Subreddit Repost: Reducing Dai Redemption Value To Fix Peg

user raiden4 posted this on the MakerDao subreddit and it was interesting so I brought the post here for discussion. If you want to see the original comments see link here.

" TL;DR: In the present Maker design, the more demand there is for DAI, the less revenue Maker makes. But we can fix that and also fix the peg in the way.

The more useful DAI is, the more demand there is for it obviously. The more demand there is for DAI, the more DAI goes up in price. As DAI price goes up Maker must reduce the stability fees to incentivize increased supply in order to push the price down. The lower the stability fees are, the less revenue Maker makes. This is of course the opposite of any normal company where increased demand for a useful product means higher revenues.

But what about DAI supply? Isn’t it the case that the higher the DAI price is, the more incentive there is to lock collateral in a CDP, mint it and sell it “at a profit”? That’s not exactly true for the following reasons:

  1. DAI price can continue to go up after you sold. If you’ll need your collateral back you will have to buy back DAI at a loss, since you were effectively short DAI.
  2. There is a risk your collateral will go down in price and you will be liquidated.
  3. There is a risk the contracts will be hacked and you will lose all your collateral.
  4. Selling DAI short for a few % might not compete with simply locking the same collateral at other DeFi projects and getting potentially better returns (e.g ETH 2.0 staking).

Case in point, right now DAI price is $1.02, which means that arbitragers don’t consider the 2% profit (from selling at $1.02 and buying back at “fair value” of $1) sufficient to cover their risks.

That leads to the question: why do we even assume the fair value of DAI is $1?

An obvious answer is that DAI is backed by $1 worth of collateral that can be collected at global settlement. So we can say that roughly:

DAI’s value = value of redeemable collateral at global settlement ($1)

However we also need to consider the “usefulness” of DAI which adds to its value. Right now there are a few DeFi projects that offer yields on DAI deposits, most of them are higher than any USD savings account. So we should revise:

DAI’s value = present economic usefulness of DAI (a few cents) PLUS value of redeemable collateral at global settlement ($1)

The irony is that the more immediately useful DAI is, the less Maker (and MKR holders) will benefit since the stability fees will tend to go down as I explained above. And we want to make DAI as useful as we can, being programmable money and all, because we want lots of people to use it and in many different ways.

This situation also creates another problem - security. We NEED high MKR price to deter attacks. The more DAI there is, the bigger target Maker becomes and the more security it requires. However, more DAI means more demand (otherwise why would it be generated), which also implies high price, which means lower stability fees, hence lower revenues for Maker and a lower MKR price overall (excluding speculation). At some point that creates a risk for the Maker system.

I would argue that the stability fees must be above 0% at all times to establish a price floor for MKR and protect the system from MKR-related attacked. Recently MKR price went up in USD terms but it really went down when compared to ETH or BTC. Part of it is Black Thursday, part of it is being undervalued but another part is simply lack of revenues or (said differently) unattractive P/E ratio.

What’s a solution? Assuming we don’t want to hurt DAI usability (e.g by introducing negative rates or demurrage) and assuming the stability fees cannot be lowered any more (because they are at 0%, like right now - https://daistats.com), the only other piece in the equation is the value of redeemable collateral. If we make it slightly less than $1 (at global settlement), we can lower the price TO $1 (right now, which is arguably more important since GS is unlikely anyway).

Lowering the value of redeemable collateral also makes it easier to open CDPs since CDP owners will need to lock slightly less collateral and/or will have lower liquidation risk. It also reduces the risk of runaway DAI price in their short position. That means more supply and therefore additional negative pressure on price.

From a technical standpoint reducing the value of the redeemable collateral is very easy - we just need to ask the oracles to report slightly HIGHER prices. If prices are a bit higher than they really are, at global settlement DAI will redeem for a bit less collateral. No change to the smart contracts is required.

The only problem that I see is some controversy because DAI is “supposed” to be backed by $1 of collateral. But that’s just not true - DAI is supposed to be worth $1, not be backed by $1. If DAI holders can sell it for $1 then that’s all that matters.

