than others can right and then again this is centralizing right because now you have some deep pocketed actor who can build the specialist relationship Who can capture these opportunities they make more money and then they can do more of this stuff

right you might have other groups that say oh we don't allow any of that stuff but there's hundreds of millions of dollars of opportunity of meev accumulating and maybe they take advantage of it or maybe it pushes on to the next block in that um uh in that rollup and so the reality is is you can't sort of scrub this stuff away there's no like wave your magic wand and it disappears um and there are very real implications to whichever architectures are picked whichever policies are picked because that determines sort of what the most um economically attractive set of actions are the general thing you want to do is you just want to make it open so anyone can participate you don't want to privilege the deepest pocketed or the best connected or the friend of the CEO

right um because again that's not great for uh the sense of in these networks so again a long answer to a short question but these are complicated issues that's for sure yeah it is I mean the incentive model for the sequencers is a little bit wonky right now because you know for example Bas is doing like $10 million a month just off friend Tech pretty much and why would they want to give why would they want to share that right and so it's like why would they so I think there's yeah that's been a a pressing issue in the rollup space but I've also seen other people discuss um other more prominent issues to further decentralize rollups and sequencers um so I'm curious if if you

have some other prominent and more pressing areas of decentralization for rollups and then I'm also just curious generally maybe you can tie these in together because it might be the same kind of issue with the economic misalignment is do you think that the rollup the business model behind rollups is is A+ a minus B+ C what do you think um again I may not be the best person to qual to categor so to comment on all this but just in general sequencer centralization is viewed as sort of a structural weakness for the rollup space you have one sequencer it's controlled by one entity it just creates all the conditions for um games to be played for

manipulation um and so there's been a lot of work into the notion of decentralized sequencers so you have multiple operators and multiple geographies but it's a tricky problem um largely because these l2s uh offer very short block times I think arbitrum is 250 milliseconds and so it's it's not an easy problem to decentralize that in a meaningful fashion across um operators in geography and and be able to do interesting things in under 250 milliseconds merely because the network hand shakes take that long sometimes um there is a lot of work in this area and most of the major um uh rollup operators have have road maps towards decentralization and there are specialist providers out there like

espresso and others who are working on this so I would say this remains this is an area of very active research and development and I think there's been a lot of progress in that so you know over the course of the next year I think one of the things that will be really interesting will be exactly how far do we get on the decentralized sequencer problem and you know how far into production they are um I would say that so far you know the the economic opportunities that seem to be presented by the leading um uh uh l2s like optimism and arrm are pretty interesting it's always tough to give something an A+ but it's certainly in the in the B+ to to a range for for that um in general what we see in these spaces is where

there is liquidity there is Economic Opportunity and so those those rollups that are able to capture significant economic flow like base um have real Economic Opportunity and so at the end of the day it's it's the uh liquidity is kind of a good gauge of engagement right it's it's the old metric like it's not so much do you build the tech it's do people use the tech and how do you know if someone's using your L2 well there's a whole lot of flow there's a whole lot of liquidity there's a whole lot of action on it there people who are building on it um I think optimism has done a pretty great job with their op stack and basically encouraging other builders to pick up their infrastructure and and set up their own l2s there's a

lot of traction there um and so in general I think that the L2 space is is pretty vibrant um and there's a handful of leaders I've mentioned a lot of them and there's a a large number of Challengers who are coming up to do interesting things um I mean I think one of the things that's interesting is will we see like a an app an app chain thesis here where each game will have will be its own rollup it'll be an island unto itself it'll be a very uh a simple rollup that's supporting a single application that will then need to you know the interesting question is how composable will it be with with other stuff that's out there you have a cross rollup or cross chain um complexities that associate with that but maybe provide a really simple really

fast really cheap way to have onchain transactions for your favorite multiplayer game right um and so I think that all of these uh ideas are being tested right now and it's it's a great ecosystem play and by ecosystem it's like let the strongest survive right all the ideas are going to get tried some of the ones that succeed might be surprising uh there'll be others like the the five-legged mammal that that don't succeed because it turns out that the ecosystem can't support them and that's fine you wind up with four-legged mammals right um and so you know we're in sort of this um Cambrian Period of experimentation uh it's interesting that it's happening during a bare Market because it shakes out a lot of the noise

um and so the best ideas rise to the top and I said this before but I'll say it again it seems too early to call winners and losers yet um and it does seem to be that there's some a lot of good ideas that are are being pursued and a lot of positive progress being made I like the Cambrian uh analogy uh and I just looked it up because I had heard that before but I it I wasn't really sure what it meant and it's the explosion of diversity at the beginning of the uh what is this the metzo era no the p ioic era of dinosaurs saw an explosion of biodiversity and maybe that's when five

