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:
- Dai cannot be confiscated or blacklisted
- 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!)
- Dai collateral is more transparent than USDC (whose deposits are only audited once per month).
- 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:
- Lower USDC and other stablecoin LRs to 1.005
- Raise their debt ceilings to whatever we need to maintain the peg (consider additional increase to USDC-A SF)
- Raise the SF on ETH vaults to 1% (MKR holders cannot subsidize these borrowers indefinitely by insuring their deposits for free)
- Keep working on RWA and other collateral types that will meaningfully add diversity to the collateral base and SF income.
- Watch Dai supply grow pass 1 billion and MKR become a leading asset again.