Where is Debt Heading? (S1E9) Transcript Samantha [00:06]: Hi, I’m Samantha Yap, and I help blockchain and cryptocurrency companies tell their stories. I’m really passionate about demystifying emerging technologies and making it easy to understand for everyone.  I’m embarking on this journey to discover the history of money, in order to better understand where money is heading today. In this series we’ll explore why Bitcoin, digital currencies and decentralised finance may play an important role in our future.  Come join me on The Story of Money, by YAP Cast.  Samantha [00:43]: We naturally tend to borrow from, and lend to, only people we know well, and for the most part we merely expect the return of what we lent. But lending money to friends and family has always been an awkward situation. That’s because since ancient times there have been formal channels for borrowing and lending money, and those formal channels themselves have always been fraught in nature. Charles R. Geisst, an academic & writer, who authored a book about finance called ‘Beggar Thy Neighbor', wrote: "Charging interest on loans is the oldest financial practice. It has also been decried almost from the beginning as predatory, with the lender seeking to take advantage of the borrower. Whether loans were made in cash or in kind, unscrupulous lenders were said to be practicing a ‘beggar-thy-neighbor' policy by ensuring that the borrowers were disadvantaged to the point of losing their collateral, or in extreme sense, even losing their freedom or families. Charging simple interest was barely condoned, but charging compound interest was unscrupulous, immoral and rapacious. It was also practiced with near impunity." In other words, what we now consider a relatively normal business function has always sat on the fringe edges of moral law. Perhaps it’s worth looking at the state of the capital markets and particularly debt capital markets today to understand what’s working and what’s not. Debt crises happen from time to time, such as the multi-year European Union debt crisis which began at the end of 2009. Several member states of the EU including Greece, Portugal, Ireland, Spain and Cyprus were unable to repay their government debt or bail out in debt financial institutions. The causes were high-risk lending and borrowing practices, real estate bubbles bursting, and hefty deficit spending. As a result these countries had to be bailed out by the European Central Bank and International Monetary Fund. So could crypto or decentralised finance have aided this? To expand on this I’d like to welcome back Sidney Powell, an expert on debt and the Co-Founder of Maple Finance, a decentralised institutional marketplace, which enables trusted institutions to borrow and lend money.  Samantha [3:19]: Hi Sid, Thank you so much for joining us on YAP Cast. Really excited to have you here today. Sid [3:14]: Hey Sam, thanks for having me onboard. Really looking forward to it. Samantha [3:17]: What is the state of debt in the economy? Debt plays an important role behind economic growth and economic activity. Could you please expand on this? Sid [3:27]: Yeah. So, one really important phenomena in modern economies is capital markets. So capital markets are how we get resources to companies that can deploy those resources productively in creating new jobs and creating new business opportunities. The capital markets are comprised of equity, which would be venture capital or purchasing shares in a company, or you funding a company initially with a partner if you're a founder. It's also comprised of debt, which is the other major piece. Now, this could be loans from a bank, there could be bonds issued by a public company, or it could be many other alternatives, like convertible bonds, but what's really important is that it is this flow of capital, which to a much greater extent, comes from debt. So the debt markets globally are much larger than the equity markets. And so the part debt plays in the economy is funding investments. So, if you ever see an airline purchase a new aircraft, that would be largely funded by debt, and that promotes global trade. For example also, shipping, if you see, Amazon might issue bonds to go and build a new headquarters somewhere, which they can then add 5000 new staff to. So, these investments are often financed by debt. But what we've seen over the last 10 years is that increasingly, debt has been used as a tool to prop up vanity metrics, and things like, say, stock prices. So, over the last 12 months, or 18 months, I would say since COVID. We've seen debt used by the Federal Reserve Bank, other central banks around the world and governments to effectively stimulate their economies. Now, I would say where debt  can be used unproductively, at an economic scale, is propping up ‘zombie companies’. So I use the example before of airlines. Now, airlines were the beneficiaries of a large amount of bailouts in the US, and this was largely kind of preserving a competitive dynamic, where you have companies that otherwise weren't profitable, that were allowed to stay in business by being given