Weekly (almost) Narrative on MakerDAO - 02 July 2019

General

During the course of the last week, the community held a polling vote where the winning proposal was to increase the rate by 100bps to 17.5%. At the time of this narrative, the executive vote looks unlikely to pass as market conditions (a DAI price that had sagged slightly below 1.0000 has since partially recovered without a rate change). Further, the underlying collateral has had some material price erosion during the same time-frame.

The overall price* of DAI has solidified around its soft peg target of 1.0000 and for the most part stuck to the peg. During the last week, the total outstanding DAI has now expanded to just slightly above 90.2mm DAI following a surge of new DAI being minted (and even after some notable CDPs closing their large positions). The above being said, as the DAI price* continues to hover right at the target of 1.0000, we can draw an initial conclusion that most of the market maker inventory has been cleared out with some market makers indicating challenges in fulfilling large OTC orders.

Even after the price decrease in ETH, the outstanding supply of DAI continued to raise even with a continually elevated stability fee. Discussions continue related to increasing the debt ceiling, and the community is prepared for further tightening of monetary policy should the price of DAI continue to erode more.

Further, the average daily maker burned (as calculated) is now right at ~70 MKR per day, down from over ~60 after the recent Stability Fee decrease. The total MKR in the “burner wallet” has now surpassed ~1950 MKR after some large CDPs closed their positions. The P/E ratio (fully diluted less the burner wallet) has also decreased as a result of both price decrease of MKR along with the earning component bring increased with the recent increase in the DAI outstanding.

During the past week, the Maker Foundation released updates related to the MCD launch. While the exact launch date is unknown and the MKR token holders must vote to officially launch the MCD smart contract, there are many governance actions the community should be taking now in advance of such a launch.

At present, the only tool in the toolbox to increase or decrease supply is the stability fee. While the nomenclature is commonly referenced, it is important to take a moment and point out how the stability fee in SCD and MCD are drastically different.

SCD:

Stability Fee(SCDx) = RP(SCDx)

MCD:

Stability Fee(MCDx) = DSR(uniform) + Oracle Fees(MCDx) + Risk Team(MCDx) + RP(MCDx)

As such, there is a fundamental shift in the thinking about how the community strives to meet its core objectives of maintaining the soft peg of 1.00000 for both pre and post-MCD.

In SCD, the objective was to control the supply by modifying the SF(SCDx) to find the equilibrium of where supply would meet demand thus by derivative the price would meets its soft target of 1.00000 That is to say the SF(SCDx) was being used to create incentives for supply increases or decreases.

In MCD, the objectives shift and are both magnified and segregated. The community must continue to meet its core objectives of maintaining the soft peg of 1.00000 via supply and demand but now must also manage risk in a way not done in SCD.

In SCD, the SF(SCDx) was only used to control supply. In MCD, the SF(MCDx) is used to control/insure the risk of a given collateral package, in theory ignoring completely the subsequent supply created as long as it is risk-adjusted supply.

For reference, a collateral package is being defined as any given collateral that has different parameters. Those parameters include debt ceiling, liquidation ration, and collateralization ratio. A given collateral may have one or more of these packages. Each of these packages when viewed compared to the system and the collateral itself must be initially priced via a SF(MCDx) to the point where DAI that is minted from that collateral package has been appropriately de-risked to the point of being “almost” riskless. While nothing is every truly completely riskless, the objective remains the same.

As such, in advance of the MCD launch, the community needs to gather rough consensus as to what the initial collateral package(s) should be. Logic would recommend that we should launch with a similar collateral package as we have done in SCD, thus using ETH. However, the next question that is raised is what is the appropriate RP(eth) in MCD? As the current collateral package was able to survive a 95% decline in the ETH price even when its RP(SCD) was set to almost zero, it is arguable whether we should launch MCD with the collateral package of ETH with an RP(eth) of 16.5% (as it is currently priced).

Further, if we view the RP(eth) to be purely that of how to de-risk the collateral package, then the RP(eth) should be closer to 2% (the value is only a suggestion and should be ultimately decided by a risk-team or the interim risk-team).

Logically, if we materially lower the RP(eth) from 16.5% to 2% in one shot, we will see a surge of DAI being minted which would no doubt erode the price of DAI in the market.

Likewise, as it is understood, the community does not plan to launch the DSR when MCD is also launched, so we do not have a way to mop-up the excess DAI.

Therefore it is recommended to launch MCD with two collateral packages.

  • The first collateral package with materially the same parameters that the SCD world is using now with a similar RP(eth) of 16.5%

  • The second collateral package with materially the same parameters as SCD (but with a $100 debt ceiling) and a RP(MCDeth) of 2%

Thereafter, it is a sequencing question of when the debt ceiling on the second is raised and by how much. More specifically, the moment any material DAI is minted from the second collateral package, the community is recommended to time the launch of the DSR in parallel. The DSR is an essential tool to offset a risk-less DAI source with a risk-less DAI “sponge”.

Ultimately, by lowering the debt ceiling on the first to zero, new participants will be inhibited from using the collateral package on a going-forward basis. Thereafter, market forces will naturally cause participants in the first package to refinance their debt to a lower cost of capital in the second.

Therefore we need to not only have general consensus as to the starting rate for the DAI Savings Rate but also the general sequence.

As the DAI Savings Rate should be viewed as a competitor to traditional saving rates or even United States Treasuries, iterations on the increase post DSR launch should be no more than 25 bps at a time in general. Further, the objective should initially be price the DSR below a UST and slowly increase to YTM harmony and then increase above it, as needed.

Further, the community should start an active discussion on what its role will be regarding voting engagement. Will it be to vote on each RP(x) for each collateral package and not the DSR, thus yielding that DSR rate decision to the interim risk team (while always retaining a veto)? Will it be to vote on each RP(x) and the DSR? Will it be to have the RP(x) be determined by the risk-teams and then vote on the DSR? Or will it be to vote on the recommended values from the risk-teams that comprise both? Or some other hybrid? Or will be X that morphs into Y? That discussion needs to be ongoing.

The single greatest challenge that Maker has in front of it will be how to correctly price that RP(x) per collateral package in a manner where voter apathy doesn’t inadvertently inject Risk Subsidy into the system. That is to say, that at scale, MKR token holders will simply not be able to keep up with the RP(x) for each collateral package to ensure the riskless nature of the desired output.

As such, in a world that will have hundreds if not thousands of different collateral packages, it is recommended to have multiple risk-teams that are compensated to evaluate the RP(x) for each collateral type and then average (or other) out their recommendations for the benefit of the community. Further, the community should avoid voting on the RP(x) directly but rather voting on the aggregate recommendation of the Risk Teams that are familiar with and can maintain the exponential nature of RP(x) for more risky collateral packages. The same holds true for the DSR.

The community needs to have rough consensus not only where we are going, but also on the short-term big picture steps on how to get there.

* price being determined by USD fiat offramp via USDC – DAI (at pro.coinbase.com)

NOTE: Not a part of the Maker foundation, just my $0.02 and not intended as advice in any capacity.

Top 250 MKR holders = 690516.588
1d 🔺: 119.480
1wk 🔺: -265.743
Live RP Fee: P/E (dilut.) 39.16 – P/E (w/o dev. fund) 29.08
FCST 50bps RP (VaR MKR burn portion): P/E (dilut.) 1297.81 – P/E (w/o dev. fund) 973.36
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