Kain Warwick, founder of Synthetix, talks about synthetic asset issuance platform, which enables people to create tokens that track the price of asset in traditional and crypto finance. We discuss the various types of assets available, why changing the monetary policy helped the ecosystem take off, why people would buy synthetic Bitcoin over Bitcoin itself, and why Uniswap has been pivotal to Synthetix’s success. He covers the role the SNX token plays, why people minting synths must over-collateralized by about 700%, and some of the changes coming down the pike, including futures, tweaks to the inflation rate, and a new oracle system. He also explains what happened when a trader made the system insolvent — and how they negotiated with the trader to keep it alive — how he thinks about decentralization and why the system’s governance might one day be handled by a DAO.
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Episode links:
Synthetix: https://www.synthetix.io/
Synthetix on Twitter: https://twitter.com/synthetix_io
Kain Warwick: https://twitter.com/kaiynne
Havven transforming into Synthetix: https://blog.havven.io/havven-is-transforming-into-synthetix-2fdf727b8892
Synthetix overview: https://blog.havven.io/synthetix-overview-f4a5a6c41210
How Synthetix works: https://www.synthetix.io/how-it-works/
Synthetix lite paper: https://www.synthetix.io/uploads/synthetix_litepaper.pdf
Changing monetary policy: https://blog.synthetix.io/synthetix-monetary-policy-changes/
Oracle hack: https://www.coindesk.com/synthetix-trader-rolls-back-broken-trades-that-netted-1-billion-profit
Synthetix response to oracle incident: https://blog.synthetix.io/response-to-oracle-incident/
How staking works on Synthetix: https://www.stakingrewards.com/asset/synthetix-network-token https://help.synthetix.io/hc/en-us/articles/360020245314-How-can-I-earn-Synth-exchange-rewards-
Reddit complaint by trader who initially made the system insolvent: https://www.reddit.com/r/ethereum/comments/d4edxm/the_synthetix_dapp_deleted_my_balance/
Efforts to resolve the front running problem: https://sips.synthetix.io/sips/sip-6
Synthetix and Chainlink: https://blog.synthetix.io/synthetix-and-chainlink/
Kain’s tweets on the censorship vector stack: https://twitter.com/kaiynne/status/1197265019169169409?s=20 https://twitter.com/kaiynne/status/1197265044204998656?s=20
Unconfirmed episode on Uniswap: https://unchainedpodcast.com/how-uniswap-quickly-became-one-of-the-most-popular-dexes/
Defiant interview: https://thedefiant.substack.com/p/theres-a-pipeline-of-etf-like-tokens
Transcript:
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Laura Shin
Today’s guest is Kain Warwick, founder of Synthetix. Welcome, Kain.
Kain Warwick:
Hey, Laura. Thanks very much for having me.
Laura Shin:
Let’s start with a basic question, what is Synthetix?
Kain Warwick:
Synthetix is essentially a synthetic asset issuance platform on Ethereum, so we create tokens that track assets, track the price of assets in you know, traditional finance and in crypto finance to allow people to have price exposure.
Laura Shin:
So we’re going to talk a little bit more about what all that means, but first let’s talk a little bit about your background. How did you come to found Synthetix?
Kain Warwick:
So I was actually running a payment stop back in 2014, 2015, and we worked with a lot of the crypto changes in Australia, and as it kind of got closer to you know, the bull market in 2016, 2017, like a lot of markets like Korea, we saw that there was a pretty big spike in the spread between crypto prices in Australia and other markets like the US and Europe, and so we had this idea that if we were able to build a stablecoin we would be able to kind of arbitrage those price spurts and more efficiently move money around.
And so we started doing some research. You know, this is before Maker obviously had launched, and really the only option out there was Tether and so yeah, we essentially you know, decided to launch this new protocol to enable people to transfer value in a stable token. That’s kind of how the project started, which was called Haven back then.
Laura Shin:
And how did you make the transition to Synthetix?
Kain Warwick:
So one of the I guess ideas that I had when we launched this was that regulated stablecoins were not going to you know, be very likely or at least were going to take a long time to launch and you know, that turned out to not be very accurate. In 2018 you had Paxos and TREOS D and USDC and a lot of the regulated stablecoins that launched, and that just meant that the kind of market for a centralized stablecoin was much smaller than it had been.
And so we looked at the model and we said okay, you know, what can we do with our model to kind of create some differentiation, and one of the things that we saw was this ability to you know, reprice debt and move between different synthetic assets. So we had a synthetic US dollar token but we were able to launch a synthetic gold token, synthetic silver token, and people were able to move between those tokens with zero slippage which was kind of the advantage.
And so at that point we decided to focus on you know, Synthetix Exchange and that ability to trade synthetic assets.
Laura Shin:
Yeah, and I think what’s remarkable is that you’ve gained quite a bit of traction in a short amount of time, so let’s talk a little bit more about kind of like what that journey was after you started creating some of these. How did you become one of the biggest projects in DeFi?
Kain Warwick:
Kind of gradually and then all at once I guess. So you know, we have the second most value locked and you know, the way that that kind of evolved I guess is as we launched more synthetic assets, LUX and bitcoin, synthetic gold, synthetic silver, new awareness and interest in the project grew really rapidly, but in addition to I guess pivoting towards synthetics we also made a decision to change the monetary policy of the protocol.
So previously like most ERC-20 tokens that launched in you know, 2017 and 2018, we had a fixed supply of 100 million and we decided that you know, we weren’t really seeing high staking rates, we weren’t getting people participating in protocol and kind of doing what we needed them to do, and so we changed the monetary policy and essentially started paying inflation to the people who were staking, who were actively participating in the network, and that immediately had a very powerful kind of feedback loop created where people got more excited and they started you know, to understand the project more and dive in, and the growth kind of accelerated from there.
