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Intro

DAI, the stablecoin issued by MakerDAO, has experienced significant fluctuations in its supply dynamics over recent months, illustrating a complex interplay between market forces and protocol adjustments. After a period of declining supply from October 2023 into early March, DAI’s total outstanding volume has surged impressively. Specifically, from March 9th, the supply escalated from 4.42 billion to 5.48 billion by May 12th—a remarkable 24% increase in just over two months.

This recent uptick in supply follows a period of notable decreases, especially at the end of January and early March, when the supply was generally on a downward trend. Key to understanding these fluctuations is the Dai Savings Rate (DSR), a mechanism within the MakerDAO ecosystem that impacts the circulating supply of DAI. 

DSR and EDSR

The Dai Savings Rate (DSR) is a foundational element within the Maker Protocol, offering DAI holders an opportunity to accrue yield on their holdings. The DSR offered operates similarly to a traditional savings account but for DAI stablecoin users. This facility permits these users to place their stablecoins into a smart contract, enabling them to accrue interest. This smart contract is designed following the ERC 4626 framework, an advanced adaptation of the ERC 20 token standard, commonly used for creating vaults that generate yield. The interest rate for these deposits is set by Maker governance and can be adjusted based on community consensus. Generally, the interest rate is lower than the typical fee required to create DAI, as the funds for the DSR are sourced from the protocol's earnings.

The DSR not only supports the stability of DAI but also serves as a tool for monetary policy, influencing the supply of DAI. This setup offers users the flexibility to transfer, stake, lend, or utilize their DAI, with conversion between DAI and sDAI managed via the DSR module. Platforms like SparkLend provide a user-friendly interface for engaging with sDAI.

However, the DSR strategy is not without its costs. For instance, in August 2023, the annual payout to DSR depositors reached ~8% Annual Percentage Yield (APY), and by January 2024, this figure dropped to 5%. These expenses have significant financial implications for MakerDAO. The revenue of the DAO not only funds the DSR but also covers other protocol expenses, including the Maker Smart Burn Engine and a surplus buffer. This surplus buffer, accumulated from protocol profits, is critical for various operational aspects of the MakerDAO protocol, including managing bad debt from over-leveraged vaults.

The Enhanced Dai Savings Rate (EDSR) is a temporary measure designed to amplify the effectiveness of the DSR, particularly in its initial low-usage phase. It works by applying a variable multiplier to the DSR. This multiplier changes depending on the proportion of DAI held in the DSR; as more DAI is deposited, the EDSR decreases, and conversely, it increases when fewer DAI are deposited. The EDSR is not a distinct rate but an augmenter of the DSR's efficacy, offered to DAI depositors on a case-by-case basis. This feature was introduced to boost DAI demand and make it more competitive with other on-chain yield-generating options.

The DSR has been quite popular, and its adjustments have closely correlated with changes in DAI’s supply. In early 2023, the DSR was increased to 1%, leading to a rapid deposit of over 35 million DAI. As competitive interest rates rose, MakerDAO subsequently adjusted the DSR to 3.3%, and later to 8% in August 2023. This increase coincided with a significant rise in DAI’s supply, which spiked from 4.44 billion to 5.47 billion, marking the first major supply increase since a surge in March 2023 following the USDC depeg.

However, the high interest rate of 8% led to over 20% of DAI being deposited into the DSR within just a couple of days, triggering an automatic reduction to 5.8%. Despite this reduction, the DSR remained attractive, though Maker’s founder suggested a further decrease to 5% to sustain the higher rate for a longer period.

Amid these dynamics, alternative yield opportunities began to exert pressure on DAI’s market position. Notably, USDe, a competing stablecoin, has been attracting attention with a yield of 15.9% on its staked offerings, challenging DAI’s dominance in the stablecoin space. This competition likely influenced MakerDAO’s decision to drastically hike the DSR to 15% in early March, a move designed to alleviate sell pressure and stabilize the token’s value.

This strategic adjustment appears to have been effective, as the substantial increase in the DAI supply following the change suggests that users are eager to capitalize on the high yield offered. The recent developments in DAI’s supply and the adjustments to the DSR highlight the intricate balance MakerDAO must maintain between incentivizing holding through competitive yields and managing the overall stability and utility of the stablecoin.