The State Of Crypto Lending | Membrane Labs

Transcript

I think we had sort of the worst in the last cycle the worst type of centralization um in the space and I think it's better now what I mean by that is you had players like FTX and three arrows they were sort of put on a pedestal in the space where people didn't ask questions and they're just like oh it's FTX or it's three three arrows and so you had the worst type of centralization or counterparty risk in crypto where people saw them as like very creditworthy and yet if you actually looked under the hood there was kind of nothing there this episode is brought to you by ZK sync join the elastic Network today at ZK sync. i/m thanks to ZK sync for making today's episode possible all right everyone welcome back to Empire we uh very excited first off we have great guests James and Carson

welcome to the show thanks for having us thanks for having us yeah but uh not not as important as the guest but this is our first official inperson in our new studio at blockwork so hopefully more of these so we'll see how this one goes this is a nice test run it's a great Studio yeah appreciate it um okay so this is um State of the Union for like lend lending and borrowing in crypto leverage uh and the reason I wanted to do this episode is last cycle was very like a leverage driven cycle and I think we all a lot of us have kind of understand what Genesis and blocky and Celsius and FTX I really have no idea what's going on with the lendon borrow market now and what is look what leverage looks like in this cycle so that's what I want to do with this

episode maybe James I could throw it over to you to just uh refresh my mind like tell us about 20 PTSD I do which is why I need you to explain it not me tell us what happened in 2020 2021 and then with the the blow up in 22 like how did this tell me about like the cycle from a leverage driven perspective yeah I think I mean well even now I think most Cycles or a lot of the Cycles are driven by a lot of Leverage it's just a function of crypto you have a significant amount of Leverage taken on by retail and institutions and so we see that in the wild fluctuations in prices on exchanges and kind of the market so we see Violent moves up and violent moves down a lot of that is leveraging the system but

specifically to 2022 um you know terraluna one of our favorites you know just really had an epic blowup with a loss of uh credibility and a loss of um uh of uh support for its stable coin system and what you ended up happening is is you had a very strong over-the-counter uh lend borrow Market obviously Genesis the middle of it um among others um you also had significant number of retail lenders blockfi uh Celsius Voyager all taking in a significant amount of deposits and looking for yield you know that was kind of the the trend at the time and so when a lot of that money gets put into a system like teral Luna and then confidence is lost in that system and

there's a massive massive massive unwind well all the money kind of leaves out the door and whoever's left holding the bag is left with a significant number of losses so on the back of teral Luna falling apart we saw um 3s Capital go down FTX was a casualty of that Cel Celsius was a casualty of that Voyager you know so we saw all these dominoes falling and because of the interconnectedness of these markets and also frankly just a lack of um underwriting standards a lot of these loans had been made on promises and trust and not necessarily significant due diligence or any at all and so a lot of that and having that be kind of in the shadows led to a lot of money moving onchain in the form of tvl that ultimately was left holding in the bag

when something um like a lunaa blows up and you know obviously there's a lot of Carnage and collateral damage that that impacts the system and then a massive loss of confidence over the next two years you know basically into 2023 2024 when now we see London kind of take back yeah take back off Carson you were running I think tokomak at the time during this last cycle and then now now obviously running membrane um who were the players in the game then like talk to me about the interconnectedness between like a three arrows a Genesis a blockfi a Gemini earn program like how are all these players connect you know family offices hedge funds retail how are they all connected yeah it's a great question and I think just to lay on for a second to what James was saying and this links to your question um three

additional things that I think exacerbated the problem um were that all of these different uh lenders in the space were effectively being run as uh venture-backed uh technology firms so rather than being very focused on risk and underwriting standards there was pressure from the board as well as their investors to just write more and more and more loans um so they were giving uncollateralized loans um to your qu point on kind of these players and how they interfaced with three arrows there was a lot of concentration risk because three arrows was sort of seen as like a Goldman esque figure in the space where it's just like they're creditworthy it's fine like if you're going to try to write more loans they have infinite appetite for Capital just lend to them uh and so you had sort of this you know pressure to write more loans um you had

uh a lot of concentration risk in three arrows um which obviously went under post terraluna um and then additionally if you look at the operational standards that these plac had um even if they were kind of underwriting in in a positive way which a lot of them weren't doing um they were generally running everything in spreadsheets um is is what we've seen on on the membrane side we've taken a look at all the operations because we've tried to build a better uh solution for the lending market and most of these groups were using spreadsheets they weren't updating their ltvs uh in real time uh they weren't um Margin Call like if they were margin calling it was something that would happen once or twice a week with an analyst looking at it and maybe calling up someone trying to post more collateral so the situation

was ripe for that kind of uh collapse I guess um when the first kind of domino fell so you kind of had three arrows cast sorry you had teruna sort of cascade into three arrows getting wiped out you then had all of these groups sort of interconnected generally in an under or uncollateralized way so as soon as tell me about the flow funds like retail would give their money to blockfi blockfi would lend that money to Genesis Genesis would lend it to three Arrow so they could trade like tell walk me the how how a dollar moved through the sure so you can kind of think of of uh blockfi um Celsius to a lesser extent Genesis um as kind of retail aggregators so the way they get their capital or their deposits or kind of who's lending into them was generally retail so they're aggregating capital from retail

retail of course is sitting on um Bitcoin or ether in less uh maybe less likely scenarios uh stable coins they're looking to get 4% or something on that so they deposit in that gives them their supply of capital um and then a blocki or a Celsius goes and lends and they lend out some in some cases to retail um with retail they're Genera doing it over collateralized but then they'd also be lending out to the street and the street was meaning the street meaning the prime Brokers the crypto Street yeah the crypto Street yes the crypto Street inclusive of three arrows and three arrows just the amount and you probably have better ideas on the actual size but they were so systemic in this entire thing so when they went down most of th those were directly affected and if you trace it back it was retail Capital that was in

these uh these venues that then were being lent out to the likes of three okay so my understanding Let Me Maybe repeat what I just heard and if I got it right so retail person I've got maybe 10,000 bucks I've got 10,000 of Bitcoin I want to make four or 5% on that Bitcoin so I'm going to go give it to uh Gemini for Gemini's earn program or Celsius or nexo or blockfi blockfi says all right I'll give you 5% blockfi then takes that money they then give it to Genesis let's say Genesis and again I don't know if I don't know if Genesis is is the block fight here if then block fight is giving it to Genesis but then they or I guess maybe you could skip Genesis here they then go give it directly to 3 Aros who says I'll pay you

