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Chain Reaction Host Tom Shaughnessy hosts Dan Elitzer: Co-Founder of Nascent and previously of IDEOVC and Lewis Freiberg, an Independent Developer to discuss Empty Set Dollar.

Episode Highlights


Chain Reaction Host Tom Shaughnessy hosts Dan Elitzer: Co-Founder of Nascent and previously of IDEOVC and Lewis Freiberg, an Independent Developer to discuss Empty Set Dollar. This is the first in a series of podcasts on Algorithmic stablecoins. The trio discuss ESD’s creation, technicals around expansion/contraction of supply, competition, risks and much more.

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Show Notes

(2:08) – (First Question) – Dan Elitzer and Lewis Freiberg Background.

(3:35) – Empty Set Dollar (ESD) Elevator Pitch.

(4:31) – Why ESD was so high above the PEG.

(8:22) – Collateralized and Centralized Stablecoins main Issues.

(10:23) – ESD’s role in DEFI apps.

(12:47) – How ESD expands supply.

(18:44) – Will ESD will get to a point where people will be debating every week on what the supply should be expanded?

(20:40) – Incentive to get ESD above $1.

(28:31) – Insights about Supply Lockups.

(31:41) – Is there a point where the majority of the Supply will be circulating.

(33:57) – Differences on speculators wanting to get involved / Issuance Risks.

(36:53) – Debt computed under $1 Walkthrough.

(39:01) – Insights about ESD as a Long Term Investor.

(43:28) – Why is ESD better than other Stablecoins.

(46:56) – Thoughts about Development Teams.

(49:17) – Where to find Dan and Lewis.

Music Attribution:

  • Cosmos by From The Dust | https://soundcloud.com/ftdmusic
  • Music promoted by https://www.free-stock-music.com
  • Creative Commons Attribution 3.0 Unported License
  • https://creativecommons.org/licenses/by/3.0/deed.en_US


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Interview Transcript

Tom:
Hey everyone, I’m your host Tom Shaughnessy and welcome back to Chain Reaction, a research-driven podcast that’s a part of Delphi Digital. If you’re not on Delphi’s research portal, you’re missing out on the critical analysis read by the top minds in the crypto space so be sure to check it out.

Tom: 
One quick housekeeping item, nothing said on this podcast is a solicitation to buy or sell any security or token or to make any financial decisions. I may personally hold tokens mentioned on the podcast and you can view our show notes below for our complete disclosures. With that, let’s jump into the episode.

Tom:
Hey everyone, I wanted to tell you about our new podcast sponsor, LVL. LVL is releasing the first free Bitcoin exchange in North America. The LVL mobile app allows you to buy and sell Bitcoin with no trading fees or hidden spreads. With LVL you get free Bitcoin trading, a hosted Bitcoin wallet, an FDIC-insured personal checking account, wires, checks, and direct deposits, and even a MasterCard debit card. If you use their premium account for $9 a month, you get autopilot automatic trading, chat with a dedicated private banker, and even a metal MasterCard. Check them out at LVL.co or check them out in the show notes below. Now back to our show.

Tom:
Hey everyone, welcome back to Chain Reaction. I’m your host Tom Shaughnessy. Today I’m thrilled to have on Dan Elitzer, who’s the co-founder of Investment for Nascent, and previously started IDOVC, it’s a well-known fund and Lewis Freiberg, who’s an independent dev and the creator of ESD.Tools. I’m sure anybody in Empty Set Dollars been on there or just has it up on their tab. How’s it going guys?

Dan:
Good. Thanks for having us, Tom.

Lewis:
Yeah, thanks for having us.

Tom:
Yeah, guys. It’s great to have you on. Going to start off with the series, you guys are the first ones one. We’re going to be covering stablecoins. Empty Set Dollar is quite the interesting one. Full disclosure, I do own some. So Dan, Lewis, let’s just start… We’ll start off with you, Dan. Give us a 60-second background on yourself.

Dan:
Sure. I started my career working in microfinance and social enterprise, then fell down the Bitcoin rabbit hole the same time I was heading to MIT for grad school, and basically have been focused on nothing other than crypto for the last seven years. So very excited, started IDO Collab Ventures. I was at IDO as part of the IDO Collab team for five years. And then recently left and started this new firm Nascent, which is an early-stage crypto investing firm, but we also take a multi-strategy approach. So something like ESD fits very nicely into that because we have a lot of different ways that we can participate in the ecosystem.

Tom:
That’s awesome. Lewis, what about yourself?

Lewis:
I’m a front-end developer by trade. I used to work at an advertising agency before. As Dan said, I fell down the crypto rabbit hole. I joined a layer one project, IOTA at the time, and I did a lot of ecosystem work for them building applications, helping translate the technical stuff into something that the community could understand.

Lewis:
And I’ve taken that thread through to a number of different projects. I did a similar tools website for the Handshake Protocol, which is focused on decentralized DNS. And then similarly found ESD and thought, “Well, this is an interesting protocol,” and I jumped in and started building some stuff for it as well.

Tom:
Awesome. Yeah, no, it’s a fascinating protocol. Can you guys give us a quick elevator pitch on Empty Set Dollar and how it’s different from other stablecoins? And if you can throw in how large or how much ESD is in circulation today, that would be helpful for framing as well. And the question is for anyone here.

