Discussion: Why fixing the peg with stablecoins is bullish for MKR and Dai

Lets face it- MKR and Dai have been in a bad place for awhile now. The peg was broken and the SF was set to 0 without benefit. MKR holders were assuming all the risk of the deposited collateral with no income to show for it. Furthermore, people were afraid to mint Dai and sell it because it seemed likely the Dai price could keep going up. The only positive was the growing Dai supply - which is now up about 600% this year. Normally this massive demand would be very bullish for MKR- but not here because stability fee income was zero. It was starting to seem like it would never be possible to have stability fees compensate MKR holders for their risks to insure CDPs because it would only worsen the peg. Finally, all of the Dai supply growth was due to farming subsidies while real use of Dai as a stable currency was in decline.

Then a positive development happened. People agreed that by lowering the liquidation ratio for stablecoins below the current Dai price, people would have strong incentives to mint dai and sell it even while paying stability fees on their stablecoin collateral- and now we have ~5m annual income for MKR holders again, almost all from USDC vaults. We are back to ~10,000/year MKR burn rates. Now that we have this incentive in place to arb the peg through USDC vaults, we can finally charge a fair rate on other vaults to compensate MKR holders for the risk of insuring them - because the risk to the peg has been neutralized.

But wait- isn’t this is a failure for Dai? Why should anyone use Dai if USDC is the main collateral backing it? they should just use USDC itself… Not in the least. Even with 50-60% of Dai backed by USDC, Dai still has the following advantages over USDC as a stablecoin:

  1. Dai cannot be confiscated or blacklisted
  2. MKR provides an insurance policy in case some of USDC’s own bank deposits are stolen, lost to fraud, or fall in value (not likely but also not impossible- some money market funds have broken their peg in the past!)
  3. Dai collateral is more transparent than USDC (whose deposits are only audited once per month).
  4. Dai can be used for whatever you want including gambling and betting (which is a violation of USDC ToS).

Yes- the change to stablecoin collateral does expose MKR and Dai holders to one black swan risk-namely that Circle freezes all USDC collateral in Makerdao without any advance warning that would enable innocent people (who are currently breaking no law) to unwind their USDC CDPs gracefully. Note- if they just blacklisted a small number of CDPs due to owners who were suspected of a crime, MKR could likely absorb. But freezing all CDPs without warning would probably be unrecoverable at this point. Personally, I consider this risk to be infinitesimally small given the rights of innocent people that would have to be violated if no advance warning was given to allow them to unwind their CDPs. Nevertheless, in the longer term, we should clearly work to diversify the collateral base to mitigate this issue (e.g. onboard RWA).

But, by accepting this risk, Dai can resume its industry leading growth and longer term mission. There are a few prerequisites for this: 1) the peg must be maintained. People will not use Dai or open CDPs if they are not confident the peg can be maintained. 2) CDPs must generate positive income for MKR holders. This income provides an insurance policy that gives Dai holders confidence that collateral risk can be absorbed by the protocol. A robust insurance system - based on a high MKR price- is one of Dai’s most unique attributes compared to other stablecoins. It also allows the system to be self-sustaining over the long term.

So my recommendations: assuming that lowering the LR on USDC to 1.01 passes without adverse effects, in the following weeks do the following:

  1. Lower USDC and other stablecoin LRs to 1.005
  2. Raise their debt ceilings to whatever we need to maintain the peg (consider additional increase to USDC-A SF)
  3. Raise the SF on ETH vaults to 1% (MKR holders cannot subsidize these borrowers indefinitely by insuring their deposits for free)
  4. Keep working on RWA and other collateral types that will meaningfully add diversity to the collateral base and SF income.
  5. Watch Dai supply grow pass 1 billion and MKR become a leading asset again.
5 Likes
  1. I don’t think we can reduce the LR’s that low as even with liquidations 2.0 if that collateral was abandoned we would not be able to fully recover the debt owed. Not sure MKR holders would vote for that.

  2. Sounds good up to a point. We have to decide what total % of collateral we want backed by one token. As long as we can force some diversity between the different options I think this is a fair compromise. Also have to be cognizant of these collateral types total supplies as we may be eating up most of the market liquidity if we lock it all up.

  3. I put in a PR for ETH-A Risk Premium increase to 2% for Monday polling.

  4. Yes. Looks like we will be polling to prioritize RWA next week.

  5. Woohoo! Finally!

1 Like

I still can’t seem to wrap my head around liquidations. Anyone wanna explain how Maker loses money if collateral is abandoned?

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Ok - you may be right the 1.0001 is too low- but 1.005 should be profitable with Auctions 2.0, as long as the CDPs were big enough.

The US Federal Government has shown that it doesn’t give a rat’s a** about anyone’s rights; if they did, the Constitution of the United States of America, as the supreme law of the land, would be enforced to the letter (spoiler: it very much is not, in fact they wipe their a**es with it on a daily basis, not to mention state and local governments). Never trust a non-code government not to turn on you, because they always will at some point. Code is law, paper is not.

No, we should not do this for USDC (or any centralized stablecoin for that matter). That would be exposing the DAO even further to that risk. We haven’t been diversifying enough in terms of which collateral is actually utilized (not which ones we’re onboarding, everything’s fine there), and we’re pinning too much on too few centralized entities. We need to make other, immutable assets more attractive. As you said:

Putting ourselves further in that hole would surely be a mistake. However unlikely it may be, I still think it’s a bad idea to pin so much of our credit on the hope that the USFG won’t bring the hammer down on Centre. For the sake of the protocol, we must assume that they will, because they can not be trusted not to.