Great question and something I’ve thought about extensively. Rather than any single reason, I think a multitude of factors come into play that make it attractive to have a constant Oracle rather than a dynamic price for fiat-backed stablecoins.
The user story behind using fiat backed stablecoins to generate Dai is market-makers and auction-keepers trying to get liquidity. The lower collateralization ratio of fiat-backed stablecoins is an example of this, as it allows more leverage (more Dai generation). To a certain extent there is a third class of user that speculates on the Dai peg dropping when the peg is above $1. These are all behaviors we want to encourage.
- It ensures auctions participants are well capitalized (leading to more competitive auction prices).
- It ensures market-makers can get on-demand Dai inventory leading to less peg volatility.
- It ensures speculators can push the price of the peg down when Dai is trading above $1.
One way to encourage the above mentioned participants is to reduce risk. Using a fixed price Oracle that means liquidations can only be triggered by stability fees and time-delayed governance actions is a very powerful assurance.
So lets change context to liquidations. Liquidations are a function of the Maker Protocol trying to protect itself from falling asset prices so the protocol doesn’t have to cover those losses (stability fees and MKR dilution). Fiat-backed stablecoins have unique guarantees compared to normal collateral types in that they have redeemability for fiat from the issuing entities.
So lets set up a few different scenarios and see how they play out. I’ll use fiat-backed stablecoins and USDC here interchangably but these arguments all apply to PAXUSD and TUSD as well.
Crypto assets start mooning. Everyone wants to get on the rocket, Coinbase and Binance are crashing due to the huge influx traders. Prices of stablecoins tank, as traders are willing to pay a 10% premium to get out of their stable assets and into the mooning crypto assets. Let’s say both USDC and DAI temporarily hit $0.90. If we had a dynamic price Oracle we would see a bunch of USDC liquidations. But why is this a good thing? What has changed about USDC? Is it really worth $0.90 if it can be redeemed for $1. Is there an expectation that the fiat-backed stablecoins should return to their $1 peg? I think having a constant Oracle is actually a great defensive mechanism in this scenario in that it inhibits liquidations that don’t need to happen.
The issuer of the fiat-backed stablecoin pulls a Tether and starts printing unbacked stablecoins OR removes some or all of the existing deposits backing the current stablecoin supply. As the market becomes aware of this, the price of the fiat-backed stablecoin starts to crater. “The money is all gone, these tokens are worthless, dump it. take anything you can get for it!”. You start to see very quickly that fiat-backed stablecoin prices are really just binary. They’re either backed and thus redeemable or they’re not backed and thus worthless. In the later case the Maker Protocol would be forced to liquidate almost every USDC Vault position and would be unlikely to recoup much. For the sake of arguments let’s say protocol obtains and average price of $0.20 per USDC. In terms of magnitude this is almost the same as a total loss.
What happens next? Well legal proceedings would start against the custodian for fraud. It may take a long time for these legal proceedings to play out. But ultimately depositors are a type of creditor that would get a cut of the payout (if any). Unlike the crypto world, there is a whole web of legal infrastructure to claw back stolen funds / recompensate creditors. My argument is that the protocol will have a better game-theoretic outcome by not liquidating the fiat-backed stablecoin and instead maintaining the legal claim on the underlying than it is try to dump the tokens and relinquish that legal claim. In other words, the expected value of the legal claim is greater than the difference in price between liquidating the fiat-backed stablecoin immediately and liquidating the fiat-backed stablecoin at a later date. One thing I want to emphasize here is that the benefit of the static Oracle over the dynamic Oracle in this scenario is that it gives the Maker Protocol more flexibility. Governance could still decide they don’t like the odds of the legal case or don’t want to wait for it to resolve and initiate governance action to liquidate the USDC at the fmv in batched amounts (perhaps even find OTC buyers and create auctions with price floors of the agreed amount). It’s a more controlled way of adminstering liquidations that leverages the unique properties of fiat-backed stablecoins.
I think even if we keep stablecoins pegged to $1 usd we should at least turn on liquidations for when vault holders go below the collateralization ratio.
Completely agree, there’s no reason not to turn on liquidations due to stability fees.