Saying The Quiet Thing Out Loud

What happens when crypto's technical design space blows open just as the mind virus spreads

Ten Little Soldier Boys went out to Dine, one choked his little self and then there were nine.
Nine Little Soldier Boys stayed up very late; One overslept himself and then there were eight.

My favorite movies never end with a tidy, heartwarming finish. I find the films I enjoy most are those that leave the audience uncomfortable, confused, or frustrated when the credits roll. That probably says more about me than anything else, but these uncomfortable, incomplete endings are more relatable to our lived reality as humans. Maybe that’s precisely why most prefer movies that close all the loops and leave the viewer feeling satisfied. We feel warm & fuzzy at the end. It’s an escape from real life.

Depending on your outlook of the world, we’re either

• wading around aimlessly in the middle of a movie that will ultimately find its way to that heartwarming finish OR

• the credits are rolling and we’re looking around at each other wondering “wait wtf?”

What do I think?

Shhhhhhh, in due time.

In any case, at this very moment the vibes are definitely off. As Mike wrote about recently, narrative cycles have – and will continue to – play a major role in asset pricing. One of the uncomfortable realities many are just coming to grips with is that the punch bowl is long gone. Everything worked in 2020-2021, especially in crypto & venture. But the question people are asking themselves now is, what’s next?

“High consensus repeatedly amongst narratives as they cycle means people are lacking depth of thought and thus grasping for ideas to hang their hat on either for themselves or their investors.

Rapid switching between narratives means that there is low conviction in any given part of the market, leading to people jumping at the newest and shiniest thing, instead of sitting with a concept for long enough to let doubt creep in and work the problems.”

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Privacy Is Once Again En Vogue

Eight  Little Soldier Boys travelling in Devon; One said he’d stay there and then there were seven.
Seven Little Soldier Boys chopping up sticks; One chopped himself in halves and then there were six.

Within crypto there was obvious shock following the events of last summer, culminating in FTX’s collapse in the fall. The Novacaine has since worn off & the fog from those days has lifted. Many builders & investors alike are looking around at each other sheepishly. And while the dominant narrative coming out of ETH Denver was “zk everything” I think it’s prudent to remember a few things specific to this:

• zk building is not a new phenomenon

• during bear markets the privacy narrative ALWAYS resurfaces & sucks up a lot of oxygen in the conversation

• the venn diagram of those talking about zk’s vs those who truly understand the technical nature and nuance of them is not what you’d think¹

All this is to say, zk’s are undeniably important technology with great builders working to implement them, but the broad brush-strokes of this narrative aren’t particularly interesting to me. Specific use-cases where zk implementation is the missing piece otoh…

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You Really Shouldn’t Say Such Things

Six  Little Soldier Boys playing with a hive; A bumblebee stung one and then there were five.
Five Little Soldier Boys going through a door; One stubbed his toe and then there were four.

A group of people all trying to squeeze through the same door.

Where have I heard this analogy recently?

As the wider crypto community takes stock of the existing landscape, I see the events of the past two weeks becoming net-positive over the long-run². A lot of our thinking at Compound is shaped by exploring what broader trends will pull forward our future and spotting inflection points. This inevitably leads us to develop very nuanced views about how certain things shape or create change. Often seemingly innocuous catalysts can spark rapid progress along these paths & from that view, the events of the past two weeks matter. How much so? That remains unclear.

Is bitcoin going to $1 million in 90 days because of these events? No, it is not³.

Is Balaji directionally correct though? Probably yes.

What I found most revealing about the discussion around SVB and the US banking system broadly was how many new voices started to say the quiet thing out loud. The crypto community has joked about dirty, worthless fiat for years. That “joke” is now permeating the mainstream discussion around the United States financial system. It’s being talked about on CNBC and Bloomberg. It’s being written about in the New York Times and Wall Street Journal. It’s coming up organically in conversation with friends & family⁴.

Watching what’s unfolded has reinforced many of the misgivings people in crypto have about traditional financial rails⁵. More importantly, it’s undeniably planted seeds of doubt with WAY MORE people outside of crypto. Almost nobody I spend meaningful time with irl works in crypto, and yet some of the things I’ve heard the past two weeks include:

• “What bank will fail next? Should I be moving my money to Bank of America?”

