Internet Financial System: Infinity Exchange and Beyond

For anyone that’s spent enough time studying blockchains, it’s clear these transparent, auto-accounting, and programmatic systems are superior to the siloed, rusty towers of traditional finance. Once the tech is understood, it becomes obvious that blockchains will undergird our digital lives, which explains why in the midst of the ‘wild west of crypto,’ we see every major bank, tech giant, and nation-state developing their own blockchain-adjacent systems.

That said, for blockchains to reach their full potential, we need more and better front-ends that are approachable not only by those at the frontier of innovation, but that surpass the user experience, safety, and compliance standards demanded by the largest institutions in the world. Using finance as an example, consider that retail trading makes up less than a quarter of the total volume in US equity markets (see graph below), while retail’s share in the much larger fixed income markets has historically stayed well below 5%.

U. S. Equity Volume by Market Participant (Source: Bloomberg Intelligence)

Therefore, using traditional markets as our reference point, we’re constraining the total crypto-market size by at least 10x by not making blockchain-based systems accessible to institutions. As long as these systems remain open and permissionless, all market participants would have access to the same assets, pricing, and tools, whereas today retail is largely locked out of ‘institutional finance.’ Everyone wins: institutions get exposure to an exciting new growth vertical of the global economy, accelerating maturation therein; retail gets access to products that were previously out of reach; and crypto-natives get the scale they’ve always dreamed of. 

One way in which we expect this trend to manifest, is a transition from Decentralized Finance (DeFi), to the Internet Financial System (IFS). DeFi came about as a rallying cry for the earliest experiments of finance on blockchains, a time when the defiance was necessary to prove out the promise. As these systems mature, the defiant components will rightfully persist, but we expect them to be complemented by compliant systems that invite the largest pools of global capital to utilize open networks.

A brief aside on interest rates and yield curves

At the heart of finance are fixed income assets, which are several times larger than equities in total value, and at the heart of fixed income assets are interest rates. Interest rates are arguably the single most important variable for financial markets as a whole, as they put a price on time, and nearly all assets incorporate time into their pricing. If interest rates are 0.2% vs 20%, our behavior shifts radically between investing in risky assets vs letting cash earn yield in a money-market account, or taking out a mortgage at low rates vs waiting for when “time” is cheaper.

Interest rates can speed up or slow down an economy, affecting all players. Yield curves are illustrations of interest rates for different assets across a range of durations. For the IFS to flourish, we need coherent yield curves for the major cryptoassets and stablecoins. Coherent yield curves require tight two-sided (borrow/lend) pricing across a range of durations, liquidity at those durations, as well as credit risk mitigation through overcollateralization and prudent risk management.

Introducing Infinity Exchange

To illustrate the delta between what is currently available in DeFi, and what we envision to be the first inning of the IFS, we’ll briefly contrast Aave and Infinity Exchange. Aave is a premier borrow-lend protocol within DeFi, boasting some of the largest pools of assets in its category. Most loans on Aave have a variable interest rate, although the platform also facilitates loans with temporarily fixed borrow rates.

Infinity, by comparison, is a rates protocol facilitating lending and borrowing across both floating and fixed rates (with fixed maturity dates). Infinity aims to create yield curves and liquidity for all the major cryptoassets, marrying the market structures and risk management of TradFi with the transparency of DeFi, all wrapped in a clean, professional interface (see image below).

Infinity Exchange User Interface

In order for yield curves to be taken seriously and used by pools of global capital, the spread between the APY a borrower pays, and the APY a lender receives, needs to be massively compressed from what’s currently available in DeFi. Additionally, there has to be a seamless experience between both floating and fixed rates. Aave has been a stellar steward of DeFi, but for an institutional player, it leaves a lot to be desired. Below we have highlighted the “Supply APY” vs the “Borrow APY” for major stablecoins on AAVE.

Stablecoin Supply and Borrow APYs on Aave as of April 13, 2023

While a retail market participant may see the above and say, “What’s the big deal, they’re only 1-1.5% off,” an institutional player operating at scale sees a spread incomprehensibly wide. While it’s a crude analogy, this spread is similar to a spot exchange that allows one to buy BTC at $40K, and sell it at $20K. If large players want to hedge duration risk, these basic spot or floating-rate markets simply will not work for them.

This is not meant to pick on Aave, but rather to illustrate the current state of best-in-class DeFi. Any borrow-lend protocol using a pooled model on the supply side, which calculates the yield to suppliers based on capacity utilization, is going to end up with a similar dynamic. Placeholder wrote about this in April 2019 in DeFi Liquidity Models, where we observed that to jumpstart liquidity formation, the pooled model was the best. That said, we ultimately expected maturation past pooled models:

“If the DeFi community figures out liquidity solutions for the long-tail assets, P2P protocols may well outpace the utility of their less flexible analogues by offering the “endless aisle” of asset types and custom exposures. These peer-negotiated contracts can theoretically allow users exposure to any asset or state of the world. Such plasticity may allow these systems to serve increasingly deeper niches as the flywheel of market completeness kicks in.”

While DeFi liquidity has stabilized after drying up through 2022, the flywheel of market completeness is gathering momentum around the next generation of products and builders, many of which are focused on enabling the IFS through institutional-grade front-ends. Infinity will offer a permissionless protocol, where anyone can build a front-end, as well as a regulated, KYC/AML front-end that suits the needs of institutional players.

Infinity’s first order infrastructure enables the IFS via a borrow-lend order book that is approachable by all players, from degens to the world’s largest institutional players. The order-book is key here, as it allows for infinite granularity, but also requires a wide-base of sophisticated market participants, and tight API integration to make sure the order book doesn’t look like Swiss cheese. All collateral maintains on-chain transparency while Infinity’s risk-engine requires complex computations currently only feasible off-chain, but that we anticipate will be feasible on-chain with the continuous computational breakthroughs the crypto industry regularly makes. 

