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- [00:00]
A
I would say so. Like right now we are probably in like a peak sort of danger zone, but I feel like we're going to move actually to a better place ultimately because AI, although it can be used on the offensive, it can also be used on the defensive.
- [00:14]
B
Hi everyone. Welcome to Unchained, your no hype resource for all things crypto. I'm your host, Laura Shin. Before we dive into today's interview, we'll take a quick word from the sponsors who make the show possible. This episode is brought to you by 1 inch Aqua, the shared liquidity layer. From 1 inch back, multiple liquidity positions with one wallet balance and keep your tokens in your wallet until a swap fills. See how it works@1inch.com aqua. Today's guest is Sam McPherson, co founder and CEO of Spark. Welcome Sam.
- [00:48]
A
Yeah, thanks for having me.
- [00:50]
B
Heads up everyone. I'm on vacation. So by the time you hear this interview, it will be a few weeks after this interview was actually recorded in mid July. And just in case something major blows up in Defi between now and then and you're wondering why Sam and I don't discuss it. So Sam, sky is the oldest Stablecoin. It's the true OG and it started as Makerdao and your Defi protocol, Spark is built on top of it. Tell us what Spark does and explain its relationship to the sky protocol.
- [01:21]
A
Yeah, sure. So sky, formerly Makerdao was originally launched in 2019 with the Dai stablecoin and there was sort of two restructurings that happened around the 2022 period. First was the rebrand from Maker to Sky and then the Stablecoin was became from DAI to usds. And then the second piece was a restructuring of the governance so that the first iteration of the daos were not really working that well at scale managing large amounts of money. So it was decided to restructure into this subdao model. So now the way things sit is that sky functions more like a central bank and wholesale liquidity issuer. So the subdao Spark being one of these is functions more as a commercial bank that is able to draw on the liquidity reserves of sky and then deploy it into commercial lending activities. And so primarily this is a mix between real world assets to get the base yield usually from treasury bills and then crypto over collateralized lending primarily like Bitcoin and Eth backed loans.
- [02:35]
B
Okay, and so what are the main products that Spark has?
- [02:42]
A
Spark started out with an internal lending market. So this is on chain money market similar to like you know, compound aave These types of things and this is like the crypto backed loans section of the balance sheet. It is focused on lending against Bitcoin eth and these types of loans have been around. It is similar to the CDP model that maker originally had. Since then Spark has expanded to cover a lot of different verticals. So we have launched what is called Spark Savings which is a vault product that will allocate, it's on sits on top of USDC and USDT and this provides a yield on top of these stable coins. And so what Spark functions as is a allocator across the space. So you, you as a depositor into Spark Savings. Spark will allocate the capital on your behalf and allocate the opportunities between Defi, CEFI and Tradfi with, with RWAS to optimize the risk adjusted yield into that product. So currently we're offering 3.6% on USDC and the USDT rate is 3 point or sorry 2.75%. So other products like we've recently also expanded into institutional lending. We do custodial Bitcoin back lending through Anchorage. So this is institutions who want to get financing against their Bitcoin on their balance sheet usually. And so they will, they will borrow from us. And this is, this is facilitated by Anchorage, the qualified custodian. And another thing that we've recently got into is Spark prime. This is a CD5 prime brokerage. We're still in the preliminary phase of scaling this up but the, the idea here is that we do lending and hedge funds primarily are able to margin their positions across DEFI as well as CI. And now actually there is support for Tradfi venues which is very interesting especially with the uptick in more like traditional stocks becoming the big hype cycle right now. So this can provide hedge funds with coverage in Tradfi venues connecting it to modern defi venues like Hyper Liquid to provide liquidity.
- [05:05]
B
Okay, so you kind of were getting a lot of buzz in the wake of the Kelp Dao hack. You know basically when you look at the TVL of Spark Fi on Defi Llama, it's very clear that you know some something happened around mid April and basically you know, Spark ended up kind of being a big beneficiary of that hack. The TVL in eth is up about 50% from that time today and even in early July it was up about 80% from that point. And you know, this is a moment where Spark kind of, I would say differentiated itself from the rest of Defi because obviously the rest of Defi took a big hit. So why do you think Spark was an exception?
