Explore the mechanics of decentralized finance (DeFi) with Professor Evgeny Lyandres, who breaks down how decentralized exchanges work and how VirtuSwap stands out in providing liquidity for small-cap crypto assets. With insights into the challenges and future of tokenization, this episode offers a clear view of where DeFi may be heading. Evgeny is Professor of Finance and Head of the Blockchain Research Institute at Tel Aviv University. Disclaimer: This podcast episode contains general information only and is not financial or investment advice.
If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.
You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.
Timestamps for EP262
- Introduction to Decentralized Exchanges and Their Potential (0:00)
- The Evolution and Functionality of Decentralized Exchanges (6:38)
- Challenges and Solutions in Decentralized Finance (22:18)
- The Future of Crypto and Decentralized Finance (43:32)
- Optimizing Liquidity and the Role of AI in Decentralized Exchanges (55:15)
Links relevant to the conversation
Evgeny’s academic web page:
https://lyandres.sites.tau.ac.il
VirtuSwap website: https://virtuswap.io/
Previous episodes on web3, DeFi, crypto or blockchain:
The Future of VC: Blockchain, Web3, and Emerging Markets w/ Qin En Looi, Partner, Saison Capital – EP256
Navigating Volatile Crypto Markets & Avoiding Scams w/ Ben Simpson, Collective Shift – EP249 https://economicsexplored.com/2024/08/14/navigating-volatile-crypto-markets-avoiding-scams-w-ben-simpson-collective-shift-ep249/
Digital Money Demystified w/ Prof. Tonya Evans – EP216
https://economicsexplored.com/2023/11/30/digital-money-demystified-w-prof-tonya-evans-ep216/
Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178
Bitcoin & books w/ author & ex-fighter pilot Lars Emmerich – EP157
Takeaways
- Tokenization of traditional assets, such as stocks or real estate, is a future possibility for DeFi that could expand its impact well beyond the current crypto market.
- Liquidity pools and smart contracts are essential to DeFi, providing a protocol-based framework where trades occur automatically based on programmed rules.
- VirtuSwap’s unique pool structure, including virtual liquidity reserves, is designed to address the liquidity challenges for less-traded assets in DeFi.
- With the aid of AI-driven systems like Minerva, DeFi platforms can optimize liquidity allocation, potentially offering higher returns for liquidity providers and more efficient trades for users.
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Transcript: Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Evgeny Lyandres 00:06
This is basically the reason why I think this market is important, right? It’s not because of its importance right now. I mean, it’s not that, right? It’s because of the potential, which I think is there, right, a potential to kind of revolutionize many of the financial technologies that that we’re familiar with.
Gene Tunny 00:29
Hello and welcome to the show. In this episode, I’m thrilled to welcome Evgeny Lyandres, a Professor of Finance and head of the Blockchain Research Institute at Tel Aviv University. He’s also the co founder of VirtuSwap, a decentralized exchange platform. Evgenys’ expertise lies at the intersection of finance and blockchain technology. Today, we’re diving deep into the world of decentralized finance or defi. We’ll explore how decentralized exchanges work, the challenges of providing liquidity for smaller crypto assets and VirtuSwaps’ unique approach to addressing these challenges.
Special thanks to Lumo Coffee for sponsoring this episode. This top quality organic coffee from the highlands of Peru is packed with healthy antioxidants. Economics Explored listeners can enjoy a 10% discount, details are in the show notes. Now let’s jump into the episode. I hope you enjoy it.
Evgeny, welcome to the program.
Evgeny Lyandres 01:34
Great to be here. Thank you very much for having us.
Gene Tunny 01:38
Excellent, of course. So yeah, I’m really interested in, in what you’re up to. I mean, you’ve got a background as a as an academic professor of finance and head of Blockchain Research Institute at Tel Aviv University, and you’re also involved in defi and in blockchain with your own company. So I’d like to ask you about your company, is it VirtuSwap?
Evgeny Lyandres 01:58
Yes.
Gene Tunny 02:00
Okay so what I’ve learned, or the information that was sent to me about it, is that it’s a decentralized exchange platform that gives traders direct liquidity for smaller cap assets. So I think what would be good is just unpack what all of that means. So one, what do you mean by decentralized exchange platform, and then what do you mean by direct liquidity for smaller cap assets? Could you take us through that, please Evgeny?
