The futurist finance world of flash loans and hypernodesIn the cryptocurrency world, you could float a loan for ten seconds and make good money — but you and your computer must be very fast indeed
In the first part of Episode 4, “What Is Decentralized Finance?” (September 1, 2022), computer engineer Adam Goad discussed with Walter Bradley Center director (and computer engineering prof) Robert J. Marks how blockchain would decentralize finance by establishing trust and security without government regulations. Now they look at how some of the remarkable new financial instruments work.
A partial transcript, notes, and Additional Resources follow.
Robert J. Marks: Before we started this recording, you mentioned something which blew my mind — flash loans.
Adam Goad: A flash loan is a loan that you take out for a very short amount of time, usually a few seconds.
But it can be for a very large amounts, like millions of dollars. So if you want to feel like a millionaire for a few seconds, you can go take out a flash loan. But the point of them, most often, is for arbitrage.
Robert J. Marks: Well, first of all, explain arbitrage.
Adam Goad: Arbitrage is when you see an opportunity to buy and sell something at a different price in different places. Let’s say you are on Coinbase and you can buy Ethereum for $2,000. But you look at another cryptocurrency exchange such as Kraken and you see that over there, you could sell Ethereum for $2,100. You would immediately want to buy all of the cryptocurrency you can from Coinbase and sell it to Kraken. And you’d make a hundred dollars per Ethereum in this manner.
Robert J. Marks: Because there’s this price disparity.
Adam Goad: Yes, exactly. And by doing so you would equalize the price disparity between the two, as they adapt to the market.
Robert J. Marks: Wow. $10 million for 10 seconds. Clearly, you pay a premium for this. You pay some sort of interest to borrow that $10 million. Is that right?
Adam Goad: Yes. You would pay a fee and flash loans are often enforced through a smart contract. You would put these transactions into the smart contract, so that the lender can be satisfied that they’re going to have the money back in 10 seconds. You’re not just going to run away with it.
Then the money being returned to you with your profits is all set into code that the blockchain executes and, in that way, it is trustless. And therefore you can trust each other.
Robert J. Marks: Now to do this $10-million loan, do you need collateral?
Adam Goad: With the flash loans — since it is enforced through the smart contract — there’s no need for collateral. It is the risk of you and the lender that it’s going to go well. And you both know that neither of you can run off with anything because you can both trust the code in the smart contract.
Robert J. Marks: Okay. Thinking about that though, if you want to do arbitrage between two different markets, for example, and you borrow the $10 million and the markets go kablooey — maybe the prices even out or something — I guess the only loss you have is the fee that you paid for the $10 million. So you risk that in a way don’t you?
Adam Goad: Yes. The lender would be risking that as well. They would risk that perhaps the value of it went below $10 million in those 10 seconds that you had it. So yes, there is risk involved on both parties that it could not work.
Robert J. Marks: I have heard that most computer trading is arbitrage. And in fact, some trading institutions want to get faster cable so that they can do arbitrage more quickly than somebody else. Have you ever heard of that scenario, of these trading houses wanting to do arbitrage by beating the other person with the speed of their computers?
Adam Goad: Oh yes, certainly. Cryptocurrency is a constant 24/7 market, where milliseconds matter. When you find these arbitrage opportunities — since there are so many people looking for them — it’s very rare to find a very large one.
You are only going to find perhaps a 1% difference between prices. And if you know that price is greater than the fees you’re going to have to pay to conduct these transactions, then you, of course, want to do arbitrage. But like you said, at the same time there’s going to be dozens of other people who found that same opportunity, because their computers were also looking for it.
So who gets there first? This is actually something I’ve been working on with an NFT project I work for. We’ve created — we call it — the Hypernode.
We’ve taken very fast computer servers and put Ethereum nodes onto them. I have modified these nodes so that only select individuals can use them, in this case, the holders of the NFTs from the project.
Note: A node in cryptocurrency usage is “a computer connected to a cryptocurrency network and can execute certain functions like creating, receiving or sending information” – Gadgets 360 (August 21, 2021)
Robert J. Marks: Let’s back up a little bit and define some of these things. What’s a Hypernode?
Adam Goad: That is the name we’ve given to the very fast Ethereum nodes that we allow holders to have access to. And we limit the access so that encourages people to enter into the project but also provides insurance that our node will remain fast.
There are plenty of public nodes on the Ethereum network and if you download any kind of app to transact with Ethereum, it will have some kind of default node it applies you to. But by restricting who can use our node and making sure that we have very fast hardware supporting it and internet connection, we can provide our users with a faster connection to the blockchain than anyone just using a public node.