Le legged mammals were were able to exist in the ecosystem so I take it like you know we we've already seen um a Cambrian explosion with the l1s back in 2017 and the sentiment back then seemed to be these are ethereum killers there's going to be one that survives we kind of realized that's that's not really been the case but a lot of them a lot of them have fallen off so now we're kind of seeing this again this like explosion of innovation that's happening in the L2 space and the rollup space and the thesis seems to have changed it seems that now there is enough room for all of these to survive whereas in the past maybe we weren't so sure um so I I think

my my question here is what what are the missing elements in the rollup in the L2 space now to ensure the survival of the most successful rollups in l2s um so it's interesting l1's basically have to to bootstrap their own Economic Security right and so you have Bitcoin which has this huge Head Start because it was the first right you have all these mining machines which are deployed against it and so you have this pretty massive basis of Economic Security on the Bitcoin blockchain um ethereum is an alternate proof of work system you know you got to realize that that ethereum came out of the Bitcoin

Community um you know the Bitcoin Community is a fundamental bet on sound economics and there is a bunch of people in that Community who wanted to push the technological barriers wanted to be really um a pro-innovation and when they realized that the the core of Bitcoin wasn't really interested in pushing the technological boundaries they split off and and formed ethereum um and so ethereum has this interesting Head Start in terms of the intellectual Capital you have a lot of um really smart uh um uh computer scientists cryptographers um economic incentive game theoretic folks and and others who have been you know gravitating towards the ethereum ecosystem and now you have this massive research Community surrounding it ethereum stood up a bunch

of computers got a bunch of uh folks to to get behind it and you had some economic security there there was this time where there were you know 12 great Engineers who had a better consensus algorithm who had a different approach and they stood up other l1s and they said hey we're going to compete with that and there are a number of l1s that are relevant that have that have real flow on them but when ethereum switched to the merge and uh to proof of stake uh the total Economic Security available on ethereum went up dramatically I think today the number is I don't know 3540 billion dollars of total Economic Security and that gives it a lot of heft it's pretty hard to move that much Economic Security someplace else it's

also quite hard to stand that up someplace cells now l2s are something else entirely because l2s inherit their security from the base L1 this is what makes ethereum so attractive as a as a home for l2s because you can inherit $40 billion again whatever the number is right now of Economic Security underneath it so uh you don't have that same cold start problem you have a you have a different set of problems and so the L2 uh ecosystem Evolution I believe will be quite a bit different than the L1 ecosystem Evolution because you have ethereum as this very rollup friendly um environment with a ton of Economic Security as part of it now basically what needs to happen with

these l2s is they need to offer capabilities that are um that you can't get on the L1 because you there are some trade-offs associated with it like ultimately you settle down to the L1 so generally they offer things like faster block times and they offer cheaper transactions right and so uh the that that turns out to be pretty attractive depending on the sort of application you're trying to deploy and then what these l2s do is they try to uh attract um you know developers to to build on their ecosystem and it's interesting to look at sort of the top protocols the top applications and see you know they're available on ethereum L1 but where what l2s are they available on um

because that's where the users are that's where the liquidity is um and then you start to see well what new application are being stood up specific to various l2s so what are applications that you can only find on optimism what are applications you can find on bass right Bas has a pretty interesting example in frch you know frch was sort of used as a um case study as a as an example of the sorts of things you could do on the Bas blockchain and friendtech is exclusive to base right now I'm on friendtech hey bu me I'm at M Cutler um uh but at the end of the day you know the the most most of these l2s are evm compatible they're often address compatible so you don't even need to

change anything um you just need to deploy on those um l2s which makes it pretty easy to add support but you know it's not so much about it's not just getting up on the L2 it's about supporting the L2 moving forward and maybe there's certain assumptions that you make about ethereum L1 that are different over there or you know that things start to work differently and now it becomes more more costly as a development team to support your application in these multiple locations it also gets more confusing for your users because was I using the application on arbitrum or was I using the application on ethereum or was I using it on optimism or base right if I want to move my assets between them am I able to do so how does that happen what