Evgeny Lyandres 02:34
Of course, of course. So starting with from from afar, to give a little bit of a background, right? So, so obviously, decentralized exchange is an exchange where assets are traded, right? In particular, in our case, it’s crypto assets, right? You know, think about Bitcoin, Ether, stable coins, and, you know, 1000s of other crypto assets. Now, there are two ways that the trading in those assets is conducted. The first and still kind of the predominant way, is trading on centralized exchanges. You know. Think of Binance or Coinbase, or maybe FTX, that you know existed until a year and a half ago, but no longer. A lot of trading happens there, and those exchanges are organized very similarly to, kind of the traditional exchanges of other asset classes, such as stocks, right? So think of, you know, NYSE or NASDAQ, right? It’s basically order book based exchanges. Now there are few issues, few problems with with centralized exchanges, and the problem basically stem from the fact that those are centralized entities in a largely unregulated environment, right? So some centralized exchanges, such as Coinbase, are regulated, right? Most are not, right? And so if you combine those two things together, right? So, a centralized entity in an unregulated environment, right? You know, bad things can happen. I’ll give you a couple of examples, right? So, of course, all of us know about exchanges that go bust, because basically they still, you know, depositors fund right? The FTX is a good example. There are other issues, right? One of them is that a lot of those exchanges engage in significant wash or fake trading, right? So basically, what they’re trying to do is they try to increase the reported trading volume, right? Because that is, you know, increasing their placement in the kind of the ranking the league table of of exchanges, right? So they’re interested in inflating volume, because this is, you know, one metric that investors or traders look at when deciding where to trade, right? Now, this is pretty bad for trader, right? Because if you go in exchange and you see an order book, right? You, you stink, you, it seems deep, right? So you want to place your trade. But the actual liquidity oftentimes is significantly smaller, right? And that basically means that your trade is going to be executed at, you know, far worse terms than you know, what you thought it would be executed, right? So basically, there is a big problem of lack of transparency that is driven by, you know, very strong competition, right? And competition is there just because, you know, the entry costs into this industry are very low. It’s, it costs very little to set up, you know, a centralized exchange. It’s basically kind of, you can use a white label software to just to set up a new one. And as I mentioned, lack of sufficient regulation, right? So the bottom line is, lot of people trade on centralized exchanges, and some of them are fine, right? So, you know, Coinbase is definitely fine. Binance seems to be fine, but not all of them, right? And there’s, you know, quite a lot of academic research on kind of the problems associated with the centralized exchanges. And so defi and in particular, decentralized exchanges, right? Is one way to address, you know, the problems that we mentioned. So let me tell you, you know, briefly, what a decentralized exchange, right? So decentralized exchange is basically a protocol, a computer program that resides on the blockchain, right? Any blockchain that enables smart contracts that basically defines the terms of trade in a very kind of precise, programmatic fashion, right? And that basically means that it’s a collection of basically formulas, right? Say, Well, you know, if you exchange this amount of one asset into another asset, right? You’re going to get precise amount of that other asset the function of some parameters of the you know, of the exchange. Those exchanges are organized using so called liquidity pools, right? And so that brings us to, kind of to the main players, right in this, in this market, right? There are two. The first one is traders, right? So those are people you know, that want to exchange one asset into another. The second, and the crucial type of players in this, in this market, is what’s called liquidity providers, right? So, liquidity providers can be, can be anybody, right? Can be you or me. It’s people who basically supply liquidity two so called liquidity pools with a goal of this liquidity, right, helping conduct trades, right? So let’s say that I want to establish a pool of two tokens, right? You know, whatever they may be. So I’m going to put $1,000 worth of one token and $1,000 worth of another token into the liquidity pool. Now the pool has been established, right? And those tokens right at this point, $1,000 worth of both could be used for trade, right? So you can come to the pool and say, Well, I want to take $10 worth of one token and supply another token into the pool, and the pool basically is going to be set at set up in such a way that you know the terms of trade are going to be defined by the amount of liquidity currently existing in the pool, by the relative prices of those two assets, right. And that basically the ratio of the two assets in the pool right, and the size of your trade. Okay, we can go deeper into, you know, what types of pools there are, but typically, you know, it’s involved in a pretty simple math, pretty simple kind of formulas for defining those exchanges, right? But it’s basically going to be a function of only two things, right, the current composition, the first state of the pool, and the size of the size of the trade and direction of the trade that you want to perform, right? So that is kind of the the basics of decentralized exchange and this type of trading technology that’s very novel, right? And does exist outside of decentralized finance, or outside of blockade based finance right is possible because of kind of the nature of the blockchain, right? That, basically, blockchains allow smart contracts. Smart contracts are, you know, no more than if that condition right, the defining if something happens was was going to be the result, right? And so, so basically, it’s possible, because of the technology of blockchain, right? But in theory, at least, you can even think about this technology being useful for trading other assets, right? So you will any pretty much, right. The financial technology is the same, yeah. So that’s kind of the basic or so decentralization, we’re very happy to go, obviously, deeper into it and, and, of course, we’re going to talk about, you know, what we do in the space. But what is our, what is Virtu of contribution,
Gene Tunny 09:50
you know? Yeah, absolutely, I definitely want to go deeper into it. Yes. So, I mean, what are examples of decentralized. Exchanges. I mean, there’s your decentralized exchange, Virtu swap, and how does it compare? What’s its differentiating factor from other exchanges? It sounds like that you’re focused on smaller cap assets. Can you tell us about that? Please. Evgeny, of course,
Evgeny Lyandres 10:17