I say we reduce the collateral value of DAI, let DAI drop a bit and then increase the stability fees to some reasonable level (not 0%)."

8 Likes

This would also allow MakerDao to not only better shift the price of Dai towards Peg more frequently, but would also solve the problem MakerDao has with not collecting stability fees at all times (which is something I have written about before).

I support the proposal since my proposal to stop ETH liquidations did not get much support. If DAI is backed by i.e. $0.8 collateral, can we get insurance to cover for the additional $0.2 through a decentralized insurer in case of the ES?

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The issue is the inability to expand the balance sheet of MakerDAO (all vaults have room to grow except WBTC) by itself and not providing an arbitrage framework (second problem).

Setting the LR @ 110% for USDC-A (0% SF and no liquidiation) sets an upper limit of 1.1 USDC per DAI. That’s a step, but not enough it seems.

Adding supply can be done by :

  • Adding more base collaterals (assuming a willingness of people to borrow DAI against it)
  • Printing unbacked DAI
  • Recycling locked DAI(Aave/Compound or Uniswap).

I think that the last one is the more important.

I wouldn’t say that DAI has more present value than other stablecoins likes USDT or USDC as they have a bigger market share. It’s just than instead of extending the supply like it should, demand is affecting the price.

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How do you propose we would go about recycling locked DAI from the DSR contract?

When there is a loan, there is DAI on one side and a collateral on the other:

  • aDAI/cDAI/Uniswap token if you are the lender
  • ETH/WBTC/something else if you are the borrower

I already touched the first part, but for the second part, we can hope than Aave/Compound use their un-lent ETH to borrow DAI at MakerDAO to lend to their customers. That would lower rates and makes USDC lending more yielding (depending on the SF). Basically, bring rehypothecation in DeFi.

I don’t know how to recycle DSR DAI. It shouldn’t be important as it’s DAI from Compound mainly if I’m correct.

1 Like

This seems very similar to this: MIP20: Target Price Adjustment Module (Vox) without negative DSR. Let me know if I’m missing something here, but if not I definitely support this idea.

On the topic of reducing collateral backing for dai: we could also lower the collateralization ratio on existing collateral types and this would bring down the amount that dai is overcollateralized by, without reducing it below $1, while increasing supply. I plan on making a proposal for this after the auction system is updated. Seems our 150%-200% CRs are just not capital efficient in this market.

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There is still a lot of room to add supply.

Lower the USDC LR @101%
I am sure that will generate a lot of backed dai
Use the surplus to generate USDC with @101% if no one is taker.
You can even put the LR @100%

We can really push down the USDC-A collateral ratio @105%, maybe 103%, but if you remove all market forces you can miss information then everything blow up Soros style.

What I don’t like about the USDC-A vault (versus a PSM) is that you don’t own the deposited USDC. You can always add liquidation and punishing rates to get out but it’s not ideal.

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We don’t own Eth neither, I think it doesn’t make difference. You can reduce the ceiling, people can’t enter anymore. If the peg if under 1 you can push up the ratio and start liquiding. Noone will lose.

PSM is still different as it creates a buffer at 1 which is probably not what we want or not. I think ideally we would like to have less resistance around 1 and more resistance after.

I think the best idea I read so far is from betfitandpiper is to buy some pool (uniswap).

But ideally we would have our own pool 50/50 for each type of collateral with dai. To push down the peg you Increase liquidity inside the pool. that way you inject 50% dai and you are sort of backed at root so you mitigate and you also create a reserve attached to the collateral.

To push up the peg you remove liquidity so you buy 50% of the collateral.

The beauty of the system is that you create an exit way for the liquidity system. It reduces volatility of the collaterals. And we can replace the oasis instant with it that way you will allow new joiner to convert directly at a decent price without headache. Currently the oasis slipping is too big.

And something you will like, we can spread the injection using different collateral to mitigate the risk attached to usdc.

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I have been lurking on this forum for some time, as I am fascinated by the monetary policy aspects of Maker. I have just decided to create an account and try to contribute to the discussion. If my ideas have already been discussed, please bear with me as I am slowly getting up to date with everything that has been previously discussed here.

