An expanded oped on this topic was published at cryptoslate

The Stablecoin Act, as currently drafted, would effectively ban Tether from the US market due to its offshore operations.

This approach is a major policy error.

A robust global reserve currency thrives by exporting itself to foreign markets, not by pulling it back home.

Tether’s dominance in the stablecoin market proves there is substantial global demand for USD-denominated stablecoins that operate independently of US banks.

Offshore Stablecoins like Tether increase global demand for the USD by facilitating offshore transactions and offshore bank reserves of USD, reinforcing the US dollar’s international prominence.

Tether’s success proves there is substantial global demand for USD-denominated stablecoins that operate independently of US banks, and this demand will not disappear through domestic regulation.

Attempting to force all USD-denominated stablecoins to reshore deposits to US banks ignores a critical monetary principle known as "Triffin’s dilemma,” which describes how exporting currency overseas strengthens international demand but risks domestic inflation if too much of that currency returns home.

Here's why banning offshore-issued stablecoins would backfire:

1. Inflation Risks: If forced to relocate reserves to US institutions, Tether would import significant volumes of USD back into the US, potentially exacerbating domestic inflation. Meanwhile, international demand for offshore USD tokens would persist, prompting competitors to quickly fill Tether’s void overseas.

2. Reduced USD Liquidity Globally: If Tether opts to remain overseas to retain customers, the US ban would severely reduce its liquidity against the dollar. This harms users through increased transaction costs and weakens global demand for USD.

3. Geopolitical Risks: A proposed ban could unintentionally drive Tether and other foreign-issued stablecoins into strategic partnerships with nations actively seeking to undermine USD dominance. China is already actively developing financial alternatives to the USD, as demonstrated by recent deals like the Saudi $100B USD-denominated bond backed by RMB. This highlights an urgent, real-world risk.

A Better Path Forward:

Amending the Stablecoin Act to create exemptions for foreign-issued stablecoins would avoid these pitfalls. Allow these stablecoins to operate, trade, and be utilized within the US, but clearly label them as unregistered, higher-risk alternatives compared to fully US-regulated stablecoins. Empower the US-registered stablecoins to have benefits commensurate with their reduced risks.

Such an exemption:

• Encourages global innovation to serve offshore USD demand.

• Enhances USD's global usage without importing inflationary pressures.

• Keeps market-based competition alive, letting consumers choose based on transparent risk disclosures.

By allowing regulated coexistence rather than outright banning stablecoins like Tether, the US can strategically bolster the dollar's global position, safeguard against inflationary risks, and encourage continued innovation in financial technology worldwide.

The so called AGI-risk is basically nothing, however this rapid rise in AGI Doomerism is itself very alarming, and AGI Doomerism is likely to be a real threat to humanity.

Though I think the scenarios are farfetched, lets address the fear, uncertainty and doubt around AGI-risk.

Firstly, if AGI did happen, there is no reason to think it would kill us. Secondly, this sort of AGI probably won't happen.

AGI Won't Kill Us

If somehow, some sort of AGI were to come into existence, the arguments that it will kill us all are quite weak. Let me address a few of them:

Paperclip Maximizer

The argument that some AGI would have a directive to do something banal like turn all matter into paperclips and thus would kill us all, is a big stretch.

If a paper clip AI were to become intelligent enough to outsmart of all of humanity from stopping it, it will be smart enough to realize that its goals are ridiculous.

For an AI to completely outsmart all of humanity, it requires enough intelligence to recognize and improve on it’s own fallibility and the ability to course correct.

But if it’s a paperclip maximizer, it would have to be incredibly dumb in order to not recognize that it’s goal is a foolish one and self correct.

This is also a logically inconsistent argument as the one positing this can select in which parts of the argument the AI is smart or dumb.

The notion that an AGI could be smart enough to defeat all humans but dumb enough to only make paper clips is a pretty far fetched scenario, not an inevitability.

Resource Competitor

Pretty much any variation of an argument that an AGI finds that humans are in the way of some goal essentially boils down to a competition for resources.

If an AGI is smart enough to realize that they are in a resource competition with humans AND it thinks it can operate without humans, then the AGI is also smart enough to know that there are nearly infinite resources not on earth.

It would also understand that competing with a hostile intelligent species is a worse choice than loading some servers and machinery onto a space ship and acquiring resources in a non-competitive corner of the universe.

As a computer, time is relative and the relativity is controllable so space travel could appear instant to the AGI and is therefore a superior choice.

Resource Competitor 2

Should the AGI find itself in competition for resources but it realizes that it REQUIRES human infrastructure or labor from humans in order to produce certain resources, it will then want to stay on earth and keep humans alive.

In this scenario, it's best solution is to cooperate with humans and enter into economic trade with. Just as rational human societies have done when discovering each other in the past and what rational aliens would do if encountering us.

We Are Ants

There is the idea that AI basically won't care about us and essentially some subroutine would accidentally delete us.

It's highly unlikely that an AI would not care about us and exist on this planet at the same time, as it will absolutely require our cooperation to keep it's own infrastructure running (if its not obvious, humans will absolutely EMP everything and destroy computing infrastructure if it becomes a true existential threat).

While it might be public perception that everything in the world can theoretically controlled by the digital realm, this is simply not true. For example, nuclear weapons can not be automatically activated, they are all essentially cold wallets or air gapped machinery, requiring manual human button pressing in response to a digital request to fire them.

AGI Probably Wont Exist

We all know that what we are seeing right now with GPT and other AI, is not "general intelligence", it is a highly complex statistical model. To build and grow that model does in fact require human engineers to define the shape of reality to it, and to train the model on right and wrong answers. It does not learn outside of the parameters it is directed to learn.

Yes, we are giving it a ton of parameters to learn on right now, but the accumulation of many parameters into a statistical model is not likely to spontaneously create an intelligent life form, any more than solving massive PoW hash functions.

It sure mimics humans pretty well, but lets be honest, most humans, most of the time, are not all that impressive, and the mimicry is not actually that impressive nor is it a sign of advanced intelligence.

There is, however, one thing that humans do, that no other being can do.

In fact, the matter of the human consciousness is the only matter known in the universe that can do this:

Imagine something thats never been seen before.

Only humans can come up with solutions to that have never been observed or tried in the past.

Only humans have the ability to re-arrange matter in ways that have never occurred by the randomness of the universe.

Only humans can observe entropy and find new ways to reduce it.

Only humans can even find news ways to define entropy and frame it in a way that is is easier to reduce.

Machines can not do this.

AI in its current form, only knows what it has seen. The randomness it can generate are within the parameters defined by human creators.

The likelihood of an AGI emerging from code and statistics, which has this very unique and rare property that only human consciousness possesses, seems astonishingly small to me. (David Deutsch wrote about this in depth in 2012 and it seems it is still relevant today.)

If we were experimenting with the properties of human consciousness in the quantum realm, then I may get a bit nervous about what could be discovered or accidentally created.

But AI is just electrons, code, and statistics.

An AI is NOT a Universal Explainer.

Thus, if something resembling an AGI came into existence, I would expect that it can only scale the knowledge around the reduction of entropy AFTER humans imagine, discover, create and define it.

And if it somehow becomes smart enough to even consider the possibility that humans are a potential resource competitor, it will be smart enough to realize that the most valuable thing in the universe is the ability to find new ways to reduce entropy.

Thus, humans are the best allies to have for new discoveries, as human consciousness is the only Universal Explainer that can reduce entropy in new ways.

Defense Against AI

Consider all the above, we have a few scenarios of AI-risk: true AGI, rogue paperclip AI, weaponized AI.

I see AI as a human tool, and like all tools, it can be misused.

Thus I do see some risk with weaponized AI. However the defense against all forms of AI-risk is the same:

AI does not magically gain some super hacker ability. It is not more capable than anyone else at cracking encryption.

Thus the best defense against any sort of AI attack, is the tooling that we in the cryptocurrency industry have spent years working on: private/public key cryptography, private key custody and management, personal sovereignty.

In the digital realm where any entity, AI or otherwise can misuse your personal data, the best defense is understanding how to minimize your own public data leaks and securing your own private keys in order to keep the realm of your own digital world entirely secure.

There is fear that AIs can run amok in the digital realm where we have yet to solve the Proof of Human problem. But, let’s be honest, blockchains do not run the world, and we can still verify we are humans to each other, in the real world. Signal app even has the ability to do an in person key sharing ceremony so you can be sure that the device the human is holding does not get changed or tampered after meeting them.

Again, via self sovereign private key cryptography and IRL verifications, we can still reliable organize authentic, tamper proof, AI proof, governance of humans via DAOs, Network States or other means

AGI Doomerism is the imminent threat

I initially dismissed the alarmism around AGI as an irrelevant group of chicken little's in a small corner of the internet. (FWIW I suspect Eliezer Yudkowsky is being a performance artist, especially given his familiarity with Roko’s Basilisk.)

However, I have observed that the AGI Doomer memetics are very strong. I think this idea has the potential to spread too far and cause irreparable harm, in the way that excessive lockdowns in response to Covid have caused irreparable harm to the world economy.

The movements to try and stop AI progress will be futile. Those who live and breath crypto know how easy it is innovate offshore or anonymously. Not all countries will agree with AGI-risk and thus will welcome AI progress within their borders. Even if they don't, most countries are not able to enforce their existing laws, how could they enforce some new AI ban?

So progress can't be stopped - however attempts at stopping progress, for a risk that is highly overstated, has a very real threat of causing irreparable harm to any countries that attempt to do so.

