How Lowering Liquidation Ratios Supports the Peg

The Maker community has voted to lower the Liquidation Ratio (LR) on USDC and PAX to 103% earlier this week and 101% as of today (9/17).

Please read on to learn more about why lowering these LRs supports the Dai peg, how Maker came to accept centralized stablecoins as collateral, and how to participate in discussions around governance and risk.

In short, the incentives provided by liquidity farming protocols have made it difficult for Maker to immediately offset the demand sink caused by the millions of DAI used for yield farming.

How Lowering LRs supports the Peg

As explained in the MakerDAO FAQ:

“The Liquidation Ratio is the minimum required collateralization level for each Vault type before it is considered undercollateralized and subject to liquidation.”

Lowering the LR on stablecoins like USDC and PAX enables more Dai to be generated with the same amount of collateral, easing the pressure that’s been keeping the peg above parity with the US dollar.

Reducing the LR affects the peg in two ways:

  • By giving confidence to vault owners that even if the peg doesn’t fall, they’ll be able to profit while leveraging up their strategy and unwind when we reach equilibrium. For arbitrage to be profitable, we need to drop the LR below the current peg.
  • The lower stablecoin LR combined with higher stablecoin Debt Ceilings allows the DAI supply to expand and contract more rapidly when demand spikes due to yield farming.

Options for Easing the Peg

As of now the current set of options that have been approved by the community (which does not disregard other alternatives that the community is currently considering) are:

  • Onboarding more sources of collateral, especially uncorrelated collateral types.

Diversifying the stablecoins available as collateral and reducing the LR helps diversify the Maker Protocol’s exposure to different collateral types while alleviating the upward pressure the demand of DAI is generating.

  • Lower the LR on less volatile assets like stablecoins.

Reducing the liquidation ratio implies a lower risk profile for investors since the asset locked has less volatility than crypto assets and supports Maker’s efforts to diversify the collateral portfolio.

Why Maker Supports Centralized Stablecoins

The Maker community chose to include centralized stablecoins in the collateral portfolio with risk parameters reflecting the nature of the collateral by having domain teams and mandated actors evaluate the proposal and measuring community sentiment through forum polling and executive vote.

Some voices spoke against reliance on centralized coins as an affront to the decentralized nature of the protocol but the others countered that including new sources of liquidity had become a necessity for the protocol, if the protocol is to scale it must have a diverse set of collaterals from which stable coins are a part of.

Conclusion

The process from evaluating alternatives to execution of tasks is derived from scientific modeling, which does not imply that all actions necessarily will have the intended outcomes.

Governance is an iterative process and the more feedback, ideas, and support we have from the community, the better the outcome will be.

More Information

Join the Conversation

Please see the Maker Forum and join our weekly Governance & Risk call on Thursdays at 16:00 UTC to join the discussion.

12 Likes

@seth You mentioned raising liquidation ratios a few times, probably a typo.

Also should we be calling it Collateralization Ratio instead of Liquidation Ratio?

2 Likes

It should probably be liquidation threshold but these are all interchangeable. What do the official makerdao docs call it?

1 Like

Yeah it’s interchangeable, not that big of a deal.

I have no idea which is preferred, I’ve used both at various times.

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