This post was last updated on April 26th, 2018 at 02:04 am
Chances are good that you’ve never met a professional crypto liquidity provider. And before meeting today’s guest in Zug, Switzerland, I’d never met one either.
Today’s guest is Benjamin Roberts, the co-founder of Citizen Hex, which is (you guessed it) an Ethereum and ERC-20 token liquidity provider.
Citizen Hex works to increase the likelihood that, when traders place buy and sell orders for ERC-20 tokens on various crypto-exchanges, that those orders go through.
This conversation is a deep dive on what it means to be a market maker and liquidity provider in crypto markets.
On this week’s show we discuss:
- How Ben sees see the cryptosphere from his vantage point as a liquidity provider.
- What a liquidity business look like at an operational level.
- Why Benjamin felt locked out of the traditional financial world.
- How Ben thinks about “value added” vs. “rent seeking” activities in the cryptocurrency space.
- What exchanges do or don’t do to encourage the participation of market makers on their platforms.
- The distinction between infrastructure and information.
- Why Ben thinks that the philosophy in the crypto space should be one of openness.
Links Relevant To This Episode:
- Benjamin Roberts
- Citizen Hex
- Susquehanna International Securities
- ERC20 Token
- Taylor Gerring
- OMERS Ventures
- Purpose Investments
- Three Angels Capital
- Khan Academy
- Chris Burniske
- Flash Boys by Michael Lewis
Clay Collins: My guest today is Benjamin Roberts. Benjamin is a co-founder of Citizen Hex, an Ethereum and ERC-20 token liquidity provider. Now I realize that many crypto investors started out as technologists first, and later came into investing because of their love of crypto specifically. If so, you might now know what a liquidity provider is. So before I even tell you what we talk about in this interview, we’ll need to take a detour to explore what a liquidity provider is, and how these businesses work.
For answers, I’ll turn to Wayne Blanchard.
Wayne Blanchard: Our question today is what is a liquidity provider? Well, a liquidity provider is basically nothing more than a market maker.
Clay Collins: So there you have it. A liquidity provider is basically a market maker. But now of course, we have to ask what is a market maker, and why do you need them? Let’s start with that last question. Why do we need market makers? To answer that, we’ll turn to John Keogh, managing director of Cisco HANA International Securities. Or at least, we’ll turn to his YouTube video with cheesy easy-listening music to explain it. Cue the cheesy easy-listening music.
John Keogh: Well, if there was a natural buyer for every natural seller, then you wouldn’t really need a market maker or liquidity provider. But that’s seldom the case.
Clay Collins: There is rarely a natural buyer and seller. That’s where market makers come into play. We get a little bit more context from a video by UKspreadbetting.
UKspreadbetting: So basically, a market maker is there to provide liquidity for people at all times. You are basically saying you will always be able to buy or sell that stock. So remember, the public can come in, and always buy or sell that stock.
Clay Collins: Like everyone else, market makers make money by buying low and selling high, but unlike most investors, they make money through volume and small price differences across exchanges, not through medium-term or long-term holding of assets. Say a stock were for sale at a lower price on Exchange A, and someone wanted to purchase it at a much higher price on Exchange B, a market maker in that case would buy those shares and arbitrage them across exchanges.
Okay, so I said earlier that Benjamin, our interviewee, is the co-founder of a business that provides liquidity for the Ethereum ecosystem and ERC-20 tokens. Now that you know what a liquidity provider or a market maker is, I should explain for those who don’t know what ERC-20 tokens are. Here to explain this is Taylor Gerring.
Taylor Gerring: ERC-20 tokens are a special type of subtoken on the Ethereum network. ERC-20 tokens are a compatibility standard that allows tokens to interoperate with each other. Having a common set of application programming interfaces makes it possible that tokens can interoperate with each other, or that wallet software can operate with many tokens without having to create a custom set of coding for each one.
Clay Collins: Let me try explaining that another way. ERC-20 tokens are tokens built on top of the Ethereum blockchain. EOS, Golem, and OmiseGo are popular examples of ERC-20 tokens. When a crypto project uses the ERC-20 token standard, they don’t have to roll their own blockchain, incentivize miners, and create an entire ecosystem around supporting and sustaining their blockchain. They just use Ethereum’s blockchain, and that provides confidence for the users of that network. It is believed to be unwise for most crypto projects to roll their own blockchain.
What all of this means is that Ethereum isn’t just its own blockchain for its own tokens, called Ether, its blockchain is also a platform that other crypto projects can use to create their own tokens. So now that you know what a liquidity provider is, and you also know what ERC-20 tokens are, we can wrap up this discussion about what Ben does.
Ben, as a liquidity provider, tries to ensure that when people buy or sell ERC-20 tokens, like OmiseGo tokens or EOS tokens, on various crypto exchanges around the world, that those orders can go through, that when they want to buy, there’s a seller, that when they want to sell, there’s a buyer. And his company, Citizen Hex, seems to be doing pretty well. They recently raised capital from Version One, OMERS Ventures, Purpose Investments, and Three Angels Capital. Anyway, this conversation is a deep dive on the liquidity business and Ben’s history in this space.