are the risks if I'm part of a a challenge like a fraud proof sort of thing what's what's that mean what are the assumptions and so you do get uh additional complexity that gets put on both the teams and on the end users um as they go down these various paths it's it's not a Panacea it's not something for nothing it's always a tradeoff um and so I I you asked the question around what's missing and I think that you know in general the infrastructure is emerging the the developing the developing the developer tooling is emerging um and you know the uh the the the um uh best practices are emerging as well and so I think everybody's in this

period of experimentation trying to figure it out um I think we'll start to see examples that really work that people can look at and learn from and say oh they did it this way I can do it the same way again or they use this tooling and they can do it the same way um it's very relevant to us at block native because we are very actively trying to build sort of Next Generation observability infrastructure for ethereum L1 and we are right now um uh actively submitting grants to other foundations to say hey we have this Grant from the ethereum foundation to build these capabilities into ethereum L1 we think it would be in your ecosystem's best interest if the same capabilities were available for your L2

um not by the way unlike sort of what ether scan does right and so um you know basically part of the tooling infrastructure the uh the picks and shovels if you will so all of that still um still coming out is probably the best way to put it but there's a lot of teams like ours who are pursuing in these opportunities yeah awesome yeah that's uh it's very interesting takes I think um I think we are almost ready for uh like onboarding a ton of users like I think the whole pwa friend Tech was mind-blowing I I think um the l2s are there um but yeah it's still just being built it's exciting definitely far more ready than

2020 2021 So Exciting in that sense shifting gears to another um hot narrative pressing topic exciting one that a lot of our fan base and communi is excited about is is the whole liquid staking narrative and what's going on there um the the specifically I'd like to talk about uh reaking um so if you want to maybe provide us with your general mental model of the landscape of liquid staking currently if it's played out as it as you expected uh things things that you've notice Trends things you're excited about but generally we would like to that to take us into reaking and some of the controversies around

reaking so two related topics so liquid staking is you stake with a large staking pool like Lio which is the largest and you receive back a token that you can then do stuff with and you can buy sell trade you can um put into defi applications and uh and uh this has created a lot of it brought a lot of people into the staking economy because it it it's a lot more fluid it's liquid then just I lock my eth up and it sits there and it acrs uh an apy and then if I want to withdraw I got to submit a request and it gets put in the withdrawal queue and taken out it it becomes a lot more uh Dynamic um what's

happening with with liquid sticking in general is you can now move your Stak much or moving forward to move your stick much more fluidly between providers and so uh you know think about it like a bond market where you have various um uh uh yields and you get locked up into a bond and so you say okay my bond is at you know 3% and then a few weeks later there's a bond that comes out that it's 3.5% and you're like ah you know now I got to sit around and wait for my bond to mature so I can move it to the 3.5 the the liquid saking stuff allows you to move this between provid much more rapidly as you pursue maximum yield um this is great if you're an eth holder because it allows you to uh get

maximum benefit from that but it's problematic from the position of the network because it creates centralization if you have certain providers that are doing things others aren't doing or have access to trading entities that other don't have or there's some sort of other mechanism that's not explicit they can offer additional yield that all the stake will just flow to them and they'll get more economic resources so they can do more of that sort of stuff so there are concerns that you're going to have sort of fundamental centralization at the validator layer which will create you know conditions where you could have people could be maliciously attacking the network and you know Lio is probably the the best known because they're pretty close to the 33% threshold that Community has said very clearly they're

not going to exceed it but again it's like it's there there's nothing structural to prevent that from happening it's the the um uh ecosystem alignment of that community and there's a whole bunch of stuff there but I think in many ways liquid staking is inevitable and is good for users you don't want to put artificial constraints on um folks ability to move value around the whole idea behind these web three systems is that they're programmable value um and therefore you know the system should encourage Innovation should encourage experimentation but you know the question is how do we create economic incentives that don't pin us towards some negative outcome now reaking is a

derivative of this meaning imagine once I have staked my eth I can then stake on top of that again I can secure additional um applications additional protocols using the eth IOD stake it's basically like creating a preference stack so if you are a stup you have what's known as a preference track you have a series of investors that have put money in at various stages and in the event of a of a of an ass of a sale right you get you get acquired or something like that there's an order in which your investors get paid out depending on the timing of their money and this is all legally uh uh constructed when you do your investment so it's not like everyone gets paid out

