DeFi Builders and Speculators: A Symbiotic Relationship

Level 3 - Virgin DeFi Analyst

Welcome Avatar! This post is different from our typical research pieces, but we were captivated by a recent debate going on in the cryptoverse. As a team of both investors and builders, the debate between builders vs. speculators as value adders is near and dear to our hearts.

TLDR; builders come first, but people are overlooking the importance of speculators in crypto and DeFi. It’s a symbiotic relationship.

The world if builders and speculators became friends again.

Quick Background

Anyone who has used Ethereum this year has noticed that transaction fees are extremely high, often ranging from $100-$250 for a simple token swap on Uniswap. High fees have driven users to other layer one chains such as Binance Smart Chain (“BSC”), Avalanche (“AVAX”), Solana (“SOL”), Fantom (“FTM”) and so on, with different chains gaining popularity over the course of the year.

Strong Ethereum advocates critique other L1s on the basis of 1) being VC backed, 2) less decentralized than Ethereum and 3) having low fees only as a result of having far lower activity and/or less decentralization.

Users of alternative L1s are critiquing Ethereum for 1) being unusable due to how expensive and slow it is 2) creating barriers to broader crypto adoption as a result of high fees and 3) Ethereum advocates effectively telling people to wait for rollups, L2 adoption, etc. instead of using other chains.

Two groups are important here: 1) crypto/Ethereum “OGs” who have been around for many years and are generally considered to be wealthy and 2) a cohort of up-and-comer crypto users trying to “make it”. The OGs are trying to protect the principles that Ethereum was built on (namely, maximizing decentralization) while the up-and-comers are protecting their right to use blockchain infrastructure for DeFi, etc.

The argument came to a boiling point after a series of tweets between 3AC founder and CEO/CIO Zhu Su and founder of Synthetix, Kain Warwick.

Here, Kain presents his perspective as an OG:

kain.eth @kaiynne

A lot of people I respected earlier in this cycle have sold out in pursuit of profit maximisation, chasing opportunistic gains at the expense of their reputation, remember this when they all coming flooding back into the Ethereum ecosystem once L2 scaling becomes inevitable.

Here, Zhu (as an OG) presents the up-and-comer’s perspective:

Zhu Su 🔺 @zhusu

Yes I have abandoned Ethereum despite supporting it in the past. Yes Ethereum has abandoned its users despite supporting them in the past. The idea of sitting around jerking off watching the burn and concocting purity tests, while zero newcomers can afford the chain, is gross.

Add in the general perception within crypto of VC investors having an unfair advantage and “dumping their bags” (selling large amounts of coins they purchased early at a discount) on retail investors and you have a recipe for perhaps the most heated debate of the year in crypto.

Speculatooor vs. Buildooor

We’ve seen many opinions and debates on cryptotwitter by now, but the post that ultimately inspired us to write this article is the one below from OlympusDAO founder Zeus.

Zeus Ω (3, 3) @ohmzeus

The future belongs to the builders and doers. Speculators are merely along for the ride.

We understand that it can be difficult to introduce nuance to tweets and so we made a substack post. This post is not a rebuttal to this tweet specifically. Rather, the tweet serves as a prompt to address the broader debate and sentiment we’ve seen on Crypto Twitter.

We agree with the first part of the Zeus’s tweet - builders and doers create the future. They push the industry forward and give speculators something to invest in. Builders come first.

We would also generally agree with the second part of the tweet, if viewed from a broad lens and not just crypto (which may have been Zeus’s intention with the tweet).

However, we disagree with the second part if viewed from the lens of crypto and more specifically DeFi.

Our sense is the broader debate stems from a misalignment around two main points: 1) the meaning and connotation of the word “speculator” and 2) what role speculators serve in DeFi specifically.

A speculator is simply someone who purchases an asset under the assumption that it will go up in the future. The connotation with the word speculator is that it more closely resembles gambling than investing (e.g. higher risk, mentality of trading rather than wanting ownership of an asset).

Regardless of the connotation, we believe speculators play a more critical role in DeFi than any other market. They provide builders with liquidity, the runway to build and, the focus of the rest of this article, they are also the users.

Speculators are users because DeFi *today* largely facilitates speculative activity. To demonstrate, let’s revisit some of the protocols we’ve covered to date and what they do.

Uniswap: A decentralized exchange to swap different crypto tokens. Users can also provide liquidity and become market makers.

1Inch: Searches for the most efficient exchange for your token swap.

Aave: Decentralized money market. Users can lend and borrow cryptoassets.