Laura Shin:
Great. So yeah, let’s talk a little bit more about what people are doing on the platform. What are some of the most popular synths?
Kain Warwick:
So we actually just launched a bunch of new synths this week, including a DeFi index token and so this DeFi index token is essentially like a basket of tokens in the DeFi space, so there’s Maker, there are obviously LINK, SNX is in there, we’re got Zero X, etcetera. So what you can essentially do is hold this token and get exposure to kind of the entire DeFi space, or at least all the tokenized projects within DeFi, and so that’s I think a pretty novel and interesting asset that doesn’t really exist anywhere else.
But in addition to that we’ve got you know, things like synthetic bitcoins, synthetic ether where a lot of the buying happens, but we’re starting to see definitely demand grow for things like synthetic Maker and some of the invoice tokens. So during the transition to multi-collateral Dai over the last few weeks the demand for synthetic Maker and invoice maker has really increased and as luck organic volume happening in there which is kind of good to see.
Laura Shin:
This is super interesting. Yeah, there’s so much to unpack. I guess, why don’t we just start with the DeFi token first. In a way it’s sort of like…I guess it’s like an index. How do you decide like what the weightings and stuff should be?
Kain Warwick:
Yeah, so we wanted it to be kind of representative of the space and obviously you know, we can only track the things that have tokens so we contract some of that compound right now, for example. But we took the weightings by mark account and then you know, tried to kind of normalize it. It was actually one of our Discord participants, one of the Synthetix members who kind of normalized the weightings and proposed it, Arthur Ox who I’m sure a lot of people follow on Twitter as well, and you know, the community then voted and reviewed that weighting and they were happy with it.
We also did some polls to work out what people wanted to include in the index, so it was kind of an open government mechanism to determine the weighting and constituents of the basket.
Laura Shin:
And then for a synth like the bitcoin synth, why is it that they wouldn’t just buy bitcoin?
Kain Warwick:
Yeah, it’s a really good question. I think you know, the advantage that we have with something like synthetic bitcoin is if you want to just hold bitcoin and you’re a long-term holder, it makes sense to just go and buy bitcoin on the spot market. But like most derivatives, the advantage is in kind of access, right? So if you’re holding bitcoin and you know, you’ve got it in your own wallet, going from bitcoin into Eth or into USD or something like that you know, there’s friction there whereas if all you want is the price exposure and you’re not necessarily a long-term holder, your ability to go from bitcoin into say gold and then back into US dollars within Synthetix Exchange with zero slippage is quite powerful.
And so that’s why I think we’re seeing a lot of people who you know, want that price exposure but also want the flexibility of being able to move out into a different asset fairly quickly.
Laura Shin:
And is there anything that they’re doing with the bitcoin, the synth bitcoin that they couldn’t do with BTC as well, aside just from being able to trade in and out of it without slippage?
Kain Warwick:
No, that’s basically it. It’s just people looking for price exposure. So think about it as kind of the difference between gold future versus the gold spot market you know, people who don’t necessarily want physical delivery of gold, they just want price exposure to gold. This is sort of a similar mechanism, you just get the price exposure to bitcoin but without having constitute the asset or a right to the asset or anything like that.
Laura Shin:
And then I was also wondering about some of these synths that are similar to stablecoins, like the sUSD. So I don’t know if this would technically be called a stablecoin but I did happen to see that the amount of value in it is ahead of for instance, Gemini USD which is an actual stablecoin, but then since the synthetic USD is backed by SNX, is that essentially just like a riskier version of a stablecoin and so it has kind of like different properties from a stablecoin, or like how would you compare this to a regular stablecoin?
Kain Warwick:
So I think in 2017, 2018 we kind of saw three different types of stablecoins emerge. There was the fiat-backed, put money in the bank, it’s a right to kind of convert that token into the fiat-style stablecoin, so that’s your Paxos and Gemini and TREOS D, etcetera, and Tether ostensibly. And then we had crypto collateral backed, so obviously Maker and Dai is the biggest example of that, so using Ether as collateral to issue a stable USD asset, and that’s really what sUSD is. It’s the same kind of principle, it’s just using SNX’s collateral instead of Eth.
And then there’s the third category which is like the outward mixed-in coins, so things like Basis which obviously unfortunately didn’t launch so we didn’t really get a chance to kind of see how that would play out, but I think there is a few more outward-mixed stablecoins that have launched recently.
Laura Shin:
And what are people doing with the synch USD?
Kain Warwick:
Well, so one of the nice things again about you know, the sort of synth ecosystem I guess is that you can take that synthetic asset and convert it easily into a different asset, so you can go from sUSD into gold. And so I guess that’s kind of a bit of a different property to say something like you know, Gemini or Tether where you need to find a counter party to trade with in order to convert it into bitcoin or some other asset.
So it’s sort of one of the interesting properties of Synthetix is that once you’ve got any of this debt, whether it’s USD or gold or bitcoin, you have the right to reprice that debt into any other asset.
Laura Shin:
And we talked earlier a little bit about how the DeFi synth was formed, but where does the idea for like any particular synth come from?
Kain Warwick:
I mean, typically it comes from our community, you know, so we’ve got a lot of traders in our community and a lot of people who are very into crypto and crypto trading and that sort of thing, so we look at what the demand is from the community, so things like sLINK which we launched recently, sXRP, and we’re kind of you know, coming from the demand that the community was displaying you know, Discord and other places.
Laura Shin:
And I heard that you’re also coming out with decentralized futures?
Kain Warwick:
We are. Yeah, that’s something that we’re working on. So essentially it’ll be a decentralized BitMEX or Deribit or Deribit or any futures exchange. You’ll be able to take a leverage position on something like bitcoin or Eth and open that position and it’ll be a perpetual future.