all at once it's that there's a a stack of preference right the same is true with reaking where you can now layer things on top of your staked eth and your other staked assets and you can get more yield as a result of it but you put new constraints and you um have new rules and you expose yourself to new risk right so at the end of the day one of the fundamental rules of investing is anytime you're making yield it's because you're assuming risk somewhere that there's no such thing as risk-free yield um there is lowrisk yield uh the US government uh bonds are a good example of lowrisk yield but there's still you're you're basically the risk is you're assuming the US government is

going to pay off its debts which as we've seen with recent events that's not always the best assumption to make as you uh do these reaking applications you now create all sorts of complexities and all sorts of of um leverage uh uh among on top of the base underlying asset of ethereum and while this is perceived as good and and healthy in so far as it enables experimentation and greater Economic Security and now you can have folks who can build what look and feel sort of like alt l1s but aren't actually an L1 they're reaking applications right so it allows the um the the economics of ethereum to be much more fluid it also

gets really unclear what the risks are and does that introduce things like consensus and stability and are there brand new attack vectors that would result in people losing a so you get a few more percentage points of yield but you potentially risk you know very sign ific amount of of Stak ether underneath it and does that then create um you know lack of confidence in the system and so there's a pretty healthy debate right now around is reaking good or bad I think most folks in the ecosystem would agree that reaking is inevitable it's happening the um the number one sort of leader of all of this is an entity known as igen layer who's been quite transparent and quite explicit about you

know their work here and their smart contracts um uh and I think we're we're still at the very beginning of all of that that igen layer the protocol is live though it's sort of constrained right now but basically every time they've they've tried to open it up it immediately sells out so there's clearly demand for these Services um why because people want to to earn more yield which is completely understandable um and I think a lot of the researchers are trying to figure out you know what are the risks and and how do they interact with each other and how do we manage that so um like I said before I think that the history of reaking is is yet to be written um a lot of opportunity a lot of potential but also a lot of unknown surr it vitalic has written a bit about this

uh with respect to um I think Leverage is a great word leveraging the consensus layer um and and that for my limited trading experience leverage implies liquidation uh so if we if we leverage the consensus layer too much it's at risk of liquidation and then uh from the L1 getting liquid the security of the L1 getting liquidated in this sense implies that all the l2s that are based on not just based on but inherit the the consensus layer security from ethereum are are liquidated uh from that as well what does that look like like if if reaking goes so far Ian layer says screw it we're open open the floodgates

everyone reakes we leverage up the consensus layer to the gills what does that what does liquidation mean for the consensus layer well I think the the my belief is the answer is we don't really know and that's scary right that that as you introduce very high volum very high levels of reaking high levels of Leverage they kind of is no Foundation anymore it's the the foundation gets unclear and you can have bugs you can have attacks you can have shocks to the system that it becomes very hard to predict sort of what the outcomes are going to be and and that may undermine overall security it may

undermine consensus it may you know create all sorts of um uh nightmare scenario outcomes become theoretically possible right but that's one of the interesting things about these systems about l1s about l2s about reaking is they're very hard to model in theory they're very hard to model in test Nets because it turns out that that when you have real money involved and you have real econom you know you have geopolitical events and you have stock market crashes and you have you know uh labor strikes and you have risk of government default on and government shutdowns like it it it affects these complex economic systems in ways that are are not easy to model and not easy

to predict in advance right and of course you get a multiple of these events happening at the same time that then create all sorts of um wedge conditions or sort of pinch conditions right so I think this is from the EF core devs there's been a lot of writing about how uh there's so much complexity that gets introduced by reaking um that that equals a lot of risk and that that risk is not very well understood and in general when it comes to the base Economic Security less risk is better right um again from the perspective of the network that makes a ton of sense but if you're a eth holder and you can make 2% yield 4% yield 8% yield or 12% yield which one do you want

right or do you want someone in the middle saying you know what you can only make 2% like what do you mean I thought this was open and permissionless I thought I could do whatever I want so there's no um Magic Bullet answers here there's no clean way to do it I think the thing that most of the folks I know who are involved in is they just want to be really explicit about at 2% you're assuming one level of risk at 12% you're assuming six times the level of risk right and and that may be you know there may be much more severe consequences for that um and I think the concern is if all of the stake rushes to 12% assumes 6X the risk then there could be some real challenges for the you know the