I wanted to do this interview because before I met Ben, I had never known or met a crypto liquidity provider, and there’s a good chance that you haven’t either. This is an eye-opening interview. We discuss how Ben sees the Cryptosphere from his vantage point as a liquidity provider, what a liquidity business looks like at an operational level, how Ben thinks about value added versus rent-seeking activities in the cryptocurrency space, what exchanges do or don’t do to encourage the participation of market makers on their various platforms, and of course, so much more. Anyway, please enjoy this conversation with Benjamin Roberts of Citizen Hex.
Ben, can you give us a background on yourself and the journey that took you to where you are today?
Benjamin Roberts: In 2013, I had the good fortune of reading the Bitcoin whitepaper, not understanding it at first, but watching some Khan Academy videos. And I remember a distinct moment when everything clicked, and I just kind of stood up from my chair, and had this real epiphany like this is actually this completely mind-blowing thing. This is absolutely going to change the world.
And more or less from that point on, I became obsessed with cryptocurrency, and decided that I was going to dedicate the rest of my career and life to operating in this space. I participated in those markets then, which worked out well. When the bubble happened in 2013, and the price went to 1200, everyone thought they were going to be rich, and this utopia was beginning. And then that was followed by a more or less two-year long bear market where all of the network effect and excitement reversed for that whole time.
But during that time, I was very fortunate to discover and learn about Ethereum, and had a similar kind of epiphany when I understood what it meant to have a world computer, to have a computer that the whole world could use at the same time, and a computer that could kind of maintain the state, the arbitrary state of anything, really. That really absolutely blew my mind again, and I guess I went even kind of deeper down the Ethereum rabbit hole that I had the Bitcoin rabbit hole, and decided to start a business on top of it.
Clay Collins: So for you, it was finance that came first, and then cryptocurrencies, and then you kind of stitched them together, is that correct?
Benjamin Roberts: I would say it was a combination of getting tech as a function of working in tech and getting finance just because I was speculating and kind of very interested in financial markets on the side. And it was really that Bitcoin and eventually Ethereum represented this perfect union of those two interests. And I think that allowed me to hopefully have insight that a lot of other people didn’t have, because I think even to this day in this space there are a lot of people that deeply get the tech, a lot of people that deeply get finance, but I haven’t met many that really kind of synthesize both in the same way.
Clay Collins: Can you walk us through some of the projects that you’ve started in the cryptocurrency space? You’re the only crypto liquidity provider that I know, so how does one ease their way into that?
Benjamin Roberts: One of the first things I attempted, this was pretty early on, I think this was before Ethereum, was a website called coinsight.co. It’s defunct now because no one wanted to use it. What I was trying to do there was there’s a very, very interesting product in traditional financial markets, called MarketDelta, that has this very unique and insightful way of visualizing bids and offers and how demand is flowing in real time through the marketplace. And I thought it would be really cool to apply that to Bitcoin.
And so yeah, I built this website called Coinsight. It was up for a while. This was more or less for the duration of the Bitcoin bear market, and I think, like many people in this space, I kind of bailed on it at the bottom. Again, all the network effects were kind of working in reverse. No one was really that interested anymore. And no one really wanted to watch the price go down day after day in this really cool way.
After that, I guess the next project was, this was quite a bit later, I was experimenting with peer-to-peer margin lending on Poleniex, finding it very painful to automate that process. Eventually, I found someone’s bot that kind of automated the peer-to-peer margin lending. And so I was using that myself, and then I started setting it up for friends, and then I had a Slack channel where I was setting it up for other people.
Clay Collins: Hey, it’s Clay cutting in here to explain what peer-to-peer margin loans are. Margin loans let you use your assets or manage funds stored within a brokerage account as collateral for a loan that you can then use to place more investments. Margin loans can help you increase your returns, but can also magnify your losses. I should note that margin lenders often have the right to sell your assets, or demand some repayment, if the amount of the loan exceeds a certain percentage of your collateral.
Let’s say you borrowed $2 million against $10 million in assets. If the value of those assets drops below $6 million, that would mean that the loan now constitutes more than 1/3 of the value of your assets. And the lender could sell some assets or ask you to add more cash to your account, to ensure that the loan amount drops below 33%. Now peer-to-peer margin lending means that instead of the loans coming from a bank, they’re coming from other traders or private lenders looking to generate returns. These loans, as they happen on crypto exchanges, are made in Bitcoin, Ethereum, or other cryptocurrencies. Okay, back to the interview.
Benjamin Roberts: I just found there were a lot of people that wanted to use this, so I ended up basically rebuilding the functionality of this bot as a web service, which was poleniexlendingbot.com. This grew very, very quickly, and very quickly this thing was kind of automating margin loans for a very large number of people. I operated that business for quite a while. And in the course of doing that, kind of discovered some very interesting things about the crypto markets. I would say the first one was just truly how global this phenomena was.
