We know that at a current 4% interest rate on debt from stablecoin collateral we have about 2.5 months before accrued fees start causing stablecoin vaults to become undercollateralized. In practice, losses from potential undercollateralization are simply offset by increased Surplus buffer by the same amount. This means that Maker could be charging those fees as long as it wants, but only needs to set aside reserves inside the Surplus Buffer for impairments needed.
However, there are two important questions that need to be addressed:
- What is the best strategy for disabling fees on stable coin debt?
- How long is it sustainable to have Surplus Auctions (FLAPs) running after Surplus Buffer is reached (estimated in about a day)?
To get an answer on the first question it would probably require a long discussion about some of the trade-offs which I don’t want to go into in this post. Also, it is likely not optimal to be disabling those fees very soon and we don’t need a decision right now. A post on this topic is following soon though, as we still need the community to agree on general strategy in the near future.
To get an answer on the second question, let us look at some numbers first. As of now, about 600.000 DAI has been accrued from fees on debt from stablecoin collateral to the Surplus buffer and we know they will be hard to actually collect if DAI price doesn’t fall below $1.01. Additional 50.000 DAI accrues daily from these assets at a current rate of 4%.
All these fees from stablecoin vaults are worth something if they can be collected and this only happens if DAI goes below $1.01. Even if DAI goes under that price, we are unsure how many of the vaults will need to be liquidated and what the outcome will be. This means that in the current situation every cash flow from those fees is essentially unbacked DAI if being conservative. These fees are already part of Surplus Buffer, which itself is not an issue if being unbacked until used (or not until at least you have FLOPS or spending it for other costs).
But once the Surplus buffer is filled and these fees are used for MKR burn it becomes an issue “slowly”, because you should be making impairments for the same amount in the Surplus buffer, which is already showing inflated value. At some point you are effectivaly reducing the Surplus buffer to zero, even though it still shows 2m value. And once it goes below zero (by applying impairments calculations), you effectively have an unbacked DAI scenario, not to mention the system doesn’t have any protection against losses.
So what does this mean in relation to recently voted Signal to continue with FLAP auctions after the Surplus buffer is filled? It means that we will be spending about 50.000 DAI daily from stablecoin fees for MKR burn, money that isn’t necessarily collected in the future. Therefore our Surplus buffer should be each day decreased by 50.000 DAI, together with an additional 600.000 DAI impairment needed from currently accrued fees. This means that in about a month, our Surplus Buffer effectively becomes drained in “DAI backing” terms, a situation we want to avoid.
This means we would likely need to very soon either a) disable stablecoin fees or b) Increase Surplus buffer soon after continuing to FLAP auctions. Since disabling fees on stablecoins currently may not be optimal for maximizing their potential collection in the future I think it may be more wise to increase the Surplus buffer. The increase should be done by an amount that makes Maker save until we disable fees on debt from stablecoin collateral. A 2m increase would mean we would have the same situation as today in about 1 month. By then, we should already have a more clear view on the timeline regarding disabling fees.
Please discuss the pros and cons of this approach before we potentially increase the Surplus buffer next Friday. I know there was a Signal already, but I think this issue wasn’t properly addressed in the past. As explained above, the more we delay the increase, the more we are effectively draining the current Surplus buffer (fees collected from other collateral) and governance needs to decide about tolerance here.