debt. Instead, what would ordinarily happen is that these companies might go out of business or be acquired. And then resources would get allocated to areas of the economy, where there is more opportunity for say, jobs creation, or more demand for the services they're providing. And I think that's how we've seen distortions over the last 18 months. And so that's in the real economy, where poorly performing zombie companies are getting propped up, instead of that money going to creating jobs in sectors where there is a lot of demand, or there is a lot of actual opportunity, the second element where debt can add distortions in the financial economy. So these are financial assets like prices of stocks, crypto assets like Bitcoin and Etherium or other financial assets. Sometimes esoteric collectibles might go up when it's an environment of really stimulative monetary policy. So anyway, what that is to say is that the creation of debt in the economy over the last 12 to 18 months pushed up the prices of stocks and financial markets, because what was happening was money was getting pushed into the economy that didn't have anywhere else to go. So instead of going to creating new businesses and new jobs, it was instead going to stock buybacks and bonuses, which I think angered a lot of people. Samantha [6:45]: So there's this distortion of debt. By the way, 'zombie companies’, is that a term that you use or do people often use that? Sid [6:53]: No, other people use that - I didn't just make it up. But it refers to companies that are not ordinarily profitable, but receive debt and the debt allows them to pay the interest on their existing debt, and just keeps them in business. But they're not generating the money that they need to pay off the debt or to remain in business. It's simply by borrowing more money over time that they stay in business. That's not what should happen. Samantha [7:17]: So there's obviously good and bad debt everywhere, whether it be personal and in the global economy. Actually, I want to take it a step back, just to explain to our listeners who may not really understand this whole ‘capital markets’ that you're explaining. So, you said capital markets have equity? Is that the two types of capital in the market? And then you mentioned the word ‘bonds’. Could you just explain to those who don't know much about finance? Sid [7:44]: First of all, to take a step back. Yes, debt and equity are what the capital markets are comprised of. And then every instrument is typically just a variation of that. So you could have listed equity, which could be shares on the NASDAQ, you could have unlisted equity, which is, you know, it's private ownership in a company. You could have a convertible bond, which is actually a hybrid of both debt and equity because instead of repaying the bond, it can be converted into equity. And then you have loans, which is obviously debt. But to get to what you just asked about bonds are also a type of debt. And you can think of those as being a loan, except the loan is written on a piece of paper. And a piece of paper is a tradable security. So if, say Coca-Cola issued a bond, they are effectively borrowing money from people who purchase that bond. Now, if you purchase the bond, you are effectively lending money to Coca-Cola, but you can sell the bond to me because it's a tradable security, and then I'm effectively lending money to Coca-Cola. And so when Coca-Cola repays that loan, instead of paying you back, they paid me to repurchase that bond. And that's effectively the repayment of the loan. So that's just one of the instruments, but it's a very common instrument used by large companies and institutions and governments. Samantha [9:01]: Thanks for that whole overview. Could you explain what smart contracts are? What does that enable, and maybe in that, also explain what decentralised finance is? Sid [9:12]: A smart contract is code. It's effectively an ‘if then statement’. So it is saying that if condition A is met, then for example, pay Samantha $100 of Ethereum, or some other money. So what that allows is this system to have developed this ecosystem, which is decentralised finance, which I'll go into in a moment, because when you have smart contracts, so that ‘if then statement’, we can then start to build a whole lot of really exciting products off of this. Because if you think about it previously, what happened in international commerce was, for you and I to do business, particularly if we're in a different country, we would need to have a trusted intermediary between us. But now we can put money into effectively this box of code. And then we can each specify conditions that we want to happen. And then we know that that money will go to its intended purpose. Like if I want to purchase something from you, or swap it with you, I know that if I pay money into this contract, you will put the item that I want to purchase into another contract, and we will each receive what we want. Whereas before, what might need to happen is that I would need to send you that money and then rely on you sending me the goods that I was purchasing. This