Laura Shin:
So let’s walk through how this works. So let’s say I’m a user, I come to your platform and I want to create some kind of synth for myself. What do I need to do?
Kain Warwick:
So if you want to create a synth…so you can’t actually create a new synth if you are just arriving to the platform, you can only choose from the existing synths and one of the reasons why is…
Laura Shin:
Right, I guess I meant mint. Mint, is that right?
Kain Warwick:
Oh, got you. Okay. Right. That’s right, yeah. If you want a mint synth then you need SNX and you essentially will turn up at Mintr which is our dApp that we use for minting and kind of maintaining your position, and you’ll lock SNX and against that value, that collateral you will mint synthetic assets. So within Mintr you can only mint sUSD but with the contracts you can mint any of this synthetic assets, so you could mint synthetic bitcoin for example.
And again, it’s very similar to like a Maker Vault or Maker CDP where we lock Eth and then you get issued this debt which is a synthetic asset priced in US dollars.
Laura Shin:
Oh, wait. Okay. So sorry, let me walk through this again. So I show up at Mintr and then I have to give it Eth in order to get SNX, is that it?
Kain Warwick:
Sorry. Yeah, so if you don’t have SNX you need to get SNX from somewhere, so you know, you would either buy the SNX for Eth or for something else, but once you’ve got SNX you can lock that SNX and issue synthetic USD against it.
Laura Shin:
Oh, okay. So I go to Mintr with my SNX and then I turn that into sUSD, and then from there I can move into any other synth, is that it?
Kain Warwick:
That’s right. That’s right. Yeah, that’s it.
Laura Shin:
So in order to create the SNX though, people need to over collateralize and I think it’s by like roughly 700 percent. Why is it so high?
Kain Warwick:
Because the liquidity of SNX is still quite low. So the idea is that eventually as SNX accrues value and as liquidity grows we’ll be able to lower that collateralization ratio, but it’s sort of a reflection of the risk profile of SNX versus say Eth right now as collateral.
Laura Shin:
Oh, okay. Well, do you have any plans to add any other types of collateral?
Kain Warwick:
We do, actually. We’re working on a proposal to add Eth as a form of collateral to the network which hopefully will go live later this year or early next year.
Laura Shin:
Oh, okay. So earlier you talked about how one of the ways that you got traction on the platform was to change the monetary supply and I guess give some of the rewards to people who were staking, so will that still be the same if they’re staking Eth rather than SNX?
Kain Warwick:
No, Laura, it’s a slightly different approach. So the people who stake SNX will get the full rewards from trading and the inflation, so the trading fees on the exchange as well as the inflationary supply. People who locked Eth just have a right to come and trade synthetic assets, so once Eth collateral goes live you’d be able to turn up with Eth. You wouldn’t need to have SNX, you’d be able to mint synthetic Eth against that Eth and then start trading on Synthetix Exchange immediately.
And the advantage I guess to someone who’s holding Eth is that it doesn’t force them to convert their Eth into SNX or into you know, once of the synths, they can still hold their Eth and trade without kind of taking the risk of selling down their Eth position.
Laura Shin:
Oh, I see. Okay. So this is sort of like how currently amongst people who have created SNX, only about 80 percent of them I think…well actually tell me if I understood this correctly, I think about 80 percent of them are staking it, is that right?
Kain Warwick:
About 80 percent of the supply is staked. So the total token supply
Laura Shin:
Oh, okay. Right. Right.
Kain Warwick:
..the total supply, yeah.
Laura Shin:
Oh, okay, and then so the remaining are doing what, trading it?
Kain Warwick:
Yeah. Some of them are just sitting on it and not staking. You know, some of them have it sitting in exchanges, some is probably lost and unstakable, you know, something that happens in crypto networks, so you know, any number of reasons that someone might decide not to stake rather than to participate in the network.
Laura Shin:
Okay, so essentially when you start adding Eth as a collateral, or when you add it as a collateral type, then what is likely to happen is that the current stakers will still basically have a similar incentive but they might earn more in fees because there might be more trading activity. Something like that?
Kain Warwick:
That’s exactly right. Yeah, that’s it. It’s just an easier way to get people to trade more.
Laura Shin:
Okay. Yeah, I was just wondering because as you know…well, actually this is an interesting question. So let’s see here, so it’s like in so many other systems, staking is correlated with security. Is that really the function that it’s providing here?
Kain Warwick:
It’s slightly different, so you’re securing the pool of assets I guess, so the pool of debt by putting your collateral there and you’re taking a risk. So when you lock SNX you take the risk of the total value of the debt pool that’s out there. So you know, you’re providing that service to someone to allow them to turn up and reprice their debt, so you’re securing the debt pool essentially, but obviously we rely on the Ethereum network for the actual security of the tokens themselves and consensus, etcetera.
Laura Shin:
Okay. So this is like a slightly weird question, but we were talking about this really high collateralization ratio and how SNX isn’t very liquid. Is there any possibility of some kind of like black swan event or something where like people somehow suddenly cannot actually pay back their positions?
Kain Warwick:
Definitely. You know, that’s one of the big risks that you take as someone who’s minting. So if something happened to the debt pool such that the debt pool increased by an order of magnitude, then there would be more debt outstanding than the collateral value of SNX which would create some kind of a downward spiral potentially.
Now there’s mechanisms that are in place to kind of prevent that from happening but you know, it’s definitely possible, and in fact back in July we had an issue with the price feeds about oracle which created just that scenario. So there was a bot that was trading on the exchange and the price feed for the Koren Won failed and the bot was able to essentially create about 2 billion dollars worth of debt which obviously was significantly higher than the market cap of the SNX collateral, so that was something that you know, was kind of indicative of one of the risks that exist in the system.