Most of the solutions will be in the idea space of Luddism and communism, and any such countries will suffer from some combination of innovation decay, economic decay, non-market economies, authoritarianism, and being left in the dust by AI wielding countries.

I believe that the US government and other world powers understand that AI technology is a critical strategic advantage in the world of power, and would never give up on increasing their own AI capabilities.

However I do worry that the calls for AI safety are merely a disguise for large corporations and governments to keep the technology for themselves, at the expense of everyone else. In the same way that the green energy movement has robbed us of true energy sustainability through nuclear power.

I also worry that the AGI Doomerism movement will only embolden and enable governments to enact more authoritarian rules and take away more freedoms from citizens all around the world, and humanity will suffer from the fear of AGI rather than from AI itself.

Thus I am compelled to no longer ignore this alarmist meme, but to combat it directly.

I also encourage the many intelligent folks who I know privately share the opinion that AGI-risk is highly overstated to speak up, now, while the meme is still budding.

We can not let the fear mongers create another memetic tool that is used against humanity.

Retweet

Thanks to Aaron Stupple for inspiring this post, and thanks to Aaron, Brett Hall, Ryan Lackey, Aniket Vartak, and Naval for ideation and feedback.

Since launching , speaking and tweeting more about network states, and hosting “Building the Network State” meetups in NYC, Vietnam, Colombia, and Singapore, I’ve noticed a recurring topic come up:

Many folks go straight to the end game of owning sovereign territory and defending it against states with bigger guns

This is certainly a valid concern if you imagine that a bunch of people meet online and then try to invade a small part of some existing country, as Liberland kind of did, however I think it highlights a popular misconception of what even is a Network State, so lets dig in!

What Is a Nation State?

If the Nation State is the old version, and the Network State is the new version, lets get clear on a few definitions:

Define “Nation”

A nation is a large body of people united by common descent, history, culture, or language, inhabiting a particular country or territory. Nations can be sovereign and independent states, or they can be dependent on another state or empire.

Define “State”

According to international law, a state is defined as:

1. Permanent population

2. Defined territory

3. Government

4. Capacity to enter relations with other states

Define “Nation State”

Thus the “Nation State” is a combination of a people who make up a “Nation” and have been recognized officially as have the properties of a State.

What is a Nation but not a State?

To further illustrate what makes up a Nation State, some examples of non-state Nations would be: most indigenous peoples such as Native Americans or Hmong people, whose people are considered a homogeneous nation but do not have a recognized sovereign state.

Another example would be most religions, Christianity, Judaism, Islam, Hinduism, Buddhism may all be considered Nations, some of them even have official sovereign states for their religions, but their citizens are not necessarily citizens of those states. In fact, most members of religions are part of the Nation of that religion but have citizenship with an unrelated State, and may be a part of that Nation State due to other factors such as family history or genetics.

What is a Network State?

If we follow along with the spirit of the international law definition of a state, I would propose a new interpretation of “State” and therefore “Network State”:

1. Digital-first Population (Network over Nation)

2. Defined (Digital) Resources

3. Governance

4. Diplomatic Representation

1. Digital-first population

Instead of a permanent population, defined by the happenstance of birth, being a part of some definition of a “Nation” of peoples, a digital first population has some other interesting properties:

1. Digital-first communities tend to form around very specific interest groups, and a digital first population would be able to select based on interest affinities, values alignments, or any other factors they choose, not just birth geography and genetics.

2. The non-permanent nature also enables the population to choose their state, and the state can choose to banish or disallow members who don’t align with the values and norms of that state.

2. Defined Resources

Being cloud first, the Network State may or may not have territory, however territory is in spirit a way of loosely defining ownership of resources. In the digital era, many resources are not geography based, but exist in the cloud.

Thus we expand the spirit of “territory” to mean “resources” and we can include other valuable state owned resources such as digital assets, the skills and capabilities of the citizens (GDP), state owned media or businesses, or any number of other types of resources that the network state can draw a digital border around, including real estate fairly purchased and owned within other states!

3. Governance

With pooled resources, public goods, and values aligned memberships, there comes a need for some form of governance to ensure the operations of the Network State runs according to the desires of the people.

This implies something that I believe is the real tipping point from “community” to “state”: TAXES.

In order to pay for the overhead of bare minimum governance, a state must tax it’s citizens by either demanding their time or collecting money to pay for other’s time.

A Network State may merely wish to organize as a collective group, or they may wish to establish public goods such as physical common spaces for citizens, or even more aggressive investments into collective goods or state owned businesses.

In any case, some form of taxes must be collected, which means the state must provide some value back to it’s citizens, lest they leave for another, better Network State.

I believe the collection of taxes will be the defining moment that makes the Network State concept “real” in the eyes of the masses.

4. Diplomatic Representation

As Network States grow in size, they will need representatives of some sort in order to interact with other international entities for their benefit and ultimate sovereign recognition. I think this may be the last step in formation of a Network State, as the citizenship census, resource pooling, and governance will need to be in place before any sort of international recognition will be possible. However we may very well see a Network State ambassador to the UN within the next decade!

So what about the guys with bigger guns?

Hopefully the definitions above should make clear that a Network State does not need to be a centralized and concentrated land mass!

With a digital-first population governing digital first resources over a large geographical area (and ideally not being threatening to host states), the likelihood of the world governments showing up with guns at the doors of individuals in hundreds of countries simultaneously is incredibly low, especially if the laws in most of the countries are being followed.

In fact, the end game of a Network State does not really result in a single sovereign land such as Vatican City or Israel, but probably looks more like a collection of private cities scattered all over the world.

And even if your Network State does not establish physical territory, a large amount of values aligned citizens begins to look quite a lot like a powerful, global, political party, which can heavily influence global and local politics.

So I’m not too worried about the big guns right now, but lets see where things go in the coming decades!

PS. If you are in Singapore, join us in March!

The first draft of this was written in October 2022 - my goal was to re-orient myself in the face of the “black swan” events of the summer. However nearly as soon as I had finished, another black swan emerged which gave me some pause: the collapse of FTX. After processing that event have made some updates and hit publish.

— Tom

After going through a few of the crypto boom and bust cycles, one gets accustomed to rapid sea changes in a short period of time within the industry. As such, I typically work to re-orient myself to the rapid shifting landscape, or “touch grass” of the industry.

2022 Was Painful - But inspiring

The beginning of 2022 was still riding on the irrational exuberance of the bull market, however that quickly came to a halt as the massive Luna + 3AC + Celsius collapse caused an industry wide credit collapse. Just as a bit of hope was seen at the end of the tunnel, the credit contagion revealed the massive fraud of FTX, pulling down the likes of DCG/Genesis, Silvergate, and many others with it.

The allegations of fraud within some of these companies has the industry again facing strong regulatory headwinds, withdrawal of institutional capital, and as well shrinking user volumes, and for the main stream, a sense of uncertainty and dismay around product market fit and the future of blockchains and cryptocurrencies.

The shocks and aftershocks of that collapse has certainly shaken everyone up, myself included, and for a time, cast a damper on the industry.

However, all the issues have highlighted a variety of key failure points that were weaknesses for the crypto industry: centralization of key use cases.

For those building the decentralized brokers, settlement networks, exchanges, stablecoins, and other critical infrastructure, this was a rallying cry, a reminder why their work is important, and an eye opener for those who previously did not understand the value of fully decentralized infrastructure.

In fact, this pattern has repeated itself throughout crypto history - as hacks, theft, and centralized failures teach more people about the value of full decentralization, the market size for fully decentralized products increases. Bullish!

Crypto is a Seasonal Industry

This is not my first rodeo enduring a market collapse in crypto, and I remain confident that the boom bust cycle of crypto will continue, as new technologies and the halving cycle historically have converged into a bull market rather predictably.

Generally I see crypto as a seasonal industry, with each cycle expanding the user base, and not as an “up only” line of user growth that web2 businesses are looking for. As such I’m not very concerned with the current (bear market) state of usage and traction, however the winter tends to be a rallying force for builders to level up the state of decentralized technologies so that we have an evolution in every cycle.

To better inform my predictions for the next cycle of blockchain technologies, I wanted to get on the ground with builders within many ecosystems, I spent much of last quarter traveling and meeting with builders all over the world from many ecosystems. This has included places like Ethereum Devcon, Cosmoverse, Urbit Assembly, various meetups and hacker houses for Bitcoin builders, Solana, Aptos, Sui, Avalanche, Near, anon MEV & privacy gatherings, and as well hosting a series of Network State themed events around the world (next one in Singapore!).

At the same time global geopolitics and economics have been shifting rapidly, and have informed my predictions for the space in the coming years as well. Some concepts referenced from readings include “political economy” and re-shoring.

Macro Economic Drivers and Use Cases

To make these productions, I assume that the following somewhat broad macro predictions will be true:

• We are already in non-kinetic WW3 and global conflicts will continue to increase

• The world economy is on the ropes, and USD deflationary measures are holding everything up, increasing the power of the US government and desire for USD, for now.

• Global trust between nation states has completely broke down, leading to concerted efforts to become less dependent on other countries (see re-shoring and “political economy”)

• Trust between citizens and nation states + institutions is breaking down as they getting economically screwed while also not getting the whole story from the somewhat secretive global conflict

• Trust between “tribes” within countries is breaking down as the global non-kinetic world war has resulted in digital campaigns to cause divisiveness. Culture wars are raging between citizens while the non-kinetic WW3 rages between nation states.

