Since we’ve just received the very first - I believe - collateral onboarding submission by TUSD, I think it would be useful to discuss a question that is often brought up: What’s the point of locking up a stablecoin to generate a stablecoin? Why would anyone ever open a CDP backed by TUSD, USDC etc if they have to pay a stability fee and there’s no possibility of the asset going up in value?
The answer is that not everyone would want to do this, but there are some who really want it: Market makers and keepers.
For market makers, being able to collateralize stablecoins allows for highly flexible and efficient inventory management, and the result is that Dai will become significantly more liquid against any stablecoin that is onboarded as Dai collateral. This is because a market maker will be able to offer large trades at very low spreads, since their capital intensity becomes very low, because stablecoins can have extremely low liquidation ratios. At scale, you can almost think of it as if Dai starts behaving like a fiat backed stablecoin itself, in that it will be so easy to exchange it 1:1 with very low spreads to USD and fiat.
Here’s some specific examples:
Imagine a USD-backed-stablecoin as Dai collateral that has a liquidation ratio of 100.5%, and imagine a market maker with 1 million of the USD-backed-stablecoin in his inventory. A counterparty then approaches the market maker with 100 million USD, and wants to convert that to Dai. It seems like converting 100 million USD into Dai in one go would be very difficult without significant slippage, but with stablecoins as collateral it now becomes trivial. The market maker simply receives the 100 million USD, converts it into the fiat backed stablecoin, and together with his own 1 million in capital he’s able to instantly generate 100 million Dai and close the trade. Because his only costs are the cost of his 1 million in internal capital, and the stability fees on the stablecoin CDP until his trades balance out in the other direction (which in a very liquid market shouldn’t take long), he can charge a razor thin spread and still make a lot of money because the volumes get so high.
Another and more simple use case is for when the price of Dai trades above the peg, like what’s currently the case. To earn some free money, a keeper can take his capital and turn it into a fiat stablecoin 1:1, and then generate Dai, buy more fiat stablecoins (at a rate above 1 USD because Dai is above the peg) and continue the cycle of buying fiat stablecoins with generated Dai. A single keeper would theoretically be able to bring the peg back down by doing this, if the debt ceiling for the fiat stablecoins were high enough. However the strategy does rely on Maker governance continuing to lower DSR and stability fees in this scenario, since otherwise the keeper will be stuck paying the stability fee on non-appreciating fiat stablecoins and could ultimately end up loosing money. However as long as there is a way for keepers to signal that they are this kind of position and will eventually unwind it, it should work well together with governance ensure much greater stability of Dai.