Laura Shin:
Right. So I was going to ask you about this, so when it’s creating 2 billion dollars worth of debt, that basically means that then if that bot or whatever wanted to kind of like close out of the SNX system then they would need to pay back 2 billion dollars? Is that what that means? What does that mean?
Kain Warwick:
So what it means is that the bot has 2 billion dollars worth of debt outstanding but there’s only you know, at that time I think there was about 30 million dollars worth of collateral so the bot would basically never be able to cash out that position. There’s not enough collateral value. It would be like if there was you know, a million dollars worth of Eth locked up to issue Dai and then all of a sudden the Dai supply was inflated to a billion dollars. You know, there’s only a million dollars worth of Eth there, so the first million can be claimed but then after that you know, there’s no value there to be claimed. So essentially the system was insolvent and the bot was unable to close that position and get the profit.
Laura Shin:
Okay, so we’re eventually going to talk a little bit more about what happened there in a little bit, but I actually just wanted to talk a little bit more about the staking and the SNX and stuff. So I think some other thing that’s a little bit interesting to me about how the staking works here is it’s not similar to staking on other platforms where people can basically just earn passive returns, am I right in thinking that?
Kain Warwick:
Yeah, so typically with staking you have some level of responsibility you know, you’re providing a service. There’s things like you know, Livepeer where you’re providing a service running nodes, if you’re staking in ETH 2.0 you’re providing the security to the network, so typically there is some responsibility and some action you have to take, and in our network that action is that you’re providing the collateral essentially for the network and securing the debt.
Laura Shin:
Okay. All right, so then we talked about how now you’re going to…and when are you going to add Ether as a collateral type?
Kain Warwick:
We’re working on it at the moment. We’re hoping to get it done by the end of the year but it’s looking like it might be early next year the way things are tracking.
Laura Shin:
And for the monetary supply you said that right now it’s pretty high inflation but that’s going to go down. So what is like the monetary policy?
Kain Warwick:
Yeah, so it’s actually an interesting question. So at the moment we have an inflationary supply that halves every year and that halving event is coming up in March, but some people within the community that have proposed a change to that inflation schedule to smooth it essentially, which was something that I was personally against initially but I’ve come around to the fact that I think it makes sense, so it’s basically been passed. We’ve had a couple of governments calls where it’s been discussed and the community has kind of reached consensus that it’s the right thing to do.
There’s a couple of minor things around the parameters for the terminal inflation that are still being discussed but there’ll be a vote on that hopefully in the next week or so, and then it’ll be implemented. So that’s something that will probably change by the end of the year and it will mean that the inflation goes from a million tokens that it started out to somewhere around 300 million tokens.
Laura Shin:
Okay, and wait, is that just in perpetuity or is there ever going to be a cap that’s reached?
Kain Warwick:
So it looks like the consensus is to have perpetual two percent inflation approximately. It might be a little bit higher, a little bit lower, and the intent behind that is to ensure that we’ve got some additional supply of SNX to fund the incentives that are outside of the system and so we’ve got some incentives at the moment around Uniswap to incentivize liquidity there, so we want to make sure that we continue to have that SNX supply to be able to incentivize those external things outside of protocol.
Laura Shin:
All right, so in a moment we’re going to discuss oracles and we’re going to talk more about that bot that could have made the system insolvent, but first a quick word from the sponsors who make the show possible.
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Laura Shin:
Back to my conversation with Kain Warwick of Synthetix. So as we touched on briefly earlier, the integrity of the system is highly dependent on the quality of the oracle, and as you mentioned there was this incident with the trader and I believe the way that their bot was able to take advantage of the system was something to do with the oracle, so can you tell us exactly how they were able to make that hack happened?
Kain Warwick:
Yeah, so they were looking at the price feeds that were being published on chain and they were reading the mempool so they were reading all of the transactions that are sitting waiting to be confirmed on _____, and they took those feeds and they were able to essentially front run the pricing changes. So they would detect that a price change was going to happen and they would move into that asset and then as soon as the price was up they would lead the asset.
And we had some measures to prevent that, speed bumps and things like that that we’re working on, but the bot was fairly sophisticated and was pretty good at detecting when a large spike was going to happen and you know, it was fairly profitable. It was making around 10 percent a day or something like that with its trading, but then we had an issue where there was this cascading failure of our oracle for the Forex APIs, so we had a number of APIs that are medianized and several for them failed in different ways simultaneously which we didn’t have a good mechanism to prevent or you know, to alert us to, and the bot was running and essentially detected this anomaly in the KRW price and was able to trade, I think it was five times back and forth between Eth and KRW, and it was able to generate about 2 million dollars worth of synthetic Eth at the time.
So you know, that essentially made this system insolvent and we then had to work out a way to kind of roll back that trade.
Laura Shin:
Wow. So let’s just give a little bit of context on how it is that the Oracle prices get pushed. As far as I understand right now it’s Synthetix, or at least back then it was Synthetix pushing the price. Is that correct, and if so like how were you determining the price, and yeah.
Kain Warwick:
So yeah, so we had some commercial API s that were essentially being pulled into a system and then the aggregates were taken, outliers were thrown out…
Laura Shin:
Like from centralized exchanges?
Kain Warwick:
Well, these were Forex APIs so they were coming from commercial Forex providers, so you know, there’s a ton of them around and we picked what we thought were you know, four or five pretty good ones. Unfortunately the Forex APIs are less robust than the crypto APIs from our experience which was kind of surprising to us, so we had a lot more protection around the crypto APIs because we were worried that they were going to be the flakier, but was actually the Forex ones that created the issue.