of course. So in general, kind of decentralized exchanges started in about 2017 2018 so you know, about seven years ago now, by two protocols. The first one was called bancor. The second was called uniswap, still called uniswap, and both protocols still exist. Uniswap at this point is the most successful and the most famous decentralized exchange protocols currently responsible for, I would say, about half, if not more, of all trades in decentralized exchanges, right? And just to put things in perspective, about a quarter of all trades of crypto assets is done on decentralized exchanges. The other three quarters are done on centralized exchanges. And out of this quarter, uniswap, you know, gets about half of the market share. So this is the predominant kind of decentralized, you know, the biggest and the most successful decentralized exchange, and also an exchange that constantly produces a lot of innovation into this market, right? So let me give you maybe a half a minute kind of history of the evolution of this market, and then we’ll get to what we do, right? So it all started with, you know, with the first version of municipal in around 2017 2018 right? And basically, the idea there was, well, you know, we can exchange assets using this, this, this kind of smart, smart water based technology that we discussed. And in the first version, the exchange work very simply, right? So the exchange could only be done, you know, between ether, right, which is the the token of the Ethereum ecosystem, right, with Bucha, Spain, and any other, what’s called ERC 20 token, which is a, basically a token that that is based according to a certain kind of standard, and within the first version, right, which basically kind of it should you can think of this as a proof of concept, right? The trading was not very the terms of trading were not very attractive, right. So think about a situation where you want to exchange your two tokens, right? You know, think you know, USDC, a stable coin and some other token, wbdc, right, Bitcoin, okay, so what you would have to do, right, is basically do two trades, right? It would need to exchange USDP into, you know, ether, and ether against WBC now. And, you know, doing multiple trades would basically expose you to to multiple costs, right? So let’s first talk about all the costs involved in a trade, right? And then we’ll think about, you know, what does mean to have all those basically doubled or multiplied, right? So generally, three types of costs, you know, for a trader on a decentralizing change. The first one is so called full fee, right? And that is basically a fee that a trader needs to pay to the liquidity providers in the pool, right? Because, you know, you need to somehow incentivize people to provide liquidity, right? Otherwise, you know, nobody’s going to put money in the pool. There needs to be something in it, you know, for the liquidity provider, right? So, and you know, the the fee, basically, is, you know, some small proportion of the trade that is not being exchanged for another asset, but instead is given to the liquidity providers, right? So think about, you know, numbers between five, usually, and between five and 100 basis points. Okay? So 0.05 to 1% that’s the first type of the cost. The second type of the cost is what’s called the price impact. The price impact, right? Is basically due to the fact that the trading function on any exchange is not linear, right? And, you know, you can think about a good analogy, is a typical exchange of assets, right? When there is an order book, right? So the bigger your order is, the deeper you’re going to go into the order book, and the works is going to be the execution price, right? So smaller trades are going to be executed and the marginal the current price, right, the bigger trades are going to be executed at worst price. Same thing happens on decentralized exchanges, right? The typical kind of the most simple and the most famous, actually, formula for conducting the trade and decentralized exchanges is what’s called the constant product formula, right? And basically means x times y equals some constant k, right? So for example, you know, going back to example, to an example, I am. I mentioned before, right? So if I provided $1,000 worth of liquidity in one asset and $1,000 worth of liquidity on the other asset, right? You know, if you divide this $1,000 by the initial prices of those assets, right, that basically defines the quantities of the assets initiative deposited into the pool, right? So let’s say just let’s take the example that I deposited in 500 units of asset a and 200 units of asset B. If you multiply those two numbers, so 500 times 200 so that’s 100,000 right? That defines that constant product, right? And any trade you know in this pool, unless the liquidity changes, right, is going to be based on this product, meaning that if I want to take a given amount of one of the assets in the pool, I need to supply an amount of the other asset, right, such that this product remains constant, and that basically, you know, defines a so called hyperbolic function, right? It’s not linear, right? It’s a convex kind of function of price. What I’m trying to say here is that the second type of the costs of trading in on this centralized exchange is basically what’s called the price impact, right, the effect on the price at which you’re trading, right, as a function of the size of the trading and then, then the third part, the third cost of training, that is basically what’s called the guest cost, right? So this is the transaction cost that need to be paid by the, you know, people, kind of writing blocks on the on the blockchain, right, recording the new blocks and kind of certifying, right? So those are the three costs, three types of costs. Now coming back to this example of trading, you know, stable coin into rev Bitcoin, right, where the intermediate asset is, for example, ether, right? All of those costs, right, the price impact, the pool fee, the gas fee, need to be multiplied by two. And so that was the issue, right. So, so the trading terms were not super attractive, right? So, as a thought experiment, this was a fantastic innovation, right? So this was really a new way to conduct trading, you know, practical terms. It was not great yet. And so then, you know, this ecosystem, you know, started gradually improving and developing. The next kind of step was the second version of the unicorn protocol that’s called v2 okay, that’s that’s what people refer to, usually. And the biggest kind of innovation there was that you didn’t have to necessarily go through ether as an intermediate assets. You could basically construct pools, or establish pools with any two assets, right? With any two ERC 20 tokens, right? And so then you could think of us about a situation where, you know, someone would establish a pool of USDC against Red Bitcoin, right? And people would be able to trade in the school directly, without going through the third assets, obviously, reducing. The point is, this is important, and this is the point I’m going to come back to, right? But it didn’t really solve all the problems, for reason I’m going to describe in half a minute. Since then, you know, this kind of, this setup, right? This technology of decentralization, is have evolved further. The first big innovation was the third version of UNICEF, unusual v3 Right? Which basically allows so called concentrated liquidity, right? So here’s the problem. The problem with, you know, the trading technology that described so far is that, basically, the liquidity that liquidity providers put into the pool, right, is sort of uniformly distributed across