Improving MakerDao

MakerDao is a revolutionary and groundbreaking system. It is a system that if governed properly can truly change the world! However. in the current form the MakerDao system has a few drawbacks that have become apparent over the last several months and could use tweaking:

  • The system encourages Dai demand even in cases when the desire is a reduction in Dai demand: One example of this is Dai being purchased above peg during vault liquidations (inefficient and counterproductive).

  • The system struggles to expand supply of Dai to meet demand leading to a price above Peg: One clear example is the current system state. Interest rates at 0% and yet Dai demand still well above supply. (improper incentives and utilization of resources available)

  • The system in the current form propels itself towards losses for MKR holders: Demand for Dai and supply of Dai are not being balanced properly. This leads to litany of side effects ranging from loss of confidence in the system and a peg out of balance all the way to issues like what were experienced in March and the necessity to inflate MKR to make up for these mistakes. (Risk/Reward imbalance and improper fee structure)

I am hoping to discuss here some pivots MakerDao can make to correct the current trajectory it is on (I feel it requires adjustment).

I would like to note that I am a big believer in MakerDao’s potential and that this post is an attempt to sound the alarm bells so that MakerDao can steer its way around the obstacles ahead and come out functioning at top performance.

These adjustments would benefit the system:

  1. MakerDao should only purchase Dai from the market at or below the Peg price. If Dai is over the peg price in the market the demand and supply are out of balance and supply needs to be driven higher to correct this. The current system does the opposite (it buys Dai from the market during vault liquidations reducing supply further) which is a disaster!

A solution would be instead to issue Dai and “buy” the collateral in the vault being liquidated. Doing so is far more efficient because the slippage is zero and the price being paid for the Dai is peg value rather than above peg value (since the system produces Dai at peg value)

  1. The system at some point is going to have collateral reserves that are owned by the system itself. This is a good thing because Dai supply is needed during these times to keep a balanced peg. System reserves could build up for many reasons but the main two are either a PSM that was put in place (I am not sold on a PSM being a good idea), or from liquidations of vaults while Dai was above “par” (the internal value the system issues Dai for). This is a new risk that needs to be managed.

A solution would be re-balancing the reserve pools as they reach their respective limits, loaning out the reserve pools at variable interest rates to generate revenue while MakerDao waits for Dai to be at or below the peg and then emptying the reserve pools in exchange for Dai when Dai is under peg price.

  1. MakerDao should always be charging a stability fee on collateral in the system. 0% is unacceptable as it means MKR holders are taking on collateral risk for zero expected return value.

A solution would be to charge a stability fee for each collateral type which balances the risk reward so that MKR holders generate enough value to offset the risks being taken. This is regardless of supply and demand imbalances as there are other ways to balance those in the system aside from setting rates below the true floor (which this rate acts as) and down to 0%

  1. MakerDao should implement negative effective interest rates should a demand imbalance persist in the system for too long. However, it is important to note that with regard to #3 above that this rate should still account for the risk MKR holders take and should compensate them for the risk they are taking on top of the aim it has to subsidize further Dai supply.

A solution would be to lower the “par” value in the system towards $.90 and still keep the stability fees running but just at their proper respective floor prices. The par value lowers over time and is voted on by MKR holders until market balance is achieved for Dai and any collateral reserves MakerDao has have been fully sold back into the market. It is important that MakerDao does not go past .90 though because there are limits to how far it can safely lower the “par” value of Dai

In extreme circumstances in order to get Dai value back on Peg it may require actually inflating the Dai supply or backing it with MKR. These are things MakerDao needs to discuss and build plan for into the future because although unlikely (so long as more and more collateral types keep coming available for the system to add on) they are still possible and need to be worked out.

If MakerDao implements these ideas it should be on a better course. I am hoping to discuss these as well as others and pin down the best ideas so that MakerDao can get back to being the titan it was meant to be in the defi space. Thanks everyone!

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It all comes down to this: MakerDao can be viewed as a massive decentralized “Value Storage Facility” with insurance.

  • MKR holders are both the insurers as well as managers of the system.

  • Dai holders are storing their “value” in the storage facility.

  • Vault owners are taking loans from the storage facility in exchange for collateral maintained in a different area of the facility + some kind of fee or possibly subsidy depending on the system state.

All of this works so long as the Dai holders want to use the facility, MKR holders are compensated properly for providing the value they provide, and vault owners can profit from interacting with the system.

In most other “Value Storage Facilities” Dai holders would expect to pay a fee for that safety and stability they are getting. This system is no different except that the fee Dai holders pay can be somewhat offset by the loans generated and that the fee is generally unseen directly (because the Dai value is expected to stay around peg value most of the time in the market) up until the point where stability can simply not be maintained period.

Here is what I am saying: If a Dai user comes and gives the system some kind of value (ETH, USDC, BAT, Whatever). If that value falls too far they have to expect that the system is going to have to reduce the value of their Dai. I mean if the risk cannot be mitigated even across potentially hundreds of different collateral types in the future, that is just the way it is (there is no perfect stability without a cost) and Dai holders can’t and shouldn’t expect that there is any better solution than to have MKR insure the assets and then there is still potential to lose value. That risk is relatively low and that is the price Dai holders pay for using Dai. They are obviously OK with that risk because if they were not Dai demand would be lower.

If we start looking at the system from this perspective it becomes clear what should and shouldn’t be done by MKR holders. For example, why would we trade the collateral we were given back out for Dai at a price of Dai higher than we issued it for in the case of a liquidation (which we are actually doing right now)? We shouldn’t as that is one way to bleed value and ultimately destroy the system.

Hey @FourthStreet, I’ve noticed you’ve make a few posts now without categories or tags set. Generally I just fix these, but I’d appreciate it if you could at least gave it a best guess.