I'll pay you 8% or 7% because I can make way more than 7% a year with that money so uh blocki makes the 2% spread they pass 5% back to the retail three arrows does a bunch of stuff on chain and degenerate gambling and stuff like that because they think they can make way more than 7% but as soon as the thing that three arrows is investing in blows up or doesn't make money then then the whole thing Cascades back to the retail user who gave money to block is that right yep that's that's yes and you had folks like and we learned this postao but you have folks like um blockfi and others who were actually trying to earn yield themselves so it wasn't just lending it out it was also maybe doing basis trades if you recall that was the

whole grayscale ARB um there was a lot of you know basically mini hedge funds sitting inside of some of these depository institutions which is kind of what you know they ended up being um or in some instances a a Celsius would Outsource the asset management to a three arrows or someone else to earn yield clip a coupon um but yeah that's roughly what could go wrong go in hindsight in hindsight it's great what would we all think in he like yeah it's nuts like that we're doing this but um there's all this leveraging the system people are farming it doing the doing the basis trade doing grayscale giving a three arrows they're doing degenerate stuff uh teruna blows up or the the I mean the market starts to unwind what November 21 prices start going down that

hurt that hurts the initial group I would say then teruna blows up what may or may I think it was of 22 that hurts things even more Genesis Genesis blows up I mean then then the whole system's wiped tell me why it didn't remain isolated like it felt like the whole industry was so inter interconnected in a way that it shouldn't or maybe it should and that's just how Finance works and everything is interconnected tell me yeah tell me how you think of that yeah I'll start on that one so I think there's probably two two things that led to that result so one is that they are interconnected in that often credit as extended or these groups are actually lending between themselves so you can have like at any given point in time if you just take like blockfi genesis um Voyager that kind of Celsius that group

they're usually trying to find um end users because they're usually going to pay the sort of highest amount right there is another middleman so they're trying to find those um consumers of Leverage or those people to lend to but if they don't have that in the given time they might look between each other and say okay what are you in the market for so there is lending between these venues and that's sort of what made the entire Street with the exception of a handful of players like Galaxy um blow up right um additionally then it's as soon as like not only from teral Luna going under but also the entire I would say um Financial Street within crypto of all those players goes under all of the confidence is shaken to the core so everyone sort of retracts there's no leverage available in the system anymore

so now all the things that usually can drive token prices asset prices Bitcoin eth Etc sort of gets the wind the wind just gets sucked out of the sales there because you can't borrow anymore uh and you can't uh you can't sort of lever up and a lot of these things as you mentioned earlier in the discussion um are leverage driven in these Cycles so that's why everything sort of Cascades out you then have people even leaving the space where they kind of like pack up shop and go home a lot of groups um become bankrupt um and it also Cascades through to the end sort of hedge funds if they were consumers of that uh that credit and then their their lenders go under often they are impacted as well yeah I also think maybe the numbers were large but the players were smaller than

you know maybe it is today but I also still think um we still are in a highly leveraged market and I think you know crypto is very reflexive when the price is is is going up dramatically everybody is kind of I don't want to say lazy but they're content with you know putting on kind of similar trades that exist when only the Market's going up and so when everyone is in the exact same trade using the exact same leverage and then everybody's trying to get out that same door you know it's bound to kind of go wrong and that's why I still think we have violent swings higher and violent swings lower in today's markets cu the same dynamic are still there it's just you know we didn't we we didn't have an epic implosion as of yet um like a teral Luna you know that that kind of set set

things off yeah we'll we'll talk about later maybe the as of yet because I I do want to hear your take on where we go from here so um maybe the last thing on La the LA on the last cycle was um I've also done the same I've talked to like Risk Managers at the Genesis and block fights of the world it is shocking to me the um how they were running these things like I think if somebody I mean you you'd fall on the floor if you looked at the spreadsheets that were running several billion doll loan books um what what did you I mean just I mean tell us about this yeah it's so I this is where membrane was born yeah exactly we really ultimately um we built memory because of what we saw um or we built the lending capabilities on top of uh

kind of membranes netting and settlement technology because of what we saw there and that's everything was you know the the technology Choice was do I use a Google sheet or I do do I use Excel that's I'm like only slightly exaggerating here like everything was in a spreadsheet um things were being updated I would even say based on um loan terms changing they weren't always updating their spreadsheet so even they they didn't always even have a full um kind of view of what their loan book was much less the price and the sort of tvl or the collateralization of these things and with loans just because I've never really been in this game are there like contracts and you sending a doc you sign for for a loan usually or is it just like handshake deal yep no uh everything is is contract at least on uh then later

we'll probably get into this but there's you know there's obviously like back then was it yeah there so there's in bilateral OTC lending which is what we're talking about versus of centralized exchange or defi lending like a so an agreement between the two parties and that spells out everything how margin calls work how collateralized they are when like when you need to top a margin but the fact is then operationally they weren't really adhering to any of that they weren't updating the spreadsheets based on all this correct so they it might be that they started with 150% um uh collateralization uh they were over collateralized and then they're supposed to Margin Call at 110 and they might be at 70% and no one even realized it like because they just weren't updating these things or they had one person on the team that was managing that maybe also

doing derivatives trading um so it it was just under and and no Tech sort of support it yeah so Master loan agreements govern the bilateral lending relationship and the issue with these documents and particularly in crypto because I think people are trying to be uh overly conservative or at least now they are is that they're bespoke they're different for every single loan everybody wants a different um kind of uh clause in these contracts and so you know what I think and we can get into this later but what I what I do think is one of the um impediments to creating a more robust and liquid sort of lending market and what some of the defi protocols have done is the harmonization of those terms and and in this bilateral Market there's not fungibility between these contracts

so it's very you know you have these bilateral relationships that kind of Spawn like a spider web um as as in traditional finance and it just it creates a scalability factor for a um a market to exist in the Len borrow that's you know not quite there and that complexity is very difficult to program into software and and to Monitor and real time and and the complexities around it this episode is brought to you by ZK sync in 2024 ZK sync took a step toward a multi-chain future by transforming from a single L2 into an ever expanding network of ZK chains the elastic Network to onboard the whole world into crypto many specialized chains must be able to coexist work together and share liquidity institutions and Global