Dan:
Lewis, you wrote the canonical piece. Why don’t you take this one?

Lewis:
Yeah. I guess the elevator pitch is that ESD is built to be the reserve currency of decentralized finance given that it has all of the elements that you would expect from a decentralized finance protocol. It’s decentralized unchained governance from day one, it’s composable, it’s one of the first elastic supplied stablecoins to be able to integrate with the protocol seamlessly, without having any issues in terms of the supply, and also stable. We’ve been a little bit around peg as of late, but the amplitude of that is slowly decreasing and we hope that it continues so that it can hover around peg a lot closer.

Tom:
Awesome. I guess, basically, ESD’s attempt to be a stablecoin, but I mean, from what we’ve seen so far it’s been pretty speculative, pretty volatile too, right? We’ve been above 110, 120, I think as high as 150 at some points. Why is the stablecoin going that high? And a lot of this goes into the dynamics of increasing circulation and stuff like that. But why are we so high above the peg over the last 30 days?

Dan:
Yeah, I think this is a case where you’re bootstrapping a new system. So for something that literally started at zero value about four months ago, there’s going to be some volatility as it goes up. Think when you compare it to something like Bitcoin or Ether, the difference here is that it is seeking eventual price stability around $1. That is the target for it here. But the supply needs to grow.

Dan:
And there’s certainly a huge element of speculation right now, and for this to be useful long-term, Empty Set Dollar needs to get integrated into a lot of other protocols, people need to start using it as a stablecoin, but in order to get supply up to a level where it’s actually useful, there is this bootstrapping phase. There was a literal bootstrapping phase that was very, very early on in the protocol, but I would say we’re still bootstrapping. The supply is just over 500,000,000 ESD at this point. And that’s still very, very small in the grand scheme of things if you think about what the demands could be for a truly decentralized dollar peg stablecoin.

Dan:
And one of the things that I think makes it very different from others is if you look at something like USDC or USDT, that has a lot of centralization risk, a lot of regulatory risk that’s been really highlighted over the past week or two as we’ve seen things like the Stable Act and this working group that the Treasury Department talked about where they literally want to require stablecoin issuers to ensure that there is on-chain KYC with every transaction. That’s insane. And that is the kind of thing that could be the future if we stick with stablecoins like USDT and like USTC. Now, those are great in that they can be able to hold the peg very tightly, but for those of us who believe in this decentralized financial future, it’s really dangerous to put all your eggs in that basket.

Dan:
The darling for a long time in the space has been Dai from the Maker protocol, and I think Dai is fantastic. It was the first decentralized stablecoin that people got really excited about and that got a good degree of adoption. It’s very capital and efficient, right? You need to over-collateralize every Dai there. It’s driven by desire for credit and leverage, which is a very cool mechanism. I’m a big fan and user of Dai, but ultimately, it’s very capital and efficient. So ESD was the first real attempt to get some traction that takes this approach of being truly decentralized while also being very capital-efficient.

Dan:
Now, I want to emphasize that it’s still very early on. There is still a lot of things that likely are going to change with this over time. It’s unclear if it will actually work and be able to be long-term stable. But it’s exploring new territory that existing stablecoins don’t cover. And I think it’s very valuable territory, and if it can work, it seems like it would be better in many ways than some of the existing stablecoins paradigms that we’re used to.

Tom: 
Yeah, Dan, that’s an excellent overview of Empty Set Dollar. It kind of dives into my next set of questions. One of my main questions was just around MakerDAO’s Dai. So Dai’s been around for years, it’s a stablecoin built by locking up ETH and you get Dai on the flip side. There’s been a lot of issues with that because demand for Dai, or really just demand for leverage, right? Demand for Dai doesn’t increase the circulating supply.

Tom:
I was going to ask what the issues are with collateral-based stablecoins like Dai, or centralized stablecoins like USD or Tether. I feel like you already answered both, but I’ll throw the puck back to you guys if you have any other comments because there’s a lot of stuff that comes into play on centralization [inaudible 00:08:55] as well with oracles, white listing, things like that. And that’s really not the world I think we’re building for in crypto. And generally the projects that push boundaries here and actually build towards that Web3 vision, generally get a higher multiple and rewarded down the line.

Lewis:
Yeah, for sure. I mean, from my side looking at something like Dai, you have the over-collateralization required and that is, as Dan said, is very capital and efficient. But then you also have the volatility risks and stuff. So you have to be kind of be long on the asset in order to have Dai not be liquidated. So you’ve had scenarios in the past like Thursday where they were issues were that and they’re still court cases progressing and things like that in that area.

Lewis: 
So with that side, Dai is trying to fix that by adding in other collateral, sometimes USDC and a few other things. But that then kind of back doors into the issue that you have with centralized stablecoins, looking at blacklists, things like the Stables Act and other things that are coming around as of late. So I think with ESD and ESD-style stuff that’s popped on recently, there is this new way of looking at how we can have an algorithmic stablecoin. And that to me, is something that’s really interesting and fits with the narrative that DeFi is trying to project.

Dan: 
Tom, you’re muted. We’re not hearing your audio.

Tom: 
Oh, sorry about that.