Laura Shin:
Okay. So one other thing that I wanted to ask you was like later on this same trader then wrote this Reddit post, and this was like a few months later actually, and this person complained that you had jacked up their fees, deleted their balance, and forced them to trade their synth for sUSD. This doesn’t appear to be sort of the same incident, it’s kind of like…well, let me recap and you can correct anything that is incorrect here, but essentially like after the first incident you had kind of said okay, we’re going to pay you this bounty fee and now anything that you do is basically going to help us make our platform better, something like that. Or actually why don’t you sort of describe what happened.
Kain Warwick:
Yeah, so it was as you can imagine somewhat of an adversarial conversation. You know, it was a bit of hostage negotiation because the trader was well aware in fact that the system was insolvent and if they didn’t cooperate with us you know, we would have had to fork the system or you know, there would have been a significantly larger impact.
So getting them to roll back the trade was definitely the best solution, and initially they wanted a pretty exorbitant amount of money to do that and we were able to negotiate them down to something a bit more reasonable. We ended up paying them back 40 thousand dollars worth of ETH to cooperate and roll back the trades.
But this trader was pretty as I said, pretty adversarial and pretty aggressive and arrogant about what they were doing and their ability to kind of front run the system and our inability to stop them, and so you know, we basically said look, you can keep attacking the system. We’re working on a number of mechanisms to kind of prevent that and you know, this is crypto, it’s adversarial, right? We’re going to try and fight back and you know, work at whatever we can do to kind of make this less profitable.
And unfortunately the kind of calculus that I guess we came to was that if you don’t have any punishment, if there’s no down side to someone who’s attacking the system, the optimal strategy is just to keep attacking. Now if the worst that you can do is not profit, then this was only going to escalate and so we basically worked out that we would need to have some kind of slashing condition implemented in order to reduce the profitability of these bots.
And so we implemented that. It worked, we were able to slash this trader and then you know, they came back and said well, I’m going to continue to attack the system. They did and you know, it was kind of this running battle, and this has kind of kept going on with different traders and different bots, probably for like the last six months. It’s been a big amount of effort that we’ve kind of had to implement a number of different pieces of functionality to prevent this from running which is kind of a constant arms race I guess.
Laura Shin:
Wow. Okay. I bet it’s making your platform better very, very, very fast. One thing that I was wondering about though, is like what exactly are they exploiting? So I understand that it’s this knowledge of you know, a trade that’s about to happen and kind of what the Oracle price is, but is part of that also because maybe just like the frequency with which you can update the prices is like a bit slower than you would like?
Kain Warwick:
Yeah, that’s exactly right. It’s just latency. So they’re observing what’s happening in the real world and we’re observing it. We published something to say this is what’s happened in the real world and they’re able to essentially publish on chain faster than us. That’s their intent, that’s what they’re trying to do. We’ve gotten to a point now where we’ve basically been able to reduce the front running to, or at least reduce the profitability of front running to maybe half a percent a day or one percent a day which is I guess within our risk tolerance from where we’re sitting now. But again as I said, this is an arms race and you know, every time we make a change the bots update and they try and attack the system and improve their bots.
So it’s definitely improving the system and it’s making it much more robust but it’s certainly been a lot of effort and a lot of engineering time to kind of work on these issues over the last six months.
Laura Shin:
And how do you make the improvements anyway if as you mentioned in the original incident the APIs that failed weren’t even in your control?
Kain Warwick:
So what we’ve basically been doing is upgrading the oracle and we’re working on moving the oracle away. You know, Synthetix still runs the oracle but hopefully by the end of the year we’ll start migrating away from our own centralized oracle to Chainlink, and we’ve been working with the Chainlink team to build a set of oracles that will be much harder to front run and put some mechanisms in place to prevent people from trading and to cover some of the edge cases that they’ve been using if they are trying to front run the system. But as I said, it’s kind of a balance between usability that some of these things impact the usability for regular traders.
And so we’d have to kind of try and find a balance where you’re never really going to get rid of front running completely but you can reduce it to the point where you know, it’s less profitable or not so impactful.
Laura Shin:
So I don’t know a ton about Chainlink but can you describe how that system will differ once it’s integrated than what you have now?
Kain Warwick:
So essentially they’re just doing what we were doing ourselves but they’ve got a distributed group of people that are consuming these external APIs, so crypto APIs, etcetera, and a lot of them are data providers that already have the data so they’ve got access to that data themselves and they take these different node operators who are kind of aggregating this data and then medianize it and publish it on chain. And so what you’ve essentially got is our oracle times 7 or 20 or 30 depending on the asset that the process is being published for, which just makes it so much more robust than what we’re using right now.
So we’re pretty confident that once we get that in place we won’t have any future issues with oracle outages but it doesn’t necessarily solve the front running problem. We still have some some edge cases that we need to handle there.
Laura Shin:
And will that increase the frequency by which you can update the oracles?
Kain Warwick:
It actually won’t. You know, there’s kind of a fundamental latency that you have with Ethereum, so something that we’re also looking at is you know, a layer two solutions that will allow us to publish prices much more rapidly. So right now the only way we can prevent people from exploiting that latency is by forcing them, which is what some centralized exchanges do, they put a speed bump in to prevent people from being able to you know, high-frequency traders being able to publish things before you know, everyone else can.
And so we’re putting these speed bumps in to ensure that someone can’t look at the transaction being broadcast and try and front run it. They’re going to definitely be slow within it, but as I said you know, there’s a tradeoff between that and usability of a platform because if the speed bump is too aggressive then it makes it harder for regular traders to trade.
Laura Shin:
I saw in a blog post that you wrote that once Chainlink is integrated, that will allow anyone to build and run an oracle to obtain price feeds for synths. So what does that look like exactly and how would you expect that would change the platform?
Kain Warwick:
I think it changes the platform because you know, it moves away from this centralized control that the team has now, you know, our core team has. So once we get to a point where there are these external oracle providers, anyone in the community can essentially request a price feed so you know, Palladium, weirdly enough people ask for pretty regularly so you know, the community can say we’re putting a proposal to add Palladium token and then provided these node operators who are running Chainlink nodes can source a price for Palladium and you know, kind of credibly produce it, we can add that synth and it doesn’t require necessarily intervention from the team directly to provide that price feed.