MakerDAO: Mint a USD stablecoin (DAI) leveraging your other crypto asset (e.g. ETH). Allows you to use DAI to farm for yield or buy other tokens without selling your ETH.

Perpetual: Decentralized derivatives exchange. Trade crypto tokens. Go long or short, with leverage.

Tokemak: Optimize liquidity provision (market making) and route liquidity to decentralized exchanges to improve swaps.

Yearn Finance: Automated asset management. Users deposit assets in a vault and Yearn optimizes for yield aka return on investment.

Alchemix: Deposit one asset to mint a synthetic version of the same asset. Uses Yearn to generate yield that repays your advance.

OlympusDAO: Asset manager and decentralized unpegged currency.

Swapping tokens, trading derivatives, marketing making, borrowing and lending, leverage and asset management - these are all speculative activities.

The builders behind Uniswap may view holders of UNI as speculators, but the protocol itself is enabling speculative activity because it’s being used to trade one token for another and speculate on the relative price of those tokens.

The builders of Yearn may view YFI holders as speculators, but users of YFI are solely looking to generate yield and get a return on investment. Yearn generates yield by farming tokens of protocols that also facilitate speculative activity.

The primary reason OlympusDAO’s bootstrapping mechanic is successful is because early speculators (OHM buyers and stakers) expect to receive significant financial reward if OHM succeeds. The desire for speculation creates immense demand for bonding which fuels staking returns. In OHM’s case, the token holders / speculators are also the future users. Furthermore, the treasury consists of tokens of protocols that facilitate speculative activity and whose tokens benefit from it.

We won’t go down the whole list, but the same general principle applies to DeFi as a whole.

Autist note: we are demonstrating the importance of speculation in the market and how projects benefit from it, *not* criticizing these DeFi projects.

If you revisit the individual protocol writeups, you’ll notice historical earnings boomed during the highest speculative periods of the year (e.g. May 2021) and fell substantially over the summer. We’re talking about revenue and earnings - not just the token price.

More perceived financial upside (aka benefits of speculation) leads to more trading, more borrowing and lending, more leveraging and so on. All of this activity generates revenue for DeFi protocols.

In TradFi, there is a “speculation index” which compares the trading volume of the NYSE American (riskier small cap stock index) to the NYSE (large cap stock index). Since we are looking at speculative activity from the perspective of DeFi usage, we plotted weekly protocol revenue for 6 DeFi protocols from the cohort we previously reviewed in the substack (based on data availability) against the trading volume of ETH.

During the period of April through May 2021, we were in a period of peak speculative activity (it was altcoin mania for those that remember). The large spike in revenue during the week of May 17th is driven by liquidation revenue.

Autist note: we recognize that this is not a *perfect* measure as it does not include all DeFi protocols and a lot of activity in recent months has taken place outside of Ethereum. However, when combining this data and an understanding of how DeFi generates revenue, we believe this data serves as a good proxy for speculative activity.

The Future

Speculators in DeFi and the developers that build DeFi tools are inextricably linked. Speculative activity is inherent to financial markets and is not going anywhere. Our point with this post is not to criticize projects, developers or anyone, really. In fact, we are extremely bullish on DeFi development as a whole and continue to onboard people and educate them on the ecosystem.

Our point is that speculators play a critical role in DeFi because they generate most of the activity. This activity creates value for the entire DeFi ecosystem, generating revenues, token value and allowing for developers to have easier access to capital to experiment and buidl. Developers build tools that speculators use which creates value for both sides and allows for more development (and speculation on that development of course).

We view most of DeFi today as the *backend* infrastructure for the future financial system. That means it likely looks like a ponzi right up until it doesn’t. Until there is a secure way to link DeFi tools to assets off-chain or a regulatory compliant, oracle-friendly way to bring real world assets on-chain at scale, DeFi is likely to remain insulated within crypto.

We remain optimistic that developers will continue to push DeFi forward and we will have the best possible system if and when real world assets are widely accessible through blockchain tech. Even then, speculators will continue to play an important role, as they do in all financial markets. However, speculative activity will be complemented by far more real utility.

Concurrently, our broader thesis is that the value of real world assets will migrate to the metaverse long-term. Metaverse assets will directly use the financial tools DeFi has created. There is also a much lower barrier to bringing metaverse assets on-chain compared to real world assets, thereby unlocking value for DeFi.

Regardless of which assets are connected to DeFi, DeFi is the only infrastructure that continues to enable permissionless, censorship-resistant financial access to all stakeholders. The future is DeFi.

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Disclaimer: None of this is to be deemed legal or financial advice in any way shape or form. You are reading opinions from an anonymous group of Wall Street and Tech Engineers in Cartoon format.