Tom:
Gosh, yeah, no, I saw that. I appreciate that. What do you guys think about one the DeFi application side though? Dai and USDC are very tightly integrated with DeFi and Web3 as we’re getting there. Every project wants either Dai or USDC. As you yield farm them, they’re tightly integrated at a protocol level with a lot of these things. Do you think that ESD could actually fill that gap? How hard is it for projects to start accepting it, or is it just more of a cultural thing where people start to say, “Hey, this is stable, let’s accept this instead”?

Dan: 
I think it’s largely going to be a cultural thing and people seeing that it’s stable and wanting to use it. It’s never going to be, at least in my view, it’s very unlikely to be as stable price-wise as USDC. That just has the ability to keep a very, very tight peg, but it comes with this regulatory and centralization risk.

Dan:
Now, ESD does use USDC currently for price oracle, right? That’s what we’re targeting when you look at how that dollar peg is being determined. There’s been some discussion about whether we should move away from that where you could still use the Uniswap TWAP to get, time-weighted average price, to get the price of ESD in USDC terms. But if we incentivized the ETH ESD pool rather than the USDC ESD pool, that would be a way where the incentivized pool that has a lot of value is really, really censorship resistant and then you can reference over to the ETH USDC pool to get that crossover into USDC.

Dan: 
There would be some pretty big changes there, that the primary pool that is being incentivized is no longer a stable pool where you expect long-term to have very little or no impermanent loss. But it is a way that the protocol could be made more resilient to regulatory capture. And I love that this is a community that is thinking about that and talking about things like that because that really is part of the core value proposition to ESD, is that it is decentralized, that it does have the ability to resist regulatory capture in a way that centralized stablecoins don’t.

Tom:
Yeah, that’s a really good point. I mean, decentralized stablecoins really don’t have a lot of recourse. The ETH ESD pool would probably add a lot more permanent loss to your point, but I guess for decentralization it might actually be worth it long-term.

Tom:
Guys, just to dig into the technicals of BIT to round out the conversation, I’d love to talk about how ESD expands and contracts supply. I know you guys alluded to it a bit, but how exactly does ESD expand supply? There’s a couple different ways. There’s the Dow, there’s staking Uniswap LP shares. There’s a couple different ways to gain issuance, which is basically increasing supply, but how exactly does that work in the wild?

Lewis:
Right. So in terms of how the system works, the protocol fetches the time-weighted average of eight hours. So each eight hours there’s an epoch, and that epoch is basically a sample size for the average price that the ESD is trading at.

Lewis:
If the price is above one USDC then the protocol will mint new supply and distribute that to people who are either bonded in the Dow, or they’re providing liquidity in the Uniswap pool. Similarly, if the supply, if the TWAP price is below one USDC, then new debt is minted and this debt can then be voluntarily purchased in the form of coupons that carry a premium depending on the debt ratio to the supply. And then they can be redeemed at the next available time that the TWAP is back above one USDC.

Tom:
What’s the cadence though from you guys, do you think Empty Set Dollar expands supply too quickly or too slowly? Because I’ve been tracking for a while, and Dan, you’re right, it’s early, it’s got to bootstrap, it’s volatile, but I always feel like although we’re expanding supply, we were always above that peg for a long time, but I guess that will normalize over time.

Dan:
Yeah, there have been… I think this is the… We’re currently at around $0.97, which is I think the fourth time we’ve gone and had, I guess we’re not even a fully back under a dollar yet, but this looks likely to be the fourth contraction that we’ve seen. I think that’s very healthy. Long-term we’re going to need to see a little bit of fluctuation more tightly pegged around that dollar point. But my fear as this has grown, and I’ve been participating in it since very, very early on, I’ve seen all of these contraction cycles go through, has been that we over expand.

Dan:
And there was a big disagreement I think within the very early community when there was a change to limit the max expansion every eight hours from 10% per eight hours down to 3%. And when a proposal passed to make that change, it coincided with a strong drop below a dollar. And there were members of the community who were very upset and felt like this was the reason why there was this contraction at the time because that 9% yield, 10% yield per day was viewed as too little. And I still think it’s insanely high, and I think the problem was the supply growing faster than demand.

Dan:
So we’re now at a half a billion ESD in circulation with a target peg of a dollar. So we’re talking about a half billion-dollar protocol here. It’s very early on. I’m very excited to see this growth, but if we continue to grow at the rate that ESD’s been growing so far, I think that’s going to overheat. So I think that their, hopefully, market forces will help keep it a little more in line and growing a little bit slower, but I also think it’s worth having a government discussion as to whether that kind of expansion and contraction limit per period would be brought down even lower. I think even something like half a percent would be more reasonable.

Dan:
That would still be, in an expansionary max, expansionary phase, at the current size, we’d still be talking about adding more than 15 million ESD per day. I still think that’s a crazy amount of expansion and it can let us get to some very, very large numbers in a very short time period. But one of the things that I think is very valuable about the Empty Set Dollar community versus some of these other stablecoin communities that emerged recently around things that are trying to do the uncollateralized stablecoin thing, or partially collateralized in some cases, has been a lot of them have really leaned into this de gen approach and encouraging people with high yields to jump in and participate.