all possible exchange rates in the pool between exchange rate between the two assets, you know, from zero to but it turns out that the price impact becomes quite significant for relatively large trades, right? So as a rule of thumb, the price impact which is a loss you know of a trader, you know from the trade, is roughly proportional to the ratio of trade size to the size of the pool, right? So if you want to do a trade which is 1% of the size of the pool, well, you’re going to pay this 1% roughly in terms of price impact, in addition to the pool fee and the guest right? So in practice, you know, in practical terms, you know, large trades are not really admissible, you know, on on decentral exchange, just because they become too expensive. This is also true for centralized changes, right? If you want to take out your 10% of the order book, that’s going to cost you a lot of money as a trade, right? So this idea of concentrated basically said, well, let’s quickly treat it not uniformly, you know, for all exchange rates, because you know, you know, trades that change exchange rates or more exchange rates, quite a lot are not going to happen in reality, right? Let’s concentrate. Trade humidity in the relevant range, right somewhere around the current exchange rate, right? We’re going to support those trades in a really good way, right, with deep liquidity, with the hope that large trades are not going to appear because those large trades are not going to be supported. So that really increased, many cases, the efficiency of liquidity provision by a lot, and improved in the terms of trading, you know, by by a significant amount for traders. And now uniswa is actually coming out with the next version of their protocol, before the fourth version, that is actually going to be quite interesting, because it allows to do many more things. It allows so called hooks. So hooks is basically additional smart contracts attached to the liquidity pool that define certain actions that the pool is going to do before, during or after a trade. Think about a situation, for example, where you know a trade changes the price, the exchange rate between the two assets in such a way that the current consider liquidity is not going to be adequate anymore to support trades, right? So the pool might define reallocation of liquidity in such a way that will support future trades as a result of an existing so before is not really active yet. It’s coming out, I believe this or next month, but this is going to, I believe, spur additional wave of innovation in defi or desks. Let’s go back to virtual swap and what you know we tried to bring to the table, right? So I kind of discussed very briefly the fact that liquidity in on Dex is often is not allocated in an efficient way, right? And this is actually an important point, because this is a big problem that currently, up to this point, actually prevents kind of the access to from from from really achieving a big success, right? Basically, from overtaking centralized exchanges, right? That has not happened yet. The reason is that it is very difficult to provide liquidity, you know, for all necessary trades, right, just because there’s a lot of assets right? Right now, if you go to coin market cap, which is, you know, the biggest aggregator of crypto data, there are 1000s, right, 678, 1000 of different assets, right, that are listed on coin market cap, and there are many more that are not listed. So if think about, you know, trading between one asset, one token, into another. Chances are that, despite the fact that it’s possible to establish any type of liquidity pool, it’s possible to concentrate liquidity. In practice, there are just too many asset combinations, right, for those pools to exist, right? So if there is, you know, 8000 crypto assets, right? You know, if you think about the number of pairs, well, it’s 8000 squared over two. That’s a huge number, right? You’re never going to have, you know, liquidity for, you know, for those trade Now, granted, most of theirs, those potential, theoretical pairs are never traded, right? So you don’t really need liquidity, right? But still, there are a lot of assets which are traded, right, but for which there is no direct liquidity, right, even now, right, with all the available technology, right? Because I know providing liquidity into pool, into the pool is a completed permission that’s connected, right? Anybody can do it, and we can establish a pool. Anybody can add, you know, money to the pool, right? People are only going to do it if it’s worth their while, right? If the returns they’re going to be getting are going to be offsetting the risks that they’re going to take in the day, right? And for many assets, it’s not the case, right? So you know, if there is, you know, some trading expected in a pair of assets. So think you know, whatever chain link against, you know, Matic, right? You know, which is the native token of olivine chain. There are going to be straight some trades like this, but probably not enough to make it worthwhile for liquidity providers to provide sufficient liquidity, right? And so, you know, despite the fact that the theoretical possibility exists in practice, right? People are still going to do two trades, right? They’re going to trade, you know, from chain link to some asset you know, with which you know, the pool of tailor exists, for example, ether or stable coin, USDC, or anything else, right? And then the others trade into the asset that they really want, right? So for the most part, the problem of insufficient liquidity is not solved, right? And it actually cannot really be solved, right, for the reasons we discussed, right? There is just not. There’s too many assets and too too little money in the pool, right? So. So that is basically the problem that, you know, I identified in, I guess, 2021 when I started looking very carefully into this, doing research on decentralized changes, right? It isn’t the problem that they’re trying to solve, right? And that basically what led to to virtual, right? So let me tell you, know, very briefly about our way to address this problem, and, by the way, before the problem, right? Just just the size of the problem, right? So those trades that involve what we call triangular trading, right? So trading, you know, through multiple pools. That’s about 30% of all trades on, you know, most important blockchain, right? Ethereum, Polygon, arbitrary and so forth. Right? About 30% of the trades are of this kind, right? So this is kind of the market that we’re trying to address, right? And, you know, you mentioned initially, kind of smaller coins, right, or smaller assets, right? So this problem is there in smaller assets, right? Because if you want to trade, you know, ether against USDC, you’re going to be fine, right? There’s enough liquidity, enough direct liquidity. That’s not our place, right? Our place is rates that I mentioned, right, which may be smaller asset, right? When I say smaller, it’s basically anything outside of top five, right? So when you go outside of top five or six on a given blockchain, that’s where the problem becomes, becomes acute. So how do we do this, right? So we basically came up with a different architecture, right, different structure of liquidity pools, right? So standard liquidity pools involve two assets. Ours are a little bit more involved. So in addition to the two