When I looked at the Google Analytics, most of the users of this service were in Brazil, which really blew my mind. I can’t think of another example of a trend happening simultaneously everywhere in the world like Bitcoin was and is happening. And I thought this made me very, very bullish on what was happening. It was also during the course of operating this business that my now co-founder and I started working a bit with Zack, who runs EtherDelta, which was one of the first decentralized exchanges.
And in kind of learning how EtherDelta worked, and coming to appreciate the power of a decentralized exchange, I kind of started to realize that the future was not going to be Poleniex and some of these other exchanges, that ultimately, all of this infrastructure would actually probably move on to the blockchain.
Clay Collins: Clay, again, here to explain decentralized exchanges. Decentralized exchanges provide infrastructure for users to exchange tokens with one another without the exchange controlling or having custody of customers’ funds. In the same way that Bitcoin or Ethereum allow you to send money over the internet to someone else without a bank, decentralized exchanges allow you to exchange tokens for other tokens in a trustless manner, and without the exchange itself being a single point of failure. Now let’s pick up where we left off with Ben telling us about his journey towards becoming a liquidity provider.
Benjamin Roberts: Through realizing that, kind of came to understand the economics of Ethereum, and the economics of maybe building a liquidity business on Ethereum. And basically, closed down, and then eventually, sold the peer-to-peer lending bot service to a friend, and started to build Citizen Hex.
Clay Collins: Do you think that you would be heavily involved in fintech in the way that you are if it weren’t for cryptocurrencies? Or would you be doing some SaaS startup, or something else? In other words, did the advent of this new potential financial world bring you in in a way that the traditional finance world would not have been able to?
Benjamin Roberts: Oh, yes, absolutely. I’ve often had this conversation with another friend who’s also very heavily into crypto, that neither of us really know what we would be doing if it weren’t for this. It almost felt like there was no purpose before cryptocurrency, and now there is. In very real terms, I was kind of locked out of the old financial system, because I had an arts undergrad, and you needed an MBA, and maybe like an Ivy League school. You needed all of these prerequisites to enter that old space.
And you don’t need any of that to work in this space. The platform is open. All the tools for interacting with it are open-source. I mean, both in terms of the purpose and kind of morality of operating in crypto, but also in the very real sense of the logistics that allow you to operate in it, it’s much more inviting and it’s much more possible to participate in it, and really gives you a much stronger sense of purpose and much more power to make a difference.
Clay Collins: I think it’s really cool to see people native to crypto getting involved in building financial services businesses, or financial businesses. What is it that you do right now with Citizen Hex? Can you tell us a little bit about what it means to be a liquidity provider in the first place?
Benjamin Roberts: Let me maybe rewind a bit more, and frame why I think this kind of business needs to exist. We’re very early in actually trying to build it, and we don’t know really the final form that it’s going to take. I can tell you why I think these kinds of businesses should exist. I can tell you what we’re doing right now. I don’t know if that’s what we’re going to eventually be doing.
I think that the main reason that we’re doing this business is because we realize something fundamental about the economics of Ethereum, which is when you democratize financial engineering, people are going to do a lot of financial engineering, right? When you let people kind of program and whip up any kind of financial contract with almost no overhead, people are just going to do a lot of that. There are going to be a lot, a lot, a lot of assets. An analogy I use sometimes is look at how many tweets there are relative to how many newspapers articles there were. Look at how many YouTube videos there are relative to how many TV programs there were.
There are orders of magnitude increase in the number of these things that you get when you just let anyone create one. And I think we’re going to see the same thing, we are seeing the same thing happen on Ethereum, or the same thing will happen on any platform like Ethereum, which is when you make it very cheap, and very accessible to do this stuff, people are going to do a lot of it. And so we’re going to see this many order of magnitude increase in the number of assets that exist from a world today of maybe tens of thousands of liquidity securities globally to a world of potentially tens of millions or hundreds of millions of securities.
But I think the problem is that when you go to a world that has tens or hundreds of millions of securities in it, it becomes very challenging to make all of those liquid enough simultaneously that people can interact with them. I think it’s also the case that in this world, there’s a much more frequent need to switch between assets, right? If you think that these utility tokens are going to proliferate, and you’re going to actually need to own these tokens to interact with applications, you may have a need to use multiple currencies, maybe even dozens of currencies daily to interact with all the things that you interact with. And so you have both this growth in the number of assets that exist, and then also the number of times people have to switch between them, and you have this real exponential growth in demand for liquidity and liquidity providers.
Clay Collins: When did you first detect that liquidity was a problem? When did it occur to you that this problem needed a solution?
Benjamin Roberts: It’s kind of theoretical. This is first principles analysis of Ethereum, which is it’s cheap to make stuff, people are going to make a lot of stuff, people are going to have to switch between those things that they make. Who’s going to facilitate that? How is it going to happen? I just anticipate that it will become more and more of a problem as there are more and more of these assets that are being created.