- [05:56]
A
Yeah, so first I'll say these types of events are unfortunate for the space as a whole. And so like we're not like wanting these events to happen even though it is relatively speaking good for Spark. But yeah, so what, what we tend to do is we take a much more conservative position compared to the wider market. So we did not engage with looping in the same sort of way that some of the other markets were doing. Additionally, we've had rate limits on all of our markets since shortly after we launched in 2023. Sparkland has. So one of the big deterrents for these types of hacks is that basically when I believe the actor is assumed to be North Korea, they're looking for ways to exit into decentralized assets, usually ether Bitcoin. And so they will take a route that is easiest to get through. So you kind of need the asset issuer to make a mistake with you know the way the layer 0 configuration was with, with Kelp Dao you and then you needed a venue to get to, to eat. And so AAVE was the main venue for this. So Sparkland has fairly tight rate limits. So this like even if there was some sort of incident with one of the assets that are on the, that are available as collateral, there's just not that much capital that can be extracted through Sparklen because as a regular user the most are okay with just waiting a bit and like you know, take some time to take out a loan if it's legitimate activity, the ones who need to go through right away, usually there's something wrong there. So we, we design the market from the ground up to have these sort of safety controls. Other features that we have, we run a triple redundant Oracle. So even if one of the major providers, so we run it between Chainlink, Redstone and Chronicle and so if one of the Oracle providers prints a bad price we actually have liveness even through this type of event. So yeah, these are just a number of features that we've been like, we're just very risk averse in this space and so we've been taking this line and sometimes it's been a little bit, you know, to the, to the deficit of like business growth and revenue opportunities. But this is a new space and I think we're entering, it's a little bit more of a dangerous time with all the AI stuff going on. But they, we know how to do best practices and so we just will continue to follow best practices and I'M I'm quite confident we will get through this. But the other, the other good note is that I, I see a lot of change in the space as a whole, like a sort of a maturing of taking security seriously. These things are all preventable with just even basic security best practices. So I'm optimistic. This, this is a tough, tough period and I'm actually glad they were able to recapitalize the market there as well. So I think it's a lesson and I feel like the space is going to get, just get better.
- [09:01]
B
And why have you made this conservative approach part of Spark's DNA?
- [09:07]
A
Yeah, we just have taken this tack throughout, like, since like Maker launched back in 2019, we have never really been chasing the newest thing. You know, there was stuff in 2021 that was going through the hype cycle. We largely avoided it. And so this, this practice it during bull markets. There's, you know, the new flavor of, of the year and things, you know, are perceived to be overtaking us. But we found that just compounding these con, like, just take the conservative view and compound the growth slowly over time has been the winning strategy. So this is why sky as a whole is over 10 billion in stablecoin deposits and is, is the market leader by far in terms of stablecoin deposits in the space.
- [09:57]
B
And what were you doing before you launched Spark and, and got involved in Maker?
- [10:03]
A
Yeah, so I was, I'm a software engineer by trade, so I had previous companies worked in a completely different space. I was working in video games before this, but yeah, then I worked in Maker.
- [10:14]
B
Oh, okay. Okay. I didn't know if you were going to say, like, you worked in Tradfi and, you know.
- [10:21]
A
No, just been picking it up.
- [10:23]
B
Okay. Okay. I don't know if you saw. Haseeb Qureshi of Dragonfly tweeted that it's a red flag if, like, a founder doesn't get good at video games or something.
- [10:33]
A
Yeah, yeah, I guess I pass.
