MakerDAO Fighting Liquidity Crunch With 0% Rates And a Dash of Centralization

Also, dapp activity surges to records, derivatives trading launches on Lightning Network.

Hello Defiers! These are busy times for crypto. Here’s what’s happening with decentralized finance:

  • MakerDAO brings out the big guns to fight the Dai liquidity crunch

  • It’s no all bad as dapp activity surges to records amid market bloodbath

  • Decentralized derivatives trading launches on Bitcoin’s Lightning Network

  • NY Blockchain Week will be largely virtual

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MakerDAO’s Drastic Times Call for Drastic Measures

Less than three years after its creation, decentralized finance’s existence is being tested. MakerDAO, which makes up roughly half of DeFi, has millions in bad debt resulting from ether plunging more than 40% last week, and is scrambling to contain damages with drastic measures.

MakerDAO last night approved to add fiat-backed stablecoin USDC as the third type of collateral borrowers can use to issue Dai. It also lowered rates even further, after slashing them last week, with the stability fee (similar to the borrowing rate) cut from 4% to 0.5%, while the Dai Savings Rate (similar to the deposit rate) cut from 4% to 0%.

The point of all these measures is to add more Dai to the system. The most serious consequence of last week’s so-called “black Thursday,” where one trader was able get more than $4 million of ether collateral for free, is that Dai liquidity, which was already low, is drying up.

Why There’s a Dai Liquidity Crunch

Traders are buying Dai, removing the stablecoin from circulation, to pay down their loans as the value of their ETH collateral declines and threatens to fall below the required 150% ratio. Some may be accumulating now, even if their loans are healthy, in case ETH suffers another sharp drop.

Users are loath from issuing new Dai on concern the ETH collateral they’d put up to back their loan, risks getting liquidated.

Others may be buying the stablecoin to participate in Thursday’s auction of MKR tokens, which MakerDAO is holding to raise enough Dai to recapitalize the system.

Market Reaction

The most direct reaction to a Dai liquidity crunch is that it has caused the stablecoin to lose its peg to $1, and traded as high as $1.1 Monday and $1.22 Thursday.

Dai price. Image source: coingecko.com

With rising demand to borrow Dai in the secondary markets (read: anywhere but MakerDAO), utilization ratios, or the total amount borrowed versus the total amount supplied for lending, are nearing 100% on dYdX and Compound Finance. This is caused lending rates to surge to as high as almost 40% yesterday, compared with less than 9% last week.

Even with lending platforms paying double-digit rates to deposit Dai, savers aren’t biting. Dai locked in DeFi is sliding, down 57% to just below 36 million, from a 83.6 million a week ago. Between drawdowns and the plunge in ETH price, total value locked in DeFi has almost halved from the start of the year, when it crossed the $1 billion milestone.

Image source: DeFi Pulse.

MKR has more than halved in price since Wednesday, the day before last week’s crash, and is now trading at $211, down from more than $500 a week ago, in anticipation of a supply shock after the auction.

What’s Being Done

MakerDAO is proposing a series of measures aimed at increasing Dai circulating in the market so that liquidators, a.k.a. “keepers,” are able to buy up the stablecoin to trade for ether collateral. This minimizes the risk of having keepers making $0 bids and going off with free ether.

The most important response was to add USDC, a stablecoin that’s backed by US dollars, as collateral. The goal is to diversify the types of digital assets backing Dai, so it doesn’t largely depend on a single cryptocurrency and is more resilient in the case of the extreme volatility of last week. Having a liquid, fiat-backed stablecoin, in addition to ETH and BAT currently accepted, also ensures there are enough assets that can be used to issue Dai.

The measure is controversial, as it means that for the first time, an asset that’s backed by US dollars in a bank, and therefore not as decentralized as ETH or BAT, will be backing Dai. To many, Dai was attractive because it was completely decentralized. Now that a fiat-backed stablecoin is backing it, it’s less so.

This was criticized by many in the DeFi space when initially proposed last year, but in times of market turmoil, it seems those concerns were overlooked.

The way the measure was approved was also controversial. The Maker team asked in a poll, whether the community wanted to add USDC, but it was only open for an hour and 45 people voted. The measure later passed in what Maker calls a “continuous vote,” which means MKR token holders who didn’t agree with the proposal, would have had to vote for the current state of the system.

Image source: forum.makerdao.com

MKR holders also approved proposals to: 1) Reduce the time for governance decisions to be executed to 4 hours from 24 hours. A reminder that this was just recently set to 24 hours from no delay, to prevent governance attacks. 2) Activate the option to freeze liquidations, in the case keepers need time to source more Dai.

More straightforward, but still dramatic, were decisions to cut the stability fee (borrowing rate) to 0.5% and DSR (deposit rate) to 0%. That means it’s now a lot cheaper to borrow Dai from Maker than from other DeFi platforms, whose rates range between around 6% and 11%.

It’s also an incentive to sell Dai, as Maker is currently offering no interest for deposits. That’s not true in other platforms though, as Dai deposit rates in Compound Finance, for example, are at almost 8%. MakerDAO has served as a benchmark for other DeFi platforms, so rates should eventually drop.

Results?

It’s early to tell whether all this will work, but for now, Dai was treading back to its peg and trading at $1.02, while Dai supply was still sliding.

Dai price (line), versus Dai supply (shaded). Image source: Coin Metrics

[Correct from earlier chart fro mkr.tools which showed supply for SCD, not MCD]

Ether Plunge, MakerDAO Crisis Spur Record Dapp Activity

It’s not all bad news in Ethereum as ether plunged for than 40% and MakerDAO deals with its liquidity crisis —activity on some decentralized applications is surging to the highest ever.

Decentralized Derivatives Trading Now Possible on Bitcoin

LN Markets, a derivatives trading platform built on the Lightning Network, is live on the Bitcoin mainnet in its public alpha. The Lightning Network is a protocol on top of Bitcoin which enables peer-to-peer, permissionless payments.

LN Markets leverages the Lightning Network as a settlement layer to provide a completely new experience where trading and transfer of bitcoin funds are done at the very same time, in one click.”

Coronavirus Spurs Virtual NY Blockchain Week

Synthetix’s Kain Warwick offers the most up-beat Twitter thread on the past days’ market turmoil.


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The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money. Sign up to learn more and keep up on the latest, most interesting developments. Subscribers get full access at $10/month or $100/year, while free signups get only part of the content.

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About the author: I’m Camila Russo, a financial journalist writing a book on Ethereum with Harper Collins. (Pre-order The Infinite Machine here). I was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. I’ve extensively covered crypto and finance, and now I’m diving into DeFi, the intersection of the two.