The idea that $DAI’s value is greater than the value of redeemable collateral at GS is true. The market obviously agrees with this, as the price of $DAI is constantly above $1, almost impervious to the efforts of $MKR holders to bring the price down.

Also, the above observation is extremely valuable (and true). It would benefit all parties involved should $MKR holders govern while holding the above in mind.

While I agree that lowering the value of redeemable collateral is the only other variable that has not been (yet) tinkered with (and I fully support this tinkering), I believe the method proposed to alter this variable is suboptimal and ultimately detrimental to the Protocol.

Whatever $MKR voters will decide the new value of the collateral should be, there will certainly be no fundamental reason behind that specific value (Why $0.97 and not $0.98? Why change it now and not in an hour?). I believe such decisions are best left floating and to the open market, rather than being hardcoded through regular votes.

As such, I propose the creation of a new mechanism to (1) stabilize the peg by (2) decreasing the value of redeemable collateral while (3) letting the open market continuously decide what % of the value of $DAI is given by the value of the redeemable collateral and what % of the value of $DAI is given by other factors (economic usefulness, censorship resistance, decentralization, etc.) while, at the same time, (4) increasing the market value of $MKR.

I propose to allow $MKR holders to mint $DAI directly by burning $MKR.

This achieves the following:

  1. Stabilizes the peg by creating $DAI. For example, if the price of $MKR is $100 and the price of $DAI is $1.02, a $MKR holder can receive $102 by burning the token in exchange for 100 $DAI instead of selling it in exchange for ~98 $DAI. From the seller’s perspective, there is no difference (there is no extra cost nor is there any extra risk) in performing one action over the other. As such, even very small deviations from the price will result in profitable arbitrage opportunities (right now, not even 2% seems to be enough to cover the costs and risks of arbitrage). At any point in time, a $MKR seller must only look at the price of $DAI to decide if it is more profitable to sell or to burn the $MKR he wanted to get rid of anyway;

  2. Decreases the value of redeemable collateral. This is obvious: by creating $DAI by burning $MKR instead of by locking collateral in a vault, there now exists $DAI unbacked by collateral. For example, if there are 1000 $DAI in existence, 900 created by locking collateral in a vault and 100 by burning $MKR, the value of redeemable collateral in the case of a GS is $0.9. This can be further mitigated by allowing the Protocol to mint back $MKR and sell it in the market to cover the remaining $0.1 that was generated through burning $MKR (for further consideration: in case of a GS, should the Protocol be allowed to mint and sell $MKR up to the number of $MKR that was burned to generate unbacked $DAI, or up to the value of unbacked $DAI that was generated by burning $MKR?). Another possible mitigation for $DAI holders in case of GS is to automatically credit them with newly minted $MKR until their $DAI is fully collateralized at the $MKR price when the freeze happened (for example, if the price of $MKR is $2k and there are 200 $MKR and 100k $DAI in existence, 90k created by locking collateral in a vault and 10k by burning $MKR, so that the value of redeemable collateral is $0.9 at freeze time, each $DAI owner will be able to claim an extra (10k/(10k/(10k*200/(($2k*200)-10k))))/100k = 1/19500 = ~0.00005128 newly minted $MKR as collateral for every $DAI he owns at freeze time. The existing $MKR supply will be diluted by minting an extra ~5.1282 $MKR, resulting in a new $MKR price of ~$1950, so that the extra ~0.00005128 $MKR minted for each $DAI is equal to the remaining $0.1. The formula I used should probably be optimized.);