assets right that we also have, we have so called reserves, right? So think about a pool that is, you know, two main assets, plus you know, some reserves, right? And you know, a good way to think about those preserves initially is basically like, say, deposit boxes that are initially empty, right? So the pool is established in exactly the same way as normal pool, right? So think about a pool of whatever ether and USDC that can accept reserves into those initially empty sale deposit boxes. So let’s say that you want to to buy, you know, ether, right? And to pay with it, with the Matic token, right, with the polygon top. Now, in a normal kind of situation, right, in the normal tax right, you’d have to do those two trades. Right triangle. Virtuous. Of what you can do is you can deposit the asset that you have into the reserve of the pool. Right, ether USDC are going to the to deposit the reserve of Matic polygon into the reserve of, you know, either USDC pool, and you’re going to take from the pool the asset that you want, right, the asset that you need. For example, ether, right? Now, of course, the question is, you know, what is the, what are the terms of trade, right? You know, how much do you need to deposit in order to take even amount of the asset from the pool? Now, you know, this historical trade are defined on purchase of via so called virtual liquidity pools. Right? Virtual liquidity pools are, you know, a result of, basically triangulation, right, of of different pools that exist virtual so they define a pool, sorry, a trading curve, you know, over which the trader can trade, right? Now, this trading curve is not a real trading curve, right? It’s not like, you know, he’s going to deposit the assets in the pool and take some other assets from the pool. This virtual trading basically, is defined by trading into the reserves, right? So you’re going to, you know, deposit your asset to the reserve, and take one of the kind of main, one of the main assets in the for a trader, it doesn’t really matter, right? It’s a seamless experience, right? You as a trader don’t really care whether you trading by reserves or by kind of normal kind of two effort trading, right? What you care about is getting the most, what’s called the mount out, right? The largest amount of the other asset that you want for a given amount of assets that you are trading now, this is not the end of the story, right? So let’s say that you perform this trade, the pool accepted those, those assets into the reserve, right? There is a problem, though, right? The liquidity provider right now is now exposed to the risk of holding some other asset in the pool, and that is not a risk that is desirable, right? So if I provided liquidity into either USDC pool, I’m okay exposing myself to the risk of those two assets, but I might not be. Exposing myself to the risk of others. Now, what do we do? What do we do with it? There are several ways in which we solve this problem. And then after I describe the ways we address this problem, right, I’m going to go to talk a little bit about the advantage of what we’re doing. So first of all, we don’t allow all of the possible assets into into the reserves, right? So every pool comes with a white list of tokens that can go into the reserves, right? Think about, for example, top 100 assets on a given blockchain. So this comes back to your initial point. Right? We solved the problem for smaller assets, not for the smallest ones, because the smallest ones are super risky, right? We don’t want to expose the liquidity provider to this type of risk. But in practical terms, you know, 95% of trading in smaller assets are, you know, it’s taking place in assets you know that are the top 100, right? So, I mean, the other ones are really not that important. Secondly, we basically limit the size of the reserves, right? We basically say that the overall value of all the assets that sit in the reserves, right? And remember, these are assets that are different in the two main assets in the pool, right? So the size of the result reserves overall cannot exceed 2% of the value of the pool. Once it hits 2% the pool basically closes itself to this type of reserve trading, right? And basically limits the amount of reserves, right? So there is some risk, but it’s not very, you know, very big. It’s up to 2% but most importantly, right? The way we, you know this risk is addressed, right? Is by a lever system of exchanging reserves between pools. Right? Think about a scenario where, you know, I have deposited money into ether, USDC pool that now has Matic reserves another pool right is, for example, Matic against ether that has USDC reserves, right, that accumulated the result of some other trade. Okay. Now, whatever this happens, right, those two pools can exchange the reserves between themselves, right, sending Matic to the pool Where it is one of the main assets, and sending USDC into my pool Where it is one of the two main assets. Now this happens without any price impact. This happens without any pool fee, right? It’s just exchange between two pools, just a little bit of gas that needs to be paid. But you know, this is, this is not a large number, usually, and that basically means that every time it’s possible, we kind of try to reduce the number of reserves in all possible pools to the lowest level possible, ideally to zero, right? We don’t want those reserves right. So those reserves are just kind of a place that allows trading, right? We don’t really like them. We’ve done, obviously, tons of simulations at this point. We have real world kind of trading data, those reserves are typically small, right? So, you know, this is not a risk that is that is large in the liquidity providers. But what is that do? It basically eliminates, in many cases, the need for the triangular trading right, and reduces the costs of trading to a single kind of type of cost, right? You still need to pay the pool fee, you still need to pay gas. You still have price impact, but only once, all right, and not multiple times. And so if you think about kind of a more kind of global picture, right, the whole ecosystem of different decentralized exchanges, and there many, there are dozens of Dexs, usually on every blockchain. The way this market is organized is that most often people are going to trade through so called aggregators, right? So think about basically the Expedia right of the dex market, right? Instead of kind of going and buying your air ticket in a particular airline, you’re going to go to Expedia and try to see where it’s cheapest. You know, what is the cheapest? In a way, to go to a particular place, and accurate, there’s a similar thing, right? It basically takes a given trade, it looks up on all the data on different decentralized exchanges, all the pools, you know, all the liquidity, and tries to compute the optimal route for the spring, right? Basically, you know, let’s say you want to swap, you know, $100 worth of stable coin into into it, right? You know, the aggregator is going to go and trade and say, well, $20 are going to be sent to this pool on this decks, and $15 is going to be sent to a different pool in different days, with an objective of maximizing your overall amount out now coming back to virtual spot, since our trading is more efficient, right? Because, you know, we don’t have to pay the multiple costs twice, right, that basically means that a disproportionate, you know, fraction of a trade is going to be sent our way, as opposed to to a. Other kind of to other debts, right? So in a sense, that means that, you know, from the liquidity providers perspective, you know, their liquidity is going to be working over time, right? There’s going to be kind of a bigger kind of bang for the Bucha, right? And that means that, in a sense, every trade carries some fee, proportional fee, the returns to liquidity providers is also going to be larger and kind of the liquidity provision to merge as well. In principle, maybe a better kind of proposition for liquidity providers than providing liquidity on other deaths, right? So that’s kind of the basics of what we do. Gotcha,
