[Action Required] State of the Peg

MakerDAO Community,

DAI continues to trade in a perilous, dislocated state at $1.02-1.03. We believe this is an existential threat to MakerDAO’s long term success. Given the state of the peg, we believe emergency action is required and would like to gauge the community for feedback.

The MIPs process may take 1-2 months to onboard new collateral. Lack of action today is an implicit resignation to another 1-2 months of DAI dislocation, which is catastrophic to the broader Maker community of MKR holders, DAI holders, keepers, market makers, dApp developer teams, and broader DeFi ecosystem.

Key Points to Consider:

Lack of Monetary Policy Levers: MKR holders have continued to express a dovish stance on rates over the past few weeks with ETH stability fees falling from 8% to 0.5% and USDC stability fees falling to 12%. We believe MKR holders have no more effective monetary policy levers to increase DAI supply given where rates stand. We see a reduction in the USDC stability fee as having a marginal impact, given market participants can already post USDC and borrow DAI at 0.55% on Compound.

Eroding Confidence in the Peg: DAI has continued to trade 200-300 bps above the peg over the past month.

  • We believe this lack of stability and liquidity is translating into uncertainty around using DAI as a decentralized stablecoin in many DeFi protocols. Anecdotally, we have heard a handful of DeFi teams express frustration over DAI’s lack of liquidity/stability, with some opting to use USDC instead. We see this as damaging to DAI’s network effects in the long run.
  • On the community side, we have seen community members continue to express concerns across the forum, Reddit, and RocketChat.

Lack of DAI Liquidity: DAI remains very thinly traded across both centralized and decentralized exchanges. DAI’s illiquid profile has continued to place additional strain on the peg as even small amounts of buy/sell activity have disrupted the market. Just 10 days ago, we saw CDP 3931 purchase ~5MM DAI, pushing DAI prices to over $1.04. The fact that a top 10 CDP holder was willing to pay 4% above the peg to exit the system is a negative signal. We expect to see additional pressure on DAI markets unless decisive action is taken to improve the liquidity and stability of DAI. As shown on Black Thursday, a lack of DAI liquidity can have damaging effects on MakerDAO and the broader DeFi ecosystem. For example, users may be unable to source DAI to keep their vaults adequately collateralized in the event of violent price movements. Keepers may be unable to acquire DAI to bid on undercollateralized vaults, thus increasing the likelihood of disorderly collateral liquidations or losses, among other negative ramifications.

Market Makers’ (MMs) Activity: With the introduction of USDC as collateral, we saw an initial uptick in the use of USDC to generate DAI with utilization climbing above 30%. However, this utilization has fallen to ~4%. This may indicate MM’s decreased appetite to open a vault, incur friction costs/slippage from selling DAI into the market, and a growing uncertainty around DAI prices reverting to the peg in a reasonable time period. MMs may also be low on inventory to post additional USDC and mint DAI. We are seeing a negative flywheel effect take place where a lack of confidence in DAI prices begets further illiquidity.

Potential Solutions:

  • Expedited Collateral Onboarding: We believe onboarding new collateral is an effective way to increase DAI supply and help bring stability to the DAI markets. We have been following the MIP ratification process and believe the MIP process will be effective over multiple governance cycles. However, given the current state of the peg, we believe new collateral should be onboarded in an expedited manner, considering the current timeline may take 4-6 weeks at least. This should stimulate new demand for vaults and stability for DAI markets.

    • While we have no vested interest in a particular collateral type, we have seen Uniswap LP tokens, LINK, PAX Gold, and others suggested in the community recently.
    • Given its marketcap, liquidity profile, and appetite for speculation, we see value in onboarding LINK into MCD. For context, lending protocol Aave has seen close to $20MM in LINK supplied as collateral since launching in mid-January. LINK is valued at over $1 billion and is also one of the most liquid ERC-20 tokens available. The tokens are relatively decentralized with no known “kill-switch” or blacklisting capabilities.
    • To protect MKR holders, the risk parameters can be set very conservatively: low debt ceiling, relatively high stability fees and liquidation ratio. We believe this should drive additional demand for opening up vaults and increase DAI liquidity.
  • Monetary Policy Changes: Governance has the capacity to lower the ETH SF to 0% and lower the USDC SF to 0%; however, we believe these changes alone may not be effective enough to drive additional DAI generation and should be done in tandem with onboarding new collateral.

    • Include a new ETH-DAI vault. This vault would have a lower liquidation ratio (125%/133%) which may drive new demand from Compound/dydx and initiate the generation of a few million DAI. A conservative debt ceiling could also be implemented.

Next steps:

We would like to hear the community’s feedback on the proposed solutions. Note that these are some general possibilities, and we suggest that they should be specified more fully by the Interim Risk Team before implementation. Please signal your thoughts below.