  3. Allows the market to continuously decide what % of the value of $DAI is given by things other than its redeemable collateral. $MKR holders should vote to slowly lower the floor, as more and more of the value of $DAI is given by things other than its redeemable collateral. I believe a floor of 99% would be a suitable value for now, so as to allow $MKR holders to burn $MKR to mint $DAI, up until a minimum of $0.99 redeemable collateral is available for each minted $DAI. The market might not even reach that floor, case in which the value of $DAI would reach $1 at a value higher than $0.99, and keep freely floating around that. In case the value of $DAI drops below $1, the Protocol can mint back $MKR to sell in the market to buy back $DAI until the peg is reestablished. In case the peg is consistently being dragged down towards the value of redeemable collateral (meaning $DAI is losing its value derived from things other than its collateral), the Maker community can either vote to bring the floor back higher or work towards improving $DAI and the Protocol so more of its value comes from things other than the collateral. This provides an incentive mechanism for $MKR holders to improve the Protocol and the ecosystem in such a way that the value of $DAI is derived from more things than just the collateral (so more and more $MKR is burned, increasing the value of the remaining $MKR), and hopefully provides a small step towards a future where $DAI is not pegged to anything else, but stable on its own;

  4. Increases the market value of $MKR. When $MKR holders burn the token instead of selling it in the market, they increase the value of all other $MKR tokens in existence. This provides a profitable avenue to liquidate $MKR without decreasing the market cap of the Protocol. Instead of giving the $MKR to somebody else, a $MKR seller instead burns the token and distributes its value to all other $MKR holders, while also providing a useful service to the Protocol (stabilizing the peg). This is important because, while on the surface it might seem the $DAI created this way is unbacked, it is actually indirectly backed by (the increased value of) $MKR in the case of a GS, by employing one of the strategies outlined above.

Some other advantages of this scheme:

  • Makes arbitrage capital efficient (it is now possible to arbitrage by using 100% of the available capital: just buy $MKR in the market and burn it to mint $DAI. As such, overcollateralization for arbitrage purposes is no longer required.);
  • Decreases arbitrage risk (removes the risk of collateral going down, of hacked contracts, etc. Just buy and sell.);
  • Lowers the barriers to entry in this arbitrage;
  • Adds another (powerful) tool in the arsenal to help maintain the peg.

In closing, I want to note that this change is not against the ethos (which I strongly support) that $MKR should not be used as a collateral of first resort. Instead of locking $MKR in a vault, $DAI is created by burning $MKR (and thus increasing the effectiveness of the remaining $MKR as collateral of last resort). By creating $DAI in this way, value doesn’t leave the Protocol. Instead, the value is distributed to the remaining $MKR tokens, increasing the $MKR price, and reducing the risk of governance attacks. This change makes it so that a value increase in the price of $DAI due to factors other than the redeemable collateral is captured by and profitable to $MKR holders, instead of hurting them through lower stability fees, further incentivizing $MKR holders to find ways to continuously increase the usefulness and value of $DAI beyond the value derived from its redeemable collateral.

Also, I would like to voice my support for permanent stability fees above 0% across all collateral types. This is an entirely different discussion, but from a monetary policy perspective, this is highly inappropriate.

11 Likes

Welcome!, and thanks for posting! I have considered this idea and I do like parts of it. However, I have an issue with the timing of these $MKR burns and mints.

As it stands with the idea in the current form the incentive is for $MKR to be burned at higher values and minted at lower values which leaks value out from the protocol. If you can think of a good solution to this concern or provide a valid reason why it isn’t a problem I am happy to come around to supporting this.

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Maybe we should let the market do its thing and not worry so much about trying to manage it.

DAI is backed by 1 USD worth of collateral. Its a simple thing, but very, very valuable to the ecosystem. Maybe we should just let the market figure out how to value DAI in the mean time. We are worried about the product market fit for DAI, but it seems like the market is already screaming that it has fit. I’d argue for this approach over reducing the collateral to $.98 or whatever (because this will likely be something we then have to manage in perpetuity).

I also agree that zeroing out all the risk parameters in order to chase the peg is extremely dangerous. Stability fees should always be higher than zero and we need to maintain safe liquidation ratios. It doesn’t matter what the peg is if the system blows up.

I also agree that MKR price is a key component to securing the protocol. I don’t know what the solution is for this, and there is a noble aversion to taking actions to pump MKR price, but it could become a real long term problem as the system increases in value.

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I don’t see how you arrived at this conclusion. Please provide further explanation.