- [10:37]
B
Well, so, you know, the reason that you were able to kind of make it through the Kelp DAO incident unscathed was because before that exploit, Spark exited RSE, which was the asset on, on KelpDAO that got manipulated. And the way that happened was that Phoenix Labs, your company, which is kind of like the main centralized entity that, you know, manages Spark, SparkFi, made a proposal to exit RS ETH, but that then had to be passed through on chain governance. So I have two questions about this. First of all, I'd love to hear kind of like what Metrics or protocols or processes Phoenix Labs uses to identify these types of risks in defi.
- [11:28]
A
Yeah, so rse, you're correct, it was off boarded in January of this year as part of a general risk reduction strategy. There tends to be during bull markets, some assets will be onboarded, some prove to be successful revenue generators and. But there's always a trade off between your risk surface and the opportunity that onboarding an asset can bring. So even with the RS ETH onboarding, even if we didn't off board it at the time, we never onboarded it into what is called efficiency mode in the market, which is this high, high leverage. With the ETH looping, it was only onboarded to borrow Stablecoins. So the LTVs are much more in like the 60, 70% range. So even if we didn't off board it from the market, it's quite likely that there would be either no or sort of minimal losses that were easily recoverable from in the Sparkland market. But yeah, sort of what do, what is the decision process for offboarding? We look at all the assets in the market continually and watching liquidity, how much people are using them and there's just sort of an ongoing calculus. You know, if something's not being used that much, we don't want this, this kale risk present in the market. So we will off board it. And to be fair, the other lending markets do this as well. Sort of just sort of a waxing and waning of the bull bear cycle is pretty natural. But I think the key point is that even when these assets are onboarded, these sort of newer, more untested assets, we keep them in very conservative risk policies until we see sort of like some actual organic adoption, demand growth and sort of transitions to be this staple. So Sparkland is, is intentionally keeping a very minimalistic set of collateral since there was a bit more before. But now we are down to just about, I believe, like five assets. There's cbbtc, WBTC eth, LIDO stake eth and then Etherfi eth. These are the prime, these are the collateral that are accepted in Sparkline. And this covers most of the organic usage in the market. So we're, we're okay with that.
- [13:47]
B
Okay, so in a moment we'll talk a little bit more about the Kelp DAO incident. But first we'll take a quick word from the sponsors who make this show possible. $540 million. That's how much concentrated liquidity sat idle in a given week in the first half of this year, about 30% of the DeFi TVL. If you're wondering, that's according to Dune research, commissioned by One Inch. But there's a solution. One Inch Aqua is the new shared liquidity platform. It lets LPs back multiple positions with the same token balance and keep their tokens in their wallet till a swap comes. Why does that help? Because the LPs don't have to split their tokens across positions. They can cover more market conditions and pairs with their full balance. That means more activity across deeper liquidity. See how it works@1inch.com aqua. Remember that providing liquidity carries risk and fees aren't guaranteed. Back to my conversation with Sam. So my second question about Spark exiting RSE just in time to avoid being hit by the Kelto attack is about that decision making process. Because essentially Phoenix Labs identified this risk, but in order to act on it, you had to propose it to the dao, you had to get it approved. That's pretty kind of like slow and cumbersome. So I was curious like how well that works.
- [15:11]
A
Yeah, so maybe you're referring to sort of like if there's some sort of emergency, is this process able to like react in time? Is that, is that what you're getting?
- [15:19]
B
Yeah. Like I was wondering when there's something more time sensitive or some kind of imminent threat, you know, how, how does governance work in that situation?
