The futuristic financial world of flash loans and hypernodes
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 professor) Robert J. Marks about how blockchain would decentralize finance by establishing trust and safety without government regulation. Now they examine how some of the remarkable new financial instruments work.
A partial transcript, notes, and additional resources follow.
Robert J. Marks: Before we start this recording, you mentioned something that blew my mind: flash loans.
Adam Godd: A flash loan is a loan that you take out for a very short period of time, usually a few seconds.
But it can be for very large amounts, like millions of dollars. So if you want to feel like a millionaire for a few seconds, you can go for a flash loan. But the purpose of them, more often than not, is for refereeing.
Robert J. Marks: Well, first of all, explain arbitration.
Adam Godd: Arbitration it’s when you see an opportunity to buy and sell something at a different price in different places. Let’s say you’re on Coinbase and can buy Ethereum for $2,000. But you look at another cryptocurrency exchange such as Kraken and see that there you could sell Ethereum for $2,100. You would immediately want to buy all the cryptocurrency you can from Coinbase and sell it to Kraken. And you would earn one hundred dollars per Ethereum this way.
Robert J. Marks: Because there is this price disparity.
Adam Godd: Yes exactly. And by doing so, you will even out the price difference between the two as they adjust to the market.
Robert J. Marks: Wow. 10 million dollars for 10 seconds. Obviously, you are paying a premium for this. You pay some kind of interest to borrow that $10 million. Is it correct?
Adam Godd: Yes. You would pay a fee and flash loans are often applied through a smart contract. You would put these transactions into the smart contract, so the lender could be confident that they were going to collect the money in 10 seconds. You’re not just going to run away with it.
Then, the money that is returned to you with your profits is entirely defined in the code that the blockchain executes and, in this way, it is trustless. And so you can trust yourself.
Robert J. Marks: Now, to make that $10 million loan, do you need collateral?
Adam Godd: With flash loans – since they are applied through the smart contract – there is no need for collateral. It is the risk for you and the lender that everything goes well. And you both know that neither of you can run away because you can both trust the smart contract code.
Robert J. Marks: OK. Thinking about it though, if you want to 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 commission that you paid the $10 million. So you’re risking that in a way, aren’t you?
Adam Godd: Yes. The lender would risk that too. They might risk the value of this one dropping below $10 million within 10 seconds you got it. So yes, there is a risk for both parties that it may not work.
Robert J. Marks: I’ve heard that most computer trades are arbitrages. And in fact, some commercial institutions want to get a faster cable so they can arbitrate faster than someone else. Have you ever heard of this scenario, of these trading houses wanting to arbitrage by beating the other person with the speed of their computers?
Adam Godd: Oh yes, definitely. Cryptocurrency is a constant 24/7 market where milliseconds matter. When you find these arbitrage opportunities – because there are so many people looking for them – it is very rare to find a really great one.
You might only find a 1% difference between the prices. And if you know that the price is higher than the fees you’re going to have to pay to make those transactions, then of course you want to do arbitrage. But as you said, at the same time, dozens of other people will find that same opportunity, because their computers were also looking for it.
So who comes first? This is actually something I worked on with an NFT project I work for. We created — we call it — the Hypernode.
We took very fast computer servers and placed Ethereum nodes on them. I have modified these nodes so that only selected individuals can use them, in this case, project NFT holders.
To note: A node in the use of cryptocurrency is “a computer connected to a cryptocurrency network and can perform certain functions such as creating, receiving or sending information” – Gadget 360 (August 21, 2021)
Robert J. Marks: Let’s back up a bit and define some of these things. What is a hypernode?
Adam Godd: This is the name we gave to the very fast Ethereum nodes that we allow holders to access. And we limit access in order to encourage people to participate in the project, but also to ensure that our node will remain fast.
There are many public nodes on the Ethereum network and if you download any type of application to transact with Ethereum, it will have some sort of default node that it will apply to you. But by restricting who can use our node and making sure we have very fast hardware to support it and an internet connection, we can provide our users with a faster connection to the blockchain than anyone using just a public node.
Robert J. Marks: I see. And is that enough to beat some of these different trading houses? I’ve heard, for example, that there have been trading houses that have moved geographically closer to the New York Stock Exchange and laid down fibers in order to get faster responses. It seems to be very hard to beat.
Adam Godd: Since the New York Stock Exchange is a centralized system, you need to be close to it to get these speeds. With Ethereum and other decentralized cryptocurrencies, you can place a node anywhere and get fast network access.
Robert J. Marks: So your business is for decentralized finance. So you don’t have to go to places like the Chicago Mercantile or the New York Stock Exchange, do you?
Adam Godd: Exactly. There is no central Ethereum market in a physical location where you need to be near. 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 far are you from the market? Are you already ready? Do you sell these services?
Adam Godd: We have been online for several months now.
Robert J. Marks: With the condition that The mind matters is not paid at all for this mention, tell me how someone can find out more about your business.
Adam Godd: The name of the project is Just Cubes and you can find out more here.
Robert J. Marks: OK. Well, I hope you will become a very rich person because of this.
One last thing I would like to ask you is something called stable coins, that you will 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 do not exhibit this volatility. What is happening here?
Adam Godd: As you said, the crypto market can be incredibly volatile. Recently, the Ethereum market fell 10% in one day. He’s also had wild swings in the past. But yes, stablecoins, there are a handful of them. USD coin, representing US dollar coin, DAO, Tether. There are several of them. They have something supporting them. They are pegged to a currency like the US Dollar, there are Pounds, Euros and other similar currencies around the world.
The one I know best with the USD coin. They actually take a dollar bill and put it in a bank vault for each of the coins they issue. You can go up to them and say, “Here are five US dollar coins, give me $5,” and they can do it for you. So, since there is something that ties this currency to the US dollar, it will always have a value of $1. Now there is a slight fluctuation around that, just depending on momentary demand. But it’s usually in the tens of thousands or hundreds of thousands of pennies [in terms] how much does it change.
Robert J. Marks: Now clearly, to back this coin to USD, it’s going to cost a lot of money. Anyone facing the big bucks must have a reason for doing so. They must be paid. So how does it work ?
Adam Godd: Many investors have gotten involved in different Web3 and cryptocurrency projects over the past few years. They would be paid the same as people who are paid for mining and such. They would take a percentage of the fees provided to transact on the network.
Robert J. Marks: So every time you trade a coin to USD you get charged a bit, almost like charging something on Visa – the merchant you charge it to has to eat a bit of the purchase price because it goes to Visa or MasterCard, or something like that. Is this a good analogy?
Adam Godd: Yes. But in the case of cryptocurrencies, it is the one initiate the transaction that needs to fund the cost of the fee.
Robert J. Marks: Very interesting. I think this decentralized finance is going to be a big deal. I was talking to a bank employee who said banks really hate decentralized finance in general. Do you think the banks will maybe try to crush this decentralized bank or do you think they will opt for physical stores, some of which have just gone bankrupt?
Adam Godd: Well, as you said in one of our last episodes, “I always hate making predictions, especially about the future.” But I’m sure there are aspects of this that the banks don’t like. It allows people to borrow money, to make loans, to invest without having to go through the centralized systems, and therefore they don’t get a reduction. Who will win in the end? I do not know. But I think it will last for a while.
Here is the first part of this episode: what would a financial system based on the blockchain look like? Adam Goad talks about the main differences between banks and blockchains in what creates trust and privacy. Hackers don’t steal cryptocurrency by breaking encryption, but by getting users to reveal information that makes them vulnerable.
To note: If you want to read or listen to the first three episodes, you’ll find links to all parts at the bottom of this page.
Download the podcast transcript