So you know, that’s obviously going to be beneficial when we look at things like synthetic equities, so you know, sApple, sTesla, etcetera.
Laura Shin:
Interesting. The Palladium thing threw me a little bit. I feel like this is one of those moments where you’re like in crypto and you’re like oh, there’s yet another rabbit hole I could go down.
Kain Warwick:
Yeah. Yeah, there’s people who are deep into Palladium for some reason, so yeah. It is what it is, I guess.
Laura Shin:
Okay. So you also had a recent Tweet storm about moving to Chainlink and you talked about how some people objected to it because it’s not maximally decentralized, and then you wrote something that I found really interesting. You said “We are very comfortable not using maximally decentralized oracles because Chainlink is more than sufficient to move the Oracle attack vector to the bottom of our censorship vector stack, which means governance and other issues become the highest priority.”
So what did you mean when you said that Chainlink is more than sufficient to move the Oracle attack vector to the bottom of your censorship vector stack?
Kain Warwick:
So essentially what I was saying is you know, at the moment you could theoretically round up five or six people in community and you know, throw us in jail and shut the project down, right? And again I think about these things from you know, a very adversarial perspective, right? That even though that’s not likely right now it’s possible and so, so long as something’s possible we want to eventually be able to prevent it from happening.
And the reason why, the main reason why you could get away with that and you know, lock up five people and shut the project down is the oracle. Once with the oracle and once the price feeds are being published independently on chain and the protocol is just consuming those price feeds, then if you were to do that, if you were to round up those four or five people and then lock them up, it would be very easy for the community given that everything that we’re doing, everything other than the oracle is open sourced to essentially fork the protocol and do a hard spoon and migrate state and redeploy it on chain and keep the system going.
And I think we’re getting pretty close to that but the limiting factor right now is definitely the oracle, so you know, as soon as the oracle is not us and as soon as it’s independent, it’s going to be a huge qualitative state in terms of the censorship resistance of the protocol.
Laura Shin:
That’s super interesting. So something we referenced earlier that we didn’t go into much was you talked about how somebody could sell you know, like a million dollars worth of bitcoin or whatever amount and there would be zero slippage, so how is that possible?
Kain Warwick:
So it’s possible because someone is able to reprice the debt. So one of the rights that you have with your holding debt, whether you minted it or whether you bought it from someone for Eth or bitcoin or whatever, you can turn up the contracts and you can say I have you know, 10 synthetic bitcoin and I want to convert that into synthetic US dollars and the system will quote you a rate based on the current spot price and what the oracle is publishing for those two assets, and then take small fee, so 30 basis point fee which goes under the fee pool.
So that’s just a right that you have within the system which is you know, obviously very beneficial, and I think I brought up Maker earlier. There was someone on Twitter, Andrew Kane who actually did an analysis of the slippage on Uniswap for Maker versus Synthetix and I think the slippage was about 50 percent less for trading Maker on Synthetix Exchange. So during the kind of MCD transition when Maker pumped up to like 650 or 700 and then dropped back down, a lot of people were trading sMaker and iMaker because it was actually more efficient to trade on Synthetix Exchange than on the spot markets.
Laura Shin:
And why is it that it’s more efficient on Synthetix than on Uniswap?
Kain Warwick:
So Uniswap, because it uses the like automatic making function, it has kind of this built in slippage so you know, the larger the order you trade the more slippage you’ll get.
Laura Shin:
Oh, oh, right. You’re right.
Kain Warwick:
Yeah, so like one percent slippage for like a 50 thousand dollar order for example whereas with Synthetix I think it was you know, 35 basis points or something like that.
Laura Shin:
Okay. Yeah, and also I guess just to…I mean, it’s probably obvious to people but why don’t you just talk about how Synthetix differs from other DEX’s and then therefore how the trading behavior on Synthetix differs from another DEX’s?
Kain Warwick:
Yeah, so typically other DEX’s excluding Uniswap, and so Uniswap and Synthetix are kind of in their own category of, these appear to contract decentralized exchanges, but in a typical DEX like Radar Relay or something like that that’s using you know, Zero X protocol, you need to find a counter body to match your order, so you know, if you’d want to trade Maker and you want to trade 50 thousand dollars worth of Maker, there needs to be someone on the other side who is willing to buy that and you know, in any market where your matching counterpart is, there’s going to be slippage.
And so that’s something that is kind of exacerbated on DEX’s and it’s one of the reasons why Uniswap is so powerful because you don’t need to wait for counter body to trade, you just have to accept that there’ll be some slippage but you’ll always get a quote, you know, you’ll never be in a situation where you can’t sell the asset or trade the asset that you want to trade, it’s just a question of are you willing to deal with the slippage, and Synthetix Exchange is kind of similar. You can always turn up, so as long as you’ve got debt and trade that amount of debt for a different asset and reprice it.
Laura Shin:
And I think I saw you were saying that the average trading size on Synthetix is a lot higher than on other…at least on other DEX’s. Is that right?
Kain Warwick:
Yeah, that’s right. Yeah, it’s typically quite a bit higher because you know, you just have people who want to trade say 20 thousand dollars or 30 thousand dollars that they couldn’t trade on another DEX, but obviously you know, centralized exchanges, there’s more liquidity because they’re just much bigger markets, but as the synthetic asset pool grows, as the debt pool grows, you know, it’s possible that we could see orders of you know, 5 million, 10 millions dollars for example.
Laura Shin:
Already. So how are fees set on Synthetix?
