March 22, 2023
After the Silicon Valley Bank collapse, what is MakerDAO's dilemma and opportunity?
Silicon Valley Bank collapse has caused the worst banking collapse in the US in more than a decade. More than a week ago, the crypto market’s concerns about the inability to fully redeem USDC caused a series of stablecoins such as USDC, BUSD, DAI, and FRAX to be unanchored. Although these stablecoins have repegged to $1, this crisis has given the crypto market a further understanding of the risks of stablecoins and has once again raised the need for decentralized stablecoins.
Can MakerDAO seize the opportunity to make DAI, its decentralized stablecoin with the largest circulation right now accepted by more users? Today, we would like to talk about MakerDAO’s dilemma and opportunity.
Introduction to MakerDAO
MakerDAO is a famous DeFi project that runs on Ethereum and integrates over-collateralized stablecoins (DAI), lending, saving, and governance. In MakerDAO ecosystem, two types of tokens are used: DAI and MKR. DAI is a decentralized stablecoin issued by MakerDAO, and MKR is the governance token of MakerDAO.
When users need to borrow funds, they can lend the stablecoin DAI by staking their crypto assets on the MakerDAO platform as collateral. MKR holders can participate in the governance of the MakerDAO platform. They can vote for changing interest rates, making proposals, and determining the future of MakerDAO. In February 2023, the MakerDAO team announced the establishment of Phoenix Labs to develop new DeFi projects such as Spark Protocol to expand MakerDAO's ecosystem.
Will MakerDAO Have Difficulty Surviving?
1. MakerDAO is operating at a loss
Rune Christensen, the founder of MakerDAO, pointed out that in the bear market, MakerDAO’s loan income and liquidation income have dropped sharply and the entire protocol requires a team of about 115 people to maintain. Employee expenses plus MKR’s compensation make the entire protocol at a loss and there is no growth. In addition, MKR's utility is limited. The price of MKR has been falling all the way since May 21, 2021, and MKR holders cannot clearly understand how the income generated by MakerDAO is exhausted.
2. Governance difficulties
MakerDAO's current governance process is time-consuming and complex, which makes the protocol unable to react quickly in Black Swan events and also slows down the development speed of new products. On March 12, 2020, the crypto market crashed. A large number of collaterals in MakerDAO fell below the liquidation threshold, resulting in $4 million in bad debts due to the failure to liquidate these collaterals in time. Afterward, the community proposed to issue additional MKR to cover the bad debts and introduce a new liquidation mechanism. On March 10, 2023, more than 700 million USDC was exchanged into DAI through PSM to escape, resulting in the unanchor of DAI. Then the community urgently proposed to increase the USDC exchange rate for DAI, but it was too late. On March 13, the community proposed to add a PSM emergency switch so that the exchange of stablecoins can be suspended without going through governance in times of crisis.
3. External competition
Frax Finance is a competitor of MakerDAO in the area of decentralized stablecoin. By seizing the opportunity of Liquid Staking Derivatives (LSD), it launched frxETH and sfrxETH. Currently, more than 110,000 frxETH have been minted. Moreover, other leading DeFi projects such as Curve, Aave, and Liquity are all ready to issue their stablecoins. The emergence of these decentralized stablecoins will continue to grab DAI's market share. MakerDAO will face more intense competition in the area of decentralized stablecoin.
4. Regulatory risk
After Tornado Cash was sanctioned, Circle, the issuer of USDC, actively cooperated with the US law enforcement agencies to freeze USDC of the marked wallet addresses. Some hackers will convert the stolen assets into DAI to escape the possible freezing of USDC and USDT. In addition, most of MakerDAO's treasury is USDC. In the future, US regulators may exert more regulatory pressure on MakerDAO.
DAI's Anchoring Mechanism
MakerDAO's core competitiveness is DAI. It is the most used decentralized stablecoin on public blockchains. MakerDAO uses four methods to help DAI anchor to $1.
1. Over-collateralized crypto assets
First of all, the risks of crypto assets which can be used as collateral in MakerDAO are relatively small. The assets are BTC, ETH, LINK, YFI, MATIC, stablecoins, and other cryptocurrencies that have undergone the challenge of the crypto market. In addition, according to the volatility level and risk of assets, MakerDAO will set a collateral ratio from 102% to 5000% to ensure that assets can be liquidated in time to avoid bad debts. It is different from algorithmic stablecoins like UST. The value of DAI is supported by a variety of less risky crypto assets, while UST is minted by LUNA and generated by Anchor, and the support behind UST is the market's confidence in UST.
2. DAI saving rate
Users who hold DAI can deposit DAI into MakerDAO's DSR contract to obtain savings income. MKR holders can vote to adjust the DAI saving rate. If the price of DAI exceeds $1, MKR holders can choose to lower the saving rate to reduce the demand for DAI, making DAI drop to $1. Conversely, MKR holders can choose to increase the saving rate to increase the demand for DAI, making DAI up to $1.