just allows that to happen, what we call trustlessly. And so what decentralised finance is, it's a collective term referring to an ecosystem of financial products built on top of the blockchain. So some really well known examples of this would be decentralised exchanges like Uniswap, money markets like Compound, lending protocols like Maple, which is the protocol that I helped co-found. And the ‘finance’ part of decentralised finance is really self explanatory. These are financially related products, like exchanges, but it's the decentralised aspect which refers to the fact that the protocols can run trustlessly. So without any central figure running or administering them. So in the example I gave before, let's say that you have Bitcoin, and I have some other cryptocurrency. Well, we can each go to UniSwap, and interact with it, and I can put in my Ethereum, and I can get something else back. And I don't have to rely on anyone making sure that that happens. There's no central team making sure that I get the thing that I was swapping for. And that's what we mean by decentralised is it can operate without the interference of people. And that's the core underpinning ethos of decentralised finance. Samantha [11:38]: That is a really great explanation, Sid. Sorry, continue. Sid [11:41]: I was gonna say what decentralised finance offers has several other advantages. So the first of these is that it's a single layer of infrastructure. So probably a good way to think about the financial system up until blockchain was it's kind of like a railway network across the US. And across every state. The railways are different gauges. So the tracks are different thicknesses. And what that means is that if you are trying to get a train from LA across to New York, in every state, you would need to change the wheels and pay someone to do that. Now, by the time you get from LA to New York, that's starting to be a really costly train journey and it's taking a really long time. What blockchain and decentralised finance does is it's a single train track size, all the way from LA to New York. So you can make the whole journey without stopping without paying additional fees and without taking that additional time to do that. So from a network perspective, this means you're going to get greater economic value being transacted. And you can have more people participating, because it just takes less time to conduct business. And so, the key innovations here is the reduction of disagreements. So with those examples I gave before, you have a reduced likelihood of disagreement. Because with UniSwap, I know that if I use it, I can see how the smart contract is written. So I can see how the code works. And I know what the outcome is going to be. And it prevents somebody from deceiving me. So that reduces the likelihood of disagreement. And then decentralised finance reduces the cost of resolving a disagreement, because it has dispute resolution built into it. So for example, if I use Compound or MakerDAO and I take out a loan from them, I would have to put in $150, to borrow $100, if my collateral drops below $120 in value, the protocol automatically sells it and then pays back my loan. So that dispute is already resolved by software code. It doesn't rely on somebody coming and chasing me up for that money, it simply repays it automatically. So in that instance, we've then reduced the cost of resolving a disagreement. Samantha [13:45]: Sid, that's some really great analogies right there. So just to explain to our listeners, what is Compound and what is MakerDAO? So you're saying UniSwap is a decentralised exchange? Sid [13:55]: Compound and MakerDAO are decentralised lending protocols. What that means is that they set up, let's call them boxes, referred to as contracts, what I can do is I can put in crypto currency into that and then use that to borrow a digital version of the US dollar, which I can then spend. So the way that they work is that there is no central company administering these, it is code that just operates trustlessly, that word I use before, on the Internet. So if I have a cryptocurrency wallet, I can go and freely interact with that protocol, and I can borrow money through it. And what we've seen is that over the course of the last 12 months, billions of dollars of loans have been created on both MakerDAO and Compound. Samantha [14:39]: Let's also touch on Maple Finance. What you explained about MakerDAO and Compound that is over collateralized. Because you said you put in $150 and you can borrow $100? Or you can borrow within that? Could you explain the difference between under collateralized and over collateralized and how Maple finance is different? Sid [14:55]: Yeah, absolutely. So an over collateralized loan is, as I mentioned it, would be you putting in $150 of some cryptocurrency like Ethereum or Bitcoin, and then you borrow $100. And then you can use that either to purchase more Bitcoin or for some other use. These forms of loans, over collateralized lending, have really dominated the space because they were very easy to implement, because they were trustless. You