Following all the discussions around VaR and our box parameter, I wanted to provide another perspective on what can hit MakerDAO in case of a crypto crash in slow motion. Results can be taken as similar in magnitude to the excellent VaR model presentation (which works differently).
The model (sources in Scala) focuses on the box issue of MakerDAO. With a box of 15M we can liquidate only 15M DAI per tranche of 6 hours. It is understood that with the OSM we have a lag of 1 hour to react, meaning that people can possibly mint DAI by assigning less collateral because the system is still relying on the previous value. Vault owners also have a 1-hour period before liquidation during which the ETH price can continue to drop, increasing the possible loss of Maker.
- Box is 15M DAI
- Each vault is modelized as a 15M DAI vault with a collateral ratio depending on the vault type (e.g. uniformly from 150% to 450% for ETH-A). One vault is liquidated every 6 hours period.
- Each vault can be managed by the user before liquidation (by default 30% of ETH-A vault and 50% of ETH-B vault).
- ETH prices drop in a linear fashion then stay at the low level. The base case is an 85% drop in 85 hours (1% decrease per hour). This is a black swan scenario, but it should be safe if we really liquidated after one hour.
- All liquidations are done with the ETH market price (i.e. a super competitive Keeper environment)
- Liquidation profits are taken into account when applicable.
- The model is a simplification and we assume there is no significant bug in the model code.
With the current situation (850M ETH-A, 50M ETH-B) it would lead to a 200-250M DAI loss. The X-axis of the graph is hours (so 12 days in the chart below)
If the drop is only 70% (1% drop for 70 hours, then price stability) we end up break-event. What is interesting is that we start by making money, then losing some to end up flat. Quite a roller coaster with an insolvency event for MakerDAO.
If instead of 30% of vault users managing their vault, we have 50% that don’t fall into liquidation, this impact quite positively the P&L with a loss reduced to 70M. It’s still a big loss (7 times the expected surplus buffer).
ETH-A increase to 1.5B
Increasing ETH-A to 1.5B DAI would increase the loss to 400M DAI.
ETH-C for 650M DAI
Instead of increasing ETH-A we can create a facility with a LR of 200%. For the modelization, we expect a collateral ratio uniformly distributed from 200% to 500%.
The loss would be reduced from 400M DAI (ETH-A increased to 1.5B) to 350M DAI (really fluctuating depending on the random numbers). This isn’t a silver bullet because vaults are still stuck in the liquidation pipeline (for days) and ETH price can continue to fall.
Decreasing the LR to 150% (but keeping the collateral ratio from 200% to 500%) doesn’t change much the results in the model. Those liquidations are stuck in the waiting line, it doesn’t matter if they are triggered earlier.
Increasing box to 50M DAI
All the previous results derive from our inability to liquidate quickly enough. If
box could be raised to 50M (assuming Keepers have enough capital), the net result would be flat. We would get a lot of profit in the first liquidations then lose this profit for late liquidations.
As seen, even with a slow decrease of ETH price (by crypto standard) would hit MakerDAO strongly. This is due to our inability to liquidate quickly enough, the liquidation pipeline becoming jammed.
While a drop to $230 seems brutal, it would only put us back one year in the past. Another factor is the amount of leverage in the system We host 2.3% of ETH. Selling it in a rush might affect prices. One can argue if DeFi is used to the balanced portfolio concept (having 50% ETH, 50% cDAI for instance), that would trigger buy orders when ETH drops. This mindset doesn’t seem degen-compatible. Liquidity tends to disappear in crashes especially if market participants are already over-exposed to ETH. In such a case, a small
box might be a blessing by giving time for the market to recover. It also gives more time for vaults owners to find a solution.
The 70% drop scenario shows that we can quickly lose our surplus buffer even if in the end we end up generating a profit. This is a strong argument to continue to increase it.
I think our main issue is still our ability to liquidate quickly but this will not be a solution good enough if ETH continues to be used as the main source for collateral.