I think we’re kind of right in the knee of the curve right now in terms of going from maybe 10 tokens that people know about to 100 tokens that people are aware of to thousands or hundreds of thousands of tokens. It was probably the case six months ago that you could have a list or an awareness of every tokenized Ethereum project and you could know something about it. But it’s the case today that I don’t know maybe even 1/3 of these projects that are happening. There’s already been this exponential growth, and I think we’re going to see that increase much, much more quickly, and even different forms of tokens, different classes of tokens are going to emerge.
Clay Collins: For, I think, the average person listening to this episode, this is probably the first time they’ve heard anyone say that they’re a liquidity provider, or that they are looking to build a business around providing liquidity. At the core of your business model, what is it that you do, and how do it?
Benjamin Roberts: Yeah, I mean, I think one very simple way to think of us is, yes, as a market maker or a professional arbitrager. I think that doesn’t quite do justice to our vision and to what we think is going to happen here, which is again, if there is this kind of anarchy of forms that happens here, I don’t think you’ll be able to to just call it arbitrage, or statistical arbitrage, or market making. I think everything will be very fluid, and there will be many, many kinds of liquidity providing that you can do.
But let’s just reduce it to the example that looks a lot like traditional financial markets, and what would a liquidity provider do there. Well, essentially, what we’re trying to do is we’re trying to narrow the spread between the bid and the ask, so that it’s cheaper for people to transact and switch between assets. The way we get paid for providing that service is by on average capturing that bid-ask spread over time.
Alright, so if we are the best bid in the marketplace, and you want to sell something, and you end up selling it to us, and if we are the best offer in the marketplace, and you want to buy something, you end up buying it from us. And our job is to try to make that spread between the best bid and the best ask as small as possible without losing all our money.
Clay Collins: Let’s talk about bid-ask spreads. A bid-ask spread is the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept to sell it. If the lowest sell order for a given token on an exchange was $10, and the highest buy order was for $5, then the bid-ask spread would be $5. Back to Ben, who’s talking about taking on risk when crossing the bid-ask spread.
Benjamin Roberts: In the process of providing the best bid and the best ask, in some sense, we’re forced to take risk, because we are stating that we’re going to buy at a price, or sell at a price. And we hopefully have better information than the average person about what is a good price. But we don’t have perfect information, and sometimes we’re going to be wrong. So we want to kind of narrow that spread, and get paid for narrowing the spread without taking excessive risk and losing all our money.
Clay Collins: I’ve heard Chris Burniske talk about how he was the first buy-side analyst for cryptocurrencies and crypto assets. And that was the first time in the cryptocurrency space that I heard anyone refer to buy-side and sell-side. What do you think differentiates fundamentally between a buy-side business and a sell-side business? How do you conceptualize and differentiate between those two kind of philosophies in businesses?
Benjamin Roberts: I don’t think you can. I’ll preface this, and say I don’t really, I’ve never worked on Wall Street or Bay Street or in that world. But I will say it’s probably no more relevant to talk about buy and sell-side in this world, then it would be to talk about your publisher or your editor on Twitter. Everything is so fluid that it kind of doesn’t matter. Businesses and entities that are operating in this space will just have an arbitrary construction. They will just find a niche and they’ll operate in it. And I don’t know that it necessarily has to look anything like it looked in the old world of finance, just like Twitter looks nothing like a newspaper.
Clay Collins: That’s a great point. I think often people don’t take this world on its own terms. They’re trying to create these one-to-one analogies, and often breaks down. So I guess, suffice to say, you do not consider or identify as sell-side?
Benjamin Roberts: No, I don’t think so.
Clay Collins: When one thinks of liquidity, is that primarily about inventory for a given token being available for purchase? Or is the liquidity both on the sell-side and the buy-side? Do you think of it from both sides? Or at the end of the day, are you doing your job if someone wants to buy token x, it’s available for sale, and the price is right, and the markets are functioning efficiently?
Benjamin Roberts: Yeah, I mean, if someone wants to buy token x and we don’t have it, we may be able to borrow it in real time and sell it to them, or we may be able to move it from another smart contract and sell it to them. We may end up securitizing in real time a whole bunch of other assets that construct a synthetic version of that asset.
Clay Collins: Time out, pause. I want to acknowledge what Ben just said. In order to sell tokens and generally fill orders, Ben can either sell his own tokens, borrow the token in real time from a lender, perhaps a margin lender on a peer-to-peer market, or securitize in real time a bunch of other assets to create a synthetic version of that asset.
This is pretty advanced stuff given how immature the financial infrastructure that exists for blockchain projects are. And I think that the sophistication of the methods Ben uses to make markets gives us insight into just how much is going on behind the scenes when we place an order on an exchange. I know that I don’t always appreciate everything that’s going on behind the scenes when I place an order. Back to our guest, who’s reflecting on all the methods at his disposal for providing liquidity.
Benjamin Roberts: Again, I think there are just so many options that it’s just hard to think about this in any way as a traditional business. It has the same property as a market maker would in traditional financial markets. It has the same job that it’s doing. But how it does that job, I think can be, again, very, very fluid.