Kain Warwick:
So at the moment it’s a flat 30 basis point fee and then there’s an additional fee if you’re moving from a long token to a short token when this is again, one of the kind of tradeoffs that we built in to prevent front running. So if you go from sMaker which is the long version, to rMaker which is the short version, you pay 60 basis points.
Laura Shin:
And who decides what those fees are?
Kain Warwick:
Well, the community decides. So we had the fee set at 50 basis points up until a few days ago and one of the community members put in a proposal to reduce it back to 30 basis points which it kind of has been sitting at historically, and that passed pretty unanimously and so the fees are updated. So it’s kind of again, you know, handled by a rough consensus within our Discord channel and within the community.
Laura Shin:
And we have talked about Uniswap a few different times but as far as I know, so Uniswap also has been kind of pivotal to the success of Synthetix. How so?
Kain Warwick:
So there’s this very strong kind of symbiosis I think with Uniswap. You know, when Uniswap was announced it was very obvious to me that it was going to become quite powerful for DeFi oracles, and particularly for us because we need liquid on ramps and off ramps and we need to know that those on ramps are always going to be there. You know, we need people to be able to get into the debt pool and out of the debt pool in order to trade on Synthetix Exchange.
And so what we did earlier this year was to incentivize people to put liquidity into the synthetic Eth pool, and so that’s now grown to be the largest pool on Uniswap and does typically you know, it’s in one of the top exchanges in terms of volume on a daily basis as well, and so now you can move in and out of Synthetix Exchange by this Uniswap pool and slippage is pretty minimal for you know, trades of like 10 thousand dollars or so which is pretty good. So the average trader trying to move in and out of Synthetix Exchange can go through Uniswap pretty comfortably.
Laura Shin:
And something that we talked about earlier was how you changed the monetary policy and how you started the project one way but it ended up going a different way and you know, how you had maybe one thought to do a synthetic stable coin and then later you realized people wanted volatility, and I’ve also heard you talk about the importance of iterations, so just with like all the different twists and turns that your project has taken, like tell us kind of what the lessons for you have been and like kind of what the different things are that happened that made you realize like oh, it’s better to you know, go this way than that way.
Kain Warwick:
I mean, I think startups just operate that way. You know, there’s a lot of capacity in trying to run a startup and trying to kind of predict what’s going to happen. It’s almost impossible and you know, really you just need to kind of place small bets and respond to what the market says. So we placed a very large bet which you know, could argue is kind of dumb, that regulated stablecoins wouldn’t be a thing, and then when all of a sudden they were we realized that you know, the market that we were attempting to address had kind of been pulled out from under us, and you just need to respond to those sorts of things.
So you know, we looked at what we built and we’re pretty comfortable that it was a very powerful oracle and would have a lot of value but we just needed to find the right market for it, and so we started issuing assets, and again, you know, another kind of small bet that didn’t really play out was this idea that if you had multiple FIA currencies people would be happy to move in between those FIA currencies, and that turned out to really not be the case, either, there’s not a lot of demand for that. But what we did see demand for is you know, trading these volatile assets and having access to a number of different crypto assets and FIA currencies and commodities and other assets on a single platform.
That was where we really started to see product market fit and generate some real interest.
Laura Shin:
And what about that moment when you had this confrontation with the trader who had built a bot that you know, had nearly made your system insolvent, like at that moment what do you feel like the lessons were for you and for other entrepreneurs in the space?
Kain Warwick:
You know, I’ve been running startups for a long time and most of them have failed as startups tend to do, and you know, you always have these crisis moments, and I do think there is a point where if you’ve been through so many crises you kind of become immune to them a little bit and you can kind of detach and not become emotionally invested in what’s happening and you know, in that moment it was really just about okay, how do I resolve this specific issue that’s right in front of me and not really thinking through you know, the implications and the consequences.
But it was almost three hours I think that we were negotiating with him to kind of roll back the system, so it was pretty high-stress environment but you know again, I think having gone through similar issues in other startups where things blew up, you just have to kind of roll with it and you know, treat the situation that’s in front of you and deal with that directly.
Laura Shin:
So something also that’s come up a few times in this show is you know, you talked about how you made this decision to change your monetary policy and I could just imagine that when you decided that you thought that that would be a good idea that you might be nervous about presenting it to the communities, so was there any community input on that and if so how did you factor that in?
Kain Warwick:
Yeah, I actually had originally came up with the idea you know, almost eight months before DEFCON 4 and so at DEFCON you know, there were a number of people that were stakeholders in the project that I kind of pulled aside and said hey, what do you think about this, and you know, it was reasonably positive. There was definitely some skepticism around it and you know, is this just kind of some Hail Mary to try and I guess get attention to the project or something like that, but I was able to kind of make the case I think that you know, the issue we had was we weren’t properly incentivizing people to understand the protocol.
And when you look at things like bitcoin for example and how bitcoin generated its network effects, it was because it was paying people to understand it. You know, the protocol itself paid people to learn how to install mining software and understand block rewards and all that stuff, and I think if that didn’t exist it probably doesn’t gain the traction that it did.
And so I looked at that and I said we need something similar to incentivize people to care about this and to want to actually learn about it, and I think we were able to convince most of them but even still I was pretty surprised, I expected a lot of pushback from the community when you know, we announced it but interestingly they were super positive about it and I think mainly because most of them already understood the network and you know, we were essentially saying we’re going to pay you for understanding it and people who are not actively participating will be punished, and so you know, it was much more positively received than I expected by a very, very wide margin.
Laura Shin:
Yeah, and this is kind of like a theme of the conversation where there is this tension because certain elements of what you’re doing are centralized, at least at the moment, but then you know, just even things like you know, when I asked about the exchange fees and stuff you said oh, actually that was you know, set by the people in the Discord and like the DeFi index was decided by community members. So what is going on with governance, like right now I know you guys have a foundation but at some point I think you’d like to move to a DAO, so what’s your vision for how this will be governed?