Assuming the market cap of $MKR is constant and the only variable affecting the price of $MKR is the number of tokens in existence, the same value exists inside the protocol, irrespective of the number of $MKR tokens in existence. Should the value of $DAI increase above its peg, marginal hodlers would bail for a small profit by burning their $MKR and redistributing the value of their burned tokens to all the other longer-term believers. This would not affect the market cap. The value of the Protocol (expressed through its market cap) is not affected by the number of tokens in existence. In essence, mints and burns do not affect the market cap, being similar to a stock split and a reverse split. If the market cap of $MKR is increasing or decreasing, it is happening for other reasons. No value is created or destroyed by minting or burning tokens. It is simply redistributed from marginal hodlers to longer-term supporters (which is a good thing for the stability of the Protocol, having more of its stakeholders aligned with the long-term vision rather than in for a quick buck).

The market has done its thing and has already reduced the collateral to 98%. I am not arguing for reducing the collateral to an arbitrary value. Instead, I am arguing for maintaining the peg. If the market has decided that a $DAI is worth 2% more than its redeemable collateral, why keep the value of redeemable collateral at $1 and the price at $1.02, when we can lower the value of redeemable collateral to $0.98 and have the price be $1. In case of a GS right now, every $DAI owner would only be entitled to collateral backing 98% of its value. It just so happens that right now that 98% is equal to $1.

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That’s where the market is today. The point is that it constantly changes. Last month it was at 1.03. Six months ago it was at 1.00. A year ago it was bouncing around, often times under the peg. Who knows where it will be next month or next year.

I think that fixing the collateral at 98% is only a short term solution that makes our product worse. There is actually a decent chance that if we do make DAI worse in this way, the market will then decide that it isn’t worth a 2% premium any more. But then you can’t really raise the amount without possibly causing liquidations.

1 Like

Please read my initial reply again.

I am not arguing for fixing the collateralization ratio to 98%. I am arguing for slowly lowering the floor for the minimum collateralization factor and allowing the value of the collateralization factor to be freely decided in the market by letting participants burn $MKR in exchange for $DAI, while at the same time maintaining the peg.

Right now, the collateralization factor is still decided by the market, but instead of letting market participants mint more $DAI to express their preference, they are only allowed to bid up the price of $DAI until the desired collateralization ratio is reached (around ~98% at the time of writing).

If $DAI drops below $1, then the Protocol would simply mint $MKR and buy back the uncollateralized $DAI (that was generated by burning $MKR) until either (1) the peg is reestablished or (2) all the uncollateralized $DAI has been bought back from the market and destroyed (so that each $DAI is once again backed by $1 worth of collateral, even if the peg has not been yet brought all the way back to $1). There is no risk for liquidations, as it will be $MKR holders that will provide the value needed to bring back up the collateralization ratio in case the peg goes below $1.

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@StefanPatatu We have different perspectives on what would take place when $MKR is being burned. I have the view that one of the two following is what takes place (both of which increase $MKR price during burns and lower it during mints):

Above peg for burns someone is looking to burn $MKR to make a profit. The market is less willing to part with $MKR in times like this is my general point (Plus there is less in the market since it is being removed by burning):

  1. If this person doing the burning does not own $MKR they have to buy it from the market to burn it which drives price up.

  2. If this person already has $MKR they wanted a position in the first place so they now will likely buy $MKR and then burn it so that they can keep their original $MKR and the price goes up. Perhaps they burn some of their own $MKR but that has not been tested yet and I see it as unlikely based on human nature.

Below the peg nobody is buying $MKR to profit from Dai being above peg anymore so all that demand dries up. Now, the protocol is minting $MKR and selling it into a market that is less willing to buy. This drives the price down fast. The result is a loss of market cap for the protocol and leaked value. It results from the protocol essentially printing Dai at higher $MKR values than it re-purchases the Dai for. It also creates feedback loops in both directions.