Does the state of the peg constitute an emergency response within the next week?

  • Yes
  • No
  • Other

0 voters

9 Likes

0% SF on ETH collateral would surely do the job. Less keen seeing USDC SF fall any further and backing more of the DAI supply with a centralized coin.

4 Likes

I’ve posted this a few times but I think that adding the ETH-DAI UNI-V1 token may be able to help a lot on this front.

This token attacks the issue at hand on two fronts:

  • Provides liquidity to the market
  • Allows for DAI inflation by partially backing new dai with old collateral.

On the topic of LINK i would personally be quite supportive of that token as well. There is enough liquidity there (currently around $1B in market cap) that we could see some impact. Maybe we should formally write up MIP6 for LINK?

5 Likes

Supportive of the ETH-DAI pool token, much less supportive of onboarding LINK.

Liquidity isn’t the only issue, Maker should be looking to onboard uncorrelated or less correlated collateral. As far as I know, LINK has been pretty correlated to major crypto market moves.

USDC, Paxos Gold and the ETH-DAI pool token seem to be less correlated.

Also I believe we’ve yet to see the long term impacts of the lowered SF and DSR.

4 Likes

I agree that it is an emergency, but I don’t think it is dire enough to push aside all the other good things that people are working on. I think everybody wants more collateral ASAP, but having a MIPs process and risk management framework is urgent too! Everything is urgent.

6 Likes

I think it would make sense to set all SFs to 0 (temporarily) and onboard as many new collateral types that the community has shown interest in, and that the domain teams state can be easily onboarded (so only erc-20’s). Taking such decisive action would hopefully have the effect of overshooting, taking the dai price below 1 USD, and from there the peg can then be stabilized from below, by increasing the DSR and the stability fees.

This way we don’t just get the peg back on track, we also get the DSR back which I think is also crucial for restoring confidence in the system and bringing DeFi back to normal.

Then when the MIPs process begins, the domain teams can use MIP12 to adjust the collateral that has already been onboarded and make sure they still go through the full process for setting the risk parameters they will have for the long run.

Everyone should list their favorite ERC20 collateral types that they’ve been wanting to see added - even if they have relatively small market caps, as long as they are pure ERC20 and aren’t scams it’s a no-brainer to have the domain teams add the best of them in this kind of situation when the confidence of the system is on the line.

Even assets that are correlated with ETH, like LINK, would help to source more Dai generation and help with restoring the peg and DSR, and can then later be hedged with uncorrelated assets that are more complicated to add (like PAXG)

15 Likes

Hi Parafi capital, happy to see you guys here.

If people have little appetite for leveraging ETH currently and are exiting the system why would a vault package with a lower LR bring in more demand right now?

On collateral onboarding, it seems that everyone mostly agrees we need to onboard more assets. If consensus forms agreeing that expedite onboarding is acceptable/necessary, then lets pursue that path.

I am a little confused by the actual poll which states “Does the state of the peg constitute an emergency response within the next week?” What is a emergency response? Specifically for emergency collateral onboarding, the precedent right now is USDC, which was added in a couple days (or something like that I forget exactly). Is the poll just asking if a response in the form of a decision on expediting collateral onboarding should occur within the next week? Obviously the 4-6 week timeline stated exceeds a week.

3 Likes

I’d like to echo @Mitote and say it’s great to see you guys on the forums and participating in governance. If only it were under happier circumstances.

Personally I feel like some sort of response is warranted in the next week. Mainly given the consistency of the price of DAI above the peg, and the fact that the monetary policy levers are having a less rapid effect than desired.

The state of DAI liquidity isn’t something I spend a lot of time looking at, but given the recent events and the argument presented in the OP I think that’s another point in favour of action sooner rather than later.

I think that perhaps I’d like to see a more measured response than firing all cylinders. I’m not sure it’s necessary to set everything to 0% and to on-board as many ERC20’s as possible also at 0%. I do worry that we need to present a calm and measured response to avoid further degrading confidence. I think setting all the SF’s to 0 and on-boarding 3-4 new collateral types also set to 0% SF will be viewed as a desperate move by the market, and may result in other issues.

Realistically, changing just USDC to 0% SF and 100% CR should result in a release of 10M of liquidity which would probably be enough by itself to significantly improve the situation (though obviously at the cost of having 10M of centralised collateral temporarily.)

Adding LINK or other stablecoins at a low SF should also have a strong effect.

10 Likes

Regarding state of PEG.

Personally I want to work on protocol around ETH and make using Maker with ETH ROCK SOLID for people and go from 1.7% ETH deposited to 2.7% and 140M outstanding and 300% deposit LR. But hey I think state of enviroment and perception via the PR optics on this is MORE important than depreciating that work for adding collateral that even at $100M cap and 3% capture (double ETH btw) will only mint $1M DAI at 300% LR.