Financial leaders choose ZK sync for unmatched security scalable infrastructure better onboarding gasless transactions and privacy first design join Over 20 chains including abstract sofon and Kronos in the elastic Network today behind ZK sync is the ZK stack it is a On-Top platform for building private blockchains on ethereum the stack solves all the typical privacy regulatory user experience and deployment concerns of blockchain without compromising performance or security join the elastic Network today at ZK .io Empire thanks to ZK sync for making today's episode possible okay so give me the now that

we're what two years post blow up or two and a half three years post blowup what are the what did we realize what was the F what were some of the like fundamental problems of that MH like was it mainly focused on the tech was it focused that there was only a few small players was it that the lenders were Venture back companies and actually lenders probably shouldn't be Venture back companies like assess the problem guess yeah I think there's three or four uh issues one was was the Venture back nature not that they shouldn't have taken Venture money but the fact that they were being valued at Tech multiples and they were just incentivized to write more loans more loans and not consider risk that was one issue second is lack of of Technology um in order to track these things in real times and in order to um take more

margin take more collateral um when the market moves so they were you know writing these things in very uh uh volatile assets not just Bitcoin and e but TS as well and when those things took Dives theyed to uh take action the fact that they were also see a number of players in the space as more creditworthy than they actually are um was also a major issue so again that goes to three arrow and others um uh they were seeing that these groups like hey you actually don't need to post collateral at all you're three arrows it's okay for me to just lend you like $25 million and and I don't need to take any collateral well there even if they had the operations that could that could uh manage sort of the duration or the life cycle of the loan they still were were screwed effectively when when three

arrows went under so I think um all three of those things um exacerbated the problem I would say in terms of concentration that was uh some of it um but there really was a handful like right now we're actually seeing the market get built back up and kind of to the number of players there were before and hopefully Beyond soon um but I think those other three things were contributing more so than the yeah I think for me the main thing was just um a very weak level of underwriting standards I mean when at that time during that point of the market I was um at Galaxy now running the lending desk but running BD but was you know had visibility into it and a lot of people don't talk about it but um it was very well managed all the loans were over collateralized so no losses were really

taken during that time so if you were managing your book correctly and you had appropriate risk management um you know throughout your throughout your business throughout your lending business um you were actually okay and we also saw that in defi I mean defi operated exactly like it should because it had you know granted it might have been more violent than it needed to be because the auto liquidations but at the end of the day those were properly risk-managed either institutions or or organizations that um were able to risk manage appropriately so for me it was just too much leverage to too little creditworthiness basically and two things I'd layer on that um yes I think one of the big learnings too was that defi even though a lot of people immediately were like oh teruna collapsed like this was a defi issue I think during the the subsequent bare

market and when lending really dried up the one spot where we did still think C activity was in defi because defi really did function like it should have I think the the last point I'd make is I think we had sort of the worst in the last cycle the worst type of centralization um in the space and I think it's better now what I mean by that is you had players like FTX and three arrows that were seen as like um they were sort of put on a pedestal in the space where people didn't ask questions and they're just like oh it's FTX or it's three three arrows um that happens in traditional Finance maybe it should maybe it shouldn't but you you have uh Banks and institutions have been around a long time so they do have the processes and people um in internally in

order to kind of manage their risk and so you had the worst type of centralization or counterparty risk in crypto where people saw them as like um very creditworthy and yet if you actually looked under the hood there was kind of nothing there interesting okay um tell me about today so we're recording this start of March 25 who are the who are the players who are the who are the people borrowing who's lending who are the are there new block FIS and you know Celsius that popped up or people realize that that business model doesn't make sense who are the new funds that borrow the most like who are the big lenders yeah walk me through the like state of the market sure I I'll start and then you can go maybe deeper on this so I would say um since the kind of 2022 Market that we were talking

about tell today the answer was credit dried up in a big way the players were sort of gone um uh you had you had a few players like like Galaxy um that that did survive because as as James was saying they had better risk management um on their lending desk um but then um we've seen over the last year um new players step into the space there has been demand again for um leverage and there hadn't been enough sort of entities to or lenders to fulfill that need um and we're seeing a lot more step in so um to your question on who's filling the void of of Celsius and um blockfi and Voyager I think it's important to note that that their inherent business model was not flawed so um when we talk about who sort of steps into the the space um it's not

that that um is in itself has to be a risky Endeavor it was more what was under the hood and how they were operating um that was the issue but doing sort of retail aggregation of deposits and then lending out um is a great business model to get in and then is one that more people should get into um I think James can probably talk on more who's doing it one of the ones we've seen sort of step into that void and I think doing um things at scale and at uh in a much uh uh better risk management uh approach than what was done in the past is is len um and there's others that we're seeing now as well both kind of crypto natives as well as in in trafi maybe if you want to explain yeah so I think um in terms of

let's just break down the bar borrowers first I think we have kind of three main categories one you know and and they remain roughly the same which is the the first category would be sort of our individual borrowers that are long crypto um and they either want to get leverage or they need money for a work for working capital or they want to live their life and they don't want to take a tax sting um that still exists you know so centralized Finance Allah the exchanges are really servicing that area but also as Carson mentioned somebody like Alin um a customer of ours has really stepped into that space and grown dramatically because of all the the exits from that space um the second group of folks I would say are sort of asset managers and institutions that are trading that are Market making that um

want to get leverage for similar things to as they did in 2022 basis trade market neutral strategies want leverage on those um on those uh strategies um and then the third would just be you know Miners And corporates so you know and wholesale lending and I would throw into that actually um and and I guess it funnels into the second category but you know so you've got you know strategy borrowing from public markets miners borrowing from public markets but then you also have a big private market for Lending wholesale lending into the Falcon X's of the world the hidden roads of the world um and and and and and the centralized exchanges and so that's and they they prefer to do that because they can write a bigger ticket it's something they can underwrite and understand and you know there's available financials