Clay Collins: Michael Lewis wrote a pretty famous and popular book, Flash Boys, where he talks about front running, and high frequency trading, and these types of market making activities, or at least activities that operate under the guise of market making and liquidity providing, but are really rent-seeking activities, and activities that don’t fundamentally add value to the marketplace. They don’t make markets more efficient or reduce friction, they make them less efficient and they add friction. When you think about your business and the range of activities that could be analogous or similar to what you do in the cryptocurrency space, how do you differentiate between value added activities and activities that aren’t necessarily adding value, and in fact, might be detracting value? Or are those types of things even happening in the latter category?
Benjamin Roberts: I think my best guess, and again, nobody knows for sure how this is all going to play out, my best guess is that these markets will be kind of much more fair and much more equal. If you want to just take kind of the exchange and high frequency trading infrastructure as an example, in traditional financial markets, you can pay exchanges, probably hundreds of thousands of dollars a month to co-locate your servers next to theirs. That doesn’t exist in this world, and so there is no opportunity to acquire such an edge as a function of a relationship that would allow the same kind of rent-seeking behavior.
Clay Collins: Hey, let’s talk about rent-seeking. Rent-seeking is really seeking to increase one’s wealth without providing new value. An example of this is taxi licensing. When the taxi lobby persuades the government to limit the number of taxi licenses so that a select few taxi companies can have a monopoly on a city, that’s also an example of rent-seeking behavior. An example of rent-seeking behavior in financial markets occurs when exchanges charge high frequency trading firms large sums of money for faster access to data, so that they can buy stocks and resell them seconds later at a higher price without adding any value to the exchange, and in fact, making the market less efficient. Back to Ben, who hates rent-seeking.
Benjamin Roberts: So I think because they’re so much more open, these markets will just naturally be more fair, and there will be less opportunity for rent-seeking. One of the things I think about a lot around crypto and blockchains that I haven’t heard a lot of people talk about is that I think there should be a natural progression towards people using the networks, and infrastructure, and blockchains, and exchanges that are all the least rent-seeking.
If the goal here is to acquire network effects around any specific platform, I think it should be the case that people will gravitate towards the platform that seeks the least rent. In the case of Bitcoin versus Bitcoin Cash versus Ethereum, maybe it’s the case that Ethereum is the winner because transactions are cheaper. There’s more degrees of freedom in terms of what you can do. There’s more incentives for people to use it because they can kind of map their own needs and worldview onto the platform. I think naturally in this space, people will gravitate towards the things that seek the least rent.
And I think if you’re building a business in this space, you have to be very, very aware of that, and attempt to build a business that seeks very little rent. The opposite of that is that in seeking very little rent, you can acquire a scale that maybe you couldn’t in traditional financial markets because the scale is so much larger. But ultimately, the businesses that get built here that are going to succeed are not going to be rent-seeking, because everything is so open.
This is a long way of answering your question, but just saying that there is so much more openness here that I think there will be less opportunity for rent-seeking, and that the functions that people perform will be maybe much more pure because of that. Because if they do resort to this kind of rent-seeking behavior, the system will just route itself around them.
Clay Collins: I hope you’re right. I think you probably are. In the long-term, at least, that’s how I see it playing out. Do you see projects like Bancor as being competitive with what you’re doing, or not?
Benjamin Roberts: I think they’re probably complementary. I think people have tended so far to overweight the benefit that you can get around liquidity from better infrastructure. Maybe this would be a good time to talk about the distinction between infrastructure and information.
Clay Collins: Let’s take a second to talk about Bancor. Bancor is a decentralized liquidity network that allows you to hold any Ethereum token and convert it to any other Ethereum token in the network with no counterparty at an automatically calculated price. Bancor says they allow smart contracts to be their own market makers. I personally have never used Bancor, and I don’t know anyone who has. And the project, like almost all crypto projects, has its critics. But it was important to mention them in the context of the conversation we’re having. Let’s get back to the discussion of liquidity as information versus infrastructure. It’s an important distinction.
Benjamin Roberts: I really view liquidity as information, right? Bids and offers in the marketplace are expressions of worldviews, in a way. Those expressions are not as firm. Those commitments are not as firm as actually buying a token, or selling a token. Because when you buy something, you really are expressing that worldview. Bids and offers can be faked. To the extent that they’re not fake, and that you’re able to hit a bid or an offer, those bids and offers are expressions about a willingness to take a view of the world, right?
They’re expressions of information. And I don’t think there’s a way to get around that fact. The people that provide liquidity naturally have to take risk. And so when projects come along and say, hey, we have this way of rearchitecting the marketplace, which will produce a lot more liquidity, what they’re doing is providing new ways for people to express that information that may be incrementally more efficient, but you still need those participants that are willing to take risk to provide that liquidity.
And so the business of being a liquidity provider, I think is kind of inseparable from the business of taking risk. And so for Bancor to say, hey, we’re going to provide infrastructure, and this is going to solve the liquidity problem, well, it’s not, because you still need those people who are willing to take risk to post those bids and offers. And yes, there may be a small benefit in them posting those bids and offers in new ways, but ultimately, you still need those people to take that risk. And so the benefit from a risk-seeking entity in terms of the incremental amount of liquidity that you get is much greater than the benefit that you get from improving the infrastructure where that liquidity is provided.
