MakerDAO proposal to lend DAI with MKR token faces heat

Decentralized stablecoin DAI is making headlines for all the wrong reasons after MakerDAO’s tokennomics Endgame. Some even raised concerns by recreating links to the Earth ecosystem collapse and the UST unlinking event.

Stablecoins, in general, have faced uncertainty from regulators around the world – especially decentralized stablecoins. If government authorities/regulators were to attack a decentralized stablecoin, it could be for a number of reasons.

Decentralized stablecoins, like other cryptocurrencies, operate outside the traditional financial system. Regulators may be concerned about their potential impact on the economy or their use in illicit activities such as money laundering or terrorist financing.

Last year, MakerDAO co-founder Rune Christensen reiterated a similar scenario after the Tornado Cash sanctions. According to Christensen, it was only a matter of time before government authorities attacked MakerDAO as a decentralized stablecoin. Consequently, he proposed Endgame, a major overhaul plan to make MakerDAO and DAI more censorship-resistant.

Maker Endgame documentation in 2023

MakerDAO is a decentralized finance (DeFi) platform that operates on the Ethereum blockchain and allows users to create and trade stablecoins backed by collateral in other cryptocurrencies. MakerDAO’s native token (MKR) governs the platform and maintains its stability.

MakerDAO has introduced a new feature called “endgame tokenomics” that aims to stabilize the price of its stablecoin, DAI, and reduce the risk of liquidation. This new system proposes to break DAO into smaller units called MetaDAOs. Each MetaDAO has unique tokens, each with specific purposes, and introduces a 25% cap on centralized assets backing the DAI, as well as negative interest rates.

Release Overview Source: Maker Endgame documentation

The MakerDAO co-founder suggests that DAI holders could produce the new MetaDAO tokens as an added incentive. However, the launch of the proposal was the target of much censorship and criticism.

calling this move

PaperImperium, a pseudonymous cryptographic Twitter account dedicated to developments in decentralized finance, drew attention to a portion of the document today. It reveals that users can borrow DAI on their delegated MKR tokens, should the proposal pass. MakerDAO risked repeating the mistakes of the last market cycle.

The commentator claimed that in the event of a sell-off spiral, the delegated tokens would re-circulate, lowering the value of the MKR. This, in turn, can expose the protocol to attacks by malicious actors who can easily hijack governance, citing the Mango DAO attack.

This new system has drawn comparisons to other DeFi platforms like LUNA and UST. LUNA is the native token of the Terra blockchain, a DeFi platform that offers stablecoins backed by fiat currencies. UST is the stablecoin offered by Terra, pegged to the US dollar, which has witnessed a massive fall from grace. Arthur Hayes of BitMEX tweeted:

Another user took to Twitter to echo the same scenario.

Like MakerDAO’s Endgame Tokenomics, the Terra platform used a mechanism called “seigniorage” to stabilize the price of its stablecoins. Seigniorage involves the creation and destruction of tokens in response to changes in demand, with new tokens being created when the cost of the stablecoin drops and devastated when the price rises.

Others described this is a possible liquidity exit scheme that allows users to exit the ecosystem through DAI without selling their MKR tokens and at the same time have a say in the governance of the protocol.

What Went Wrong with Earth’s Ecosystem

Terra is a blockchain platform that aims to create a stablecoin ecosystem. One of its stablecoins, TerraUSD (UST), is backed by a reserve of other cryptocurrencies, including the platform’s native token, LUNA. LUNA’s backing of UST is intended to maintain a stable peg with the US dollar.

To hold the pin, Terra uses a mint and burn mechanism. When the price of UST exceeds $1, users can mint new UST by depositing collateral such as LUNA and receive UST in return. On the other hand, when UST prices fall below $1, users can burn UST to get the underlying security.

However, the value of the UST fell below its peer against the US Dollar, leading to a death spiral where users started selling their UST to avoid losses. This caused the value of UST to fall further, triggering the minting of excess LUNA as collateral to hold the peg.

SwissBorg UST Risk Report Source: SwissBorg
SwissBorg UST Risk Report Source: SwissBorg

As more LUNA was minted to back the UST, the value of LUNA also began to drop, compounding the problem. To address the situation, Terra implemented measures to stabilize the system, including burning excess UST and LUNA and introducing new mechanisms to maintain the peg.

How significant is the risk? Should we be concerned?

The incident highlighted the challenges and risks of maintaining a stable currency, particularly in volatile market conditions. It also highlighted the importance of transparency and communication in managing such situations, and the need for sound risk management and contingency planning.

On the contrary, not everyone saw this movement as negative. CEO and creator of Frax Finance, Sam Kazemian, stated:

Another researcher highlighted the low-risk nature of the given development despite the unrest. Here, shedding light on the market value disparity between DAI and MKR meant that the perceived risks for DAI were small.

BeInCrypto has reached out to MakerDAO representatives for comment on the ongoing situation, but has yet to receive a response.

What is the current situation?

Overall, the attractiveness of MakerDAO’s Endgame Tokenomics to platforms like LUNA and UST lies in its potential to reduce the risk of liquidations and stabilize the price of stablecoins. Currently, USDC backs the DAI with 40.8% of all collateral. This adds stability and lessens the chance of a detachment.

DAI stats overview Source: DAI stats
DAI stats overview Source: DAI stats

One can also use assets other than USDC and MKR as collateral. This reduces the risk, but it’s still not a good move by MakerDAO. With this movement, the MKR is linked to the minting process. By creating a buffer against price volatility and incentivizing users to keep stablecoins stable, these platforms can provide a more reliable and predictable environment for DeFi users.

DAI price performance over a year Source: BeInCrypto Pricing
DAI price performance over a year Source: BeInCrypto Pricing

As of this writing, DAI has succumbed to some pressure given the uncertainty within the community ahead of the latest development.


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