Gene Tunny 35:35
okay, geez, there’s a lot, a lot there a few, a few terms I want to go over. So you talk about gas fees. So I remember you defined them. I just just wanted to make sure I heard that right, and I looked it up and checked it is gas. So that’s a new one. I’ll have to have another look at at that. And then you mentioned ERC 20, and that, that means ERC
Evgeny Lyandres 36:01
20 is basically just a technical term for particular crypto assets, right? You know, having certain characteristics, right, that are compatible, you know, with other assets on a given block, right? You know, there’s nothing deep there. It’s just certain conditions that need to be specified, but you need to be kind of fulfilled by an asset to to be classified as ERC 20, right? I don’t want to go deeper into this. It’s just that is not a very kind of interesting part. The gas fee is actually more interesting, right? So, you know, any blockchain right, is basically maintained in decentralized fashion, right? So blockchain has nodes, right? Nodes are basically computers who record, maintain and update the state of the blockchain, right? But those nodes need to be compensated. They’re different and, and, and, you know, those nodes need to agree among themselves about the contents of the blockchain, right? So we need to make sure that blockchain, which is a database, distributed database, you know, is the same across all nodes of the of the block, right? There are multiple ways to achieve this, so called consensus between nodes. You know, of course, you know, everybody heard about proof of work. You know, which is, you know, what Bitcoin uses for proof of state, which is what most other blockchains use at this point. But the point is that, you know, the nodes on on a blockchain, any blockchain, need to be compensated for what they do, right? So you know, you’re not going to kind of run this, you know, Blockchain software for no reason, right? You’re only going to do it if there is something for you and and that’s why, you know, we need to somehow generate some revenue for the for the nodes of the blockchain that maintain it, right? And this revenue typically is generated by those gas fees, which are basically fees attached to, you know, by people who want to perform transactions on a blockchain, right? And those fees, you know, you know, I’m simplifying a lot, but those fees basically are paid by the people making transactions to people who maintain the blockchain. Gotcha, do
Gene Tunny 38:13
you know why it’s called gas? Why is it? I
Evgeny Lyandres 38:16
mean, it’s, it’s like, it’s like, gas in a car, right? That’s more, makes the makes the blockchain go.
Gene Tunny 38:21
Okay, that’s that’s as good as his explanation as any. Is just wondering if there was some particular reason, actually,
Evgeny Lyandres 38:29
in fact, there may be others. This is the one that I heard, and this seems reasonable to me, so I didn’t explore further.
Gene Tunny 38:38
Okay, we’ll take a short break here for a word from House sponsor.
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Gene Tunny 39:13
now back to the show. Okay, so just want to go back to just the what I’ve read about virtue swap, so you get about 50% cost reductions and then 400% higher returns for liquidity providers. So this is what you’re what you’re claiming. Yeah, right, got
Evgeny Lyandres 39:38
it very much depends on the parameters of the, you know, the pool, gotcha, yeah,
Gene Tunny 39:44
it has a TVL of $3 million What do you mean by that? What’s TVL stand for?
Evgeny Lyandres 39:51
Right? So, actually, the number is smaller right now. Some, some rough kind of periods of market. The market is improving right now, so hopefully it’s going to. Bigger, but TBL stands for Total value locked. Total value locked is the amount of liquidity that people provided into the into the protocol, right? So, so you know, any exchange be centralized or decentralized, relies on liquidity, right? And basically assets that some other people have deposited into the into the exchange rate in order to facilitate trading, right? So the bigger the liquidity, the more trades are possible, and the better terms at which trades are possible, right? So, so for every decentralized exchange is striving to increase the liquidity that’s deposited into it,
Gene Tunny 40:47
yeah, gotcha. Okay, so it’s still fairly, I mean, it is a niche product. So you’ve said that you’ve carved out a significant niche, right? Okay, and you’ve partnered with defi leaders like uni Zen, open ocean, odos, lifik, what are those companies doing? What partnerships have you developed?
Evgeny Lyandres 41:09
Right? So most of the names that you mentioned are basically aggregators, right? So we mentioned aggregators is basically the from the starting point of most trades, right, the experience of this office of this market, right? So any decentralized exchange wants to be, wants to eat, to be integrated by by as many aggregators as as possible, right? Because, basically, you know, like an airline, right? The airline wants to be on Expedia. It wants to be on Kayak, it wants to be on Skyscanner, right? Wants to be on every aggregator that people go to to kind of search for for air tickets, right? Any decks wants to be part of, and all aggregators that people go to submit their trades, right? So at this point, we are, in fact, have been. We have been integrated by most of the of the important aggregators. So I’m quite, quite happy about that. And you know, this is not trivial, right? Because integration takes time, right? So you know, the aggregator needs to basically go over the smart contracts of of the decks, right, and make sure they’re compatible with what they’re doing. Right? Our smart contracts are quite different from those of existing or other desks, right? We are not a so called fork of another protocol, right? We just didn’t just take another product code and make some small tweaks to, right? You know, we wrote everything from scratch which make, makes aggregation heavier endeavor, you know, from the or integrations and heavier endeavor from the aggregator sentiment, right? So I’m quite happy that we have been aggregated by by several, well, all basically important aggregators, right? And so that’s where the majority of trade and virtue are coming from, right? So, you know, we have our own website, our own trading app, our own UI, UX. People can go there and trade. Most people do that, you know, otherwise, right? They go to an aggregator, and the aggregator computes, you know, which part of the trade it makes sense to do on versions of, right? And we get, you know, those bits and pieces of trades immediately.