base economic layer and therefore the security of the l2s but will really probably happen in these circumstances would be less of a catastrophic economic event and more of a real shaking of confidence where people sort of go Oh I thought this web 3 stuff was ready for prime time but maybe it's not I'll just sit on the sidelines and so I think that that a lot of what we're trying to do in the ethereum ecosystem is demonstrate that um you know we're reached a new level of maturity we've reached a new level of of of Sol of being solid and that institutional um funds can start to participate in ways that are are meaningfully interesting to them but also don't expose them to to unknown consequences that they're going to be

unhappy about down the line yeah you segmented it perfectly um I was just gonna say we've got this week we had the Futures ZF pass and this conversation has been entirely about ethereum and I know that you're you're uh very well entrenched in the circles of uh should we say humbly influence out there in the west coast of the states so what's going on in the Social Circles over there what's go what's your Vibe on the institutional flows um yeah what's the uh what's the uh big boy you know liquidity trying to do is it eth is it bin is it um you know are are are these things that these guys are thinking about are they considering

staking is that appealing too much risk um yeah I'd love to just kind of hear as we wrap up a summary kind of of what you've been hearing and what you think has been going on behind the scenes um well so among the Builder community it's we're in the still in the heart of crypto winter it's heads down and build um you know it's this is not a time of crazy token launches this is not a time of mass evaluation and big fundraising so it's very sort of heads down serious making stuff happen which is of course for folks like me preferable to the alternative um among you know it's it's always hard to sort of paint too BR of a breaststroke but um certainly the world of crypto has been on the minds of

institutional investors for a while now and in particular you have uh High net worth clients who are seeing dramatic yields right or seeing dramatic returns and they go to their existing providers and they say I want access to that and the providers say we don't touch that and they go I thought you were my financial adviser I thought you were managing my funds and you're basically limiting me um in this class of assets I can you'll you'll give me assets to raw materials they'll give me assets to you know access to real estate and to equities and to bonds but you're not going to give me access to digital assets well I guess you're not my my wealth adviser anymore I guess you're not my my my financial partner right and so I think many of the large financial institutions realize that for them to

service the needs of their clients they need to be conversent in the category no question about that pretty much universally they've all stood up teams they've all uh begun experimentation and I think what they're seeing is encouraging right that there is growing regulatory Clarity there is sort of growing stability in the markets there is a small number of players or small number of asset classes that seem relatively solid relatively serious relatively investable and the Smart Ones are going in and getting Hands-On so um I I am personally aware of some very large uh uh players who are very actively working on staking projects right whether it's themselves or through

partners and the reason is not because they want to drive a whole bunch of yield the reason is because they really want to understand the problem very well and they know that if they're going to incorporate this in their operations or they're going to advise their clients on it they can't do it from the cheap seats they got to say hey here's what we did internally and here's what we know and here's what we learned and here's what we recommend to you so I I do not anticipate massive inflows or sudden shifts but it seems pretty clear from the Black Rock ETF filing all the way down that the the largest financial institutions are paying attention um are interested want to do relevant things and are doing the homework right and that I think is long-term bullish for the category um it's just going to take

a little while to get there so uh we also we didn't touch on this but you have things like EIP 4337 um which is or not EIP ERC 4337 account abstraction which makes this stuff much easier to use and you know theoretically and I've talked about this publicly your credit card could become a crypto wallet with its own private keys and you can do all sorts of super cool stuff about airdropping nfts into Visa cards that are on file at Spotify based on your listing habits right so like suddenly things get super cool I wrote a long form post about intense today and it's just like I this offchain onchain combination of intense

is just like boom yeah there's a lot there's a lot happening and again I think this is probably the best thing is building making things easier making things you know uh more attractive to get involved in and um just taking this all seriously not being you know crazy pump and dump or or you know crazy speculative I think that's long-term healthy for the ecosystem and that's why we're still here that's why we've been building for five years that's why we plan to be building for the next five years when Moon any minute now any minute now dude thanks Matt thank you so much man such a such a fun time to just sit back and relax for almost an hour and just get school so thank you

sir you bet my pleasure and again thanks for having me on and uh looking forward to seeing everybody out there check out block native check me out on Twitter or X I guess it's called now um and uh let's let's keep building everybody bid build thanks Matt this was tons of fun cheers