- [15:28]
A
For sure. So there are definitely emergency processes. We did not perceive any emergency with the regularly scheduled off boarding process process. So the governance process takes on on the order of about a month. It has to go through several stages including a risk council which sort of checks that Phoenix Labs as the proposer is doing things that make sense. So we have three teams sitting there that are doing reviews on, on sort of what's being proposed and then we'll make sure it's all okay. Then it will go out to SPK voters who, who vote on it on a snapshot poll and then it will be sent to sky and sky is basically there to put a final check on it. That is not, there's not something odd going on. It's like as long as Spark is sort of following the rules that sky sets out for doing lending, it will, it will pass it provided it adheres to the risk framework. So in the emergency situations obviously this is way too slow. So what we do have emergency multi sigs that can pause the protocol and just to see what's going on if there is some sort of emergency situation. And yeah there will be like if there needs to be some Sort of like emergency change done to the protocol. Everything is behind time locks, so there is like certain minimum constraints and this is for safety. Having assets under custody with no time lock is actually quite dangerous and makes you a target for North Korea as we can see with like the Drift hack for example. So having a time lock on the assets in the sky protocol as a whole is incredibly important. But if, if we really need to move quickly, there is expedited emergency processes that can be done on the order of a day or two to do these sort of administrative changes. But first and foremost the, the multi sigs provide this protection. They're not custody in the assets, but they're like a pause and let's, let's take a beat and see what's going on sort of protection. And this is pretty standard across defi.
- [17:36]
B
Okay, yeah, I'll ask you a little bit more about that governance bit in a while, but I do also now want to ask about another question that came up quite a bit during that whole period because it wasn't just the Caldao attack, but obviously there was Drift and then there was this whole slew of other ones that seemed to pop up because of AI becoming just so much more capable. You know, we saw that a lot of people began debating what the fair yield was to offer people in defi for the risk of putting their assets on chain. And I wonder how you think about that question.
- [18:15]
A
Yeah, I think it's a fair question. I'm more in the camp. I would say that, you know, whatever the market rate is, is, is, is what it is and people are willing to accept this risk. I, I do think it's important that we make the risk clear to the depositors and this is something we've, we've been striving for at Spark is having defi ratings because I think this has been a big missing piece is that people, they'll often look at like, you know, what is the highest apy and not really understand deeply what sort of the risks that are involved with these with structures. So first and foremost we, we, we want the user to be aware of like what, what they're getting into when they deposit now. I mean why is, why is the yield sort of around sofr? And I guess it's being argued that it, you know, should be much, much higher because this is the new space. There's lots of risk. You know, that might be true but like also there is just an excess of stablecoin liquidity searching for yield and in the space. So this just naturally Leads to more compressed rates. And so for us, sky has around 10 billion on its balance sheet and about 40% is deployed or so into various forms of lending. A lot of it sits as idle liquidity and so the rate will naturally converge to around sulfur. But yeah, I think as, as more and more like stablecoin use cases come on chain, I think having this like highly liquid base yield is, is, is, is a good thing. People want sort of the, the treasury yield at, at all times on their cash. And so this product we're aiming for Spark to be sort of like the conservative version of this where you can just park your cash and not have to worry about it. We are in very conservative strategies. As I said, most of it is cash T bills and crypto backed lending which has been quite solid over the years. There's been no major loss event against like ether bitcoin collateral. And so yeah, we, we think it's a, a fairly safe product and like, but we want everybody to be aware of the risk because it's ultimately the individual's judgment call.
- [20:37]
B
Yeah, I mean it's very difficult to make that judgment call when things are shifting so much, you know. So speaking about how things really have changed dramatically for DEFI recently, this whole wave of new hacks that are happening because of the AI threat is obviously causing first of all a lot of people to pull their assets out of DeFi. But it's also resulting in calls in the industry for DEFI daos for founders to think more critically about how to protect their systems. How do you think about that and how do you think the industry should be approaching that threat?