• “So are they just going to print more money again? Can you do this forever?”

• “If you bail out SVB, don’t you have to bail every single bank out then? Who actually makes these decisions anyway?”

• “Should I buy gold?”

• “Do you think hyperinflation is possible?”

There is increasing sentiment that the US banking system is shifting toward the European model – this is not good.

The major European banks are effectively nationalized and really have been ever since the GFC. Anyone who doesn’t think Deutsche Bank has been a de facto government entity for the past decade is taking crazy pills. If you want to be even more dystopian you could argue the US is flirting with the Chinese banking model⁶ where 4 banks are king-made, and all credit creation runs through them. Part of the United States brand is that it’s a melting pot. That analogy extends to how small businesses and the tail-end of the economy are financed. A world in which all economic activity runs through 4 banks is a much worse outcome than a network of smaller regional and community banks that service very diverse local needs.

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Looking For a Big Idea Anon? Right This Way…

Four Little Soldier Boys going out to sea; A red herring swallowed one and then there were three.
Three Little Soldier Boys walking in the zoo; A big bear hugged one and then there were two.

So here we are, at a stage where more and more regular people are questioning bedrock assumptions they’ve long held⁷. I mentioned earlier how we think of things at Compound – this is *potentially* one of those moments for crypto. We’ve already covered the societal and behavioral forces at play, but there’s reason to believe technical breakthroughs are on the verge of unlocking important milestones for crypto.

ERC-4337 was deployed earlier this month: a standard for how smart contract wallets and various sponsoring entities can operate. I don’t think it can be overstated how significant this is. As far as I’m aware, the earliest proposal focused specifically on account abstraction was EIP-86, all the way back in 2016. Much simpler times, but also a revelation for how long this has been in the works.

One of the biggest issues for EOA’s today is the signature scheme⁸ – it’s extremely restrictive and better alternatives already exist. Smart contract wallets introduce much more flexibility here, but the design space is vaster than that.

• New levels of automation and permissions are now possible and way more customizable; in the existing EOA world, automation wasn’t feasible because of signature requirements while private keys defined everything when it came to permissions.

• Bundling transactions is now possible whereas previously every action required sign-off

• Session keys & spending limits can now be programmed

• Account recovery is infinitely more approachable for regular users as well; basically any encoded logic can now be implemented meaning the days of “lost my seed phrase, down astronomically” will become a thing of the past

Ok but smart contract wallets are super gas-intensive, and if we’re really going to Valhalla then for the average Joe/Jane who denominate in USD, this won’t work.

Instead of relying on your wallet to pay eth gas fees every single time you do anything on-chain, you can have your user operations sponsored by a paymaster.

What’s most compelling about this particular point is that dApps will be able to create their own paymasters and interact sans friction with smart contract wallets. They can also choose to rely on third-party paymasters to implement their customized code if they so choose. On top of that, the ability to bundle transactions allows for use-cases that previously weren’t possible (or were too expensive to practically implement).

One specific example that now seems plausible is the idea of what I’d call smart contract yield-seeking assets⁹. What do the bones of this look like?

• Simple, clean UI

• 1-click connect

• Users can add stables, eth, btc to the protocol

• Simple tiered risk parameters – or better yet a sliding scale – ranging from low risk (stables only, in lindy, hardened protocols) to high risk (new farm launches for example)

• Users can easily slide along the risk curve as they see fit

• 1-click deploy

• Smart contracts route aggregate balances across Ethereum (better yet x-chain too) to search and deploy for optimal yield based on liquidity depth & rewards/incentives

• As yields change, smart contracts continuously & automatically re-route liquidity

• Easy & intuitive to quickly see how performance is

one visual example from midjourney

There are caveats here and the specific details of session keys, frequency of updates & gas fee minimization will matter. But this is low-hanging fruit in my opinion and is now possible thanks to ERC-4337¹⁰.

DEX aggregators alleviated much of the fragmented liquidity problem specific to DEXs. Yield-generating protocols face an even more extreme version of this same issue. My view is that it’s likely additional aggregation layers continue to surface and users will opt for the “most passive” layer since very few want to think about deeper levels (i.e. unlock schedules, emission schedules, ve token ownership, etc.). I also feel very strongly these users will have appetite to pay for this layer. Look no further than GMX.

