Peg Stabilization Modules: A Pre-MIP Discussion

The proposal is a refreshment among the current solutions that do not work. Can we vote for it (yes/no)?

3 Likes

There is now a live forum poll for the community to decide the timeline for the Peg Stabilization Modules implementation. The poll will be live for at least 24 hours but might be extended based on the results after the initial 24 hour period has passed. See forum poll details at the below link:

4 Likes

Due to the abbreviated discussion period, I’ll briefly add some summaries of thoughts here. An attempt will be made to come up with a more prolonged and reasoned and comprehensive response soon. I will say that the speed with which is moving should be concerning to everyone.

This proposal represents a fundamental change from what Dai is, i.e. a decentralized stablecoin with an overcollateralized basket of currencies backing it, to a hybrid token that is partially overcollateralized and partially collateralized at a 100% ratio to a competing stablecoin.
As a Dai holder, I am more attracted to the former and less to the latter. Many in the community will feel the same if Dai no longer maintains the same guarantee of overcollaterization and loses some of it’s luster as a premium collateral. This may be a non-issue in the short term if Dai is clearly in demand, but I am concerned about the mid-to-long term view of Dai as a collateral. This will spark competition from those seeking a more decentralized alternative, and some may find themselves wondering what benefit there is to holding Dai as a proxy for USDC, when they can just hold USDC itself.

Due to it’s current standing as an investment-grade collateral type, Dai has lately maintained a premium against USDC, I would argue that this premium exists because of Dai’s nature as a permissionless, overcollateralized, and decentralized stablecoin, a superior product to USDC in many ways, and assume that many who use Coinbase as their fiat onramp immediately convert their USDC to Dai when it’s available on mainnet. If my suspicions are correct, then Dai could theoretically have to absorb hundreds of millions of additional USDC in this market in order to reach saturation and partity against USDC. A $20mm PSM would immediately get tapped out and we would be in the same situation that we are in now, with the exception that Dai would now be less collateralized.

The PSM alters the incentive mechanism of vaultholders by subtracting market incentives that they could have actualized by generating and selling Dai at the premium. It stunts the organic growth of Dai by socializing the USDC risk into the protocol for a one-time fee. By adopting this approach, we disincentivize essential market makers from participating in the system.

Dai is currently in a period of extreme demand. Our debt ceilings are full, the solution for now seems to be to raise the ETH debt ceiling to a level that can consume this demand. ETH is still the premier collateral type for the MCD system, and it’s clear that there is market demand for additional ETH vault capacity.

Due to the seemingly overwhelming desire to provide additional Dai liquidity in an emergency situation, it is difficult to come out entirely opposed to this solution, however, it is important to understand and express how this seemingly simple modification will alter the public perception of what Dai is and what draws people to it. Use of Maker by vault holders is not a foregone conclusion and it’s innate incentive mechanisms are the incentive to particpate and generate more Dai to sell on the market. Every Dai that is sold by the PSM contract is effectively some amount of profit lost to a market maker, and also a reduction in the perceived security of Dai itself as an overcollateralized stablecoin. In current conditions, the current market could easily eat tens to hundreds of millions of USDC and still not return Dai back to the peg, while reducing the percentage of overall collateral subject to a custodial stablecoin. Any artificial cap on this mechanism in today’s market will quickly be reached and we will be in the same position that we are in currently, with the exception that we will have a less secure Dai, a less desirable Dai from a collateralization perspective, and a protocol that is subject to additional regulatory pressure.
If this mechanism is to be considered, I would urge that the fee bands be wide enough to avoid market interference except in the most extreme of circumstances of demand. It is not clear to me that we’ve reached that point, the current debt ceilings are maxed and the market has an appetite for further leveraging. Give the existing mechanisms room to breathe. During an acute spike, use the PSM as an emergency valve. The rest of the time, the market must be permitted to work as designed so that the incentive mechanisms have the effect of naturally increasing and decreasing supply.

Anyways, I’m sorry if this seems disjointed. I haven’t had time to fully collect my thoughts on this. In the same vein, we have not had a chance to perform any sort of economic or public perception survey on how this change will affect prices or sentiment.

11 Likes

You make some good points but as someone who uses USDC as collateral to arb the peg, I think you’re missing some key issues. Overcollateralization of Dai is a red herring when it comes to USDC - the real issues are the USDC debt ceiling (because this is what creates the risk for MKR holders), the income that is generated for MKR holders from USDC collateral, and whether Dai minted from USDC helps restore the peg. The problem with the current situation is that people minting DAI from USDC are not helping the peg- they are leveraging it on Compound to farm COMP. This is terrible for the system since we take on the risk and the bad publicity of using USDC, we get a small SF income of 4%, and there is no selling of Dai to help restore the peg.