did not have to worry about defaults. So you could originate loans at a much faster rate. But this type of lending is not really useful for job creation or business expansion. If you can think about it, there aren’t a lot of businesses who are willing to put down $1.5 million dollars worth of stuff to borrow a million dollars. It's not really conducive to growing your business. But what we've found is that over the last 18 months to two years, companies have now emerged who have found product market fit, they have really strong balance sheets that generate profits, these companies in the ordinary economy would be excellent borrowers. These are not zombie companies. And what we found, though, is that because they're in the crypto space, they're not able to access borrowing from traditional lenders. So these companies, there are market makers, which would be firms that trade on exchanges that might be arbitrage funds. They could also be crypto miners, or they could be other exchanges, or myriad other crypto native companies. But what they have in common is that they have a great growth runway ahead of them. And they need capital to reach that growth potential. So what we try to do with Maple Finance, which is an institutional capital marketplace which provides under collateralized loans to crypto native companies, is that we provide credit creation. So lenders on the protocol can extend loans to these crypto native companies and those crypto native companies can then use those loans to expand their business. So it's proper credit creation, they would be putting down, let's say, they might put down $500,000, to borrow a million dollars, or if they're really strong enough, they might not put down any collateral at all to borrow the million dollars to put in their business. How Maple Finance works is, given what I've said, risk management is really important. So what Maple Finance does is we have pools on the protocol. This is where capital is aggregated, and that capital can then be lent out. Each pool has a kind of manager. And we call this role, which would be a fund, usually we call them a pool delegate, and they would perform the credit assessment. So they make sure that that borrower is going to be able to repay the loan. And then they also negotiate and agree the terms of the loan with them, and then approve it. So what happens then is you get a borrower who's able to come to Maple Finance, take out a loan, expand their business, you get the pool delegate who performs your credit assessment on them, and is able to share in the revenues generated through the protocol. And then you get lenders who are able to earn a yield from participating in the growth of the crypto native ecosystem or digital economy. One of the other really important innovations or the way that we actually manage risk here is through a concept of staking. And this means that the pool delegate and other people put capital into a reserve, which is available in case there are default within a pool. And so this just offers a little extra protection to the lenders, which makes it a more suitable product or source of yield for say institutions or more risk averse participants. Samantha [18:15]: So just to go back to what you said. Thanks for explaining all of what Maple Finance is and also how decentralised finance is enabling financial markets to bypass a lot of the bottlenecks, as you said, and you mentioned that ‘this is the real FinTech’. So let's talk about FinTech today, right? FinTech and DeFi see debt differently. Basically clarify that for people. Sid [18:37]: So, DeFi is different from FinTech and it's operating on an entirely different layer of infrastructure. So it has several advantages. If you were to look at FinTech today, you could probably divide it largely between payments processing. Now, this could be something like Stripe, which is quite innovative, or it would be, say, consumer or commercial lending. This is largely just a fancy front end on top of existing core banking infrastructure with some fancy machine learning, deciding who is able to take out a loan or not. And then the other element is in wealth management, which is products like Wealthfront who are doing effectively kind of like Robo investing products just making decisions about whether to buy or sell various investments. So these are all things that are built on existing infrastructure, whereas DeFi is built on a whole new layer of infrastructure. As I said, it's really the equivalent of a single railway system or train track spanning the entire breadth of the United States. So it just makes it that much easier to conduct business globally. And it significantly lowers the cost of running a financial system. So in DeFi, what we are seeing is, it's far more advantageous for two reasons. So first and foremost, it's globally aggregated. So it's kind of the difference between, say, you going to your local bookstore, and using Amazon. With DeFi, you have access to, in Maple Finance sense, a capital market that truly spans the globe versus just the network, as I said before of the Rolodex and email inbox of somebody at