for them to underrate they understand the business models um so that that was is what I would say um on the borrower side on the lending side you know we mentioned Lin and others have kind of stepped into that that uh retail side of the market the exchanges have ramped up their lending and still still providing leverage we've had new entrance come in um that I think are really interesting and I think a trend that we'll see is uh more custodians getting into the lending game we recently announced you know we're we're working with bito on their Prime offering um but we think that's just the beginning because there's conversations we're having with other custodians where you know they View um custody fees as not necessarily a race to the bottom but compression in price and so um what else can be done well

services around either trading or lending and otherwise and so they will need additional pools of capital to come in and we've seen um where regulation is much more uh defined like Switzerland for example there's been a bunch of Swiss lenders and banks that have stepped in that have come in to provide credit facilities uh to those folks um like Signum jumps out as a name there um and and um and so that's been kind of a big um you know basically what we've seen there this episode is brought to you by ZK sync in 2024 ZK sync took a step toward a multi-chain future by transforming from a single L2 into an ever expanding network of ZK chains the elastic Network to onboard the whole

world into crypto many specialized chains must be able to co-exist work together and share liquidity institutions and Global Financial leaders choose ZK sync for unmatched security scalable infrastructure better onboarding gasless transactions and privacy first design join Over 20 chains including abstract sofon and Kronos in the elastic Network today behind ZK sync is the ZK stack it is a One-Stop platform for building private blockchains on ethereum the stack solves all the typical privacy regulatory user experience and deployment concerns of blockchain without compromising performance or security join the elastic Network today at ZK sync.

iempire thanks to zync for making today's episode possible do you think um it seems like the lenders there's three big buckets it's actually the custodians who are fee compression they're layering we saw them layer on trading services in the last couple years now they're L layering on lending um then you've got the exchanges who've got all the capital with them and then you know they they layer on lending as well do you think that we'll see um uh traditional Capital markets players like the I don't know the Goldman or the JPS or the big PBS from the traditional World start getting into this game uh do yeah um well actually one one group of people we didn't mention that are actually really big lenders are the actual layer ones and protocol and

Foundations to go so that's that's another one that we we didn't mention so forgive me I skipped that but they're huge right giving loans to market makers um uh really kind of we can come back to the institutions let's actually double down on on this because I don't think people understand what this GS like so like when when a tge happens you have to L out your tokens to a market maker to make a market take us as as detailed as you're able to go on on what happens there yeah sure effectively market makers will need to be sitting on exchanges with inventory right because they have to actually hold cash to sit on the exchanges and there needs to be active liquid markets that exist both in defi as well as UNC centralized Financial exchanges so in order to do that they need inventory of the local token um

now there's been a bunch of advances that have made one-sided tge events and and liquidity pools possible um but you know historically the model and still exists to this day is a foundation will lend their token to a market maker it'll usually have an option embedded on top of that that that loan and the market maker with that inventory and and and some instances if the foundations um leveled up enough you know they're lending actual Stables right for for them to actually hold that on on the exchange and um yeah and there's a significant amount of kind of Leverage provided in that way to be able to provide double-sided markets on the various venues which care to that particular entity what does the option say uh so yeah I can I can dig in here

so generally these things have sort of two pieces to them and and as you would expect the foundations are usually the especially for kind of recently tge tokens um it's sort of the only place you can get the token so it makes sense that they're the kind of lender in the market it's generally a loan with 0% interest so it's um it's it's uh I would say strong-handed in favor of the market maker and then they usually have an option that depending on kind of the size and scale of of the um uh of the token project as well as sort of what the past financing history is of the project and and valuation um it may be in or out of the money in other words let's say the token's trading at a dollar um it may be something where they have a call option the right to buy the

token um at $2 or above and generally um it's an option where they need to make markets for a year and then after the end sort of that year uh year period Then They can they can exercise the option to buy the token so they're hoping that it goes above $2 they then exercise their option which lets them buy at $2 and then they sell it on the market at $5 now some which is the nice incentive the foundation likes that because it's an incentive to hit a certain price correct but then when we you know on the timeline if you see like oh winter mute is dumping it's because of this right because winter mute may maybe I'm not picking on winter mute yeah just as an example yeah yeah yep and to then to go to the other side if it's a foundation or a new token that

doesn't have much clout they often have to write ones that are sort of uh like give these options that are either at the money or already in the money so if they're trading at a dollar they might have to give ones that are at 75 cents and that's just a function of like who what will the market maker sort of take to do this to make it worth their time um and I know that today the exchanges generally also are taking more than a pound of Flesh where in the past it was like easier if you go back to sort of the last bull cycle right now it's something where if you're going to say the tier one tier 2 like Asian exchanges I think they are taking $250,000 to $750,000 either in cash or uh or the underlying token so it's this game that

they have to play Not only for Lending out for Market making purposes but also to even get on the the venues in the first place this feels like a short-term game that just can't last forever like right now if you're if you're a foundation right you have to give X percentage of your token Supply to a lot of the exchanges right if you're small exchanges you might take like 25 bips or something if you're like a binance you might take 5% or something like that or 2% or 10% even um and then so so that's one bucket and then the other bucket are these loans that are heavily favored towards a market maker feels like this is not the end game of how this should work yeah I think I I would generally agree I can't tell you exactly what it goes to next but I would

say that most of the groups I think um previously when defi was was booming um more groups were exploring doing more of their liquidity um over in the defi side so they would incentivize a Unis swap pool or sushi swap pool back in that um uh and the way they would do that is they would allocate a certain amount of their treasury again still in tokens but so that it could attract uh put a nice enough APR or yield on the actual LP pool and then they would do less um with market makers you're saying put more instead of going to the market makers create basically like a uni poool or something like that correct and I think at the moment the reason why you're seeing such um Market M Market maker and exchange favorable terms um uh for these deals of Foundations make it's just

because right now volumes on a trading perspective not necessarily lending but on a trading perspective in and defi are still very muted they're very um subdued compared to what they were last cycle with the exception of like you know uh 2024 mem mcoin trading in Solana but for governance tokens and Foundations um they kind of see that hey the where there is activity is on these centralized exchanges um and so I do think that over time some of that might go back maybe at least to a balance maybe it doesn't go up pure defi again uh and that should sort of balance out so that the deals are a little bit more um balanced between kind of the market makers exchanges versus the foundations and and token some of the innovations that we've seen at least in this cycle is more about and meme coins are all

about just single-sided liquidity you know you don't need to give out loans you can bootstrap liquidity um with novel pricing mechanisms and we're seeing that across defi so I ultimately yes I think the market self-corrects and most of it can live on chain um but you know until the market moves further away from CI and centralized finance and over into the defi world then you know we we still are kind of stuck in this world where if you want liquidity on an exchange you need the big market makers to to play yep um tell me uh maybe James going back to the question about institutions lending I'm curious if you think this will happen my view So when you say institutions lending you mean the bigger regulated Banks coming into the space and sort of and and non- crypto natives I would bucket it as yeah