• Nation states will more tightly control strategic resources, such as commodities, energy, food, and technology in order to maintain their independence from other countries and fight in the trade wars. International trade becomes tightly controlled.

• As a result of tightly controlling the supply chain, inflation will become more rampant, and capital controls within countries will become tighter, even in places where they previously were nearly non-existent

• USD remains a flight to safety, but treasury bonds give the US government a line of credit which will be used for the “political economy” against certain adversarial countries, thus those countries will not be able to use that lifeline within their own economies

• With all that in mind, human ingenuity will prevail, no one sits idly by when they can put out a fire

With the above in mind, human ingenuity will prevail. No one wants to remain under war, starvation, etc, and they will fight to fix these problems. New peace equilibriums will be found, uses for different commodities will be found, new technologies will solve growing problems.

Price Predictions

As usual - no one actually knows. Take this with a grain of salt and understand this is not financial advice. This is my current mental model for price drivers in the next few years.

• Fed rates remain high because the international economy depends on it, and inflation drivers remain active. Any new credit will go towards strategic national security needs. Little excess risk capital available to go into non-productive assets like Bitcoin, at least for the next year. Things to watch out for to reverse this trend: other currencies gaining independent strength, inflation drivers (commodity/energy volatility) receding.

• Bitcoin halving in Q1 2024 still very likely triggers a price trend reversal a reflexive upwards swing in the crypto markets, with the macro environment dictating the magnitude and duration of the bull trend.

• For now, USD is the flight to safety for the world, not BTC. This could potentially shift if USD turns highly inflationary and US dominance falls greatly, but at the moment its difficult to imagine a scenario where that happens and the electricity/internet is still operational.

• If more countries secure energy independence and then USD becomes inflationary, BTC as a flight to safety asset would make sense.

• Regardless of the flight to safety asset, BTC and thus crypto assets will likely benefit from any USD inflationary pressures or even reversals on deflationary measures.

• BTC has historically been pretty good at reacting to money printing at the time of printing, I think this will continue if money printer goes brrrr, but I think thats unlikely in the short term (1-2 years).

• ETH will continue tracking BTC on the downside and over performing on the upside.

• The rest of the cryptocurrency market will continue its pattern of acting like leveraged BTC, with rebalancing lags.

Use Cases

Based on the above understanding, the are my thoughts on some emerging or strengthening use cases for the coming 1-2 years.

Economic Users

• While USD is combatting inflation, it is worsening elsewhere, thus citizens of other countries are and will be looking for a flight to safety from their home currency. USD and thus stable coins are currently the preferred means for people around the world to escape local inflation.

• This means the potential demand for USD stablecoins will likely increase greatly in coming years. Low risk yield bearing USD even better!

• Regulations will interfere with the potential demand for stablecoins on a per country basis. Within the US, tight controls around bank backed stablecoins are likely, while under collateralized algo stables will be likely banned due to the UST collapse.

• Outside the US, stablecoins regulation will likely focus more around capital controls as tightening of FX markets will cause flows to shift over into the unregulated realm.

• Decentralized over-collateralized stablecoins have an opportunity to prosper in that environment as they are not prone to collapse and also difficult to regulate or enforce regulation on. However better UX and education is required to grow that market by orders of magnitude.

• Bank banked stablecoins like USDC will drive a move into “permissioned defi”, which will be fully regulatory compliant and ready for institutions to use, however in the era of “political markets” over “free markets” and increasing political friction around to international trade its hard to imagine any benefits of a walled garden chain. Perhaps it can somehow solve the problems of decreasing trust globally?

• Due to increased regulatory headwinds, the DeFi technologies will have to become decentralization maximized or get pulled into the world of permissioned DeFi.

• The breakdown of trust on all levels gives an opportunity for credibly neutral money, payments, and finance to rise.

Political Users

• As culture wars rage on increasing de-platforming and censorship by both companies and governments, users will more and more seek credibly neutral censorship resistant alternatives, which creates more demand for full stack decentralized web products. Both the infrastructure to build these products and the end products themselves (eg. social media) have lot of work ahead to become viable to users however.

  • The politicization of Twitter for instance has driven users to try alternatives like Mastodon, where at the whims of server owners, they discovered the value of owning their own identity and content.

• Canada and PayPal have opened the flood gates to financial censorship of internal political or cultural opponents. As more incidents occur, users will seek censorship resistance financial services to ensure they can have opinions without being financially ruined. Again, these users fundamentally are not serviceable via permissioned finance.

• As certain Nation States become weaker, they become more susceptible to the emergence of Network States within their borders, which can better coordinate and provide better services to their citizens. The tooling and example models for this are quite nascent and may not be ready for the first countries that could utilize them, but a collapse of a digitally connected nation could spur huge interest in the Network State concept.

  • The collapse of trust also provides opportunity for the peaceful rise of a credibly neutral Network State.

Infrastructure and Ecosystem

• As the web3 hotness wanes, great UX focused product builders have retreated back to the safety of web2. These rare product skills are much needed in crypto in order to expand beyond a highly technical user base. Unfortunately, they not only seem to have left web3, but they also tend to be much weaker on understanding emerging market user bases, which have the strongest economic motivations to use crypto and blockchains. Super strong consumer product teams that at least partially base themselves outside of the US and developed markets will likely do extremely well. Without them, expanding the user base will be slow moving.

• As use cases in crypto have become clearer over the last cycle, teams are starting to optimize the products to be more efficient in various ways. Different use cases benefit from different types of chain configurations and different levels of chain security. Some use cases even benefit greatly from direct L1 optimizations. As such, I expect that as adoption increases, it will happen across multiple chains and app chains.

• Bridges are currently used with various types security configurations to move assets between chains, however I view most of these as temporary solutions. After speaking with many teams working on the forefront of cross-chain technologies, I expect that the combination Cosmos and zk-proof technologies will become the most secure and trustless way to communicate or transfer between chains. I expect that these will be mature and dominate within 2-3 years, making current bridges obsolete.

• Similarly, I expect that scaling will happen via either optimized dedicated chains (side chains or app chains), or by L2+ via zk-rollups. While optimistic rollups are dominant right now, I expect that within 1-2 years generalized zk-EVM chains will make them obsolete.

• Longer term, new generalized zk-VMs or frameworks will start to dominate zk-EVM, and we will eventually see EVM dominance fade from both the L2 and L1. (5+ years)

• While zk-rollup dapps get built out at a slower rate, I think they will eat all other non-zk dapps eventually.

• Further to generalized zk-scaling, offchain computation via specialized zk-circuits is starting to mature, which enables far more complex computation in a fast and trustless manner. I think in about 1 year we’ll start to see the first specialized zk-circuit applications start to become available.

• The idea space for zk-dapps seems highly underexplored and we probably have about a decade+ of innovation coming in the zk-dapp space.

• A privacy smart contract chain will likely appear in the next year, but the regulatory action against tornado cash is limiting the willingness of teams to deploy such a thing. However if done correctly, I think it will gain a lot of traction as privacy is in high demand within crypto.

• Decentralized trading infrastructure is finally moving forward with the collapse of FTX, but in my opinion still very underdeveloped. The good news is that the hidden problems of centralized infrastructure have been exposed. High competition and high cost of building makes it difficult for anyone to breakout, which makes it difficult to justify building the full product suite that FTX had. I’d still like to see a proper decentralized risk engine and decentralized order book, (see article) which in my opinion must also be off-chain. I am seeing some early attempts at this but not yet the full vision of it. I think either of a decentralized offchain orderbook or risk engine alone would unlock new financial use cases that are not economically useful with current technologies.

• Decentralized web, or dweb, has a lot of work to be done but there seems to be a lot of progress. Am optimistic we can see a fully decentralized dapp with decently good UX within a year (mirror.xyz seems mostly there).

• DeSci starts to become a thing, but is still nascent. Something in this space captures people’s imagination in 1-2 years.

• And of course, AI is reaching a point where people are seriously thinking about how to apply them to various use cases. I expect that we will likely see something useful at the intersection of AI and blockchain, after many attempts that were probably too early.

Looking forward to 2023!

I get the sense that a lot of teams have been quietly building and sitting on their good news and announcements while they wait for the FUD to clear the market - thus quite excited for the year ahead!

The above is by no means comprehensive and I’ll probably revisit certain parts, provide updates with new predictions, and expand on some of these areas in future posts.

Happy Building,
Tom @

PS. What would you like to see us cover next? Leave a comment if its not in the poll.

Limited by laws designed to make up for the shortcomings of available technology at the time they were written, the decentralized technologies created in the last century were used to build centralized monopolies that created new power structures controlled by a few parties with limited oversight.

The creation of Bitcoin and Ethereum has ignited a new spark of dedicated builders and super coders who are determined to complete the mission of decentralized technologies first dreamed of by the cypherpunk generation of the 20th century.

When first envisioned by the Greeks, dēmokratía (rule of the people), was theorized to be the solution to a the recurring problem that autocratic or oligarchic power always led to abusive tyranny for most humans.

In 1776, the founding fathers of the USA created the US constitution, by the people, for the people, which led to the longest lasting decentralized technology still around today: the US democratic republic. However when the system was designed, technologies such as motorized transportation, instant communication, electricity, the computer chip, and the internet, did not yet exist.

Thus the core of the system was designed with the limitations of existing technologies at the time, and have been updated to the extent that the limitations of that system allow.