Today we have passive vaults, limited strategies and a real lack of diversified choices. There are no longer-tail exposure options, no baked-in user-designed choice and projects ask way too much of users. It’s unrealistic to demand people actively monitor vaults/strategies lest they risk seeing their returns nuked. Crypto-natives will cringe here but look no further than the proliferation of ETF’s in the tradfi world – the shift in investor behavior has already happened and many want 1-click exposure to “tldr products”.

You want exposure to tech? QQQ’s.

Want exposure to financials? XLF it is.

You want exposure to just the muh fuh Empire State building? ESRT is for you¹¹.

There’s a lot of adjacent design space here and it’s possible this is even the avenue where on-chain insurance starts to actually work lol. Hand-waving about account abstraction is all too common but we need actual products to be built using these new capabilities. I’m certain there are far more creative people than I who are already building weird stuff that is now possible thanks to these technical changes. These are the folks I’d most like to hear from!

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Liar, Liar

Two Little Soldier Boys sitting in the sun; One got frizzled up and then there was One.

I lied earlier.

Well, I told a half-truth. I do mostly enjoy films that make you feel uncomfortable, with one notable exception: Pixar.

Pixar movies are goated for a lot of reasons but for me it’s their precision in exploring the human condition, regardless of the story. I was re-watching Wall-E the other day and couldn’t help but sigh when the Axiom Humans showed up.

In some ways I felt their passive attitude to the systems around them is hauntingly similar to many of our own today. And in that sense, maybe Wall-E tugs at the uncomfortable thread more than I realized before. But it is Pixar, and so the story resolves quite neatly, and everyone lives happily ever after.

I promised earlier I would share my opinion here…

Depending on your outlook of the world, we’re either

• wading around aimlessly in the middle of a movie that will ultimately find its way to that heartwarming finish OR

• the credits are rolling and we’re looking around at each other wondering “wait wtf?”

I can’t besmirch those of you who believe the latter is where we stand. I mean, as Nic Carter pointed out, in the last month alone these are all the regulatory punches we've taken¹²…

And yet, I think we’re seeing Captain B. McCrea take his first steps. People are waking up to the idea of self-sovereignty – not just for financial systems but more broadly as well. The funny thing about humans is we are often looking for guidance, or more specifically looking toward the actions of others to determine our own. True transformation and behavior change gets put off until some traumatic event shoves us over the edge. Call me naïve but that seems to be happening just as crypto is making meaningful technical advances that should rapidly improve usability and security.

I remain bullish humans.

uponly

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If you’re building or investing in and around any of the areas covered here, I’d love to hear from you. Also, definitely check out our live, working theses database which we update regularly.

As always, my dm’s are open @0xsmac on twitter.

You can also reach me at 0xsmac[at]compound[dot]vc

s/o to to Mike for informing my thinking on this piece

1. i’ve been told this is not unlike the common trope of AI last cycle: “AI is like sex in high school, everybody is talking about it but nobody is actually doing it"

2. This isn’t meant to minimize the stress, difficulty and existential fear many people in crypto – but moreso traditional tech – felt as silvergate, svb and signature shut down

3. NFA

4. Non-crypto native division

5. I think it’s worth highlighting that A LOT of people do not really understand how the traditional banking system works. It’s news to some that if everyone pulls all their money out of every bank at the same time, there won’t be enough to go around. But fractional reserve banking is a feature, not a bug. It’s how credit creation and economic expansion happens. Incidentally, it’s also why we always talk about how “inefficient” fully collateralized DeFi protocols are.

6. Which Arthur did recently

7. This is just the latest instance where people are questioning existing systems. You can apply this underlying principle to financial systems, education systems, health systems, information systems, etc.

8. EOA accounts only allow for ECDSA signature scheme

9. the name needs work & I’m open to suggestions :)

10. “isn’t ____ doing that?” the short answer here is no. If you think I’m wrong please send me who you think is doing this but I’ve posed this question to a ton of people already & almost always am sent back things that look like remixed yearn vaults…happy to be wrong here though so please do tell if so

11. the contrarian of all contrarian bets innit

12. add the CFTC going after Binance to the list