I think um so let's take CI and defi so in in CI I think it you know we had seen some of these shoots in 2022 of um bigger Banks stepping in and actually lending against in very limited cases lending against uh Bitcoin coin specifically that's kind of where they're willing to play because um there was a little more regulatory certainty if you could even call it that at that time around that so they could gained some level of comfort doing that um what what really needs to happen is there needs to be um a global set of harmonized uh rules in and around um how regulated institutions can touch crypto physical crypto in order to uh lend you know to be involved in this market in a

in a much more bigger way other than you know regulated venues like CME Etc um at least to trade but also lending I think they're we're starting to see them now really step into this and we've seen that with um uh them recent announcements around uh custody services but I do think we're getting there as more and more of these dominoes fall into place in terms of um uh the regulatory regime and just getting Comfort around okay what am I allowed to do what am I not allowed to do um and then you know and then that takes us into Defi and I think there you know getting and and I think there's a difference between you know um systemically important Banks versus you know on the fringes and other asset managers that can kind of Step into the space um I think in defi the

big issue in terms of you know you know why would these big guys not want to be on a I think because there's a big pile of money there waiting to be borrowed right I you know a few billion dollars in there um uh one I think it's the kyc AML situation and and can can the market coales around um scalable products that enable folks to to basically signal who they are and have institutions get comfortable around that I think there's you know kind of Novel um novel things we're seeing around ZK proofs that might be helpful in that that that might lend in in in in that as well and then I think the second thing honestly which in my opinion is actually might even be bigger is it's very difficult for uh a major institution that has fiduciary

responsibilities to its customers to put $500 million worth of collateral into a defi protocol and then see a smart contract get hacked by the Lazarus group and then have that run off into the sunset and so I think there could be some interesting um Dynamics at play around how can we keep money on chain but maybe in a qualified custodian like what sort of interesting Dynamics can we can we have where money can feel in the same way that copper clear Loop and others have kept money off exchange I mean I know that kind of defeats the purpose no we saw with the buit and I mean this was a now 1.4 billion is a lot of money but it was drastically better because it was held in Copper clear Loop right exactly exactly for the folks that

you know had money um yeah exactly on the exchange and so that's what I I think we might be headed into that world unless there are some sort of security guarantees that can get there around insurance but really we haven't been able to see that may work yet and and I'd layer one more thing on to the traditional Finance institutions coming in so I would kind of separate it uh buy side versus sells side so meaning kind of the the banks and then the the funds um I would say last year in 2024 we had a number of groups again probably more on the buy side or or credit funds that were exploring coming into crypto lending but it seemed like they were um not quite ready to make the jump and we've had a number of those even in the first quarter of this year Circle back

to us um we're now I think with the the change of administration and what looks like some more clarity on the policy side hopefully incoming um they're willing to kind of jump in I think compare contrast that to the cell side meaning the actual Banks they're going to wait need to wait until there's actually the clarity so you know the the promise of upcoming regulations is not enough for a big bank to come into the space um but I know like right now the the stable coin bills for example that are that are making their way kind of through the the house and the Senate um I think that could unlock sort of the first layer of this um and then you might see more of these Fringe Banks come in than eventually the GBS so this episode is brought to you by token.com the social first platform

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next yeah I actually think this is like way more important than people will realize because on a personal level and at a corporate level so the reason it's and I don't you know I don't see anyone really talking about this and the reason it's important is because I mean like I went and applied for a mortgage right in 21 through through Wells Fargo how go I mean they my wife calls me Mr zero cuz Well Fargo thought that my I mean like 99% of my money is in crypto basically and they were like and I run a crypto business which they did not enjoy so they they basically got diversifi basic yeah right yeah not in 2021 I should have I should have uh that's not how I was thinking back then

but um but yeah they basically treated me as a zero because they're like yeah you got all this all these all Bitcoin and stuff but like we don't we don't treat it as anything and then at the corporate level like let's say um you know blockworks was sitting on 50 million of Bitcoin we could take I mean like let's say we banked with JP Morgan or or a Wells Fargo a Bank of America if we go to that we're like oh 50 million of Bitcoin super liquid you could go get out of it's a very liquid asset they're again treating that as zero right now but once we get uh once we get these regulations I think you could see corporate financing mortgages all that kind it's a massive unlock that nobody's thinking about I think huge unlock and just the fact that Bitcoin and eth and

stables and all these things are so liquid I think that they're going to when they get comfortable they're going to get really comfortable with it because they're used to L against things that they have to then shop around and they're liquid and yeah and so these things like even if they're volatile there's always a market for it yeah and people will pay a good amount to to borrow against yeah that's what we were saying is that we're starting to see a lot of really Savvy credit funds whether get spun up in the space or offshoots of larger funds because the yields are so attractive so obviously that'll compress and there's pent up demand so we'll continue to see more of that yeah um what are the how do you see so there basically defi CI and like OTC if you had to break that up into like market

share where's the market share today and how do you see that developing it's a great question it's a tough question only because um not everything obviously functions like defi so I think those are the right High Lev buckets defi obviously you can look and you can say yeah exactly x billion on a and then you look at Moro and and compound and all those things and you can total it up um on the OTC bilateral Market that's much more of a you find uh a couple different players for example um if this was back kind of when James was at Galaxy he'd probably have an idea then oh it was this size and then you sort of extrapolate okay there's four other big lenders and so that's how you try to get your your handle on but the the truth is that's a very opa Market no one knows