a local investment bank, so it's quite different there. So it's that aggregation aspect, and then it is the coordination of large groups of people, which is kind of tied to aggregation. But because we can rely on smart contracts to execute decisions, it means that more people are willing to participate, because you don't have that same requirement for some trusted single controlling party, who needs to manage everything. And that just means that what we've seen is all these super exciting products, when you've got small teams of like 10 people who can code up some product, like UniSwap that can do billions of dollars of economic value and transfers over the course of a single 24 hour period. So I think this is really the exciting element of DeFi. It's kind of like the Internet of finance, or the Internet of money, the same way that the Internet of the late 1990s was occurring, where you just had all this innovation - that's what's happening now and has been happening over the last 18 months to two years. And people are building new products every day. You see there's teams raising money all the time, and launching new products and I think that's super exciting. The pace of innovation is like nothing we've seen before in the FinTech space. So, yeah. FinTech is very underwhelming, DeFi, way better. Samantha [21:21]: Yeah, that's so exciting. And as you said, we're seeing, like what you're building, I guess, traditional financial tools and products just being built on DeFi and money flowing in. Sid [21:31]: And I was just gonna say, and the other element is the inclusiveness of DeFi. So because it can be accessed globally. And because it lowers the technology hurdle for accessing this stuff. Anyone with a browser and has cryptocurrency is able to participate in DeFi effectively. It has become a far more powerful product. And it's lowered the cost of, say, remittances in third world countries where somebody who is working in one location might want to send money back to their family, well previously they would pay a huge commission in transferring that money and it would take days. Now, it can happen in 15 seconds or less, and at a fraction of the cost. So I think that financial inclusion, creating new opportunities, and just creating new and exciting products and experimenting is something we haven't seen in a long time. Samantha [22:16]: Well, so you're very, very passionate about this. And it sounds like you said, innovation is happening at a speed that we've never seen before. Closing points, Sid, where are we heading? And what needs to happen for more people to see the potential and the value of DeFi? Sid [22:32]: So, I think of a couple of elements. So, where are we heading, we're seeing more interest in participating in DeFi from institutions. Maple Finance is a more institutionally focused product. And so what we've seen is that there was the initial wave of participation in cryptocurrency. DeFi was wanting to hold assets, like Bitcoin and other cryptocurrencies. Now, we're seeing more interest in its ability to generate yield. And this was really something that was seen over the last 12 months with the DeFi summit. So I would say increasing institutional participation, and also more accessibility. So the number of apps and teams I meet who are building apps and things that people can access on their mobile is huge. And I think this on ramping is one of the key elements to increasing adoption. So I'd say, adoption takes time. And we’re now benefiting from the Lindy effect, the longer that these protocols are around, the more people are likely to trust them. We're getting new security standards. So teams take security very seriously, and would be getting their code audited. And they're increasingly working with trusted institutions. For example, Circle is one that has built a fantastic reputation in bringing more traditional financial markets players into the space. And I think this bodes really well for this technology no longer becoming something that is separated, but something that is just built into the financial system.  Samantha [23:48]: Awesome. So just to sum up, DeFi is growing. The longer it's here to stay, the more people will trust it. It's inclusive. Sid, thank you so much for joining us on YAP Cast and for giving us an overview on debt and decentralised finance and where we’re heading today. Sid [24:03]: You’re very welcome Sam, thanks for having me. Had a great time. Samantha [24:06]: We learn from Sid that Decentralised Finance is inclusive, accessible and anyone with a web browser and cryptocurrency is able to participate in it. This also means anyone can also borrow and lend on DeFi. But does this new technology solve the problems of debt in our day? For me, until I see people borrowing money on DeFi lending platforms to buy a physical property or physical assets, I think the technology, while very promising, is still very early in its development.   If you’d like to watch my full length conversation with Sidney Powell, head to the YAP Cast youtube channel. I’m Samantha Yap, and you’ve been listening to The Story Of Money, by YAP Cast.