tldr: Dai’s Peg Stability Module (PSM), which integrates Dai deeply with USDC, is critical to maintaining the Dai peg in a crisis. The Gyroscope mechanism can complement Dai by providing the path to decentralizing the PSM (and so re-decentralizing Dai). With this post, we’re looking to gauge interest in developing Gyroscope closely with Maker toward this end.
The PSM allows users to swap collateral such as USDC for DAI at a fixed exchange rate without needing to take on debt or manage a Maker vault. A particular advantage of this PSM approach is that it provides an upper bound on the Dai price as Dai can be minted for 1 USDC, and liquidity is guaranteed.
The 12th March 2020 or ‘Black Thursday’ made it clear that guaranteeing liquidity and establishing Dai price ceilings can be as important as having Dai price floors. During this period of market stress, where collateral assets such as ETH rapidly depreciated, Dai was driven above its peg, aiding a ‘deleveraging spiral’.
In Maker, a ‘deleveraging spiral’ occurs when (i) margins shrink, (ii) leverage becomes too high, and (iii) positions are unwound and must be paid for in Dai. Since asset prices are rapidly depreciating, there is also little to no demand for leverage on those assets, resulting in a supply squeeze. This supply squeeze pushes Dai above peg, further decreasing the effective collateral margin, as a future deleveraging becomes more expensive. As vaults are incentivized to avoid liquidation penalties, this cycle perpetuates, with more vaults buying Dai on the open market to deleverage, driving up the price of Dai and so on.
Enter the PSM. With the PSM, these deleveraging spirals are bypassed, and system stress is now restricted to market-developments and not artificially bloated by a Dai peg deviation.
The PSM is working as intended, as displayed below. The time ‘t’ specifies a major shock to the value of ETH before the PSM was implemented (12th March 2020 or ‘Black Thursday’) and after the PSM was implemented (19th May 2021).
So far so good. However, introducing the PSM also surfaced Dai’s ‘Gordian Knot’ - the old optimization problem of having the two seemingly conflicting goals of decentralization and price stability. This goal conflict is particularly present if the intention is to avoid a high degree of over-collateralization. While there might not be a silver bullet to magically resolve this goal conflict, there is still much room for improvement.
Improvements that can also address some of Dai’s persisting collateral and platform dependencies.
The two charts below show MakerDAO without (left chart) and with the PSM (right chart) during two market shocks with rapidly depreciating collateral value. Liquidations and Dai price during Black Thursday Growth of PSM balance during most recent ETH shock
Based on data from Dune Analytics and Dune Analytics as of 6th June
Displayed on the left, the Dai price and the liquidations during the Black Thursday of last year (12/03/2020). Dai peaked at 1.11 USD, exacerbating liquidations of vaults. Before Black Thursday, positions worth 850k USD had been liquidated, roughly one month after the Black Thursday this figure was at 19.5m USD. Displayed on the right, the ETH price and the share of Dai that has been issued via the PSM. PSM Dai contributed to ˜17.5% of the total circulating Dai at the beginning of May, but contributed to ˜41% at the end of May. Notably, vaults worth about 75m Dai (including liquidation fees) were liquidated in May, but Dai retained its par value.
Before coming to the actual proposal, we have to go through the high-level set-up of Gyroscope, which - on the surface - looks similar to Maker. Gyroscope issues a stablecoin, GYD, against collateral. However, Gyroscope differs in several important design decisions:
- is a basket of reserve assets, that jointly collateralize the issued stablecoin
- is only slightly over 100% collateralized, as most reserve assets are stablecoins
- diversifies risks of protocols / asset types / assets 
- is continuously growing from harvesting reserve asset yields
the stablecoin, GYD:
- is redeemable for its underlying collateral assets
- is supported by a currency peg coordination game should the reserve ratio of GYD fall below 1$, disincentivizing bank-runs, but maintaining exit liquidity
- past in-/out-flows are monitored and inform incremental changes to the redemption price, effectively acting as a circuit-breaker
- secondary market AMMs (S-AMMs) concentrate liquidity in the price band set by the primary market (P-AMM)
- limits other risks, such as Governance Extractable Value 
- may replenish the reserves by auctioning off governance token
- includes a mint, the Gyroscope app, which in turn
- acts as a P-AMM to mint and redeem GYD in a defined price band
- informs and enables arbitrage cycles, functioning as a price backstop to prices on secondary markets
- acts as a single router, allocating assets to individual vaults/ AMMs
A different frame to think of Gyroscope is to imagine multiple ‘lines of defense’ that are supposed to unlock synergy effects, i.e., become stronger as a total than the sum of its parts. Consequently, we see the Gyroscope design as the keystone to a fully liquid and decentralized stablecoin.
In this analogy, the first line of defense is the diversified ‘all-weather’ reserve, while the second line of defense are the Gyroscope AMMs, which include the currency peg-coordination game as a circuit-breaker. Recapitalizations of the reserve by auctioning off governance tokens will be (a part of) the tertiary lines of defense.
An example of the first line of defense - i.e., a reserve configuration that diversifies on the dimensions of protocol, asset type and asset - is shown below. Notably, the below graphic depicts a stylized Gyroscope that is independent of Dai. If Gyroscope were to deeply integrate with Maker, Dai should not be a major reserve asset of GYD. Similarly, the precise form of the Gyroscope reserve is intended to coevolve with the changing ecosystem of crypto assets and applications.
The second line of defense relies on two market types that can be summarized as below:
- A P-AMM design that accounts for potential shocks to underlying assets and maintains peg within a price band
- Multiple S-AMMs that concentrate liquidity within the primary market band
The stylized P-AMM redemption curve is shown below against the example of a 50-50 Uniswap pool. The shape of the redemption curve is a function of the current reserve ratio and outflows.