exactly those uh the size sort sort of of the bilateral OTC market and then the centralized Exchange Market generally is also very opaque except that you can see you often have a feeling for how many how much uh assets or how much uh how many balances are on a given um exchange and then you can do some sort of back of the envelope so I think the the general uh and it's changed I think in the past um like if you if you went through the uh the last bear cycle there was very little happening for bilateral OTC sort of until say say 2024 at some point um and then I think when we did some sizing we figured this was kind of like mid 24 that there was 50 billion is I think when we were doing some sizing exercises uh last year in the um so that would

sort of be of available um uh lending capacity in the OTC bilateral I think it's much higher now um because it's gone up um but at that time it was sort of um probably on the order of magnitude or or maybe uh sorry on the same order of magnitude or maybe a 2X to what was happening in defi um at that point time us alone we've done 5 billion in to give some yeahor you guys have done billion not lending so who tell let's go into membrane a little bit like I actually I should have done this at the beginning what what is membrane sure so so membrane is is basically an Institutional platform um for Prime services so um users can um use this to manage their loan books their derivatives books their trading books manage all the margin uh and collateral

associated with that and then it's linked down to the actual wallet um and custodian infrastructure so it can ingest those financial transactions map that into debits and credits and then people can actually um operationalize all of that move funds with their counterparties Etc through the platform so you can think of it as an Institutional operations um platform that either institutions can internalize and use it themselves or they can also um give a version of it to their clients as well um and so for example um recently announced with with bitgo their Prime Services is run on on membrane as as sort of the backbone uh to it for their clients got it so so money is not flowing through membrane it's the your fix ing hey back in 21 all the The Leverage was basically built up on spreadsheets now you're you're you're a

platform for that that's correct and then and then um uh you're right that none of the money actually flows through us they always bring their own custodians their own wallets their own venues but they can link that in this shows everything and then you're able to um sort of map in real time what the collateralization levels the health of the loans are and then people can sort of top up and and manage all of the uh the operations and life cycle of the loan through membran got it yeah uh 5 billion this year so far first 60 days 5 billion yes yeah of of of lending activity and is that OTC is that CI defi is it who's tell me more about that that's allot at the moment that's all who is borrowing and who is lending I mean it's everybody we've just talked about um on this podcast it's I need

names I I wish I could want people I yep addresses yeah yeah yeah home phone yeah no but I think I think and ubos it falls into the general categories we were talking about which is it's um it's uh retail aggregators it's institutions that are making loans to other institutions in the space it could be foundations making loans um it's all the above it's kind of what we talked about we're seeing Market the reason I ask is because I think there's this question of like everyone has so much PTSD of 2021 so everyone's you know we're already asking what's gonna blow up the cycle what's gonna blow up the cycle and uh so I'm curious how you guys think about that like because you see all the leverage so what what is going to blow

up the cycle yeah so I'll I'll say a few things with it so at the moment we see much more on the bilateral OTC side um and at the moment we don't have the full connectivity into like a and defi we will have in the future we're going to have more of that as well and then the centralized exchanges are kind of their own black boxes so I'll get to that in a minute but on the OTC side what I can tell you the the good news here is that we're seeing people generally with much better underwriting um capabilities meaning they are taking collateral this is you know rampant in in the 2022 crash was that everything not everything a lot of it was uncollateralized or underc collateralized here we're seeing mostly um collateralized yeah we should say we we probably do have adverse selection

right because people are coming to us because they want to apply higher lending standards so there's obviously lending going on that's unsecured UND secured it's just we see less of that probably than the average bear um but you know we we continue to think as markets get better and better we'll probably see lending standards you know as they typically tend to do drop just because it's generally people that are looking for better ways to manage their risk to then um use membrane now um to your question kind of on like where could things blow up I think or like what happens this cycle um I think in the previous cycle CI and defi were more disparate in other words like it was through entities that these things were connected and I think you have much more co-mingling of the concepts this cycle um so so things that are defi in nature

or rized into a stable coin but on the back end it's centralized um exchanges so I think the um the mixing of these things may lead to interesting ask you know I don't want to presuppose this and I hope this doesn't happen but I think there's um whatever does blow up eventually um you're going to have this like that yeah positive thoughts but but I but you did want to know sort of what could happen this and I think there's just it's it's a little bit more blurry this is separate from membrane and from bilateral OTC but I do think the line between CI and defi specifically has been blurred um in the space kind of uh more broadly yeah by the way not just crypto where there's blowups like uh yeah absolutely so we're going to say something else um yeah I was just going

to say in terms of and not that we're obviously rooting for anything to blow up but I think byit as a Harbinger for you know potential other foundational layers of crypto and seeing um you know additional security breaches that is an area where you know you just continue to it's like wackel you know so that that does kind of worry me particularly for institutional entrance into the space um because there's a lot of concentrated risk particularly in and around like ETFs and custodian providers and just you know hopefully that system you know holds up really really well um but um just concentration risk in and around that too yeah I I think bybit well um as you were saying the the copper clear Loop portion was was a success story but

just the general um shaking of the foundations again like I know um uh at a conference last week it was like everyone was talking again about uh about bybit and just about risk again which I think is somewhat healthy but it's unfortunate that it has to be that event to make people uh talk about that again who got hurt the most on bit was it retail or was it the foundations who had lent tokens them or who I I think and I'll say I think uh that actually it was bybit itself um directly financially because supposedly they had enough to cover like it effectively is just impacting their own balance sheet um but I think sort of where this I think it really just hurts sort of all the central really everyone because confidence is shaken and then I think um and I think honestly centralized

exchanges um I think probably there's a lot of centralized exchanges even at the same tier Maybe even better than by I can't say this firsthand but that probably have worse opsc even than than bybit like that was a very sophisticated um hack and uh and and yes should they have been using nosis proba or safe like probably not but I almost guarantee you that there's exchanges that use far worse operating um procedures and so I think it's you know not great for the centralized exchanges and in uh rightfully so has made everyone sort of skeptical again of this yeah but I would just say kudos to them for the way that they handled it I mean I wasn't that close to the situation but coming out in front being communicative you know we should only hope for when things go wrong that Community rallies around