Better as discussed is to do the following drop SF on USDC to .5% (same as ETH), personally would like to see DC drop to 5M so we can stagger DAI injection in 5M DAI stages. LR on USDC left alone.as well.

If we go the USDC route and leave DC at 10M I really would like to see the USDC OSM and liquidations enabled like normal colalteral type.

The PEG is concerning and I would like to see it move back to $1 but it is clear that people are removing ETH from the system and/or not minting much. I don’t see that adding other collateral types with limited DAI minting is going to do much. $1M - won’t do much and this will take effort and time for virtually no real DAI being added to markets. We need to see about 6-8M at least.

I would prefer to see this come out in a measured DC controlled fashion in 5M tranches up to but not to exceed 10M to start and maybe 20M if necessary (but no more than 20M or 1/4-1/5 entire outstanding).

Literally everything else if done properly and without massive haste simply won’t do as well as focusing on completing the USDC onboarding past the ‘emergency state’ with OSM formally pegged to $1 and liquidations off.

I am completely against a LR lower than 120 here as it would only take approx 2M to mint I want more players doing this with more USDC than less and a future look of adding on liquidations, and OSM here. SF of .5% is somewhat arbitrary and matches borrow rates elsewhere especially since DAI is paying a higher rate on secondary markets atm.

BTW: God NO on new ETH vault with 125-130LR - we already completely shattered like 1/6 of our deposited ETH do we really need to suck them in again? Please no on diff ETH facility agree with @Mitote this won’t do anything except crank up liquidations and annoy people even more.

3 Likes

LINK has actually been quite uncorrelated to the rest of the crypto market if you look at the long time frame chart of both LINK/BTC and LINK/ETH (though it also crashed on black thursday like all other cryptos). I’m a bit biased here as a LINK holder, but what I can say that there are many other LINK holders who would be equally as willing as me to mint DAI against their LINK to purchase more LINK.

I also think mTokens (mDAI, mUSDC) from DMM DAO would be another good collateral type to add as those tokens are overcollateralized by a basket of interest-generating real world assets which currently includes $8.5M in automobiles from the United States, but are expanding to more asset classes like aviation, construction, and real estate. These would be much more stable/uncorrelated to crypto as whole and is already ERC20 compliant with an in-built exchange rate, collateralization/valuation determined by chainlink oracles, and metatransaction support.

Interestingly, mDAI most of the time technically wouldn’t even need to be liquidated through an auction as there is a reserve of DAI held in the contract (in addition to the real world asset backing) so mDAI can be exchanged for the corresponding amount of DAI (same for mUSDC but then that USDC would need to be auctioned for DAI). This method would be subject to the liquidity of the reserve ratio set currently at 50% but liquidity is actually sitting at above 100% right now to attract more liquidity. If this isn’t the right path or there’s not enough in-built liquidity, then auctions can be performed as usual. Just as a disclaimer for transparency, I do work at DMM, but I do think there is real potential here and wanted to bring it up to the community.

3 Likes

On a personal note what has held us, as a medium-sized fund, back from minting DAI with ETH is the volatility of ETH. Black Thursday showed that you absolutely cannot get liquidated.

So what price floor do we see with full confidence for ETH in the short term? Maybe $70, but with some cascading liquidations currently lurking at $79, perhaps $50? Ok so set the liquidation price at $45 and the whole exercise is not worth our time anymore.

Long story short: we need uncorrelated, price-stable collateral.

I’m not too informed about PAXG, but it would at least be uncorrelated and price-stable.

2 Likes

Why is PAXG more complicated to add? (Serious question)

FYI, there are like 1000 messages in https://chat.makerdao.com/channel/governance-and-risk?msg=yp9n5ufWEHgNX7kn3 today discussing this forum thread.

5 Likes

I keep my liquidation < $60 for the most part except in rare cases and only for short times. Right now I am at like $45 with a collateralization of 450%.

I also believe - and will comment when I have time that we can do quite a bit of things to improve this system for both vault owners and DAI owners. But each time I toss out something it usually is a protocol change - and unless we have a DAI emergency seems to move in glacial time, vs. instant time when others see a change as critical (i.e. the auction halt mechanism add), we need a DAI minting halt, as well as collateral removal halt - which if we have all three that can happen instantly and only can be removed after GSM delay is a better way to halt the system than an ES imo.

My goal is to create a system where the ES for the most part is off the table and instant halts can be on the table. Then lets talk about liquidation insurance additional SF rate. Most of these people if they could have had 24hr grace here with a fee for the service would NOT have been liquidated - or at least would have had a guaranteed 24hrs to get their vaults in order (i.e. liquidate themselves avoiding the 13% liquidation fees).