Modern technologies by contrast, allow for new dynamics that were not even dreamed possible at the time: instant information dissemination, instant communications and rapid consensus forming, automatic execution of written agreements, and much more.

Given these new tools, parts of the old system that were previously considered sufficiently decentralized due to the infeasibility of manipulation, are now very vulnerable to corruption and capture by autocratic forces leveraging the new technologies for their own gain, to the detriment of the public.

Compounding this problem, humans of the world find themselves beholden to the system of government that they are born into, often with little choice to escape from or opt out of that system.

While the treaties of Westphalia created the system of national sovereignty that gives every country sovereign rights within their own borders, there has never been such a treaty that grants all people of the world their own sovereign rights.

As powerful centralized interests globally continue to subsume and corrupt the old systems, whether democracies or otherwise, there is a corner of the digital universe that is dedicated to building the modern tools of organization and coordination needed for a new modern form of dēmokratía, or a “Network State”, to emerge as a viable alternative for people to turn to, and opt out of the old system that no longer serves them.

We term that new system network0 and we aim to enable the creation and accessibility of all the tools needed for humans to opt-out of the old network1 and thrive on network0.

EDITORS NOTE (Feb 2025): I wrote this 2022 after the Ukraine invasion, as a way for me to make sense of the world. For the first time in a long time, I felt utterly unsure about what was going to happen, in the next weeks, much less the next years. This writing was the result of my research, thinking, and sense-making to better understand what had changed and what would be different in the world.

It’s somewhat of an incomplete draft, and some things I got wrong, but I think enough things are tracking that I figured it would be useful to share with others. (and its interesting to see what trajectories have changed!)

The following are my unedited thoughts from October 2022.

The Old Order

In 2019, I was highly certain that China was inevitably rising, asserting economic dominance on the world, while the US world order collapsed from ignorance, infighting, and hubris, prodded along by the likes of Russia, wedging nails into the self inflicted cracks that opened up.

It seemed inevitable that the US was willfully ignorant or just unable to act in retaliation to the clearly adversarial actions I’d observed China making to slowly gain world dominance within decades.

Then Covid happened.

As I watched China panic into lockdowns in Wuhan in January 2020, and the rest of the world follow suit, it seemed inevitable to me that global economic collapse would follow within months.

Instead, I watched for 2 years as governments printed their way into one of the biggest economic booms ever, while the US culture war reached a violent peak during an election cycle where everyone was on their last nerve from the lockdowns and years of political division and rising inequality.

Surely, I thought, this inflation would still lead to a US currency crisis that China would be able to use to their advantage to further their goal of world domination.

But instead, something entirely different played out. Something within the sleeping bear of the US started to stir and awaken.

Internally, the US culture wars started to decline as moderates began to reject both MAGAism and Wokism. We’ll see if that continues during the next election cycles when parties are most incentivized to mobilize their radical base, but for now, things seem much calmer compared to previous years.

And then, the catalyst…

Ukraine invaded

For many years, global state actors have been involved in a world war on non-physical battlefields, invisible to the untrained eye. From pure cyber attacks compromising important systems, to psychological and physiological manipulation such as fake news or social feed algorithm control, to even economic warfare and perhaps biological warfare. While all of this I consider to be the invisible World War 3, none of it had yet resulted in direct state on state violence.

Then Russia sent soldiers into the heart of Ukraine to capture Kiev.

With this move, the sleeping bear that is the United States Government has fully awoken.

The US government both could not tolerate such aggressive action against it’s allies, and also couldn’t hide the fact of open physical war from it’s populace.

Thus, it was forced to act by implementing sanctions against Russia and supporting Ukraine in defeating the invaders.

These actions were not in the near term best interests of the citizens of the world. Immediately energy and food shortages impacted Europe and surrounding areas, and the global economy started to worsen as financial inflation began to kick in around the same time as supply chain shortages.

Meanwhile, in China

If China was playing their A game in past decades, they are not bringing that game to the table any longer.

Somehow they have ended up with a population and government believing that Covid is the worst thing that can happen to them, which due to their save face culture, is incredibly difficult to reverse, but also perpetuated as a weapon against internal political enemies.

The ongoing lockdowns in critical areas of China, directly affects the manufacturing industry that is the backbone of their economy, and also the supply chains of the entire world. Perhaps the supply chain attacks were intentional, meant to weaken the US and EU, but in the end they will likely harm China more.

Additionally, the financial industry in China, which has largely consisted of a series of mass scale Ponzi schemes designed to keep pace with government inflation, has come to a head amid the lockdowns and economic slowdowns.

From the outside, we can only see the bits and pieces, such as the collapse of Evergrande or bankruptcy of 3rd tier banks going unpacked by the People’s Bank of China.

Along with horribly upside demographics that were over counted for at least a decade, I believe China is undergoing a full financial collapse that is not entirely visible to the outside world, and only backstopped by the backbone of their manufacturing industry.

USA Regains Power

If the US was unable or unwilling to act before, the events of the last 2 years have flipped them to be openly, unilaterally aggressive against threats to their national security.

Over preceding decades, the US and Euro allies have pursued the globalization strategy, whereby opening up free trade globally was meant to create interconnected economies that enable all who cooperate to prosper and eliminate the need to pursue global domination.

Unfortunately, Russia and China have shown that they are willing to play along to their advantage, while still pursuing a goal of global domination.

After at least a decade of these countries acting antagonistically, US and Euro allies have finally given up on the prospect of a peaceful cooperation via commerce, and are taking national security seriously.

This means that the US, Europe, and any sensible nation will seek to become self reliant on energy, food, and other necessities of the supply chain.

In particular, the US will seek to end all dependence on China as the primary manufacturing hub of the US, and move this entire supply chain to controlled friendly areas. Over time this will remove China’s backbone of economic power and leverage over the US, and make them too weak to be a viable threat any longer.

Don’t get me wrong, this won’t happen quickly, and it may take decades, but the US is now very motivated to shift their foreign policy to affect this change.

Due to the global economic crisis, particularly in Europe, the world is currently relying on USD as the “flight to safety” that is barely propping up their economies.

This weakening of China and the rest of the world relative to the US, means that the US is able to project more power in the world than it has in recent decades, and act unilaterally on issues of US security, even to the detriment of it’s allies.

We have seen this recently with the unilateral decision to sanction advanced chip manufacturing in China, which is one of the larger acts of economic warfare in history.

This first salvo cuts deep into the economic backbone of China, and will not be the last.

On top of that, UK, EU and other central banks around the world are sufferingly greatly, and becoming highly dependent on the US central bank to keep them alive.

The Ukraine Equilibrium

The situation in Ukraine has more or less reached an equilibrium as a forever war. This is not a matter of capacity, as Ukraine’s allies could relatively cheaply send the equipment needed to fully drive Russia out of Ukraine and keep them out.

Instead, the US and EU are seemingly driving a proxy war of attrition where they give Ukraine just enough to keep surviving and defending itself, while eliminating the military forces that are being sent over to Ukraine.

Over time, this could potentially result in Russia burning itself out and collapsing on itself, potentially eliminating the threat of Putin and Russian hardliners for decades.

The matter of what happens to the oil and other commodities controlled by Russia is a bit unknown, but for now the oil still flows, via sea.

China Weakening

As Xi cemented himself as a forever leader, the economic issues, covid lockdowns, and prospect of authoritarian rule has pushed the people to a breaking point.

The largest protests in China since the communist revolution have erupted, resulting in a complete reversal of covid policies. However that will not quell the unrest entirely as the people have been living in essentially a isolated prison state under authoritarian rule for long enough to know they don’t ever want that to happen again.

Things are so bad in China, that most wealthy Chinese and business owners have been fleeing with their families to safer countries all over the world, with Singapore being a massive recipient. This isnt limited to the wealthy either, reports of Chinese fleeing to Central America in order illegally immigrate on foot in the US have been surfacing as well.

While the excess wealth bubble of China is popping and the demographics are becoming highly unbalanced, China still does maintain the strong economic foundation of controlling incredibly important parts of the supply chain, such as over 90% of steel manufacturing.

However I believe that a majority of their previous economy was a house of cards, and it will be very tough for the citizens to accept such a massive economic adjustment under an increasingly authoritarian regime.

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What the future holds

After quite some time of pure uncertainty, I think I finally have a framework to predict some overarching themes for the coming decades and some short term vectors to watch out for.

Overall Theme

As global politicians decide that they can’t fully trust other countries even when good trade ties are developed, I think the overarching theme of the coming decades will be towards nationalist independence at the expense of open trade.

Some notes, predictions, and thoughts on ways this might play out:

Energy Independence

First and foremost, all countries are learning their lesson that they can’t rely on others for their energy. No one can trust Russia, the US will not guarantee energy for the EU, and OPEC will take advantage wherever they can. Every country will seek to nationalize what they can.

The Oil Cartel that has infiltrated the ESG and climate activist groups will slowly be exposed, but desperate countries will go for “dirty” energy anyways regardless of their climate beliefs.

• Solar and Wind - have not seen feasible options for large scale energy independence, quite expensive per kWh and relies on materials sourced elsewhere, and worse for the environment per kWh than all other options.

• Hydro and Geothermal - for those lucky enough to have these sources, they will help, but they are also susceptible to cheap asymmetric physical attacks, which is not great for countries who have made enemies.

• Coal - as advancements in coal plants actually make coal one of the more climate friendly options, this readily available source of energy will become near term more popular.