Gene Tunny 43:25
Yeah, gotcha. Okay, that makes sense, yeah. So it sounds like you’ve, you’ve found a real niche there and in the market. And, yeah, I mean, it’s, it all sounds. I mean, I think I was five years too old to have got into crypto, perhaps, but yeah, I really haven’t got into it in a big way, but I have a lot of guests. I’m having, increasingly, having guests come on the show talk about crypto and web three. It’s all, all very, all very fascinating. So it’s something I’ve still got to learn a lot more about. Can I ask you, where do you think all of this is going? Because you mentioned the huge number of coins there are out there. I mean, a lot of these coins. I mean, you have to wonder about the future of them. I mean, where’s, what’s the future of crypto? Where do you think this is all headed? I mean, will crypto become, you know, will people start using it as a currency, as a medium of exchange? Will all of these coins survive? What’s the future look like? What do you see is the future of crypto of yeah, please tell me. I’m fascinated. I’d like to know what the, what’s the, what’s the use case for all of this?
Evgeny Lyandres 44:40
Yes. So then this is a bunch of very loaded question in one. So let me try to kind of, you know, to the extent possible. So, so crypto, obviously is a new industry, right? And up to not too long ago, it was a real kind of wild west, right? So you might remember the time. Time, a few years back, of initial coin offerings, or ICOs, right? Where basically projects were raising money for something that they intended to do in the future, and there were tons of scams in this market. I mean, this market was very far from clean, coming back to the lack of regulation. Right now, ICOs are dead at this point, but the market is still not very well regulated, right? So different countries approach regulation of crypto in very different ways. You know, I’m sure that, you know, with the with the outcome the US election, we’re going to have big changes in the regulation, in the US of the crypto market, to predict in what way, but I’m sure that there’s, I mean, it’s going to be easier to do to the business, you know, in crypto, that I think that’s that’s pretty clear, but regulation is still still not there, right? And so there are several uses in of crypto in general, right? So you mentioned payments, right? So payment is kind of the first thing that the people thought about and that basically, if you read the Bitcoin white paper, right, it basically says that, you know, Bitcoin was supposed to become a medium of exchange, right? For many reasons, it didn’t happen. One big reason is that just the throughput of this, of this system, is very low, right? So you can only do very few Bitcoin transaction in every second, right? So it’s incomparable. Orders of magnitude is smaller than, you know, transaction Visa or MasterCard or suite or whatever. So they didn’t happen. But it doesn’t mean that it’s not possible, right? So, you know, it is definitely possible to transact in crypto. Stable coins are very convenient for it. Central Bank digital currencies that many central banks you know around the world are working on are going to, in principle, replace kind of traditional, traditional money. So that’s, that’s good, that’s what. That’s one kind of use case, clear use case of crypto is used, you know, just for Allah says about this use case, right, even now, right? So, crypto is used a lot in places where it’s hard to do business or make transactions in fiat currencies, right? So think about kind of countries or organizations under sanctions, right? You know, think, think about places with capital controls, right? So crypto is useful, or, you know, is a potential replacement for for fiat money, whether it’s good or bad. I mean, that’s that’s irrelevant. It’s but it’s definitely possible. The second use of crypto is, basically, you know, a as a fuel behind different types of finance applications, right? So pretty much any protocol in decentralized finance, right? So let’s take uniswap as an example. Since we mentioned that before, has its own token, right, its own currency, its own asset that the use that is used for incentivizing people towards a certain behavior, right? So think about a protocol. Well, we do it in virtual right? We basically want to try to influence where the liquidity providers are putting their liquidity right. Because, you know, we have developed, you know, a system of optimization of liquidity, right? And, you know, we think that we know better than a typical liquidity provider where the money is going to be, you know, bring the biggest, you know, benefit about right now, we did not force people to do anything. It’s their money, right? They’re going to put their money where they want to, but we can try to influence them, and the way we influence them, and, you know, many other protocols do it as well, right? It’s basically trying to give them extra rewards for doing certain things, right? In our case, you know, if I want a person or people to, you know, to put their liquidity in a particular place, well, I’m going to say, Well, if you do this, I’m going to give you something extra, right? This extra is going to be the token of my own protocol, right? So, in addition to the fees that people are going to generate, you know, as a result of liquidity provision, they’re also going to get something extra, which is the protocol token, right? So, and you know, protocol tokens, as most, most defi protocols, have their own tokens, right? And you know that is mainly used for for this purpose, and that basically defines kind of the valuation of this token, right? Is derived from the utility of the protocol, right? So uniswap token is very valuable because a lot of people trade via virtue purchase or generates a lot of fees, you know, for the liquidity providers, right? And that’s why uniswap tokens currently worth, you know, several billion dollars. Other tokens are worse less, right? It all kind of depends on, on, on whether and to what extent the protocol gives utility to to its users. Most tokens that are currently traded or, you know, registered on coin Mar. Cap are worthless, if you ask me, right? So, you know, I expect that many of them, the vast majority of them, probably including different mean points, are eventually going to go down to zero, right? So, you know, mean points is a definition of an asset that does not have any, you know, inherent utility, right? It’s, you know, it’s price, basically, is a function of the temporal demand that that exists, right? You know, there is nothing, nothing kind of behind it now. So if you think about the 1000s of assets that are currently, you know, out there in my prediction is most of them are going to go down, to go down to zero. And I don’t think many people are going to argue with that, but I think what’s really important, right? And it’s probably more important than, than the than the use cases that we discussed, is the possibility to to tokenize real world assets, right? So think about a Tesla stock, right? A Tesla stock is currently trading on, I believe, NASDAQ, but it’s trading in one place, okay? And in order to trade, you have to go to a particular exchange, okay, and play by the exchanges rules, right, including be limited to the liquidity on that particular exchange. Now think about a situation where Tesla stock is tokenized, and what it means is is the