- [21:14]
A
Yeah, I would say so. Like right now we are probably in like a peak sort of danger zone. But I, I feel like we're going to move actually to a better place ultimately because AI, although it can be used on the offensive, it can also be used on the defensive. And formal verification is really where we're going with all of this. Smart contracts in particular actually have a, are quite safe just because of the simplicity of the code. If you look at the major hacks, these are all OPSEC hacks and opsec like again we know how to do this correctly. You just have to follow best practices and you can, you can like, you don't have to worry about. The AI is not like a magical thing that can just do anything. It does follow the rules of physics and so we do know how to deal with it. Yeah. Where I'm optimistic that we're going though. So already smart contracts are quite robust we are using internally at Phoenix Labs AI for. We still have human auditors, but, like, we are complementing that with the addition of AI, it is starting to become good enough that is actually catching up to some of the best human auditors that are available. And yeah, again, including formal verification, this is where you have the highest confidence that the code is indestructible. So this is just going to make the industry a lot more robust. So I think what people are seeing is there's hacks in all this software that's been around for the longest time, but these code bases are like millions of lines, so it's more just about the surface area. Of course there's going to be someone that made a mistake in these large code bases. And this is where we're seeing a lot of the hacks. It's not so much in the smart contracts, where most modern smart contracts are intentionally kept as minimal as possible. Human reviewers can have high confidence after auditing themselves like that this thing is safe. And now we're going to get this extra piece that just, I think, cements smart contracts as one of the safest ways to custody assets.
- [23:21]
B
Okay, well, I want to circle back to what I asked earlier about when you had to propose that, you know, RS eth be exited and then had to wait for the full governance process. You are probably very well aware that we're at this moment in time where daos are either disbanding or they're being paused or they're, you know, basically just becoming more centralized in various ways, or there's wars over attempts to, you know, centralize at least certain aspects of their function. So I wondered how you think about that. Because you operate a centralized entity that is, you know, managing these decentralized protocols. You have to deal with this decentralized governance. Are there any thoughts about changing it in either direction, or do you have thoughts on just the trends that we're seeing where some daos are just becoming more centralized?
- [24:20]
A
Yeah. So there's a few things on the token versus equity. I believe there needs to be one instrument that value accrues to. So for us, that is the SPK token. And then the broader sky ecosystem has. Has a fairly good track record of keeping everything under sky as much as possible. There are realities of, you know, interfacing between, like, legal and smart contracts that just aren't there yet. So you have to make do. But to the best of our ability, we do put all of the value into the. Into the token side. So Phoenix Labs exists as just a operating company that we are not raising money under Phoenix Labs or anything like that. And so that I think I'm very clear on that. I guess the next part of your question sort of where the dao structure, I guess so we, we kind of went through this like dao issue like back in 2122 with Maker was actually like one of the first daos that was like operating a large scale protocol and really tried to do the dao thing for real like the maker token voting and then you had, there was teams that were operating within, within it. But just this, we do quickly realize this like flat structure just doesn't work. So what, what happens and it's not much different than any sort of like governance with humans is you get political factions forming and sort of informal alliances structures and so you really kind of need a more natural way place for that to sit. And so this is why the subdao model was conceived is that the core dao no longer has to make decisions about what to do. It will just set the rules and the risk policy that the subdaos have to follow and then the subdaos can, can splinter off into these, into political factions even that then compete in the free market to deliver the most value to the core dao. So we're still in the process of, of scaling this up. Will it work? It's not proven yet, but I having worked in both structures before, the subdao model is just a much more natural fit for sort of getting the advantages of like more things that look like a little bit more centralized and can move quicker with the emergent decentralization of the structure as a whole.
- [26:53]
B
Super interesting. Okay, let's also now talk about stablecoins because we're just in this moment where clearly stablecoins are probably going to be the next big onboarding tool in crypto. Less sexy than ICOs or DeFi Summer or NFTs or even DATs, but they're still going to be probably I would imagine the biggest onboarding tool ultimately for crypto. Now along with all this new stablecoin activity, we're seeing like the flourishing of neobanks and there's just so many players that are competing to offer yield on stablecoins. Robinhood Chain is now offering 7% in its earned product with USDG. How do you think about competing in that environment?