Robert J. Marks: I see. And is that enough to beat some of these different trading houses? I have heard for example, that there have been trading houses that have geographically moved closer to the New York Stock Exchange and laid fiber in order to get quicker responses. That seems to be very difficult to beat.
Adam Goad: Since the New York Stock Exchange is a centralized system, you have to be close to it in order to get those speeds. With Ethereum and other cryptocurrencies being decentralized, you can place a node anywhere and get fast access to the network.
Robert J. Marks: So your business is for decentralized finance. So you don’t have to go to the places like the Chicago Mercantile, or the New York Stock Exchange, right?
Adam Goad: Exactly. There is no central Ethereum market in a physical location anywhere that you need to be close to. What matters is how close you are to a node and how fast that node is.
Robert J. Marks: So let me ask you, how close are you to market? Are you geared up yet? Are you selling these services?
Adam Goad: We have been online for several months now.
Robert J. Marks: With the stipulation that Mind Matters News is not being paid at all for this endorsement, tell me how somebody can find out more about your business.
Adam Goad: The project name is Just Cubes and you can find out more here.
Robert J. Marks: Okay. Well, I hope you become a very wealthy person because of that.
One final thing that I’d like to ask you about is something called stablecoins, which you’re going to have to explain to me. It turns out that most cryptocurrencies are incredibly volatile. They will go up and down, their variants, their volatility is just wild. Yet these so-called stablecoins are cryptocurrencies as I understand them that don’t display this volatility. What’s going on there?
Adam Goad: Like you said, the crypto market can be incredibly volatile. Recently, the Ethereum market dropped 10% in a day. It’s had wild swings in the past as well. But yes, stablecoins, there’s a handful of these. USD coin, standing for US dollar coin, DAO, Tether. There’s several of them. They have something backing them. They are pegged to a currency such as the US dollar, there’s ones for the pound, the euro and other such currencies around the world.
The one I’m most familiar with USD coin. They actually take a dollar bill and put it into a bank vault for every single one of the coins they issue. You can go to them and say, “Here’s five USD coins, give me $5,” and they can do that for you. So since there is something actually pegging this currency to the US dollar, it will always have value of $1. Now there is a slight bit of fluctuation around it, just based off the momentary demand. But that usually is in the tens of thousands, or hundreds of thousands of a cent range [in terms] of how much it changes.
Robert J. Marks: Now clearly, in order to back up this USD coin, that’s going to cost big bucks. Whoever fronts, the big bucks has to have a reason to do it. They need to get paid. So how does that work?
Adam Goad: There have been plenty of investors getting involved in different Web3 and cryptocurrency projects over the past few years. They would get paid the same way that people who get paid for mining and such. Tey would take a percentage of the fees that are provided to transact on the network.
Robert J. Marks: So every time you trade a USD coin, you are charged a little bit, almost like charging something on Visa — the merchant that you charge it to has to eat a little bit of the purchase price, because that goes to Visa or MasterCard, or something like that. Is that a good analogy?
Adam Goad: Yes. But in the case of cryptocurrencies, it is the one initiating the transaction who has to fund the cost of the fees.
Robert J. Marks: Very interesting. I think that this decentralized finance is going to be a big deal. I was talking to an employee of a bank who said that banks really hate decentralized finance in general. Do you think that maybe banks are going to try to crush this decentralized banking or do you think that they’re going to go with a way of brick-and-mortar stores, some of which have just gone belly up?
Adam Goad: Well, like you said on one of our last episodes, “Always hate to make predictions, especially about the future.” But I am certain that there are aspects of this I’m sure banks don’t like. It’s allowing people to borrow money, to do loans, to invest without having to go through the centralized systems, and therefore they’re not getting a cut. Which one will win out in the end? I don’t know. But I do think that this will be around for a while.
Here’s the first part of this episode: What would a financial system based on blockchain look like? Adam Goad talks about key differences between banks and blockchains in what creates trust and privacy. Hackers don’t steal cryptocurrency by breaking the encryption but by getting by getting users to reveal information that makes them vulnerable.
Note: If you want to read or listen to the first three episodes, you will find links to all parts at the bottom of this page.
- Adam Goad at IEEE Xplore
- Dr. Austin Egbert at IEEE Xplore
- ”Just As Cryptocurrencies Went Mainstream — a Huge Collapse!” by Jonathan Bartlett at Mind Matters News
- American Kingpin at Amazon.com
- ”Blockchain hackers stole nearly $1.3 billion in Q1 2022” at AtlasVPN
- Just Cubes