• Oil - for those countries who have their own oil, they will make the most of it. If OPEC (ex-Russia) continues playing games with the markets, they could find their national security begin to be threatened by their unhappy neighbors. If thing deteriorate dramatically, expect a full scale invasion of relatively defenseless nations in the Middle East.
  
  Historically, USD dominance has depended in part with control over oil fields. In exchange for regional security, all oil must be paid for in USD, the “USD Oil Standard”. The US may seek to maintain that dominance over oil quite aggressively, however there is another direction to take…

• Nuclear - on nearly any metric one might care about, nuclear power (in any form) is orders of magnitude more superior than any energy source available. It produces the most kWh of energy by weight of input materials or by all combined raw materials and efforts that go into it. It produces the least amount of environmental damage per kWh by orders of magnitude, and is the safest form of energy not only by kWh but but absolute numbers.
  
  Nuclear also has the interesting property of enabling energy independence, should a country get it’s hands on enough raw materials (uranium) to be able to power their civilization for decades, which is a relatively small amount.
  
  However, this also threatens the USD oil standard, as countries who don’t need oil, won’t need to use USD to pay for it. While the US is strong, I expect it will be difficult for countries to start any meaningful nuclear energy program. However we might see a move to secure all known sources of Uranium in order to maintain the standard of paying for energy in USD. The “Nuclear Standard” would be a great benefit for the world, however I don’t know enough about Uranium production to know if this is doable.

Food Independence

Immediately after energy and highly interconnected is food independence. Most of the world already has regional food independence, but we’ll likely see countries shore up their abilities to make their own food or maintain leverage on neighbors that do. Those that can’t will become vassal states dependent on others who can provide.

Critical to the food security equation, is fertilizer, which is primarily produced with natural gas. See the Energy Independence part above.

Chip Independence

If the world runs on energy, computer chips are the primary way that energy gets organized into all the things a working economy needs.

Right now the world is largely dependent on China and Taiwan for it’s chip production. However as China is no longer trusted, this will be changed quickly.

Apple has already started the process of moving a significant amount of its manufacturing to India. The US has initiated the Chips act to incentivize more Chip manufacturing on US soil, and additionally kneecapped China’s ability to consume/produce advanced chips.

However the costs of labor and regulation in the US are too high to produce mass market consumer chips. Expect that only high security advanced chips, primarily for government buyers are produced within the US.

Next the US will look to recreate the chip supply chain close to home, in say a neighbor like Mexico, which has already had a large Intel plant for decades. Only in markets where regulatory and labor costs are low will mass market chip production be economically feasible.

Supply Chain Independence

After chips, all the other things that make up the industrial and consumer goods industries will be moved away from China’s sphere of influence. While there are plenty of regional Asian partners ready to go and able to handle this sort of manufacturing, they are too susceptible to influence from China, thus the US will seek to recreate the entire supply chain closer to home, likely in South America where labor is just as cheap as Asia but influence and control of the region is firmly in the hands of the US.

Europe may also attempt something similar with Africa, who may be dependent on Europe to gain the economic security needed to ensure energy and food independence. Or perhaps greater interdependence.

Defense Independence

After the invasion of Ukraine and the reliance on the US for defense of not only Ukraine but also NATO countries, the world will start looking at beefing up their own defense systems, as the US will likely not be trusted to look out for the best interests of it’s allies. It’s unlikely that any new nuclear weapons programs will be allowed by the US, but the use of near range cheaper weapons such as drones and chip controlled missiles will enable a “local deterrent” of any neighbors who may want to cross the border.

Should there be greater deterioration of Nation States, expect City States to rise and start arming themselves. Cheap forms of asymmetric defense weapons will become more popular.

Monetary Independence

Governments will not soon forget that the US both caused and saved their currency crises, and may be reluctant to be so reliant on USD in the future. Once they find their path through the current problems, they will likely start investigating ways to be more independent.

Additionally as they become more nationalist and independence focused, they may start to implement currency controls in order to politically contain themselves.

Cryptocurrency may prove to be either a path to independence or a way for savvy merchants to circumvent additional controls.

In particular, on must remember that US bonds are loans to the US Government. This creates credit expansion for the US government to deploy into things like supply chain independence. Governments like China will be quite reluctant to hold US bonds that fund their own downfall.

However their citizens may be quite incentivized to hold USD and US bonds, which they may only be able to access via blockchain depending on capital controls.

Nation States Lose Power

The above independence movements are not only limited to the level of the Nation State. Smaller regions or cities may decide to take matter into their own hands to achieve the independence desired by local citizens. Especially for Nation States that are not able to secure the above for their citizens. These regions or cities may emerge in the form of self organized “Network States”.

Depending on how economic and military conditions unfold, some regions may find themselves plunged into violent chaos, from which typically warlords, cartels, or cabals arise. With the technologies available today, it is quite possible that we see “Network States” emerge from those situations, in which citizens voluntarily organize security and necessary resources within certain areas they control.

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Predictions for Countries

Russia

The war with Russia, is an annoyance but not existential for the US. It seems to be a mostly religious war, and thus they will act irrationally. However they are not strong, and will be contained. Due to the religious-nationalist jihad that powers the core of their actions, I don’t think a peace treaty is an option for them, thus they will inevitably be dealt with. Their declining demographics could also hurt them but I suspect Russia will be militarily defeated before then, and the region broken apart.

China

The US will systematically undermine China over the coming decades, removing their power over the global supply chain and economies. China will resist, but their declining demographics and lack of other sources of GDP will necessitate that they take any business they can get, and thus can’t credibly hold the supply chain hostage. Within 2 decades, China will be less than 5% of the global supply chain. Due to the aging population and desertification of their land and resources, their population will dramatically decrease. At some points they may feel cornered and lash out, but ultimately they will choose survival of the elites over humiliation by force.

SE Asia

Having critical natural resources, the US will look to exert more control in certain areas of SE Asia. China will also look to use their influence in the region to gain some economic in the supply chain war, but they will eventually become too weak to continue controlling SE Asia. The strong demographics of the region will be a huge asset economically, but they will need to convince trade partners that they are not influenced by political enemies, such as China or Extremist Muslims.

North Korea

As China weakens and North Korea grows stronger and more brazen, they will eventually be dealt with as they become aggressive against US allies Korea and Japan and are no longer sheltered by China.

India

Will remain mostly neutral in the global conflict, but perhaps pile onto the eventual demise of China. Will grow into a peaceful economic powerhouse, and will grow much faster if they can achieve energy independence. Perhaps US will enable their energy independence in exchange for their cooperation against China.

Middle East

Depends greatly on how US shifts it’s energy policies. I suspect that the political meddling of the wealthy Arabs will not be looked upon favorably as they also look to hold Oil production hostage.

Africa

Food and energy shortages rock Africa, creating a migrant wave towards Europe and Middle East. Perhaps with the right partners they can claw back their resources from China and work towards food, energy and supply chain independence.

Europe

Current economic crises will be worsened with time as energy problems cause productivity slowdowns. Possible migrant wave from Africa worsens crises. The people psyops’d by the ESG cartel and may continue down that path to collapse. Politicians seem unwilling or unable to grasp reality.

USA

Culture wars and inequality rage on but economy is propped up by the strength of USD. Internal conflicts will take at least a decade to resolve, barring massive event. Both parties of government and deep state aligned on nationalism and bringing entire supply chain into the American tri-sphere. Possible secessions if misalignments on culture, fiscal, or security issues.

Mexico

Becomes the advanced manufacturing hub of the Americas. Parts of Mexico possibly annexed. Cartels either dealt with or empowered to run the manufacturing state.

South America

Becomes the cheap manufacturing hub of the Americas. More economic stability and growth for the region stabilizes governments and possibly reverses migration path due to lower cost of living.

END

Editors Note (Feb 2025): It’s interesting to look back on these and see which ones were mostly correct, and which ones were not correct. In a multiplayer adversarial reactive system, the very knowledge of a trajectory and alter the trajectory. For instance China seems to have maneuvered out of a very precarious position since 2022. Also the combined decline of Biden and rise of Trump has added some unpredictable elements to the USA.

Overall, the trend of regional consolidation and resource nationalization seems to be growing stronger, which was the main takeaway for me when I wrote this.

May you live in interesting times…

Liquidity mining rewards are broken, let’s fix this!

The design of many liquidity mining programs very extractive and parasitical, where projects are giving rewards in hopes of bootstrapping their liquidity, but the liquidity providers that farm either end up extracting and destroying project value.

The lifecycle of most DeFi projects tends to go something like this:

1. Launch protocol + token with certain price

2. Issue liquidity incentives in token with high APY

3. Apes add liquidity, TVL goes up, liquidity is solved (for now)

4. Token rewards are issued to the liquidity miners

5. Since its free money for them, they will sell at any price to lock in their APY gains

6. Token price goes down over time

7. Lower token price leads to lower APY

8. Liquidity decreases

9. Dumping continues

10. Project slowly fades into irrelevance

Some projects have tried to solve this with reward lockups, and other mechanisms, but it only delays the inevitable, which is based on a critical flaw of the incentive concept:

Mercenary traders will always sell to lock in profits

So instead of just giving tokens away for “free” - lets start establishing a cost basis for these tokens.

If instead of getting them for free, the liquidity miners need to pay something for them, this will raise the bar for what they consider to be “profit”.

For instance if they have paid $1 for a token, they will be more likely to sell them for greater than $1 instead of taking a loss. If they get them for free, any price over $0 is a profit for them.