Dan:
I think that the ESD community has largely, although not entirely, been very long-term focused in saying, “We don’t want to overheat. We don’t want to grow too quickly. The goal is to be a stablecoin, not to be money printer go burr meme thing here. We want to actually have this be long-term useful, and if it can be long-term useful, then everyone is going to be better off.” But there are tons of ways of DeFi right now to go out and do really degenerate things. And the hope is that Empty Set Dollar will have this community that will long-term focused. And hopefully yes, folks will make money from it, but the core community members I’m seeing involved in the forums and the Discord, and through discussion, they are not focused on maximizing the short-term returns, they’re focused on maximizing long-term returns by building something that does actually meet this goal of having a price stable asset at a massive scale.

Tom:
Yeah, that’s really important. The funny part is I noticed that 3000% APY early on, and then I realized to get to potentially billions in circulating supply, you have to have that increase. I guess the funny part is… An annoying part about MakerDAO early on was every day, every week we were on calls to determine the interest rate there, and the collateralization ratio and stuff like that, but… or not the collateralization of the interest rate. I’m thinking back way to far here. Do you think that ESD will get to a point where people are just kind of debating every week on what the supply should be expanded by? I’m kind of hoping we get to a point where it’s a bit algorithmic where we don’t need that governance because people tune out.

Dan:
Yeah. Sorry, go ahead, Lewis.

Lewis:
Yeah, no, I think this has been a hot topic in the community. But I think the end goal for me, or what I’m really interested in seeing, is that ESD becomes as boring and as ubiquitous as USDC. It’s not going to hold its peg as tight as Dan said, but I think in the end, we hope that the circulated supply will be unlocked and being used in various DeFi protocols, and there will be maybe a group of people who are interested in staying in the Dow, in the LP and looking after the peg and maintaining that.

Lewis:
When we had these discussions about trying to fine tune the details, I mean, we have to get the incentive structure right for the long-term, but what that looks like is there’s research grants that are being put out already from the Treasury to tackle these issues. But I think ideally this just becomes a stablecoin in the true sense. That it’s a volatility head. You exit out into it when things are looking a bit tough and you use it as you would a normal stablecoin. It just has those extra features of the decentralization, that is something that I think a lot of people would be keen to look for.

Dan: 
Yeah, I think everybody that I’ve talked to in the project is really on that same page of not wanting this to be a governance-heavy thing because of the way it’s set up and the mechanisms and the fact that this is not, I would say, long-term sustainable in its current form, it’s going to need to evolve and grow. There’s a little bit more activity and governance discussion needs to happen right now, but long-term, absolutely nobody wants to be on governance calls every single week trying to tweak this. And being a decentralized head, the idea is that the protocol should become self-regulating over time.

Tom: 
That’s awesome. Yeah, I definitely don’t want those stability fee calls every week, so it’s good to hear. Guys, I just noticed, I woke up and noticed, because the first time that I’ve been involved with the project that I’ve seen it under a dollar, right now I think we’re on $0.91. I’m on ESD Tools. What’s the incentive to get that back to a dollar? My understanding is that people will earn ESD, which makes it more scarce, people will buy ESD with bidding it up to then burn it, making it more scarce, to then convert into coupons to eventually get back more ESD above a dollar. Is that the way it works, and has this worked in the past, and do you think that is a strong enough incentive long-term to help stabilize those?

Lewis: 
Yeah, at the moment, the price is below that $1 peg so new debt is going to be issued. And then that will increase the premium that you get for burning ESD for coupons. And one misnomer that commonly comes about is people are thinking that the lockup that we have when you enter the Dow, enter the LP, is there to increase the expansion cycles. But in reality, it’s there to make sure that we can incentivize people to purchase new ESD with USDC to increase the price and get it back to peg, and then burn that for all the coupons when the price is… So it’s redeemable when the price is above that $1 TWAP.

Lewis:
I mean, in the past, this is our fourth cycle so far, I mean, it looks to be our fourth cycle so far, three previous times people have gone and purchased coupons and had them redeemable. I don’t think anybody who hasn’t intentionally let their coupons expire have had a loss on that front. But I do think that that time would come if we continue with this system, and the demand for ESD as a stablecoin is met by the supply.

Lewis: 
These coupons aren’t a sure thing. They carry risk and as why they carry a premium. So as it goes at the moment, coupons have been a way to get back to the peg and it’s worked in the past, but there’s some discussion around the community about how we can improve the system or replace it with a different one, and just so that we’re able to make sure that we have stability moving into the long-term.

Tom:
Lewis, can you expand on what those new ideas are? Because I’m not sure if I’ve saw them, or just wondering what they were.

Lewis: 
Yeah. I mean, as with any decentralized protocol, we welcome all ideas to come in and we’ve funded one grant proposal, the only grant proposal that has been looking at new mechanism design that replaces coupons. And while I’m not any authority on what that system will look like as it’s being developed, there was an article written by Scott Lewis and Will Price that was published on Medium about what the design would look like. And that moves closer to something like a semi-collateralized, or like a fractional reserve kind of stablecoin. So that helps smooth out some of the price peaks and troughs, and helps it get more stability in the long-term.

Tom:
Yeah, that makes sense. And Dan, from an investment perspective, I mean, the incentive to purchase coupons is obviously that increased return you get. So the further you are below zero, or sorry, below one, the higher the premiums, so the more you’ll get when you’re back above one. So there’s an incentive there. But I guess there’s only incentive if people believe we will be back above one, right? Empty Set Dollar feels large enough, it has a good community, but are you out here in the wild purchasing coupons, or is this something that’s a bit more speculative at the moment?