following, I buy a certain number of Tesla stocks, right? I put it in some custody, right, of the reputable custodian, right? And I issue Tesla tokens, right? Tesla tokens that are compatible with, you know, trading, or, you know, any activity on a blockchain, right? Those tokens are going to be one to one backed by Tesla stocks, you know, sit somewhere in a safe deposit box right now. Those social tokens, you know, can be traded on dexes, okay, they can be traded with all the advantages of the sophisticated kind of trading technologies that we discussed, right? And future technologies that are going to be not to be developed, right? Because this, this market is developing very fast and kind of and progressing very fast, right? If you think this possible, definitely right. What is currently not really possible, right, is this whole issue of custody, right? So regulation, right, is not there yet to, kind of to define, you know, what a sufficient kind of efficiently secured custody is, right, in order to allow this type of activity, right? I know the lawyer, right. I don’t know how the optimal regulation should look like, but imagine for a second that there is regulation that allows and makes this activity relatively easy, right? Once this is possible, the sky is the limit, right? So, so basically, think of any asset, you know, stocks, bonds, real estate, precious metals, you know, energy, anything can be tokenized, right? And this is the point where I think this defy decentralized finance. Markets, including decentralized exchanges, are basically going to explode. Because right now, this market is limited to a very particular, very niche type of assets, which is crypto. Crypto is still, you know, a tiny asset plus relative to stocks and bonds, right? So currently, the market cap of all of crypto is $2.7 trillion if you think about stocks, global stocks, about 100 trillion dollars, slightly more bonds, similar numbers. So, so crypto is small, right? But once you kind of allow trading in other assets, right, stocks, Bond, real estate, right? That could increase the importance of this market, but by at least two orders of banking, right? And so, so this is basically the reason why I think this market is important, right? It’s not because of its importance, right? Now, I mean, it’s not there, right? It’s because of the potential, which, I think is there, right? And potential to kind of revolutionize many of the financial technologies that that we’re familiar with,
Gene Tunny 54:13
yeah? Look, I think that’s a very good answer. No. That’s yeah, I actually see the potential there, particularly if you can have like that can give like you could have people getting tokens here for Australian government bonds, for example, that are typically not there’s no retail Australian government bond offering at the moment, but this is a way that you could get, you could get that exposure With the tokenization. I think that’s yeah. That’s fascinating, yeah. The whole regulation side of things is yeah, that that needs to be sorted out. I know that in Australia, the Treasury is supposed to have been looking at it, but it’s just taking them forever to come up with a regulatory framework. Which is, you. Which is rather disappointing, right? Okay, well, I’ll have to have a, I’ll have to have a closer look at all of that. Yeah, it looks like we’re coming up to time. I mean, yes, lots of fascinating things to talk about. I mean, I’ve got a lot, a lot to learn. There were some really, there’s some really technical concepts in there, and it looks like what you’ve done is a very clever way to to solve this, this problem of these thin markets, to actually make sure there’s enough liquidity there. So I think that’s for these trades that’s very good. Is there anything? Anything else we should cover before we wrap up? Kenny
Evgeny Lyandres 55:42
talked about, kind of the whole market. We talked a little bit about Virtu sock. I do want to mention that kind of this, this financial technology is sort of not the only thing we’re doing right. Another kind of aspect or facet of our productivity is, is basically trying to optimize liquidity allocation, right? Basically trying to make liquidity as useful as possible, right? You know, in the presence of the financial technologies we’ve discussed, right? So, you know, I briefly mentioned this, right? We have this, the system that you know, the fancy word, word for it right now is AI agent, right? It’s basically an AI based system that, you know, take some data from outside and make some decisions. So in our case, it our, our AI agent is called Minerva, and Minerva basically has two, two sides to it, right? So it first takes lots of data, right, concurrent, constantly updated data from, you know, from the markets, and tries to predict the distribution of future trades. Right? For example, Tunny speak, right? And, you know, we want to know right, how many trades are going to be, you know, Bitcoin against USDC, and you know any other pair that you can think of, right? So we build this distribution of expected trades, right? And then, you know, you know, conditional this distribution, we say, well, let’s say that, you know, we have a certain number of of tokens that we can give out to our liquidity providers as an incentive for what they’re doing. Let’s say that our liquidity providers require a certain rate of return on different pools, right? We also have estimates of that. What is the best way to distribute liquidity across pools in order to maximize some sort of objective function, right? And this objective hash function can be either the overall returns liquidity providers or overall volume of trading for versions, or, you know, some combination of the two or more, something else. Okay, so the system basically tells us, you know how to distribute our rewards and our token right to liquidity providers to maximize something. And this basically the combination of the financial technology and this data science, right? Is what brings to the up to 400% increased returns to liquidity provider, right? So it’s not just financial technology, it’s also basically pretty sophisticated, I think optimization that we do to further improve, you know, the what liquidity providers earn,
Gene Tunny 58:28
right? Okay, okay, so, Minerva, I like it. That’s excellent. Oh no, we better wrap up there. Kenny, that’s this buddy for me to absorb already. And I think, yeah, I think your explanation of the potential for for crypto, with tokenization, I think that’s, yeah, I think that’s that’s worth considering. So I’ve got to think about that some more. Again. Thanks so much for your time. It’s great that you could, you could join me and, yeah, really value your insights and and learning, it’s good for me to learn and get exposure to this, and I think it’ll be of great interest to listeners. So again. Afghani, thanks so much for your time. I really appreciate it.
Evgeny Lyandres 59:12
Thank you very much for the kind words and for having me. And yeah, it was a great chat, I
Gene Tunny 59:16
think, very good. Thanks. Evgeny, all right.
Evgeny Lyandres 59:19
Thank you very much,
Gene Tunny 59:22
righto. Thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explored.com or a voicemail via speak pipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested. About it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week. You.
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