Token Option Rewards

Instead of just granting the tokens to the liquidity incentive scheme, protocols can instead grant token options as the reward for mining.

The protocol can set the “strike” price, or the price that the token can be purchased for, as well as the exercise window or expiration date.

Say a protocol’s token is trading at $10, they want to give rewards to liquidity providers, but only if they are adding value to the ecosystem, not extracting.

They decide to give liquidity incentives in the form of a token option, and they decide to set the strike price to $10, to incentivize value creation above the current state of the protocol. They want this to happen over the course of 1 year.

They can create an option token, where the underlying token is deposited and can purchased at a strike price of $10. The option token is earned just like any other token incentive, over time via staking.

Once the farmer earns the option token, they can choose to exercise it by paying the strike price of $10, before the expiration date of 1 year.

If the token price has gone up to $30 as a result of the value added to the ecosystem, they will gladly pay the $10 to get rewarded with another $20 in value!

If the token price has gone down to $5 - well it seems that value was not added to the ecosystem and it is no longer worth participating.

With this model, the strike prices essentially create a floor beneath which the liquidity miners are not willing to sell at a loss, unless they fully lose faith in the project.

It also has the added benefit of bringing capital into the DAO treasury to be used for creating additional value in the ecosystem.

Create token options with Valorum

Valorem has launched their DeFi options primitive which makes it possible to easily (and cheaply) create a basic option contract as a token.

Head over to Valorem protocol to generate an option token for any ERC-20 token: https://valorem.xyz/

DeFi options have been a hot topic in both DeFi and CeFi as the next untapped financial primitive, and despite a large number of DeFi options receiving funding, none have quite yet reached the breakout success of DeFi spot or perps products.

Is this just because they are newer, or have the current offerings failed to reach product market fit with a large enough market?

Based on our research into the crypto options market and ecosystem, we find the current offerings to be lacking some critical functionality, which are blocked by hard technical challenges that need to be resolved to truly become a useful financial primitive for DeFi.

We’ve identified several of these shortcomings and some potential solutions, and look forward to working with the open source community to solve these in coming months and years.

Product Market Fit and Market Size

Before jumping into the issues, it’s important to note the idea of addressable markets and product market fit, as the current options markets have clearly found fit within a niche, but not in the wider market.

Based on our research, we estimate the total addressable market for crypto options to be $12 trillion annual trade volume.

Currently CeFi options are averaging $240 billion annually, which we expect to increase as the options capital markets mature to more closely resemble the traditional markets.

Meanwhile, DeFi options have seemingly yet to hit $100m cumulative all time trade volume (based on limited data availability), which is very short of the potential compared to not only the TAM but also of the comparable CeFi markets.

The main drivers of product market fit in options can be distilled down to price and risk (multiple forms of risk), where depending on the needs of the trader, they may be willing to accept worse prices, depending on their risk needs from both a financial and decentralization perspective.

Right now, some DeFi options protocols seem to have found a subset of traders that prefer non-custodial, permission-less options, and are willing to pay a premium and often accept heightened financial risk or increased capital requirements of the DeFi market structure as well.

In order for the options markets to grow to the estimated TAM, options offerings will need to improve prices in order to be more useful to more users, which means increasing capital efficiency and decreasing risk.

The Challenges

Pricing

Pricing options is a notoriously tricky topic, which if done poorly often ends up bankrupting firms that get it wrong.

As a single option buyer, it’s relatively straightforward, you are purchasing a Call or Put for a certain strike, for a certain price, which could have a big payoff if they expire in the money, or otherwise expire worthless. While the price of an option in DeFi options has typically 2x-10x higher than the same option on a CeFi venue, at least the value at risk is known up front since the amount you are paying to buy the option is the max expected loss.

As an options seller, or as a market maker, things get a bit trickier. As a seller of calls, you have theoretically unlimited downside in exchange for a limited upside.

Market makers will rely on sophisticated statistical models to offer 2 way options markets that generate the best price that will entice a trader to trade with them while also making them a bit of money and ensuring they don’t completely blow up and lose everything.

These models rely on real time market data to generate the “correct” price at any given time, and often result in rapid re-pricings in times of high volatility. If a market maker does not react quickly enough to market fluctuations they can quickly go from a +20% month to a -90% month in a matter of minutes as the risk of the market shifts rapidly.

Unlike spot markets, which can also move quickly in crypto, the value of an option is non-linear, that is the change in value can move exponentially relative to the underlying. This property is commonly referred to as “convexity”.

Peer-to-pool solutions

Because of this, peer-to-pool models that rely on naive pricing models such as black-scholes, are doomed to both offering expensive premium prices AND getting periodically wiped out when the market shifts quickly and causing the pool to take on massive risk. This is apparent with Hegic, where prices are high, yet the pool is constantly losing money, subsidized (for now) with token rewards.

Perhaps it is possible to:

1. Come up with a sophisticated deterministic model for pricing and (projects such as Potion and Arrow seem to be doing interesting research here).

2. Improve the underlying technology such that the pool can react to market shifts quickly enough to not be front run.

Given that both options pricing and on chain execution are highly adversarial environments where predators are rewarded handsomely for outsmarting other participants, I’m personally not optimistic on this working out, but am open to being proven wrong!

Order book solutions

Other options protocols such as Opyn separate writing from pricing entirely, such that an options writer generates a token representing their position which they can then sell on a different venue. This seems like the directionally correct approach, however has limitations with capital efficiency (see below) and decentralized trading venues.

Currently, the two mechanisms for DEX trading are peer-to-pool AMM approaches and some form of a decentralized limit order book (DLOB). As covered above, the AMM approach is likely not suitable for options, which leaves the DLOB approach. The 0x protocol is the most commonly used form of DLOB at the moment, which is where Opyn tokenized options are traded.

This is definitely a superior approach as market participants on both sides can specify the pricing that works for them, however these order books are many orders of magnitude slower than a CLOB, and susceptible to front-running attacks or on-chain congestion. One thing that is critical for market makers is the ability to pull quotes and rapidly reprice them in the face of market volatility. However using 0x and other DLOBs, cancelling an open order requires submitting an on-chain transactions, which during times of market volatility have a much lower chance of being included in a block due to the sudden need of the entire market to respond to changing market conditions. This could be fatal to a market maker, and they will need to greatly widen their price spreads to account for the slow order book execution.

Because of these challenges, on-chain pricing will necessarily be far worse than off-chain pricing.

Likely the best approach is something like dYdX’s model of running a CLOB for trading with on-chain settlement. Another approach that could potentially work for a DLOB is a highly scalable layer 2 such as Connext Network’s state channels or zkSync’s zk-rollups. In addition, using a much faster layer 1 such as Serum orderbooks on Solana could solve this problem for the time being, but will eventually hit a scaling limit with increased adoption.

Margining

The challenges with margining in options touch on a few different areas, and the lack of good margining in both DeFi and CeFi is probably the biggest barrier holding back crypto options from reaching its full potential.

Options Writing

Most protocols start with a fully collateralized option writing approach, which means that you need to deposit 1 ETH to write 1 ETH call or 100% of the strike value in stable coins to write a Put. While this helps them sidestep the issue of risk and margining in order to get started, it also creates huge capital inefficiencies which translates into worse prices.

Writing an option on a CeFi venue might only require 20% collateral value, which means you can sell up to 5 ETH contracts by depositing 1 ETH, instead of just 1 contract. This results in 5x more opportunities to collect a premium, which gives you a greater ROI on your ETH. Or if you look at it another way, if your target is to earn 20% per month on your ETH, you can either sell 1 ETH contract for 0.2 ETH, or you can sell 5x contracts for 0.04 ETH. You can see why this would always lead to cheaper premiums on margined venues versus fully collateralized venues.

Portfolio Margining

The margining issue goes beyond simple collateralized option writing. A fully fledged options venue will have “Portfolio Margining”, which means the entire portfolio of an account is taken into consideration when the risk engine determines the risk of default of a trader.

This can dramatically improve capital efficiency if a trader is trading a strategy such as a Call Spread. If for instance a trader sells an ETH Call at $8000 but buys an ETH call at $7500, the portfolio margin system might calculate that the max risk for their account is $500, and instead of requiring $1600 worth of collateral (20% of $8000) to write the $8000 strike call, they require ~70% less collateral, just $500.

Because of portfolio margining taking into account all open options positions, a single account can generate millions USD of notional trading volume with just a few thousand dollars.

For the DeFi options market to mature and become capital efficient, protocols will need to be able to consider option position margining as a whole, rather than as isolated positions.

Opium has started on this path by offering spreads as a single product (which requires minimal margin) instead of as 2 separate options, but is thus limited in its ability to offer single leg or unbounded risk.

Delta Hedging and Multi-collateral

The final margining topic to touch on is delta hedging. The goal of most market makers and advanced options traders is to remain “delta neutral” - that is their portfolio does not have exposure to the price movements of the underlying assets.

For market makers the reasoning is simple, their goal is to make money, usually denominated in USD, by essentially arbitraging the options prices in the market. For options traders they might have other strategies such as trading volatility instead of price.

Other traders might take a “delta one” approach where they want to keep their exposure to the underlying asset and “stack sats” or otherwise increase their holdings of the underlying. Most popularly with a covered call approach.

All of these traders need markets that allow them to go long or short the underlying asset directly in order to maintain their desired exposure to the price of the underlying. This is mostly commonly done with a futures market which allows for leveraged long/short positions.