Clay Collins: So from an operational perspective, what is a liquidity provider doing? Are they for example, scanning a bunch of exchanges looking to purchase tokens at a given price because they believe that demand might spike, or because they’re seeing an imbalance between exchanges, and there’s an opportunity to benefit from maybe small and temporary market inefficiencies? At the end of the day, you’re buying and selling, but how do you operationally see the world, and what are you paying attention to and thinking about on a day-to-day basis as you kind of execute your business?
Benjamin Roberts: Yeah, I think our job and the thing we’re paying attention to is really just aggregating information about the world, so that we can express that information in bids and offers, and not lose our money. So aggregating information, and then monitoring risk to make sure that on average we’re kind of in a neutral position. Those are the things, operationally, we want to do.
So, I mean, a very simple example of that would be okay, let’s integrate with some new exchange that just started up because there are a whole bunch of bids and offers that provide information about a price on that exchange that we don’t currently know about, so let’s add that. On the other side, an example of what we would want to do is let’s build a new facility for monitoring our risk in a new way, or looking at correlations between things, so that when we use that information to post those bids and offers, we’re not committing to something that would be a bad idea for us as an organization if some kind of long tail event happened that we would have too much exposure on any one dimension.
Clay Collins: Are you executing trades algorithmically and in an automated way?
Benjamin Roberts: Yeah, it has to be automated to achieve the kind of scale that we want to achieve. Right now, because we’re pretty early in the history of this business, we’re doing this in a very simple way. Over time, that will become much more sophisticated, and over time, it may actually incorporate a prediction of what might happen in the next few seconds, or few minutes, or whatever. But today, we are literally just looking at the state of the world and saying, hey, can we copy the information from over there to over here and act on it without, again, taking undue amounts of risk and losing all our money?
Clay Collins: Do you anticipate having an OTC component to your business at any point?
Benjamin Roberts: You mean, kind of manually accepting bids, or making a market for specific individuals?
Clay Collins: Well, let’s say an institutional investor, or a large family office, or a multi-family office wants to purchase a certain volume of a token, and doesn’t want to risk that the size of their order will move the price, and they’d rather deal with someone they trust, and just call you over the phone, and say, we’d like $10 million, or $20 million of this token. Do you see that in the future, or do you intend to keep it all on exchanges?
Benjamin Roberts: I wouldn’t rule it out. We could use our software to do that. But again, getting back to doing things at scale, and also doing things that aren’t rent-seeking, I would imagine the most efficient thing to do would be for us to just provide the equivalent liquidity on exchanges and allow anyone to transact with us there, right? I mean, in your example, that kind of is a rent-seeking activity to the extent that the counterparty in the trade, we have way, way more information about that transaction than they do, right?
And we are not competing with anyone else for their business at that time. So that is a, again, something that seems more aligned with traditional financial markets where margins are high, and rent-seeking is high, and transaction volumes are low. In this world, I would much rather that we just provide this almost like a protocol, right? Almost like a global service on every exchange and every smart contract in any form of any market that emerges on Ethereum.
We can be there and offer that same service to everyone in an automated fashion versus that kind of one-to-one negotiation that would’ve happened previously. And hopefully, it’s the case that other people go out, and actually build the tools that institutional investor could use to acquire that liquidity across all those exchanges. And we would provide it on the exchanges, and they could access it on the exchanges. It’s much more likely that this world plays out like that than a phone call.
Clay Collins: On many traditional financial exchanges, at least in the United States, the taker is charged a fee, and that fee is then given to the maker, and that incentivizes market making activities. Are exchanges aware of you? Do they actively try and solicit your participation on their exchanges for the benefit of their customers? And if so, what kind of incentives might they provide to a liquidity provider? Maker taker fees offer a transaction rebate to liquidity providers and market makers while charging customers who take that liquidity.
For example, for a given stock market trade, a liquidity provider might receive a one cent per share rebate, and the taker would pay three cents per share to take that liquidity, and the exchange would keep the one cent difference. Okay, back to Ben’s answer.
Benjamin Roberts: Yeah, I think that opens up a whole bunch of very interesting questions. So no, at the moment, exchanges are not really aware of us. I mean, they give us technical support sometimes, but they’re not really aware of us as an at scale customer. Part of the reason is it’s early days, and we’re not at very significant scale. But part of the reason is also that I think, again, the participants in the space at the moment are not super sophisticated, and they don’t even realize to an extent that this is where things are going.
So at the moment, we pay the majority of profit for providing liquidity to the exchange, because the exchange fees are so high, right? The exchange fees make up probably more than 1/2 of the profits on any given trade, and we’re taking on a risk to do that transaction, unlike the exchanges. So on a risk-adjusted basis, I would say we’re somewhere around break even. The reason that we are continuing to pursue this business even though that’s the case now is because I don’t think that is going to continue to be the case.