Dan:
Yeah, what I’ll say is coupons are for advanced users only.

Tom: 
Yeah, that’s fair.

Dan: 
I would not recommend someone who’s not monitoring this very closely to come in and buy coupons. Coupons carry a lot of risk. All of ESD carries risk to be clear. It’s very early. The whole system could not work. We don’t know. But the kind of shelling points of the $1 price one ESD means that whenever it’s below a dollar, the further it trades below a dollar, there’s incentive just to buy ESD and wait for it to go back up to a dollar and then be able to sell it at or over a dollar. Right?

Dan: 
So there’s already that incentive just if you believe in this $1 shelling point, which has been very powerful early on. I’ve been very pleasantly surprised on how strong that’s been. If you want additional leverage there, you can buy ESD below the peg and then burn it for coupons to get even more leverage. Now, the essentially premium that you’re getting on those coupons is based on the amount of outstanding debt versus the total supply of ESD. So the longer ESD stays below the peg, the more debt is issued, and the higher that premium will be on the coupons.

Dan: 
Now, the risk with the coupons explicitly is that if you are not able to redeem them within, currently it’s 30 days, they will expire worthless. So the bet when you’re buying coupons is not just that ESD will return to a dollar, it’s that it will go above a dollar and stay above a dollar long enough for you to be able to redeem your coupons, which are currently on a first-come first-serve basis for redemptions. And that’s created some friction in the community, and there’s been a lot of proposal of discussion around how to improve that coupon redemption process so that it feels more fair and that it creates better incentives around the coupon behavior.

Dan:
But I want to be very clear, due to some of the dynamics around that, I would strongly discourage people from participating in the coupons unless they feel like they’ve got a very strong understanding of the system, and/or a ton of capital to help ensure that the peg returns and stays there long enough for them to be able to redeem those coupons.

Tom:
Yeah, and that’s great color. What’s the point of burning those coupons after 30 days? Does that mean that, “Hey, demand hasn’t kept up. We’re not above a dollar so supply has to come down”? Because on the flip side, if they didn’t get burned we would just have circulating supply increase.

Dan:
Exactly. That’s the idea there. I think the proposal from Scott Lewis and Will Price would replace that because a lot of people I think don’t like the idea of that permanent contraction through burn. It feels very scary. People don’t want to have that. So they are proposing replacing the system that’s more like a longer term, zero coupon bond system. So it would remove circulating supply now and it would pop up again later, but hopefully at the point where demand has returned and grow. So we’ll see where the research leads and if they do develop evidence that this would be a more healthy, more stable system long-term, but I do think that the coupon system, while not perfect, has been effective thus far at returning to the peg.

Tom:
And Dan, that’s another… I mean, we’re talking about when we’re below a dollar people are burning ESD to buy coupons, but on the flip side, this helps stabilize the other way. Because if we’re above one, say 110, 120, people can redeem those coupons for ESD, maybe increase some sell pressure and go back towards a dollar.

Dan:
Correct. Yeah, and that’s the idea is that there should be pressures on both sides, right? That’s the idea of increasing the supply above a dollar so people will sell and push the price back down. Once below, give people incentive to buy or to burn and reduce the supply to help push the price back up. So that’s the core mechanisms around ESD that it’s trying to use to achieve that stability around one dollar.

Tom:
Got it. Lewis, before you mentioned the lockups. If I’m in Dow, there’s a lockup, I think it’s 15 epochs.

Lewis:
Yeah.

Tom:
I think that’s what, three days? And then the Uniswap LPs, I think it’s shorter. What’s the reasoning for that lockup? Because if it goes below a dollar and I’ve locked up, I really can’t burn my ESD for a couple days later.

Lewis:
Yeah, I guess this wasn’t actually in the original design of the protocol. This was added in later. And the reason that we added it, well the community added it, was because there was issues when we were going above a dollar people were immediately unbonding. No, when we go below a dollar, people were immediately unbonding and purchasing coupons with those tokens. And that wasn’t doing anything to push the price back up to the peg. So in that sense, having a lockup it distances and advises you from, or it removes the ability for you to be able to work in that way, which requires new capital to come and push the price back up to a dollar and re-achieve the peg.

Dan: 
Yeah, I think a common misconception around coupons is that if people just burn ESD for coupons, that that reduces the supply and restores the peg. It doesn’t if those ESD were not in the market already. What you need is for people to buy ESD out of the market, which pushes the price back up. And absent that, the only way that buying coupons helps is to reduce the supply is if those coupons expire and ESD is permanently removed from circulation

Dan:
If you just took people who were long-term Dow bonders who purchase coupons every time, in a way they’re kind of free riding essentially at that point. So the purpose of coupons is to really create incentive for those who are going to do the work to basically push it back up to a dollar and give them a way to get, effectively, additional leverage on that activity of restoring the peg.

Tom: 
Makes a lot of sense. And you kind of have a weird reflexive thing where once ESD gets large enough, now it’s at 500,000,000 in issuance, once you hit potentially a couple billion, there is a large incentive for those wells though to go out in the open market and buy ESD and burn it below a dollar, right? Because they’ll have a lot of locked up capital in ESD that they potentially don’t want to lose. Is that the right way to think about it?