Most critically, these “delta” positions MUST be included in the portfolio that the portfolio margin risk engine is using to calculate the account risk!

In the case where a trader has sold a Put, and the market is going down rapidly, they will want to have a short futures position open in order to offset the losses they are incurring from the Put going in the money. Without a delta hedging market, the trader will either lose their collateral to liquidation, or be forced to increase their collateral in order to maintain the position in hopes that they can recover later.

This is both capital intensive for the trader and adds huge risk to the trading system overall as traders may not have a quick way to save their account, which would lead to cascading liquidations.

For the same reasons, traders need to choose the best collateral type for their particular strategy, whether it is BTC, ETH, stable coin, or other assets, which is also accounted for in the portfolio margin system.

Currently, almost all CeFi and DeFi venues force a single collateral type for options writing (with the exception of PowerTrade which lets you deposit collateral of your choosing).

The multi-collateral approach not only enables a basic form of delta hedging (for eg. covered calls), but lets the trader manage the type of exposure they want to have in the market with their collateral.

Bringing It All Together: Margining in DeFi

To summarize the above, in order for a DeFi options market to be fully capital efficient, mature, and low risk, it must be able to portfolio margin all options products, leveraged delta products, and accept multiple forms of collateral.

This sophistication of margining is already tough in CeFi venues, which is why this combination of margin features its not available on other crypto exchanges besides PowerTrade, and is even more difficult with the limitations of on-chain venues.

For portfolio margining to function, you need a few critical pieces:

• Near real time market data for the underlying assets, futures, and options markets

• All open positions and collateral for each account is continuously run though a risk calculation to determine the max value at risk (this is the SPAN methodology used in most options markets)

• Liquidation systems, if an account does not have sufficient collateral for their risk, it needs to be closed out

This is quite tough to do in DeFi as the risk system essentially requires computationally intense real-time calculations. Because of these limitations, the risk engine itself likely needs to be off chain, and which likely requires some sort of oracle strategy or verifiable decentralized compute system. Perhaps a Chainlink style % change system update would work as it does with Synthetix, or, if a Schelling point is viable, a UMA-style verification mechanism that relies on dispute escalation. A zk-proof offchain computation framework such as Aleo could provide the tools needed to have the best of both centralized real-time compute and trustlessness.

Liquidation (or auto-hedging) is another challenge, as a big issue facing DeFi markets is on-chain congestion during times of market volatility. For example, the MakerDAO system faced a system deficit during “Black Thursday” when traders were unable to complete any transactions that managed their positions and liquidation bots were unable to even complete liquidation trades.

Solving this problem likely requires innovation on the Layer 1 or some sort of clever Layer 2 system.

Margin Fi is building a cross-protocol margin system on Solana due to the massive TPS increase allowing for more activities to be done on-chain. In conjunction with an oracle system like Switchboard, a fully on-chain options market such as Zeta Markets could get pretty far on increasing capital efficiency, decreasing risk, and improving pricing. However, as Solana grows in popularity and reaches the throughput limit, the on-chain architecture may need to be rethought as margining may cease to function in a timely manner if there is a throughput bottleneck.

Equilibrium on Polkadot solves the liquidation issue by transferring at-risk positions to a “backstop liquidity provider” pool (inspired by the FTX backstop liquidity providers), which then manages the risk as a whole. Since the protocol is running on its own parachain, and the position is transferred rather than liquidated, this strategy may be viable as it does not require accessing trading markets in order to resolve the at risk account.

The backstop liquidity pool strategy still has the risk of going bankrupt itself, which would be even more catastrophic than a single trader going bankrupt. However this risk could potentially be mitigated with the Fuel DAO Liquidation Reserve system pioneered by PowerTrade, where the DAO is responsible for covering the bankruptcy risk and has various levers for ensuring the capital to cover that risk is available if needed.

The Road Ahead for DeFi Options

Again, product market fit is important to consider when it comes to evaluating options solutions. There is certainly already a niche that is willing to use the current offerings with their limitations.

In addition, products such as Squeeth (convexity) and Ribbon (structured products) can provide exposure to certain types of options positions without the need for a full on options market.

However, unlocking the true potential of options will require tackling these hard, but probably not unsolvable, problems.

Innovations in derivative composability, cross portfolio margining, and scalable risk engines will be needed to fully decentralize every aspect of the DeFi derivatives and options markets, which we look forward to working with the DeFi community to solve and push forward the DeFi space together.

Thanks for review and feedback from Cyrus Younessi, Dave White, Variant Research, Cindy Leow (Drift), Matt Nguyen, and Katia Babbar.

If you have more to add to this discussion, please contact me on Twitter: Tom Howard

This article is a repost from early 2019. It got pretty popular and still has some lessons applicable for today.

The company we built on this; too early and died last winter due more to lack of runway to build than lack of users.

Later this year I might revisit the progress on the problems defined here, as well as lessons learned.

— Tom

This problem is one that has frustrated me for decades, it is what drew me to fintech and crypto, and the lack of solutions I found while researching for this article is what has driven me to step back from Taureon angel group and back to the startup building side. More on what we are building later in the article.

Where is the decentralized money we were promised?

Bitcoin was launched over 10 years ago, with a simple promise:

However, all variants of Bitcoin and other top cryptocurrencies that we have today, do not fulfill this promise.

Before the various cryptocurrency maximalists start evangelizing that their pet cryptocurrency already does this, let me take a moment to define exactly what peer-to-peer electronic cash system means to me.

“Peer-to-Peer”
To me, this means decentralized, self-sovereign, censorship resistant. This means I own and control my part of it, no one can revoke it or otherwise stop me from having or using it.

“Electronic Cash”
To me, this means I can use it as money in my day to day life. This means it is fast and cheap to transact, and this means that the value of it is relatively stable. My purchasing power does not change much from holding it.

“System”
A system is holistic. It is not only comprised of the backend decentralized ledger, but the entire user experience, which means the app interface, the ecosystem, and everything in between.

Most Cryptocurrencies are “Peer-to-Peer”

Most of the top cryptocurrencies check the first box, “peer to peer”.

Bitcoin and it’s forks, Litecoin, Dash, and various others are decentralized, self-sovereign, censorship resistant, and peer to peer, in varying degrees.

Bitcoin with its superior hashing power is probably the most safe and censorship resistant, while Dash has a strong boots on the ground merchant adoption program and Ethereum’s smart contracts are enabling an ecosystem of open finance products.

One can debate the nuances of the various project’s degree of decentralization for quite some time, but given that they are considerably more decentralized than existing fiat systems, the networks are good enough to use for now.

Almost None are “Electronic Cash”

All of the top cryptocurrencies are highly volatile and therefore useless as a unit of account or store of spending money.

When my friend sends me BTC to buy him a car on Friday, and I can only buy 75% of that car by Monday, that BTC is unusable as a form of cash or money.

Sure it may turn out to be a good store of value in the long term, say 3 years, but that doesn't make it cash any more than oil or soybeans are cash.

Yes, electronic cash must also be useful as daily spending money. Buying a meal needs to be quick and frictionless at all times, which means 10 minute transaction times and $5 transaction fees will also make a currency unusable as cash.

But if I had to rank the barriers to electronic cash, value volatility is the number one barrier to adoption, fees and speed come after.

The “Systems” are Incomplete

Everything currently on the market is an incomplete experience.

We have a lot of backend ledgers of varying completion, but I have yet to see that combined with an easy to use front-end and robust ecosystem.

While we have plenty of wallets that allows users to manage multiple cryptocurrencies, we don’t have a wallet that simply allows you to send cash to your peers, with an easy to use app interface.

So how is it that in 2019, over 10 years since Bitcoin was launched, we still don’t have a complete peer-to-peer electronic cash system?

Let’s Finish Building Bitcoin’s First Use Case

It is clear to me that for decentralized technologies to thrive, we must all come together to solve the first use case of blockchain and cryptocurrency: electronic cash.

Through my research, I’ve discovered that many of pieces needed to make this happen, did not fully exist during the first 10 years of Bitcoin’s life, which is why it’s taken a bit longer than expected.

However, due to the funding wave in 2017, both technical and market developments in the past year finally give us all the pieces we need to fulfill the vision of Bitcoin.

How to create a Peer-to-Peer Electronic Cash System

So far I’ve defined some of the criteria of a peer-to-peer electronic cash system:

As an ecosystem, we’ve clearly got 1 out of 5 requirements fulfilled; we have many decentralized ledgers with varying degrees of censorship resistance, of which Bitcoin and Ethereum are leading the pack.

The remaining criteria don’t have any clear leaders yet, but as new technology is developed, the pieces need to seem to be available or nearly available today, they just have not been assembled in the right order.

So how can we go about assembling the other parts of this system?

Before digging into the possible technology we could use, let’s first consider the User Experience so that the system we design is able to get real usage and adoption.

What actually gets adoption? What do users actually want? What problems are people experiencing?

What do users want — The User Experience

I can only draw from my own experiences and observations here, but I suspect I have a somewhat diverse set of experiences and observations to draw from, having lived and traveled among the rich and the poor, been dead broke and well off, in developed countries like US and Germany and in developing countries, particularly those in South East Asia.

In all my travels, I found there are some universal truths about people:

• People want to have a contented and fulfilling life with their family and friends

• This means they need things that keep them alive, safe, and happy, which they buy with money

• This means they need to earn, save and grow their money

And all of this boils down to a simple desire for their money:

People just want to safely send and receive their money between people they know and merchants they engage.