The Infinity team is stellar, and includes the type of builders that even a few years ago seemed like a far out fiction. Infinity is led by Kevin Lepsoe, whom we first met in September 2022. In his past life, he was the Head of Structuring and Financial Engineering at Morgan Stanley for 5-years, and held that position through the Great Financial Crisis. Kevin operated at the heights of TradFi when structuring was at its most complex, and holds a global view on markets. After leaving Morgan Stanley and before getting blockchain-pilled, he started a successful enterprise software company that services Fortune 500s. He is surrounded by a group of builders that understand not only how to architect a reliable system, but also how to get the largest players in the world to use it.

For Kevin and his team, finance and blockchains are about efficiency: architectural efficiency, capital efficiency, infrastructure efficiency, and user experience efficiency. There are too many layers of middlemen within TradFi, which profit at the consumer’s expense. The Infinity team knows that system intimately, and wants to disintermediate it with a simpler, more efficient protocol and application interface. 

With institutional-grade interest rates addressed, the crypto industry can tackle credit at large, a major opportunity for innovation at the heart of global finance. While many are focused on the Fed’s “money printing” and the $5+ trillion of cash in the US (M0), let’s not forget the astounding $93+ trillion of total credit in the US. In that chain of credit, innumerable unnecessary players suck out small fees from the consumer, and most can be automated or done away with entirely. 

For an example of inefficient and dangerous complexity, look no further than TradFi’s dependence on shadow banking. Shadow participants account for the majority of TradFi’s assets, surpassing that of banks, and leaving its opaque nature for regulators to manage potential systemic or ‘black swan’ events. An illustration by Zoltan Pozsar in a 2010 New York Fed paper has become infamous in piecing together the complex layers of shadow banking, shown below.

Graphical Representation of the Shadow Banking System (Source: Pozsar et. al., 2012)

When we combine expert knowledge from TradFi with an intimate understanding of blockchains, we can better tackle the institutional shortcomings of the current financial services industry. Infinity holds the core tenets of the IFS central to its product roadmap, which include transparency, efficiency, and scalability. At the same time, its regulated KYC/AML front-end will open up the IFS to new pools of institutional capital. Once interest rate markets are sufficiently mature, we unlock the market for at-scale, efficient, and transparent credit, which may ultimately be benchmarked off Infinity’s yield curves. 

We expect protocols and front-ends like Infinity to succeed, with transparency at their side, where centralized and opaque borrow-lend companies of 2022 failed. The ability to borrow and lend with maximal capital efficiency is one of the keys to market completeness of the Internet Financial System, and we’re thrilled that the team behind Infinity has chosen to help the crypto industry in pursuing this mission.

Across Thesis

Across is a bridging protocol on Ethereum that transfers value between Mainnet and Ethereum layer-2s, and soon will connect to any EVM chain. It differentiates from other bridges by its fixation on efficient value transfer, and combination of financial and technological engineering to make the experience seamless for the end-user. In a space that has a tendency to over-engineer solutions, the protocol is refreshingly minimal in its approach while also providing strong security properties.

Across relies on relayers, who fulfill deposits for users at the destination chain the user desires. For example, let’s say a user has DAI on Ethereum but wants to use that DAI on Polygon. Using an interface on Across that’s as simple as a Uniswap trade, the user can transact that DAI from Ethereum to Polygon. 

When the user submits the transaction, a relayer already with DAI available on Polygon can elect to fulfill it, and send the user the DAI minus fees on Polygon. From the user’s perspective this can lead to extremely fast fills, as the transaction to fulfill the user’s request all happens in the destination environment (in this case, Polygon), as opposed to having to hop through multiple execution environments.

From there, the user is done with the transaction, hassle-free. The relayer will get reimbursed for their time and capital by the Across LP pool, which sits on Ethereum Mainnet for maximum security. The relayer does this by submitting a proof-of-relay to UMA’s Optimistic Oracle (OO), and once the proof-of-relay is verified by the OO, then the relayer is paid out. Within the OO design, all it takes is one honest actor to dispute a relayer who is attempting to get reimbursed nefariously. So far, Across has facilitated the transfer of $1.4B+ in value for 165,000+ users without a hitch.

For people that don’t want to be active relayers, but like the idea of passively staking capital in the Ethereum Mainnet LP pools, there are attractive yields available. Below is a dashboard of yields, where we see ETH yielding ~8-22%, WBTC yielding ~5-12%, and ACX yielding ~10-29%. Across transparently displays the proportion of this yield that comes from pool fees denominated in the staked asset, versus reward fees denominated in ACX. Furthermore, the protocol has implemented an innovative feature called “Age of Capital” that amplifies yield the longer capital is committed to an LP pool, incentivizing loyalty over mercenary behavior. 

Across also harnesses learnings within traditional finance, where it nets flows of funds between destination environments to avoid wasteful transfers, and bundles repayments of relayers for maximum efficiency. Therefore, the user gets maximum speed and convenience, while the relayer absorbs some of the inconvenience but gets paid for doing so.

Because Across’ design relies on financial engineering as much as it does upon technological engineering, it often provides the lowest slippage transactions of available bridging solutions, making it least costly for the user to move capital between environments. Low slippage becomes particularly impactful for large movements of value, and is another way in which Across outcompetes many of its pooled, bridging-peers.

It’s our view that the most capital efficient and secure bridges will win out over time, as other bridges chew up precious resources or lose user funds, and Across is well positioned to prove its secure and efficient design over time. While Across currently only supports Ethereum L1 and L2 movements, the expansion to other EVM environments is trivial given the design.

See you on the bridge.