Kain Warwick:
Yeah, I mean, you know, obviously we’re quite a small team. I think people don’t realize how small our team is and how hard working the engineers and everyone on the team is to kind of keep the project going. But it’s just impossible for seven or eight people to kind of anticipate everything that could happen. We can respond to things but the trying to kind of understand where we should go next just requires the insight of a much larger group of people.
And so the community has kind of really stepped up and become pivotal in helping us to you know, understand where we need to go next and see some of the issues and you know, oftentimes we don’t necessarily immediately agree. The core team might kind of look at a proposal and say oh, we don’t think that’s a great idea but the rough consensus model kind of allows for those debates and those discussions to kind of evolve over time and you know, most of the time we kind of reach consensus both internally you know, within the team and within the community and are able to kind of move forward.
But it’s just not possible with a project as complex as this is to not have that outside input and so we really try to foster it as much as possible and be as open as we can to kind of bringing in those outside views.
Laura Shin:
But then, I mean, for the future do you think that you might move to a DAO?
Kain Warwick:
I think we might. You know, it’s something we’re looking at right now. In order for us to I guess stay ahead of the kind of potential regulatory issues that are coming up we need to not be in control of protocol and so rough consensus is helpful in bringing in those external parties, but at some point we need to I guess relinquish control of the protocol operateability, and so that’s something that we’re looking at that potentially could be managed by a DAO but you know, it’s something that we obviously need to I guess understand a little bit better and work through what the implementation looks like as well as you know, working with the community and letting them kind of I guess help us to understand what they want from that because you know, if you move to unchained governance and you implement a DAO and the DAO is kind of controlled by this plutocracy as we’ve seen in a couple of other projects kind of emerge, I think it has a really chilling effect on participation within the community and so we’re really wary of trying to thread that needle and kind of manage that I guess.
Laura Shin:
And as mentioned earlier, you guys also did an ICO and I think you raised about 30 million, is that right? In 2018?
Kain Warwick:
Yeah. Yeah, that’s right.
Laura Shin:
And I believe from a conversation that we had, you think it was maybe from about 70 thousand wallets, is that right?
Kain Warwick:
So there’s about 70 thousand wallets who hold our token, but a lot of that came from a very large airdrop that we did that was I think about 65 thousand wallets. So there were 5 or 6 thousand people who participated in the sale, in the open sale, and then there were bounties and airdrops and things like that.
Laura Shin:
Okay. Well, in addition to that you also recently did a small VC raise, like what was the purpose of that raise?
Kain Warwick:
So you know, we have a large treasury obviously that is mainly SNX tokens, and it was really about bringing in I guess some new stakeholders, and there had been a lot of interest in people participating in the protocol, and one of the challenges I guess of having not that much liquidity in the spot markets is that if someone wants to get 2, 3, 4, 5 million tokens they really can only get it from a foundation, and so as that demand grew and more people were interested we started to kind of have some conversations and vet those people and we ended up going with Framework Ventures who’ve been amazing. They’re participating in all aspects of the system, they’ve kind of helped to work on the inflationary change as well, so you know, I think we picked the right team to kind of come in and help us, but we need as I said to bring in external stakeholders and people who can kind of help to push things forward.
So you know, if you find the right people in the future, we’ll probably look at selling tokens out of the treasury to them as well to get them into the ecosystem.
Laura Shin:
And there were also rumors about Andreessen Horowitz taking an interest. What was that about?
Kain Warwick:
There’s a wallet that is controlled by a16z that has SNX tokens in it. It didn’t come from the foundation directly but you know, it looks like they do have a position in Synthetix, if you look on chain, so you know, I can’t really find it much more information on that because that’s kind of all I know, but you know, there’s a lot of people in our community who are very good with chain analysis and were able to kind of work out what was going on and you know, it was on Twitter before I knew anything about it so it was kind of an interesting incident I guess.
Laura Shin:
There are so many incidents like that in crypto.
Kain Warwick:
I know, it’s crazy.
Laura Shin:
But anyway…well, yes, like the whole space. In other interviews that you’ve mentioned that you have confidence that decentralized finance will consume centralized finance eventually but that right now there’s a lot of challenges. What are the biggest challenges?
Kain Warwick:
I think the main challenge is that we still haven’t abstracted enough complexity away for you know, the average user, and that kind of flows all the way through the stack, right? So you know, user interfaces and user experience is still pretty far behind centralized finance.
I think the other issue is there’s a lot of friction getting money in and out of the system, getting value into the system, so it’s going to take at least a few years I think before we can kind of bring all of this kind of complexity much lower and just remove it and kind of provide I guess experiences for users and products for users without them needing to really understand what’s happening in the background.
Laura Shin:
All right. Well, we’ll see how you and others resolve all these problems, or all these challenges. Where can people learn more about you and Synthetix?
Kain Warwick:
Best place is probably to you know, if you really want to dive in to jump into our Discord channel, but you can go to Synthetix.io if you want to have a look at the system and get an overview. We also have a dashboard which is dashboard.synthetix.io which gives an overview of the network which is kind of cool. You can see all the different synths and what the interest is, etcetera.
Laura Shin:
Great. Well, thanks for coming on Unchained.
Kain Warwick:
Thank you very much for having me, really appreciate it.
Laura Shin:
Thanks so much for joining us today. To learn more about Kain and Synthetix, check out the show notes inside your podcast player. If you’re not yet subscribed to my other podcast, Unconfirmed, which is shorter, a bit newsier, and now features a short news recap, be sure to check that out. Also, find out what I think are the top crypto stories each week by signing up for my email newsletter at unchainedpodcast.com.
Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss, Josh Durham., and the team at CLK Transcription. Thanks for listening.