If GYD is undercollateralized and trades below par, the redemption curve starts near $1 to enable good liquidity around the peg and eventually moves to the ‘circuit-breaker phase’, if continued redemptions occur.
The goal is to disincentivize bank-runs and attacks on the currency peg, while enabling users to exit, but rewarding users that wait for the transitory downturn to pass. Even if GYD holders decide to exit, Gyroscope provides rational reasons to bet on Gyroscope repegging soon, as either outflows equilibrate back towards zero or the reserve recovers (e.g., through yield), leading to improved redemption prices and closer liquidity around the peg.
The stylized S-AMM redemption curve is shown below against the example of a 50-50 Uniswap pool.
In Gyroscope the secondary market AMMs concentrate the liquidity in a price band that follows the minting and redemption quotes set by the primary market AMM. With healthy reserves, S-AMM liquidity is concentrated within a narrow band. If there is a shock to the collateral and the P-AMM sets new redemption prices (as described above) this price band will widen. Notably, S-AMM liquidity provision is very robust, as S-AMMs are redundant (i.e., provide different paths in/out of GYD) and independent from each other (e.g. if the paired asset fails, remaining S-AMM pools can still function, unlike one common Curve pool).
The interplay of the two different market types (i.e., S-AMMs and P-AMMs) is illustrated in the below graphic. This interaction is fundamental to realizing our vision of a highly liquid, yet decentralized stablecoin that is not forced to rely on custodial stablecoins as go-betweens for maintaining peg and does not pool local risks into a global system. It is thus a keystone to the strategy of Gyroscope to build decentralized liquidity for GYD and - after the integration with Maker - for Dai, as we discuss next.
In case you still have open questions on how GYD intends to sustain its peg you can listen to an explanation of Gyroscope, look up details in the docs, whitepaper and Github, or reach out on Discord. Also look out for our P-AMM technical paper and implementation coming shortly.
In summary, we propose the addition of a GYD denominated PSM. Initially, this GYD-PSM could be merely complementary and grow over time, to eventually fully replace the current USDC-PSM.
Whenever a (i) ‘Black Thursday’-type collateral depreciation would create a mass liquidation of Maker vaults, the (ii) GYD denominated PSM could - in the fashion of the current implementation - (iii) avoid a Dai price appreciation after a (iv) supply squeeze, that would otherwise (v) trigger new liquidations.
The main benefit of using GYD over USDC is that GYD is able to provide very similar guarantees as USDC while featuring drastically decreased centralization. GYD is a claim on a basket of collateral assets, not only on USDC. But Gyroscope is more than a stablecoin that is issued and redeemable against a collateral basket, as the core value proposition of GYD is to mitigate systemically important risk factors. Gyroscope is aiming to do so, by segregating risks and generally optimizing for resilience.
As such, Gyroscope’s ‘all-weather’ design is built to withstand:
- credit defaults of collateral assets
- smart contract exploits of single AMMs
- adverse local legislation affecting a collateral asset or AMM operator
- bank-runs on GYD
- censorship of GYD
While there are several relevant concerns that could be raised in regards to a GYD:DAI PSM, many of these concerns can be addressed.
Price variance around the peg:
- Even if GYD is pegged to 1$, it is likely that GYD will not always trade exactly at peg value, but fluctuate within a price band. Under normal conditions, this price band would be very narrow, but it may expand during shocks to reserve assets.
- The acceptable range of a GYD price band is influenced by various parameters that are yet to be defined. Whenever, GYD is trading above peg, for example, newly minted units trade at par + premium. That premium can be tweaked to allow for a broader or narrower price band.
Credit and smart contract risk of GYD:
- Gyroscope uses several assets and protocols and is thus exposed to a wide range of risks (e.g. credit default, smart contract exploit, …).
- While there might be a greater sum of individual risk factors, risks are segregated and never system-relevant on their own. In order for GYD to be severely impacted, it would not require one black swan event (e.g. Compound exploit), but several black swan events that would have to occur simultaneously.
- With over 4bn Dai in circulation, the demand for the PSM asset is significant. Meeting this demand could be a challenge, even for USDC, which has a current circulation of about 14.3bn units (Dai x ˜3.5).
- While the USDC supply provides an upper bound for its ability to function as a PSM peg asset, there is no such direct upper bound for GYD. True to its DeFi origins, minting new GYD to meet demand spikes is possible irrespective of bank opening times. As GYD is further issued against more than one asset it is generally more scalable than USDC.
Lastly, it is foreseen for Gyroscope to have several secondary mechanisms that are deemed complementary to the main stability mechanism. It is intended that leveraged ETH loans are one of these mechanisms. As such, a Dai-GYD PSM would be mutually beneficial.
Gyroscope is still under heavy development. There is currently an alpha testnet implementation with gamified levels that anyone is invited to try. Read a guide here or jump right to the Gyroscope dApp. The full v1 is being developed with an aim to launch in Q4.
With this post, we’re looking to gauge interest in developing Gyroscope closely with Maker.
We can foresee two different ways on how to eventually build out the proposed integration with the Gyroscope launch:
- Create a GYD-PSM with an initially very low debt ceiling and increase the debt ceiling over time to eventually completely replace the USDC-PSM.
- Start Gyroscope as a USDC wrapper and collaborate to transition the system to Gyroscope’s full features.
The overarching goal is to smoothly unwind PSM risks by gradually decentralizing and diversifying the PSM. We would be happy to work together with Maker to bring a version of Gyroscope to market that can serve as a Dai PSM.