I can best show this through an extreme example to emphasize what I am saying: If the price of $MKR say rises from $500 to $2,500 because nobody is willing to sell it and it just keeps getting burned as Dai demand persists above the peg level. The market could print say 500 million Dai and sell it for an average price of $1,500 per $MKR. Now, after that if the market conditions change and Dai starts dropping below the peg the protocol needs to repurchase Dai and if $MKR price falls back down to the original $500 during this time faster than it rose (which it would) the average sell price might be only $1,000. Which means a 33% loss of value and it was offset by only say Dai being 1.02 and .98 so 4% or so. This is a massive loss. That is the potential problem I am seeing and I argue that a loss on the round trip for the protocol is more common than people might think. If the market cap was the same after there would be 29-33% more $MKR than there was before meaning a 29-33% dilution of value to holders. The greed around increased ownership during buybacks and the fear of dilution during $MKR prints will act to further make these swings more violent. Extending this out to the largest of swings. The protocol could actually go belly up from this if the market no longer believes that MakerDao can back the value of the Dai. If we raise rates on the loans and the vault holders flee the system and the market loses confidence as the peg falls from $1.00 there may not be enough people willing to step in and buy $MKR at all and the whole system implodes.

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Hey Stefan, to my knowledge this is a unique proposal. And I think it’s one that should be explored. I’m a fan of it at first glance.

I wonder whether there should be a ‘debt ceiling’ of sorts for the amount of MKR that can be burnt by users. This ceiling can be increased as desired by Executive votes. This might add an element of safety and control.

I think this idea has big positives:

  1. It increases DAI supply which should lower the peg.
  2. It increases MKR value by removing MKR sellers from the open market.
  3. MKR holders are incentivised to burn for DAI if DAI is above peg.
  4. MKR holders are incentivised to trade on open market if DAI is below peg.
  5. Holders burning MKR would only be doing so if they were planning to sell anyway. This wouldn’t incentivise MKR holders to burn.

@FourthStreet, I’m not certain that this necessarily would burn MKR inefficiently. I would be open to being proven wrong though. In fact, I think it may also be the opposite. Someone burning DAI is

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To complement The_Rajt I agree that this is a completely different proposal which I personally find interesting and worth looking into

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Thank you for elaborating on your concerns.

While I believe your view of how market participants would act in the aforementioned cases is generally correct, I still disagree with what you think the consequences of such actions would be.

Still, I have considered your concerns. I think they have validity and should be addressed. Markets are not (always) rational and efficient, and I agree with you that we must limit the possibility of enabling feedback loops that have a chance of negatively impacting the Protocol.

With this in mind, I propose the following changes to my initial design.

Instead of letting market participants burn $MKR to generate $DAI, we let the Protocol do it.

We implement a function that allows users to lock $MKR whenever they want, but they can only unlock it back when $DAI is at or above the peg.

This locked $MKR is then used by the Protocol to burn $MKR to generate $DAI at a profit when $DAI is above the peg. The newly generated $DAI is then used to buy back $MKR in the market and to add it back to the locked $MKR. For example, if $DAI is $1.02 and $MKR is $100, the Protocol can burn 1 $MKR to generate 100 $DAI, use that $DAI to buy back 1.02 $MKR, and then add that 1.02 $MKR back to the rest of the locked $MKR.

This acts like a DSR for $MKR holders (MSR?), like a $MKR investment account. Users that lock their $MKR inside the MSR take the risk that they can’t sell their $MKR in case the peg drops (so there is always value in the Protocol in the form of a large number of unsellable $MKR to avoid the risk of a downwards spiral), but they are paid in $MKR when the peg rises.

To further stabilize the system, I propose 4 variables that can be decided through votes by the community:

  • MSR Stability Fee: instead of distributing 100% of the profits back to MSR users, a percentage of the profits are set aside in a similar way to the current System Surplus, but denominated in $MKR and with no maximum cap. This $MKR in the $MKR Reserve is then used by the Protocol to be sold in the market to buy back uncollateralized $DAI in case the peg drops, without needing to mint back any new $MKR (unless the peg drops significantly). The $MKR Reserve is used to smooth out day-to-day market movements, without needing to bring new $MKR into existence every time the peg drops temporarily below $1 due to regular market noise. My intuition tells me we should start with a large fee (like 50% - in the above example, 0.01 $MKR would be distributed as profit to MSR users and 0.01 $MKR would be added to the $MKR Reserve), then slowly bring it down to a reasonable level, aiming to maximize the fees collected for the $MKR Reserve (see Laffer Curve);
  • Peg Range: this is a powerful tool that should only be used when the peg deviates significantly. As such, I propose we bring the peg down by burning $MKR only when the peg is above $1.03, and to buy back $DAI only when the peg is below $0.99 (in the beginning, until we get a proper grip and understanding of this tool). Between $0.99 and $1.03, all the other tools that are currently in use should continue to be used to keep the peg stable. In this way, we assume a ~4% range (in the beginning) within which we let the peg float. If the peg goes outside this range, the Protocol will employ the MSR mechanics to reestablish the peg. As the community gets more experience and $DAI gains more liquidity, this range can slowly be lowered (let’s say we aim to bring it to $0.99-$1.02 within the next 12 months);
  • Maximum Daily Burn Rate: to further limit the effects of this tool on the peg and on the Protocol in general until we get more experience with it, we can start with a low MDBR (of let’s say 10 $MKR per rolling 24 hours). If we find it is beneficial, we can slowly increase the MDBR to increase the effect it has on the peg when the peg goes above the range defined above;
  • Burn Ceiling: as proposed by @The_Ratj above, a burn ceiling, in combination with an MDBR, both decided through votes, guarantees this proposed tool is well contained in both range and velocity.

In this way, $MKR also becomes a utility token. If the peg goes above $1.03 (or whatever the community decides the value of $DAI where the MSR mechanics kick in should be), locked $MKR benefits more than unlocked $MKR (unlocked $MKR still benefits from the increased value of $MKR due to it now being less $MKR in existence, but locked $MKR also increases their nominal $MKR holdings). To get increased benefits, locked $MKR takes on the extra risk that it can’t be monetized in case the peg goes below $1 (this should be hardcoded to $1, as locked $MKR should never be able to be unlocked unless the peg is at or above $1, regardless of what the above peg range is ($0.99 in my examples above)), so there is always some $MKR that is unsellable and available to dilute, even if everybody else wants to sell at the same time, significantly lowering the risk of a detrimental feedback loop.

The last part of the MSR mechanics is voting. As it stands, my proposal (described above and in my previous replies) assumes every $MKR locked in MSR still has the same voting power as the unlocked $MKR. I am not sure this is beneficial for the Protocol, and I encourage feedback on this particular matter. Here are some other possibilities that might be more beneficial for the future of the Protocol:

  • Locked $MKR receives a static voting power multiplier (for example, every vote cast by a locked $MKR is worth 1.05 votes). This is to further incentivize $MKR holders to assume more risk to secure the Protocol, while at the same time lowering the probability of governance attacks (evil actors wouldn’t want to lock their $MKR as they would be unable to sell it if the attack succeeds);
  • Locked $MKR starts with standard voting power, but it slowly grows for up to a maximum of 2 years (for example, when $MKR is locked in, it still has the same voting power as unlocked $MKR, after one year it has 1.05 voting power, and after 2 years it has 1.1 voting power). This encourages longer-term locks over shorter-term locks and further lowers the risk of governance attacks (as evil actors would have to lock capital for an extended time to increase their voting power);
  • Only locked $MKR is allowed to vote, $MKR freely floating in the market is no longer allowed to vote. This might be the most controversial, but maybe also the most beneficial for the long-term success of the Protocol. It renders governance attacks almost impossible (as all the $MKR purchased to attack the Protocol would no longer be liquid if the attack succeeds, virtually guaranteeing the complete loss of capital used to perform the attack). This is somewhat similar to how Class A and Class B shares work in the outside world (see Class A Shares vs. Class B Shares). An investor who is only looking to ride the market can buy in and out of $MKR as he pleases, while an investor interested in governance and believing in the long-term success of the Protocol takes on more risk for the added benefits. Even more, the $MKR locked in MSR can be tokenized and then a market can exist for the equivalent of Class A and Class B shares in the Protocol, finally providing a way to gauge how much of the value of the $MKR tokens is driven by speculation, as opposed to being driven by voting rights.
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