Dan: 
I think that could very well be. It’s hard to know what the motivations are going to be of any individual player. But yeah, long-term, that is one of the mechanisms that hopefully helps to maintain stability is that there’s enough people invest in the long-term success of the system here that they’re going to do what will be both profit maximizing for themselves in the short-term because there are essentially these arbitrage opportunities if you believe in the long-term success of the system. But then there’s also the long-term incentive if you do have a lot of capital tied up in this that you want to help make this a self-fulfilling prophecy and ensure that the system does work, and so doing your part to support it for the long-term investment that you have as well.

Tom: 
Makes sense. Guys, one thing I’m kind of wrestling with here, is there’s a large amount of the supply locked up, right? I think it’s 70% is in the Dow, I think 10% or so is in the LPs shares, or actually 80% is in the Dow because some of that is staged, some is bonded. When do we get to a point where a majority of the supply is circulating? Because we want a free-flowing stablecoin. We want people using this. Do you think that… Dan, not to read into your earlier thoughts, but as ESD gets larger it’ll be used more in the wild and less in the Dow because eventually returns will come down, but if you have a lower percent of the Dow and returns come down, returns could still be quite attractive I guess, if that makes sense.

Lewis: 
Yeah, no, I think, as I mentioned before, the idea is that this becomes boring. The returns will drop because as the supply gets closer and closer to the natural demand for the protocol, and we start to huddle within this $0.06 band around the $1 peg where incentives move up on a gradual scale and [inaudible 00:32:42].

Lewis: 
Once we get to that point, the requirement, or the want to be able to bond in the Dow to receive returns will diminish, and only those players who are interested in staying in the Dow to maintain and to receive those rewards will do so. But the majority of people might hold it in their wallet, or they might use it in other protocols where it’s integrated, or they might look at other opportunities if they’re just there for speculation.

Tom:
That makes a lot of sense.

Dan: 
Yeah, I think the long-term steady state of this works would be the folks bonding ESD are essentially just receiving effectively the inflation rate in dollars, would be if this were absolute steady state long-term, I have no idea, A: will we ever get there, B: if we do, how long would take. I would imagine a very, very long time. But that would be what I would expect in a steady state system here. So yeah, eventually, yes, to answer your question, Tom, we should hopefully see a lot more free-floating ESD being used as a stablecoin rather than seeing it locked up in the Dow.

Tom:
It’s wild to think about having a US savings account that accurately tracks inflation. Meanwhile, we get a few Basis points.

Dan: 
Yeah, yeah.

Tom: 
Yeah, hopefully we’ll get there eventually. And can we talk a bit about, just to close up the technical discussion, just the differences between speculators wanting to get involved? Why would somebody choose to stake or bond in the Dow instead of providing equal parts ESD and USDC on Uniswap and staking those LP shares? What are the differences on issuance, risks, and what would you guys prefer I guess?

Dan: 
Well, I think the system needs both, right? So only those, and there’s been some discussion of whether this should be changed, but currently only those who are actually bonded in the Dow have a vote in a governance. So if you want to help influence the long-term direction of the protocol, then you should be bonded there to do so.

Dan: 
However, the current split is when we’re expanding 80% of new issuance goes to the Dow, 20% goes to staked LP shares. So that ends up creating an equilibrium where you end up with pretty similar rates of return on the value that’s been locked in both is where it’s tended to equilibrate. One of the advantages for the LP is that you’re able to I guess unlock sooner, you’re able to free up your rewarded ESD from the inflation every five epochs is a way that you can do it from unbonding and rebonding and then claiming.

Dan: 
So it’s a way, if you want to help maintain the peg, if you want to add liquidity, if you don’t want to buy in as much ESD, you just want to do half USDC, you can do that there. But we have seen relatively similar rates. Generally the total return on the Dow has been a bit higher, but you really are locked in there for longer term. You’ve got 100% price exposure to changes in ESD. So there are certainly tradeoffs.

Tom: 
Make sense. And on the LP share side, so while the Dow returns are higher, I think they’ve been pretty significantly higher, like two or three times, but to your point, there’s different risks involved with a longer lockup. But the LP shares, you’re also earning fees from Uniswap, those 30 BIPs. I’m sure it’s not much compared to what they’re earning on ESD issuance. But they’re also taking some permanent loss. So that’s a good point. And both the Dow and the LP shares don’t get issuance if we’re under a dollar, right? I thought the LP shares did, but I think I’m wrong there.

Dan: 
The LP shares get issuance once it’s back over a dollar, while coupons are still being redeemed. The Dow has to wait until enough new ESD has been made available that it could redeem all coupons and then there is new issuance going to the Dow. The LPs, immediately once there’s any new ESD issued, are receiving their 20% in order to incentivize that liquidity.

Tom: 
Got it, okay. And last I guess technical kind of question, how exactly is the debt computed when we’re under a dollar? That was always a thing I didn’t quite understand. How does that happen?

Lewis:
Yeah, when you have expansions on the positive side of the TWAP there is new tokens minted. And that’s kind of the function of the percentage increase, which is maxed out at 3% at the moment. And that’s 3% of the total supply is then created and distributed to the LP bonders in the Dow.