The beauty of the PSM is that all USDC collateral is used to directly restore the peg (because the protocol is buying USDC and selling DAI) vs. the current system where no DAI need be sold on the market. The trading fees can be implemented to restore any lost revenue from the current SF on USDC. You might wonder why people don’t take advantage of the current high Dai price to mint Dai from USDC collateral and sell Dai on the market hoping to buy it back once the peg is restored. The reason is that it just too risky to make the arb. There is no guarantee the peg will be restored in a short time frame and MKR holders keep raising the SF on USDC collateral (0–> 4%), which is basically an attack on people who are trying to use USDC collateral to help restore the peg.

tl:dr: currently we could raise the USDC debt ceiling to 100m USDC and all new Dai would go to farming comp and not restoring the peg. No dai need be sold on the market. Under the PSM, we could take on 100m in USDC collateral, and every Dai minted would be a market sell to restore the peg, and MKR holders would make the same income.

4 Likes

To be clear, with the PSM you would pass in, say, 1.01 USDC and receive 1.00 Dai in your wallet. There’s no market sale or mandate to do so. Dai can still be sent to Compound by the transferor.

2 Likes

Exactly- but the exchange in the PSM is the market sale. Currently, when you mint dai from USDC, you retain your ownership of the USDC and if you send the Dai to Compound, there is no sale of Dai that occurs. Under the PSM, every exchange involves someone purchasing Dai at a price below the market (assuming Dai is above the peg) - which has the direct effect of lowering the Dai price. This is a huge difference than the current system. Agree with you that at 40m debt ceiling, we may not restore the peg, but at least every USDC in the 40m has resulted in a sale below the market price putting pressure on the Dai price as you have a seller offering Dai for less than others. At current exchange volumes, if you sold 100m Dai at 1 USDC, you would absolutely make the price of Dai fall.

Basically the PSM is identical to a large market sell order of Dai at a price of 1 USDC. As long as the sell order is large enough, the peg will be restored. In current system, you could mint a billion Dai and if it all got sent to Compound and leveraged there, the Dai price would not change.

3 Likes

Assuming MakerDAO governance is still targeting a soft peg of 0.99USD to 1.01USD, wouldn’t the following implementation suffice:

USDC<>DAI Stabilization Module:

  • Trades 1:1 DAIUSDC
  • Fee: 1%
  • Effective Buy Price: $1.01USD
  • Effective Sell Price: $0.99USD

This would further reinforce the current soft peg range and provide support around the edges of that range. Benefits and drawbacks for using fixed pricing instead of floating pricing:

  • + Less DAI minted at non-critical levels
  • + Creates an obvious range within which it is “okay” for DAI to trade (this can be adjusted from ±1% by governance).
  • - Reduces the time governance has to respond to DAI price changes (stabilization module will only start filling up once DAI reaches 1.01USDC).
  • - Less useful as a stablecoin trading platform (less utility for the ecosystem).
  • ± Fees earned by MakerDAO protocol may be higher or lower than a floating price based approach (similar to curve).

One thing I’d like to add is that any proposed stabilisation module will do nothing to restore the peg. It is meant to stabilise the peg but it will not help a peg that is outside of the targeted range. To address those scenarios, the only option is to incentivise DAI creation, or penalise DAI drawing.

2 Likes

This is false. The PSM is basically a large market sell order below the current Dai price. As long as that sell order is large enough it will definitely restore the peg. Imagine if we made 1 billion Dai available at a price of 1:1 USD. You don’t seriously believe that wouldnt restore the peg at current exchange levels and current Dai price?

What a genius idea! Let’s just mint unbacked DAI to fix the peg!

It is meant to stabilise the peg but it will not help a peg that is outside of the targeted range

We already have a USDC-A ceiling of 40M USD, the protocol is not sustainable if we can’t raise the base fee above 0%. There is obviously outsized demand for DAI compared to demand for trustless crypto leverage. Normally, this would be solved by introducing a negative DSR (like a funding rate). However, this is never solved by simply having the house force trading at a certain price like you’re proposing.

There is no unbacked Dai in my example. It seems like you don’t really understand how the PSM works. Let’s take the example where Dai is trading above its $1 peg with a price of $1.05. Now, if we set the debt ceiling for the PSM at 1 billion USDC, you would effectively be creating a market sell order of 1 billion Dai with a limit price $1. Every Dai sold at $1 is backed by 1 USDC. With this kind of debt ceiling at current exchange volumes, you would definitely bring the Dai price down to $1. I’m not recommending we set the debt ceiling at 1 billion USDC, but you could do it, and it would restore the peg.

