MKR holders: I need your vote! There’s a subtle but important vote going on right now that I believe influences the long-term health and incentives of the keeper ecosystem. https://vote.makerdao.com/polling/QmcALf82?network=mainnet
Backstory: typically, arbitrageurs / keepers mint and short Dai to provide liquidity to the peg, with the expectation of a small profit. They also assume that governance will act in the protocol’s long-term self-interest in helping keep the peg stable. If governance fails to coordinate properly, and keepers lose faith in governance, then the peg will start to drift upwards without anyone stepping in to sell it. This is why we saw the peg drift as high as $1.05 over the summer (after the surge of yield farming demand), and stay there. Keepers weren’t confident enough that governance could act swiftly enough and apply the correct incentives. Clearly, we can see how incentives are important in all this.
Eventually, governance pulled through and the USDC-A Liquidation Ratio (LR) was lowered to 103%, and the peg came down to $1.03. This was much needed relief. But the peg was then just merely stuck at $1.03. So, then, the LR was lowered to 101%, and the peg dropped down to $1.01. These actions were HUGELY beneficial to the peg, especially in light of the fact that governance does not or would not want to consider negative interest rates at this time. Myself, and several other keepers (and long-time community members) I have spoken to, continued to stay short due to our expectation that governance would remain vigilant in its duty to restore the peg, and continue to take actions that would eventually bring the peg down to $1. Remember, these shorts were put on 2 - 3 months ago.
Instead, what we saw was no further action with respect to the LR, and, worse, an increase in the Stability Fee to 4%. An increase in the stability typically is counter-intuitive when the peg is strong but in this case made sense since governance assumed that a lot of the newly minted Dai was being used for yield farming. While this is partially correct, it ignores the fact that a significant portion of the Dai generated from USDC was actually being used purely to arbitrage the peg downwards using recursive leverage on Compound. These keepers (myself being one of them) are vitally important actors in this ecosystem. And they were now losing money, while governance sat on its hands a bit. Our principal bled dry while the peg remained broken.
Recently, it came to light that Dai was losing integrations from key partners. This is simply unacceptable when governance has the ability and power to fix the peg. We’ve reached a point where it makes sense for the protocol to take urgent action to immediately fix the peg (as closely as possible). While I advocated for dropping the LR to 100.1% (due to its simplicity), the community has decided to implement the Peg Stability Module (PSM), which was originally proposed in July (and then stalled). While this is a valid option, it could take several months to implement, according to the current senior smart contract dev
at the Maker Foundation (audits, testing, governance, etc).
In the meantime, the keepers, who are the primary stabilizers of the peg, are at risk of losing all of their principal on a trade they should, reasonably speaking, be making money on. For MakerDAO to delay fixing the peg by going the PSM route (remember: if they wanted, they could fix the peg this week by dropping the LR to 100.1%), and still keep the stability fee punitively high at 4%, eroding all of the profits of the keepers, is a very, very poor incentive. This short term greedy move by the MKR holders will end up driving away a significant portion of the keepers in the ecosystem. The next time the peg breaks to $0.94 (like in Q1 of 2019) or $1.05 (summer 2020), the keepers will not have the confidence to step in and take the other side of the trade.
This post is already pretty beefy so I’m going to stop here but happy to answer questions. Plenty of stuff to expand on from the above. Also, this is obviously a nuanced, subtle topic. I am not arguing there is a definite right answer here. I can totally understand this both ways, but genuinely believe that my framing is better for the long-term health of the ecosystem. That’s how I positioned my trade. Ethically, I wouldn’t put on a trade and then expect MakerDAO to act against it’s own self-interest and try to convince it as such.
Full disclosure: I’m short Dai and I am talking up my book. I post this message not from the perspective of a risk manager, but from that of a profit-motivated keeper.
tl;dr: please vote for 0% in this week’s stablecoin stability fee governance poll in order to preserve and protect the keeper ecosystem until the PSM can properly be put in place.