I think the current form of markets is like you were saying, this real kind of copy paste of the old way of doing things, and that people still fundamentally believe that there’s value in owning the infrastructure. Right now, there kind of is value in owning the infrastructure, because that infrastructure has to be off-chain. Once that infrastructure moves on-chain, it will be cheap enough that there won’t really be any value in owning the infrastructure, because nobody will own it.
Bittrex or Liqui can charge 1/4 of a percent per transaction because they own the infrastructure, but once we move onto, I don’t know, 0x, or EtherDelta, or any of these on-chain exchanges, I think how the fees are going to work is that the only costs to transact will be the settlement costs, which will just be the cost that the miners will charge for mining that transaction.
And I think probably also this maker taker fee rebate scheme should go away as well, because right now, I think the maker pays, on certain exchanges, the maker pays less fees than the taker, but both parties are taking fees. But in a kind of rent-seeking free world, I think how this works is the miner gets paid for settlement, and the taker pays the maker for providing liquidity. And there’s nobody else with their paws on the transaction, right? The bid-ask spread represents the fee that the taker pays to the maker. The taker has to cross the spread. The maker, in theory, is earning the difference between their bid and the midpoint of the spread, right?
And the miner is going to get the fee for the settlement, however that settlement happens later. And there’s nothing else. I think that is just how it’s going to work. This, again, gets back to the reason you want to build a liquidity business, and not an exchange business, right? People have said to us, well, you guys have all these skills. Why don’t you just go build an exchange? ‘Cause these exchanges are making a huge amount of money. And that’s absolutely true today, but if you want to be forward-looking in this space, the value is going to be not in the infrastructure, but in the liquidity, and that’s why we’re building a liquidity business.
Clay Collins: That’s the most impressive articulation of the future of trading on-chain that I’ve heard. That’s incredibly compelling. Have you spoken to anyone else who shares that vision with you? I’ve just never heard a version of the future that’s articulated in that way. It’s obvious that you think about this all day long. Who do you collaborate with? Is there a community of people that do what you do? Do you guys get togEther? What do you talk about? Or are you kind of alone in this right now?
Benjamin Roberts: I think there are people with similar ideas. I think we’re kind of alone in our view of how to do this. I think, again, there’s this real separation right now between the people that get the tech and the people that get the finance. And I think the people that get the finance are doing a lot of that copy pasting of the old world way of doing things onto the blockchain. And the people that get the tech don’t really get how the mechanics of these transactions work.
Hopefully, over time, you’re going to see a lot more collaboration between those two parties, a lot more organizations that get formed that kind of synthesize the skillsets of both those parties. I can imagine that there will eventually be more businesses like ours. Obviously, it would be good if we were the only one and the biggest. But I think just in terms of the value for the ecosystem as a whole, it would be good if there were a lot of people that were kind of inspired to become liquidity providers.
I guess the other piece of our business here which kind of benefits from this is I hope that eventually over time, and I’m talking in, I don’t know, maybe five years, or 10 years, that the bid-ask spreads actually narrow so far that this business would be a tiny, tiny, tiny margin, huge, huge volume business. I think over time, again, if this Ethereum vision is right, if it’s possible to support a world with all these tokens, and the low cost of infrastructure, and the anarchy of infrastructure allows those bid-ask spreads to narrow sufficiently so that everyone can use a different token for a different application, if all of that plays out, then eventually, there’s not that much room anymore for these market making businesses.
But the other side of that is at that point, the Ether commodity, Ether itself, is hugely valuable, because if the spreads have narrowed so far that you can no longer do a market making business, then that means there’s so much activity on the Ethereum network that owning the Ether commodity is fantastically valuable.
At that point, Ether is the greatest commodity in history. It will have been one of the greatest bets of all time. Our view is let’s be market makers, and let’s help those bid-ask spreads narrow and help the ecosystem. But in the long run where we accrue the most value in the business is by actually owning the Ether commodity, which we accumulate as a function of narrowing the spreads.
Clay Collins: Let’s shift gears for a second and talk about Ethereum. So just to recap, you operate 100% with ERC-20 tokens and Ethereum, is that right?
Benjamin Roberts: Yes, that’s correct.
Clay Collins: Is what you do right now operationally, is that possible on any other blockchain at the moment?
Benjamin Roberts: It’s not. It could be possible on the meta-layer, like you could maybe do the same thing if you wanted to be a liquidity provider between all the different blockchain tokens. But then of course, you’re constrained to the centralized exchange world. And again, I think the economics of this business are favorable assuming Ethereum can scale, and that transactions become very cheap, and that lots and lots of tokens that can interoperate emerge on the same platform. So that’s why Ethereum makes sense.
Clay Collins: To me, the most impressive quality of Ethereum is not the stuff about the world computer, and smart contracts, it’s really that it seems to be benefiting from second-order network effects. In other words, it’s not just network effects that exist around Ethereum that are propping up Ethereum, but the network effects around the tokens that are built on top of the Ethereum blockchain. Do you see the world computer vision becoming actualized with Ethereum? Or do you think that Ethereum becomes more of this blockchain of blockchains, or this token of tokens, or this kind of platform for decentralized exchanges, interoperability between ERC tokens? Is that the killer app? And do you think it continues to be?