Lewis: 
Similarly, when you’re below peg, if you’re below $0.97 then 3% of the supply is then minted as debt. So that debt is accumulated in the pool up until a max ratio of I think it’s 35% at the moment, or 20% I think as a new governance proposal just passed. So, as that debt is sitting there, if it hits max it cannot increase anymore. And then at that point, you’re at that highest coupon premium that you can get, which I think is 45%, or maybe a little higher with this recent governance proposal.

Lewis: 
So as new debt is being issued every eight hours below the $1 TWAP the premium is increasing along the curve. And then as it gets closer to the end and closer to the 35% debt cap, or 20% debt cap, then it kicks up and the premium goes up quite a lot higher. So as you burn ESD through these coupons, that actually removes debt from that pool and then it gets pushed down, the premium gets pushed down along that curve as well.

Lewis: 
And then one thing to note as well, is as the dollar goes back above $1 for the TWAP then the debt is zeroed out. So this stops people from playing games where they will go and they will push the TWAP above a dollar, purchase coupons and then start to redeem them if they’re having a big bought or something available to be able to redeem the coupons first, and then push the price back down by selling, and then repeating that cycle. So by clearing the debt, we’re removing that opportunity to manipulate the price as well.

Tom:
It’s fascinating. You’re right, it’s definitely for pro users only. So people know the risk before you get involved with the coupon game. Guys, this is an awesome discussion on the technicals. I want to get it to some more fun questions hopefully on Empty Set Dollar.

Tom:
Dan, you’ve been around a million projects, you’ve seen invested in some of the best. What’s your feeling on Empty Set Dollar as a long-term investor? Because I think back to Yearn six months ago and nobody knew what it would become but we all knew it was fantastic. And I think we all here agree that DeFi’s going to be a massive opportunity, way bigger than it is today, but it’s very hard to contextualize that when we have very early risky projects that are the building blocks that may end up becoming key Legos down the line. How do you feel about… How do you weigh that risk now with Empty Set Dollar versus where you think the space is going to go?

Dan:
Yeah. I think any project in DeFi right now is very early in terms of meeting the true market potential for decentralized finance protocols in the long-term. So it’s all very early, it’s all very risky, even Blue Chips, Compound, Uniswap, things like that, right? They could all still fail and fail to reach their potential.

Dan:
That said, I think that one of the things that has gotten me very excited about Empty Set Dollar has been the factors that we talked about earlier in terms of being really decentralized, very capital-efficient, but also the strength of the community. Empty Set Dollar has really kicked off this trend where we’re seeing a lot of new innovations and other attempts around either uncollateralized or partially collateralized stablecoins, but those projects I don’t think have as strong and early community. Where the Empty Set squad, this pseudonymous group that initially put out the protocol and has continued to be very involved in governance and in development, they’ve managed to pull in some really fantastic folks.

Dan:
Folks like Lewis who got involved very early on and built some tools and has been helping to moderate in the Discord and be a really active community member. There have been all these folks who’ve shown up, who participated early on. I remember back in I think it was maybe September or something, shortly after, maybe it was August, shortly after we’d come out of that first debt cycle, just chatting in the Discord, just being like, “Wow, there is incredible people in here who are having really very meaty discussions around the protocol and around how to grow this thing, and people who are very excited about it, some of whom have very large Twitter followings, and no one’s talking about it.”

Dan:
I’ve just not been part of a community like this before where you have so many people so excited about a project and involved early. And I don’t know if people were trying to get their entry price and fill up their positions first, or my presumption is actually a lot of it was people recognizing the power of some of the mechanisms and the fact that they could lead to some really ridiculous yields, and not wanting to encourage de gen behavior and wanting to say like, “Hey, let’s slow the roll. Let’s let it grow a little bit more quietly under the radar first.” And I think that ethos of all these individual actors who’ve been involved in a bunch of different projects, all independently coming to the conclusion of this has a lot of potential.

Dan:
The best way to kill that potential would be to shill it really hard. Let’s put in the work and let’s grow this community, let’s grow this protocol so that it actually can achieve that potential long-term. That’s something that is incredibly rare and has gotten me very excited about the potential with Empty Set Dollar. And it’s why I’m spending more time focused on this than any other project right now because I think there is that potential, but only if that ethos is maintained and if people really put in the work to get it there. And that’s not going to be just the founding team, or just folks who have received grants or put forth formal proposals. But really, anybody can come in there, make suggestions, participate in conversations, and help push this thing forward. And that’s very exciting to me.

Tom: 
Excellent long-term call, Dan. I loved your folks on the community and the ethos of the project and where they’re at now. And Lewis, one of my last questions for you given you’re in the weeds here on a lot of this stuff, and this is a very multifaceted question so feel free to just dive in at any key point that comes to mind, but why is Empty Set Dollar better than… There’s a bunch out there, Basis Cash, Frax, DSD, other elastic stablecoins. There’s a lot of technical differences, there’s a lot of community differences, some are copy and paste with tweaks like DSD. But when it comes to ESD, in your mind, why will it be the go-to elastic stablecoin versus its peers?

Lewis:
Yeah, I mean, I think that there’s a little different aspects, and I think the community aspect that Dan touched on is one of the main ones. Having a protocol that’s been well-designed like it has with the single capital-efficient structure with a single token. I think TokenTax recently tweeted out about how it’s one of the easiest to do in terms of taxes. And then you have this community alongside it that’s really interested and engaged to push this long-term and not see short-term opportunities and try and maximize yield.