1 Like

Okay, so when I say it won’t help restore the peg. You obviously don’t think it’s a good tool to restore the peg (too risky), yet you fell the need to mention that it could restore the peg?

Yes, theoretically it could but realistically it won’t be used in such a manner due to the huge amounts of USDC risk we would take on.

We are both on the same page it seems, just arguing for arguments sake…

@latetot and @OliverNChalk please try to remain respectful in your discussion.

2 Likes

Since I’m apparently not going to find the time to write-up something comprehensive today, I thought I would at least start to make an argument that we should think very carefully about adding the PSM, and the details of its implementation. I too had this idea back in April, but decided that there are very heavy implications for what DAI is, it’s market based peg balancing mechanism, the risks and rewards of those mechanisms, DAI growth, and a while host of other implementation details. My PSM was more of a fly-wheel that would unlock liquidity over time so as not to completely destroy the existing market mechanisms that balance the peg:

As you can see I eventually walked away from this idea. I had one other iteration in my head that solved some of these problems, but it started to rival the complexity of the Maker Protocol itself, and without the careful thought and economic analysis, I started to find peace with, and wisdom in, the existing mechanism design.

So, perhaps we want an emergency facility for peg management that activates at some spread, or perhaps we want to unlock more DAI with time (fly-wheel), and perhaps we want both mechanisms or none at all. I can assure you that what we’re discussing is technically possible, and is even possible to do with little technical risk; however we need much more time to think about all the macro implications of this module, in addition to its possible implementation details.

As @BrianMcMakerDAO indicated earlier, we are hoping to work up and release a forums post with more details that should be considered before we fast-track the PSM through the MIPs process. Much of those considerations strike at the heart of what DAI is, how it’s used, how it grows, and the interplay of these, sometimes at odds, goals.

6 Likes

Many of us had these thoughts because at the time it seemed like the Peg was out of balance and needed to be corrected. This is still true today. However, as you said, most of us (myself included) abandoned these ideas because when we looked at them for awhile, we started to realize that the raptor we were chasing in this case was just luring us to a place his other raptor buddies could maul us to shreds. The system needs negative rates, or some other balancing factor to solve this issue. Soaking up potentially billions of dollars in USDC is more like cornering ourselves…

1 Like

Its hard to know before trying what effect the PSM will have on the peg. Currently we have ~22m DAI backed by USDC but almost none of it is helping the peg since its just sent to Compound to farm COMP. If we implement the PSM and add a 20m limit sell order at 1 dai for 1 usdc, it may be enough to meaningfully improve the peg. The demand for Dai is not infinite. I think 50m sell pressure could restore the peg given when we are today, and that amount of risk is acceptable right now to address the peg problem.

2 Likes

People are buying DAI at >$1.01 to stake on compound, why do you think the PSM would be more successful than the current USDC facility? The PSM is arguably more capital efficient for compound farmers ($1.01USD locked up instead of 1.25USD with USDC-A)

PSM is a direct and powerful method, and I very much agree.
Because we directly intervene in the exchange rate market, it is more effective than the indirect method of using zero interest rates.

1 Like

I think we could use the auction system to liquidate towards 1 on both sides of the spread. A question of whether to liquidate entirely the side of the facility vs. saving some USDC for the low side of the spread will need to be asked. How much USDC do we want to ‘retain’ in the facility as the low side of the spread liquidity stabilizer. So consider that we will want to have some amount of USDC in the a DAI/USDC PSM facility so we can make both sides ot the trade on this spread. Use the liquidation system to manage the assets in each facility via reverse auctions to sell towards 1 from the outsides of the spread if we exceed the nominal collateral level in the facility. Keeping some stablecoin in system as the nominal collateral level to provide liquidity in the spread will be important. Using keeper system to auction towards 1 to relive excess pressure until nominal stablecoin level is reached will be another tool to drive the price towards 1 using the liquidity provided by takers hitting the outside of the spread.

2 Likes

Right - this could work as long as you weren’t buying back Dai with the PSM USDC prior to having the PEG restored. You could auction the stored USDC for ETH, e.g.

Negative rates won’t work because it breaks the usability of Dai in many DeFi protocols, AMMs etc.

Dai not being $1 doesn’t work because it destroys the PMF of Dai.

What will work is paying people to generate Dai using newly-issued MKR tokens.