Benjamin Roberts: I mean, I think it may be kind of a false distinction. I think all of this stuff just emerges naturally if you can build a world computer that is cheap enough to operate. It seems to me that if you do that, then again, this anarchy of financial engineering just works itself out like the, I don’t know if you want to call it the market, or just the opportunity space just eventually settles on a world that probably looks something like this.
You just have to focus on the low-level infrastructure on the protocol, and then all this other stuff will just naturally emerge on top of it. And I don’t know if the way it’s currently playing out with all these tokens and communities around tokens is the way that it settles long-term. There are only a very, very tiny percentage of all the people in the world that are actually even aware of this, let alone using it and engaging with it on a level that we do day-to-day. So I think, at scale it may look completely different than it does today, but all of that stuff can only emerge and work itself out if you have in the first place a world computer with all this power.
Clay Collins: Before we wrap this up, is there a question I haven’t asked, or is there anything that you’d like to discuss that we haven’t covered yet that you think is important to cover?
Benjamin Roberts: Yeah, I think I would just like to reemphasize that as a community, and as people working in this space, the thing that we should be thinking about is building businesses and protocols that are as neutral or non-rent-seeking as possible. And I think if we do that, people will adopt them, and things will get better, and those are going to be the winners. Sometimes, when I think about Bitcoin and the lack of resolution around the Bitcoin block size, the Bitcoin block size at one megabyte seems to me to be an artificial constraint that allows miners to seek additional rent.
Sure, I understand that there are theoretical benefits that emerge when the block size is small, but I think there are greater benefits that emerge when it’s not artificially constrained. And I think the Bitcoin community should think about, I’m talking about BTC community, should think about if they want their platform to be the one that everyone in the world is using, which is the thing that makes the Bitcoin commodity have the most value, they should think about making it as non-rent-seeking as possible.
The reason I like Ethereum is that it is as neutral a platform as possible, both in the sense that it is aiming to get the cost of a transaction, right, and the cost of a transaction is literally the cost of rent on that network, it is aiming to get the cost of the transaction as low as possible, and then also aiming to make the expressiveness of the platform as great as possible, so that people can map their own vision onto it. So I think the reason I’m excited about Ethereum, the thing that we should all be thinking about is how do we make these platforms as neutral as possible, as non-renting as possible, because if we do that, then nothing can compete with them.
I think a thing that people have not spent enough time thinking about, I think, is that as far as I can tell, the value of any one of these commodity tokens is nearly perfectly correlated with its utility. And the utility increases when the rent-seeking decreases. So the job for all of us is to make these platforms as non-rent-seeking as possible to increase the utility, which increases the value. And in increasing the value, you have to make sure that the rent-seeking stays low. This is what happened in the case of Bitcoin. It was when the value was low, the rent-seeking was low, but now the value is high, the rent-seeking is high. So I think we all need to think about how do we create the maximum amount of value while seeking as little rent as possible?
Clay Collins: Amen. Ben, you’ve been really generous. I imagine that there are people who are listening to this who might get into the liquidity business, or decide that this is something interesting to delve into. It strikes me that you might benefit from being more obscure, or having a certain opacity around what you do. Why did you do this? Why did you say yes to this interview?
Benjamin Roberts: I’ve actually thought about that quite a bit. I don’t know that there’s any, other than maybe this kind of myth of people stealing other people’s secrets, that just in terms of talking about one’s business model, if there’s any evidence that that would actually adversely impact the business model. I think it may actually be the opposite, that the more open you are about what you’re doing, the more people know about what you’re doing, and the more people get excited about what you’re doing, and the more people get behind your vision, and then you have more talent and more people that want to work with you.
It may be the case that being more open is actually better than being more closed. So that’s part of the reason. You could say that’s even a selfish reason to do it is people should understand what we’re doing, and maybe they’ll want to come and work with us. The other part is that the philosophy in this space should be one of openness. We’ve seen what happens in the non-crypto world when everything is closed and is a walled garden. And I think just as a philosophy, we should invite openness, and collaboration, and open-source, and all those things kind of go hand in hand. We don’t want to be some secretive hedge fund that is hopping in front of every transaction that happens on Ethereum. We want to add value to the network and to the ecosystem, and get paid for doing that. So I think having people aware that we’re out here, and wanting to work with us and collaborate with us is ultimately a good thing.
Clay Collins: That’s fantastic. I think the benefits of openness versus closure and opacity is the most consistent thing that I’ve heard during this interview. So in that spirit, if someone would like to find out more about what you do, and perhaps get in contact with you, what would be the best way to do that?
Benjamin Roberts: They can email me at email@example.com. They can follow us on Twitter @citizenhex. They can go to our website, citizenhex.com. Feel free to reach out. We’re very committed to building a team of deeply technical people. If this stuff seems exciting to you, even if you don’t get financial markets, but you’re deeply technical and you want to work on these problems with us, we would love to hear from you.
Clay Collins: Ben, thank you.
Benjamin Roberts: Thank you.