folks like that and kind of steps up I think it also woke people people up to how much these uh centralized exchanges are uh printing yes I've heard numbers like you know three billion in profit a year like but it also it also you going back to the point that um you had made earlier which I I think is is very interesting in terms of bigger institutions coming in you know their comfort level with those types of exchanges is basically zero they're going intera with cpto Market of centralized exchanges we're going to see in our opinion proliferation of EC's dark pools and other places where you can um confirm and feel comfortable about the sanctity of the assets and maybe that's an area where we start to see green shoots and a lot more leverage

being applied there which um we're starting to see a lot more folks that's where the institutions are going to come they're not going to come to The Bu bits The Bu dances the world and the sanctity of who is borrowing corre this money right that was um I remember when compound launched institutional product and then a launched I think it was called a Arc yes and it's like permission Defi and you'll know who's on the other and they didn't work no one took to it yeah that didn't work um right now a lot of the uh but kudos to them for taking a swing because that's what we need that's what we do uh a lot of the lending borrow is over collateralized like if you look at like Al then um but I'm curious like the future of under collateralized lending especially like like onchain under

collateralized and like what what has been preventing this and what is needed yeah it's a it's a tough problem um because I think right now you have sort of these different worlds of of off fully offchain um uh and sort of the trust us uh uh model that usually happens in in traditional Finance where you have to just provide um you know balance sheets and all that stuff and then in crypto generally if they actually want it properly over collateralized it needs to be sort of in the smart contract so you need to sort of paint the paint between those two spaces meaning you need to allow people to show assets in a way that still has recourse in some way but without actually pledging them into a smart contract so if you can have um a model where the assets can be in someone's uh

wallet or custodian and Via Tri party or an account control agreement there is some recourse in the event of default then you can start doing under and uncollateralized I think you have thought yeah no I just think that needs to be linked up with um uh with the sanctity of how we hold assets but in terms of yeah so to to your point around um onchain credit I I think we need a lot more credit scoring the question is is if a lot of those assets live offchain um it's very difficult to to kind of get those things on the same page so I think you know hopefully as our waas as um other tokenized stocks as as things start to move on chain you'll have a better chance of encapsulating all the assets that could stand as collateral or all the assets that could

represent credit creditworthiness for a particular entity um but it's just hard at this point um to see in without it being Walled Garden because the issue you have is is that money is in a wallet but then in the next second it's not and so how do you kind of prevent that and there needs to be kind of guardrails and and um and and rules around being able to lock up particular assets and have recourse to them in the event something go sideway I was playing with this thing called ethos Network it's on base and you basically it's invite only and you get scores based on like how like how many transactions you've made on chain how like who invited you who you're connected with on Twitter how long your Twitter accounts been around how who who interacts with your like I actually

don't fully know what goes into the score but they give you a score and the first thing and then you can review people and then you can actually vouch for people too on the platform and then you can down rate people so I've seen people tweeting about it as like oh it's cool like it's kind of like Kito Yap score like V2 but the first thing I thought was like this is onchain credit for like for a lending platform yeah I would also say there's some interesting um uh there's some interesting developments in and around like for example what drift's doing where you have the ability to pledge assets into a vault behind a trading strategy and then the next step would be okay how do you verifiably prove that that entity is is actually executing those trades so almost like proof of trade if the trades are not

taking place on chain if they're taking place offchain you know how can you verifiably prove that this is actually what's going on under the hood um and you know and keep those assets um safe um and keep them kind of in a place that um you know ultimately at the end of the day when something goes wrong you can adjudicate sort of an asset seizure yeah what do you guys think of these vaults like Morpho vaults drift vaults like I like I'm sure a bunch of other people have vaults but it feels like that's where a lot of the retail will flow I know uh lein and Arch both have great platforms but it does feel like more flow will go into these vaults this year than than ever before what do you think of them and like what is the risk of these vaults um I think like everything

it's always the the actual protocol of the smart contract um risk but I think the core concept of vaults is very powerful um especially for retail like you're saying um because if for example it's an ERC 4626 then you remain composable with um with the rest of defi which is what everyone wants so they want to be able to take advantage of whatever the strategy is being run in the vault um and then still be able to pledge that as collateral elsewhere so I think that's an interesting thing that's sort of one of the models by which um membranes infrastructure more on the bilateral OTC side can also plug in there so if you get a receipt token from one of these vaults then within membrane as long as you can find a counter party that's willing to do it um you could borrow against um those positions as

well so I definitely think on the defi side vault um are and will continue to be the yeah what I what I find really interesting about those vaults is take for ex take for example a macro hedge fund you know you invest given uh an assumption of a given strategy but you don't actually know what they're holding on any given day and you don't actually know um if they're actually performing the strategy only postao can you but these vaults if there's a verifiable way to um look at trade history to understand what's actually going on in those vaults then there's real-time risk management around different strategies that are being executed or if you're a k and you're on um a centralized exchange is there a way to verifiably prove your trading strategy so that any of us could back anyone else that has a verifiable

pro uh trading strategy and they stick to it when once you know your money's out the door and you've lent it to that strategy um do you guys so I'm looking right now genesis's Q4 2021 numbers and they're just shocking it's 50 billion in loan originations 12. half billion in active loans 31 billion in spot volume traded 21 billion in doas traded so the two numbers relevant for this conversation are 50 billion in loan or donations again just in Q4 12 half billion in active loans do you guys think we get back to those numbers this cycle I mean I think as we talked about before um I I to to me it's entirely levered to um markets if markets can continue to be strong can continue to

you know perform well and we don't fall off a cliff which things have been really tenuous here recently um I actually think yeah I think no it won't be tomorrow but I do think that over time you'll have more and more money coming in more and more safety being provided to folks around you know how they lend um more and more uh providers stepping in like custodians Etc and so I think we can get that high I'd also be curious and I I didn't see anything recently but there's also publicly available figures for coinbase puts out a report s do Lin um that are are um that are really informative and I curious what those numbers are at the moment forgive me I don't know this off the top of my head but um yeah I don't see any reason why not um but I do think

it is contingent on the actual Market's behaving yeah I just to layer on that everything is it's such a momentum trading uh or momentum driven trading game in crypto um at least uh from the beginning up until now not a fundamentals um game and so as soon as markets go in One Direction um the demand for leverage and just lending exacerbates those moves so they're sort of the flywheel connects so as James was saying if it it it gets going on the price movement side um you're going to see a lot of that going I think you could blow through those numbers um that Genesis was often seen during that time like you'd take that and you'd put a multiple of like four on that and that was like the overall bilateral OTC just because they were so um uh they were kind of one of the few games in town it