Lewis:
I think when you look at the market out there, the addressable market for stablecoins, you can see tens of billions of dollars, and there really isn’t something that exists that’s able to meet that demand and do something in a decentralized manner. And I think with ESD being the first and having an active community that’s thinking about the protocol mechanics and actively participating in governance and upgrading the protocol as we go, I think that’s really, really powerful.

Lewis:
I think that sets us apart a lot from some of the other communities that have sprung up afterwards. Not to say that those projects aren’t great, and as a community are looking closely to see if we can learn anything from them, and hopefully they learn some stuff from us. But from that perspective, I think with that strong community, the great protocol design, and the new network effect that we have, I think it’s going to be one of the stronger projects out there. That’ll fill that niche of that decentralized algorithmic stablecoin.

Dan:
We place a pretty big bat on [inaudible 00:45:42] on this community. That said, long-term, myself and my colleagues at Nascent, we’re very long-term focused on the potential in decentralized finance, in creating these global open financial systems, and believe that a truly decentralized stablecoin is something that is incredibly valuable long-term for the world.

Dan: 
So while I personally hope Empty Set Dollar does achieve that vision, I think there is a bit of a feeling of we’re all in this together, we all see the promise of this innovation. If it ends up being another project, it ends up being another project. There’s likely room for multiple stablecoins. We’ve already seen that, right? If there’s room for USDT, and USDC, and GUSD, and all these different centralized stablecoins, I think similarly there will be room for multiple decentralized stablecoins. But the bet here is that Empty Set Dollar can be the largest one and hopefully most stable long-term in filling that goal.

Tom: 
Yeah, no, it certainly feels like network effects. There definitely could be multiple winners. I guess with elastic stablecoins it’s kind of a chicken and egg where you want it large enough that people will use it, and given Empty Set Dollar is currently the largest, it does make it hard to compete with.

Tom: 
And Dan, my last question for you while we have you guys, how do you feel anon development teams? I used to love them and now I’m a little one the fence because hey, they could… We’ve seen a lot just pack up and leave. There’s no social link there. But on the flip side, they can do things that people with real faces can’t do. So I guess, what’s your take on them just packing up and leaving? And Lewis, you’re a dev here with a face, so I guess that kind of slaps my question in the face.

Dan: 
Well, I think the fact that we’re participating in an industry where there’s currently 70% market dominance from an asset created by a pseudonymous developer, you can’t say that there’s no value to pseudonymous development teams. I think there certainly is additional risk and uncertainty, but also advantages to having a pseudonymous development team.

Dan: 
So I was also an early backer of Hegic, which has another pseudonymous developer, there. I think there are always additional diligence questions that you need to ask yourself and go through when there is a pseudonymous developer that either in some cases they have administrative control early on. That is not the case in Empty Set Dollar very, very clearly from early on. But the pseudonymous development team does have a meaningful portion of the supply.

Dan:
So I do understand people viewing that as a risk. As I’ve spent time with one of the founders in particular, I’m not personally too concerned about that. I’ve had some conversations with them. They’ve talked about doing some sort of vesting for their share. So hopefully, that is something that they will do and help give greater confidence in their long-term commitments. But every indication I’ve seen thus far has been around real long-term orientation here. Not that we haven’t seen other [brug 00:48:52] polls from pseudonymous developers who have shown seemingly good intents, and then done some things that really aren’t great. So yes, ask the questions, yes to your diligence, but I think that completely writing off pseudonymous developers and what they bring to the table, would be a mistake as well.

Tom: 
Yeah, I totally agree with you there. That makes a lot of sense. Dan and Lewis, this was an awesome conversation. Thank you so much for coming on, on such short notice, especially given the holiday week and weekend. Dan, we’ll start with you, and then Lewis, where can people follow you and Nascent?

Dan: 
You can follow us on Twitter. I’m @DElitzer, and Nascent is @NascentXYZ. And yeah, we’d love to hear what people think about Empty Set Dollar. If they want to get involved, if you go to EmptySet.finance there’s a link to the Discord and I think to the community forum, and a number of other places where you can get involved too.

Tom:
Yeah, awesome.

Lewis: 
Thanks for having us on. Yeah, I’m @LewisFreiberg on Twitter and yeah, I hope to see you on the Discord or the telegram. And if you have any thoughts or any suggestions, we’re more than happy to entertain them and put in a proposal and we’ll go from there.

Dan: 
And ESD.Tools Lewis, you got to mention ESD Tools.

Lewis: 
Oh yeah, yeah, yeah, yeah.

Tom: 
C’mon Lewis, it’s your child, man.

Lewis:
Yes, ESD.Tools.

Tom: 
Awesome. Well guys, thanks so much for coming on. We’ll talk again soon.

Dan:
Thanks, Tom.

Lewis: 
Thanks.

Tom:
Hey everyone, thanks for listening to the podcast. If you enjoyed it, please support the show by hitting subscribe on iTunes, writing a review, or sharing this episode on Twitter and LinkedIn. Stay tuned for our next episode out soon.

Dec 31, 2020 | 50 minutes | Chain Reaction

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