- [27:41]
A
Yeah, so Spark was selected as one of the three asset issuers to back that 7% vault. So our product we have there, which is Spark Savings, USDG provides a yield that can is cross chain yield that can be used on a new chain like Robinhood. So what we're seeing in the market right now is this playbook that Coinbase started where it's you have the exchange or even more generally you have the distribution channel, you connect it to a chain on the back end it being copied. So we see this with Robin Hood now, but we also see with Stripe and Tempo. So we're seeing a repeated pattern where you have distribution, you have the chain and you have your own stablecoin and each of them is pushing their own stablecoin you see with the announcement of like O even for Coinbase for example. So everybody wants to own the own the net interest margin that comes from having users using their stablecoin within the DeFi ecosystem. So where Spark comes in, this is one of our biggest growth areas is that we because of our position as a fundamentally on chain protocol that has 10 billion in deposits we're holding between us and Hyper Liquid. Sky is one of the largest holders of USDC on chain. So we are able to pair with these newer stablecoins such as usdg. We can provide a yield but we can also provide market making to the, to the issuer to basically kick them right up to scale very quickly so that people who are in USDG and they need to go to USDC for whatever reason, they don't have to like and this is for large scale, they don't have to go through the banking system which is slow, they don't have to pay redemption fees, they can go on chain. And this is a new product that we launched recently with Uniswap called the stablecoin FX layer. And this is a. I think this is just a very cool use case for Defy where you really have all the Legos kind of coming together and providing a fundamentally superior product than what is traditionally done with, with market makers and liquidity because of, because sky as a whole is holding all these stable coins as idle inventory anyways it can, it doesn't have. There is not a cost of capital basically to be doing this sort of market making with all these upstart stablecoins. And it really helps improve sort of what you call like the singleness of money where in the traditional banking system the Fed backs all the US dollar deposits into banks and so bank deposits are largely interchangeable. This doesn't exist in, in Defi. And really kind of you see sky with usds is emerging as this. This sort of connecting this into the singleness of money of USD stablecoins and Spark providing all the infrastructure and technology to do the automated allocation market making within the sky ecosystem.
- [30:46]
B
All right, so let's now turn to the SPK token, which is Spark's token, which is used for both governance and staking. Despite the fact that Spark is doing quite well now, you know, after these last few months and especially having, you know, made it through that really existential moment for nearly all of DeFi with flying colors, it's at or near its all time low. And I was wondering how you think about how to bring more value to the SPK token.
- [31:20]
A
Yeah, I can give my view more broadly on how I view the way tokens are going in this space. So I see largely consolidation. I think there are a few like sort of store of value exceptions and you know, the individual can decide where this is cut off, Bitcoin, E Soul, et cetera. But the rest of the tokens I think are just going to converge on like a DCF valuation. And so at least like the ones that are structured more like equity. But so what we can, what we have with Spark is that the protocol is revenue, it is profitable. Post all of our numbers on data Spark Fi and we have quarterly financial reports that go out. So people are free to look at this and sort of, you know, underwrite the token as best as they want. But yeah, and, and I guess the last piece is, is the value accrual. So excess profits will go to buybacks in, in the token, as this was voted through governance. So all of these things connected together basically mean that because there is a fundamentally strong business here, I'm not too worried about pricing in the short term.
- [32:35]
B
Okay. All right, well, is there anything else coming up for Spark that you would want to talk about?
- [32:43]
A
Yeah, I mean, just, there's been a lot of growth in the protocol. So the institutional lending, we've seen a lot of traction. We launched this at the end of last year. We are up to 250 million in loans issued there. And we're on track. We have a robust pipeline that is on track to grow to I think a billion and beyond by the end of the year. So yeah, this is the new revenue stream, our Spark Savings usdt. This is a new product that we've introduced again at the end of last year already one of the most liquid USDT products on the market. And I expect this to become market leader in the near future. So yeah, I think like nothing in particular, just we're getting a lot of growth overall on all the products.
- [33:32]
B
Yeah, okay, perfect. Well, thank you so much for coming
- [33:36]
A
on Unchained Yeah, thanks for having me.
- [33:39]
B
And thanks to everyone for joining this live stream. We'll catch you next week. Bye now. Nothing new here on Unchained is investment advice. This show is for informational and entertainment purposes only, and my guest and I may hold assets discussed on the show. For more disclosures, visit Unchained Crypto.com. It.