seemed like a lot of the volume really funneled in through then and now that's much more diffuse and it's opaque because it's all living in not a report basically they're not putting out the no one person putting out the but so to just to use that as an example I think you said 50 billion at that point um when we did even even late last year when we did sort of the uh estimations on this stuff the market already looked like it was almost at that level so I think you know we're probably we're not a factor of 10 off um at least a month or so ago I think right now the demand for leverage is muted over the last four weeks but before that we were already um you know probably a factor of I don't know three to five um from like getting

to the the old Heights um and I think the the question more is like will we through that by a 10x I think is probably the the real qu question um and I do think that the way that you get much more much more um lending and Credit in the system is these custodians uh stepping in I know James mentioned this earlier but as they go from from custody into other services I think that sort of unlocks massive potential for all these people that otherwise are just sitting in qualified custody or cold storage or whatever that now are willing to to interact with that market that would be a huge unlock for just um leverage in that additional regulatory Clarity I mean these are medium to longer term things need to get ironed up is there a trading firm that you see becoming it's going to have a horrible

connotation I was going to say the next three arrows but not so obviously but in but in a good way of just being before the collapse so so I'm yeah I'm actually reading the next part of this report which is Genesis was the biggest uh creditor to three arrows they lent them $2.4 billion who I'm trying to think in my head who's who wants to borrow two2 and a half billion dollars right now uh so luckily I can't and I want to see what you think but I can't think of anyone that's at that scale at the moment which is good like I think it's I don't want to name anyone related to three arrows how am I going to put a cop there and say oh yeah these guys are just like three arrows but I but so take comparison to three I'm like is who

could even like the big Venture firms don't need to borrow three and half billion or two and a half billion like the liquid funds like are way smaller and they're playing in like smaller coins like who well I think that shows just the fact that like and I would throw one out unlike what Jame is saying I would throw it out right now there's really not one that's that I think is consuming at that level and so that probably is just indicative of a more healthy lending Market where it's not 70% of it's not going to one bar or less opportunities on chain yeah I agree I think once the like if we do have an ALT drip in cycle in 25 and everyone says holy [ __ ] I can make 40% instead of my you know right now it's Bitcoin Soul mem coins maybe you hit hype and that's it

but if you can if they all start running the fun say boom We're Off to the Races let me borrow as much as you'll give me then we'll see the next three arrows poent hopefully not on the blow up side but on the size yeah yeah and then James will tell us who it will be right um uh this is a horrible segue into the next question I wanted to ask I should have put a filler in between here but the if you if you ask 10 people who what will blow up the cycle I think the most common answ is end up being like micro strategy got off sides Athena I don't understand it but like it looks like a little sketchy to me or something like what what do you guys think of these actually maybe i' ask about those two specifics cuz I think and the reason I

ask is not my personal takes it's those are the most common answers of like right now what will blow up the cycle so I'll I'll start on Athena and then maybe I'll look to you for for micro strategy and and just other uh Concepts so I think um Athena is sort of the uh poster child I guess for what I mentioned a little bit earlier on the call about sort of the co-mingling between CI and dii and I actually think what they're doing is very Innovative I think it's a an interesting model um when I first saw it I had the exact same probably reaction that you were just saying that You' you've talked with people where it's like oh boy this this looks scary um no mine was why didn't I think of that yeah well exactly or I did think of that but that's that's great well from a

yield perspective yeah it's like it it makes a ton of sense and then it's just the question of okay on these exchanges now you saw with bybit right it was like immediately everyone looked at okay is Athena okay and they had things in Copper clear lip so I do think these models where you run these things but you hold them at a custodian um Can deris them significantly I think it's like everything it's if behind the scenes everything is functioning as they say it it wasn't that that it is then it should be be um you know might not blow up but I've I've noticed in these things anytime there's centralization it's often the like where's the one thing that doesn't exact function exactly as someone says it does and I'm not trying to say that that's the case with them but that's always my concern with any of

those kind of models where their centralization like behind the curtain is everything happening and functioning like can you verify everything or not and if not it only takes one sort of move in the market to all of a sudden unwind things um but I think I think that um they've unlocked something that is is quite novel and as James was saying kind of OB in hindsight um but but cool um I and I think gets to the broader this time there's more because of models like that Athena and others there's just more blending between centralized risk and decentralized risk so I think that or or decentralized model so I think you know if one of those exchanges gets hacked and if they don't have everything on copper clear Loop then that's where you have to be concerned maybe the last question here Carson I direct this at you is there

used to be these um these like networks that linked the whole industry together it was like what silvergate and um there's another one and then now there's new sign thank thank you um uh yeah again PTSD I'm blocking things out of my memory me the rest in peace yeah and then uh there's you know new ones that are getting created like you know fire blocks has their own thing and clear you know bit go has their own one now and copper has clear Loop and stuff like that how do you guys think about the like a settlement Network for Lending and borrowing in the industry because like James was mentioning and it's all oneof and here and there and there have you guys thought about that yeah absolutely so actually the the Genesis or the beginning of membrane we really wanted to create sort of a settlement

Network yes no pun intended we wanted to create a settlement Network that was custody or wallet agnostic um really something that Maps up at the services level so what one of the big things that we're doing looking forward um with membrane is as these custodians are trying to layer on Services trying to layer on lending trying to layer on trading membrane can offer these Services sort of in a Walled Garden in each of these venues so a bitgo and then if you go to a b and c more custodians eventually we want to link those together into a Services Network that connects these there's all kinds of interesting things you can do to sort of drisk the space at that point where funds can be held um in qualified custody or cold custody at these spaces at these custodians um but then you can access the lending markets you can

access ecn you can access um credit between these and and in a way that follows rules almost in a sort of Clearing House esque model um that that unlocks some really powerful things so I think that's where the space goes next and that's where we want to um really evolve memory into is a a settlement and Services Network between the custodians nice cool James Carson thanks for the time gu thanks so much it's fun appreciate it thank you [Music]