3. Peg Stability Module(PSM)
Users can use the PSM module to exchange USDC and DAI 1:1, with a total daily limit of 950 million (changed to 250 million on March 14, 2023). This non-slippage stablecoin exchange reduces transaction costs for users and incentivizes users to exchange and hold DAI. This expands the adoption of DAI in general, and at the same time, when DAI faces unanchoring, the market can use USDC arbitrage to help DAI repeg to $1.
4. Curve’s stablecoin 3pool
Curve's stablecoin 3pool consists of three types of stablecoins DAI, USDC, and USDT. Through the 3pool, DAI is bound to USDC and USDT. Under normal circumstances, when there is a stablecoin in 3pool that deviates from $1, ordinary users and arbitrageurs can make profits by depositing the stablecoin which has the smallest proportion in 3pool or withdrawing the stablecoin with the largest proportion in 3pool to help 3pool return to a balanced state.
Through the anchoring mechanism of DAI, we can find that, in addition to the DAI minted by collateralizing encrypted assets, DAI can also be exchanged directly with USDC through PSM, and exchanged with USDC and USDT at Curve's 3pool. The diagram below clearly demonstrates the collateral behind DAI: Fed Reserve.
At present, 62% of DAI is exchanged with USDC through PSM and less than 20% of DAI is minted through crypto assets. This makes DAI more and more centralized, and DAI is likely to bear the risk of USDC and USDT.
On March 10, Circle, the issuer of USDC, had a $3.3 billion risk exposure in Silicon Valley Bank. The bankruptcy of Silicon Valley Bank may cause USDC to be unable to be fully redeemed. The panic in the crypto market continued to rise, and USDC was unanchored, with the lowest unanchored to $0.88. A large number of USDC fled, among which more than 700 million USDC were exchanged for DAI through PSM and fled. In addition, most of the collateral of DAI is also USDC. The market is also panicked about DAI, which led to the unanchor of DAI. At present, USDC and DAI have re-anchored to 1 dollar, but the concern that DAI is becoming more and more like USDC has not disappeared. How to reduce the impact of USDC and USDT risks on DAI is a problem that MakerDAO needs to think about.
In addition, USDC held as collateral in MakerDAO vaults is used to purchase US Treasury bonds. At present, MakerDAO has purchased 500 million 6-month US Treasury bonds and proposed to allocate an additional 750 million USDC to purchase US Treasury bonds on March 8 to increase the revenue of the treasury. On the one hand, this has turned most of DAI's collateral into U.S. Treasury bonds, which are subject to centralized government agencies and are likely to face more strict regulatory scrutiny. On the other hand, this de-risks USDC and increases revenue for MakerDAO.
MakerDAO's Future Plan
1. More investment in bonds.
Although MakerDAO's purchase of US Treasury bonds has caused a lot of controversies, after November 2022, the benefits of Treasury bonds will become MakerDAO's main income, and most of the MakerDAO community also supports this investment. The benefits of bonds could help MakerDAO continue to operate and develop new products in a bear market.
2. Launch MetaDAO to simplify governance and increase MKR's utility.
Each MetaDAO is a sub-DAO of MakerDAO, which can have its own tokens and treasury, and focus on the division of labor, governance, and activities within its own DAO without being distracted by other MetaDAOs. Each MetaDAO can issue its own tokens and form a liquidity pool with MKR, and MakerDAO will provide additional MKR as a liquidity incentive. The upcoming Spark Protocol is the first MetaDAO, whose business is lending, directly competing with Aave. In the Spark Protocol, it is possible to allow MKR to be collateral to lend DAI, which will greatly increase the demand for MKR. Spark will support stETH and other LSD to lend DAI to attract more capital from Ethereum and reduce the proportion of USDC in DAI collateral.
MakerDAO is currently facing losses and intense competition, and the centralization issues and regulatory risks behind DAI cannot be ignored. Spark Protocol is an opportunity for MakerDAO to be a leading project in DeFi. Its successful launch will increase the demand and usage of DAI, and increase the utility of MKR: lending and liquidity farming. The subsequent launch of other MetaDAOs will continue to increase the demand for DAI and the valuation of MKR.
Previously, Beosin had established a strategic partnership with HashPort, a Japanese blockchain company, to cooperate in security audits and compliance assessments of blockchains and smart contracts. The audit projects included DAI and other stablecoins. Currently, DAI is being monitored by Beosin EagleEye, a security risk monitoring, warning, and attack blocking platform in real-time.
Beosin is a leading global blockchain security company co-founded by several professors from world-renowned universities and there are 40+ PhDs in the team. It has offices in Singapore, Korea, Japan, and other 10+ countries. With the mission of "Securing Blockchain Ecosystem", Beosin provides "All-in-one" blockchain security solution covering Smart Contract Audit, Risk Monitoring & Alert, KYT/AML, and Crypto Tracing. Beosin has already audited more than 3,000 smart contracts and protected more than $500 billion funds of our clients. You are welcome to contact us.
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