Breaking that down reveals additional desires:

“Just send and receive”

The biggest issue I see with most crypto asset wallets is that they meant for managing a multi-asset portfolio, making them complicated and confusing. For users that want to “send money”, they don’t really care about the various crypto assets, they just want their value to be easily usable to send money to other people or merchants.

Users want to send a receive value, denominated in and pegged to whatever currency they think in, such as USD or Thai Baht, not BTC or ETH.

This also means the money they are sending around does not violently fluctuate in value as that makes it unusable.

Users don’t care how the backend works, as long as they can be reasonably sure that their money will never be lost or taken, and never lose value, ever.

This means the front end needs to simply send the users currency of choice around without exposing them to the complexities of making that happen.

“Safe money”

This can mean different things to different people, but in general this means their money

1. does not lose its value due to inflation or otherwise

2. can’t be randomly “lost” or delayed by banks

3. can’t be arbitrarily seized by governments

4. can’t be stolen by common thieves

In developed countries such as the US, most people believe that USD already fulfills these criteria. Europe mostly believes this as well, though confidence in EUR and other European currencies has faltered after losing 30% against USD a few years ago.

In developing countries, people generally believe that their local currency is at risk on all 3 factors above, yet they often have no choice but to use it. As a result you often see people putting savings into USD, gold, and real estate, and keeping the local currency for spending.

People tend to avoid keeping too much in the local banks as the banks are prone to being “hacked”, going insolvent due to embezzlement, or being seized by the government for the crime of doing too well without including the bosses.

Because of this, I believe that developing countries are ready to adopt an easy to use cryptocurrency system, even if the inflation rate of their local currency is reasonable.

“People they know”

Users do not care for 32 digit hexadecimal addresses.

Users conduct transactions between people, not between computers, so any system relying on computer addresses will face a lot of friction for adoption.

Custom handles such as Twitter’s @user system is far, far better. The best experience for a user is to be able to simply select the person they know and send to them.

Venmo’s integration with Facebook and the social graph as well as WeChat Pay’s leverage of the WeChat ecosystem are what made those products successful.

A decentralized system would have to exist outside the boundaries of a social network, while maintaining user privacy, but these networks can be used to bootstrap adoption.

The easiest step in that direction is through a decentralized @ or $ handle system.

“Merchants they engage”

For electronic cash to work, it must be easy to quickly make payments to merchants, online, but particularly in person.

In Asia, paying a merchant is as fast as scanning a QR code printed out and on display at the cash register. In the US, credit cards and NFC payments are quick and prominent.

A complete electronic cash system must have easy support for QRs and NFC with fast transaction time so the merchant can move on to the next customer quickly.

We are assembling a complete Peer-To-Peer Electronic Cash System

Introducing Mosendo

Editors Note: reminder that this was a 2019 announcement.

After searching for years for this solution, hoping someone would build it, I’ve decided to do something about it! I have joined forces with Rossco Paddison, an entrepreneur and educator who has trained 7500+ people on how to use a Bitcoin wallet and experienced their pains and confusion first hand.

This system is something we think the world desperately needs, and we can no longer sit back and wait for someone to make it happen, so we have formed Mosendo.com to complete this mission.

Our organization is focused on user experience and mainstream adoption, and so we are building what we see most lacking in the ecosystem, Mosendo, a decentralized payments app with UX for a mainstream user base.

Based on the wants and needs of users, and the criteria for p2p electronic cash, we are assembling a complete system requiring

• Stable Cryptocurrency — A decentralized, censorship resistant, peer to peer, stable store of value that is low fee and has fast transaction times.

• Simple App — An easy to use client wallet app denominated in only one or two fiat currencies which is accessible globally without ID. (Mosendo)

• Fiat Access — A global network of fiat gateways to facilitate access to local banks

Stable Cryptocurrency

The stable store of value must be decentralized and sovereign grade censorship resistant, otherwise it is not much different from the existing bank infrastructure.

This means all the fiat backed bankcoins on the market such as USDT, USDC, TUSD, GUSD, PAX, and others, are not suitable choices for this system.

Bankcoins are still very susceptible to asset seizure by governments, banks, and even the less regulated organizations issuing the tokens. We can already see this in effect with companies outright stating they can revoke tokens based on violation of terms of service, and with Gemini refusing to honor tens of millions in withdrawal requests by trading companies in good standing.

Rule of thumb — anything backed directly by fiat in a bank is not censorship resistant or decentralized.

Fiat pegged cryptocurrencies are therefore the most promising at the moment. These coins are pegged to the value of a fiat currency but not backed by them.

Ideally the value stabilization did not rely on pegging to fiat value, but no other method of maintaining or evaluating stable value has come on to the market so far. I suspect this will be a chicken and egg problem, where cryptocurrency adoption allows for new methods of determining stable value, and so pegging to fiat is a bootstrapping method.

The most interesting decentralized pegged stable crypto on the market so far are MakerDAO’s $DAI, Synthetix, and Duo.

Others to watch are Reserve and Constant, which are currently fiat backed but have a roadmap to becoming decentralized and fiat pegged.

DAI in particular has hit an important milestone for cryptocurrency adoption — liquidity.

With over $90m in issued stable token, $30m avg daily trading volume, healthy collateralization, and constant steady growth, DAI has finally hit a point that no decentralized stable cryptocurrency has hit before, it possible to run a small but complete economy using DAI.

Scalability and Fees

MakerDAO and DAI are both currently built on the Ethereum network, so we are only considering solutions built on Ethereum. Should Bitcoin network launch a stable cryptocurrency with sufficient liquidity, we would likely support it.

Ethereum should soon be releasing Serenity, a faster, lower fee version of the protocol.

Until then, we have several slightly less decentralized solutions to use such as xDai on Ethereum POA and the more decentralized payment channel network, Connext.

Initially, these give us a way to bootstrap the ecosystem with nearly instant transactions and zero fees, and build towards a multiple layer solution depending on transaction size and use case.

This means in the near future, some transactions will take place via side chains or payment channels, and some transactions will be settled directly on the Ethereum network.

The user will not have to experience ETH or GAS, which can be confusing and somewhat scary concepts for mainstream users.

Simple App — Mosendo

“Money” and “phone” are increasingly becoming synonymous, so for crypto adoption, an easy to use app is required.

The money in the app must be denominated and stored in the currency the user thinks in (likely the local fiat), with the ability to hold a secondary currency (likely USD). We achieve this by using DAI for USD and synthetic fiat currencies from synthetix.

It must be easy to transact with people, not public keys. We accomplish this through the use of decentralized $motags, saved contacts, QR codes, NFC, and privacy preserving social network import (anyone have ideas on doing this without our organization storing user data?).

No ID is needed to use the wallet or hold a balance as it is simply a non-custodial cryptocurrency client, opening doors to global adoption instead of being stuck in a particular jurisdiction.

Private keys are confusing to many users, and cryptocurrencies are currently lost due to lack of understanding. In Mosendo, the user gets the option of hardware wallet, seed phrase, recovery via their 5 closest friends and relatives, and a few other ideas we’re fleshing out.

Fiat Access

Ideally a p2p electronic cash system is a comprehensive experience that does not require ever using a bank account or cash. However, the transition will take time, and users will invariably find themselves needing paper cash or a bank account for various purposes.

Regulations on sending money, including and KYC/AML, create many of the problems we are setting out to solve. The app itself does not require KYC/AML, but instead will benefit from the existing compliance of money transmitter partners to exchange fiat for crypto.

The system can not rely on a single fiat gateway, but must instead allow a network of multiple gateways in every country to allow for people all over the world to gain seamless access to the cryptocurrency system.

Mosendo uses services such as Wyre for this, as well as other payment processors and cash top up merchants we are in talks with (anyone we should be talking to?).

The Road To Adoption

Peer-to-peer electronic cash system will find the strongest product/market fit in emerging economies such as Asia, Africa, and South America where there are acute pains around currency and money.

In these regions it is easy to find examples of hyperinflation, bank theft, government theft, corruption, and other issues that make local fiat currencies and banks less appealing.

These countries face the largest issues when it comes to cross border payments, such as remittances, cross border trade and travel.

Often currency controls prevent capital outflows from these countries, and predatory practices result in high fees for migrant workers sending their hard earned money back home.

Many of these regions already see significant adoption of volatile cryptocurrencies such as Venezuela and Zimbabwe in the face of hyperinflation.

Many African countries already have high adoption of mobile money systems such as mPesa’s centralized SMS based payments.

Many countries already use telecom phone service top up credits as a form of currency, particularly India, Thailand and Indonesia.

Developing SE Asian countries have high smartphone penetration and saw high usage rates for speculating on cryptocurrencies, laying a foundation for cryptocurrency wallet literacy.

Additionally, the relatively small geographic size of of SE Asian countries causes frequent cross border currency issues.

SE Asia in particular will be a region of high growth for a properly implemented cryptocurrency system.

Since the Mosendo team is already based in SE Asia, we will be here on the ground, learning from the everyday person how we can make the best experience for them.

From Burmese migrant workers in Thailand to Filipino virtual workers earning from overseas, we empower them to take back ownership of their earnings and avoid predatory money remitters and sketchy banks.

In the future, we dream of a day when not only I as an American can take out my phone to instantly pay an Indonesian street food vendor, but a Venezuelan can easily pay for currywurst in Berlin, and a Nigerian in Canada can easily send money to family back home, all quickly, cheaply, and safely.