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.
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.
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?