I already have DSR-L not released as a full auction l iquidity backstop mechanism that can literally catch the system while it falls. But we literally have to halt the system when market prices against OSM are massively disjointed >20%. I have a growing list of ways to almost bullet proof this system and backstop it with OPD (other people’s DAI) and give people options but they all require contract changes that people tell me will take ‘years’ - well hell crypto years are like dog years - projects literally live and die in year time frames. I know there is a lot of the plate here of Maker - mostly because foundation wants to move aside - fast. Personally I think we need to think about our clients and to improve robustness of the system first before we grow the thing.

I was told once by a business person I valued. To have a successful business focus on doing your business better than anyone else and everything else will follow. There is one caveat before this - make bloody sure the market(s) you want to enter are large. There is no point in having 10 businesses to make $1M when 1 can make you $10M if you focus and do it right.

All IMHO.

2 Likes

Hi all! Tom from Dragonfly Capital here. I strongly agree that Dai’s recent drift from the peg is a problem, not just for Dai users, but for the Maker ecosystem overall. The truth is that Maker does not exist in a vacuum, and people will shop Maker against other options for getting leverage on underlying collateral (mostly ETH, for now) and will shop Dai against other options for stablecoins, and I worry about competitiveness on both fronts right now. For Dai specifically, we’re (anecdotally) speaking with a few teams that are considering switching to USDC away from Dai, and we see this switch already happening through on-chain data. dYdX posted its first day with more USDC-WETH volume than DAI-WETH volume last week. Currencies, even fully-backed ones like Dai, still rely on network effects and strong narratives, which can often unwind just as quickly as they grew.

With this in mind, it’s important to think about the problem itself, which is that ~6-10MM more Dai needs to be minted in order to re-peg. So, where is this going to come from? Problematically, overall interest in ETH leverage is down substantially since a month ago, almost 50% lower by Skew estimates. Screen Shot 2020-04-18 at 2.59.09 PM Thus, trying to win the ETH leverage market is already going to be a less fruitful way to get this Dai minted than it would have been in March. Not to mention that with the SF at 0.5%, Maker is already the cheapest way to borrow Dai and get ETH leverage (looking purely at interest rates) from all the decentralized lending protocols. Because the ETH leverage market has shrunk and Maker is already winning this market on pricing, it’s unclear to me that dropping SF even more will have a meaningful effect.

We’re open to proposals on new collateral – I think many of the candidates (LINK, PAXG, etc.) seem reasonable and I appreciate the Risk team’s work to vet them – but it’s also essential to keep our goal of minting 6-10MM more Dai in the next week top of mind. In this light, assets that are too small to generate meaningful Dai demand and assets that are too complicated to add in such a short time frame seem like they should be held for future discussion.

19 Likes

LINK is promising but can bring some troubles, it s surely uncorrelated to the main cryptos, but it s owned by a very small group of people… and it can be wildly volatile. It is a risky solution…but we need a solution quickly.

2 Likes

Thanks for sharing this tom. I completely agree that if we are going to do something it has to be of substance and reasonably quickly.

I see only option here with least questions is USDC which I discuss in above post. I’d like to see the DAI come out in 5M tranches but not against starting with the 10M DC limit and SF drop to .5%. I DO NOT want to drop the LR as I am sure enough USDC will come to mint DAI and want to keep this LR sane against turning on OSM and liqudations.

3 Likes

While I support a lower LR for USDC in the short run, I think it’s important to stress this point. No matter what LR is chosen, there has to be decent room to drop it further once liquidations for USDC are turned on - otherwise it will immediately cause mass liquidations when it gets turned on for those that have generated the maximum amount

6 Likes

Per one of the Devs, with the small Time frame, it would take some engineering work for a new type of medianizer. I think the same goes for uniswap liquidity tokens. Also Ilan Gitter of Paxos stopped by Rocket Chat recently and he mention something about a fee with PAXG?.. You might know more about that

That’s a good point–I saw this piece written by ChainLinkGod which sort of tries to give you an idea of some of the owners:

"During this monopoly period, Binance steadily held between 110M to 125M LINK tokens (31% to 35% of the circulating supply), but sharply decreased to 100M LINK (28% of circulating supply) in June 2019 with the Coinbase listing. Afterwards, Binance’s holdings of LINK continued to drain outwards due to user withdraws over the next ten months down to where it is today at 70M LINK (20% of the circulating supply).

Coinbase’s holdings on the other hand have continued to grow from the initial 20M to now 70M LINK tokens (5% to 20% of the circulating supply). Binance and Coinbase together now account for over 40% of the circulating supply of LINK. LINK’s distribution across the two exchanges have just recently come to parity with each other with both exchanges holding 70M LINK. It should be noted however Coinbase does not make their wallet addresses public, so this information was aggregated by tracking particular wallets that exhibited identical robotic accumulation behavior which started at the same exact time as the Coinbase listing."