With Terra (UST) De-peg Drama, Is the Natural Safe Haven Maker (MKR) and DAI?

By Michael @ CryptoEQ | CryptoEQ | 10 May 2022


 

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The Maker (MKR) token was created by MakerDAO and its principal purpose is to underpin and secure the DAI token which was launched in 2017. MKR is also used as a governance token for participation in the governance decision associated with the Dai ecosystem. Holders of MKR make key decisions on the operation and future of the system. The Maker ecosystem contains two cryptocurrencies. The first, called Dai, is a crypto-backed cryptocurrency and the flagship product of the Maker ecosystem. Maker is a Distributed Autonomous Organization (DAO) on the Ethereum blockchain with a platform designed to keep the DAI price stable. MakerDAO uses the MKR token to act as a counterweight to price fluctuations. This combo is the basis of a simple crypto banking system built on blockchain technology that allows for simpler international payments and peer-to-peer transfers.

 

Maker Strengths

  • Maker is one of the first DeFi projects and still currently boasts one of the highest total value “locked” (TVL) in a DeFi application at ~$11 billion.
  • DAI is the leading decentralized, permissionless, trustless stablecoin that plays an integral role in Ethereum’s DeFi ecosystem with ~$8 billion in circulation. It remains a top choice for anyone looking to transact in a stablecoin without a trusted third party.
  • Over 400 apps and exchanges now use DAI, becoming a top-3 trading pair within the Ethereum DeFi ecosystem. 
  • Maker continues its commitment toward the full decentralization of MakerDAO with the return of 84,000 MKR tokens from its development fund to MakerDAO's governance module in Q2 2021.

Maker Weaknesses

  • The historic March 2020 Ether price collapse and subsequent network congestion proved to be a long-tail systemic risk to Maker at the time. The system essentially did not perform as intended and allowed some users to lose all their collateral.
  • The issuance of new MKR after the fallout of March 2020 undid years of MKR value accrual and also illustrated the possibility of future MKR holder dilution in the future.
  • Regulatory clarity around the MKR token is non-existent but a strong case can be made for it to be deemed a security under the US Howey Test.
  • In a move to reduce dependence on solely Ether, Maker now accepts multiple assets as collateral, including centralized stablecoins and assets. Introducing centralized collateral may reduce price volatility but opens up new censorship attack vectors. 
  • Because DAI’s stability is predicated on over-collateralization and incentive mechanisms within the Maker system, it exhibits more volatility than its fiat-backed counterparts and rarely trades at exactly $1 while also being less capital efficient due to over-collateralization requirements.

 

Maker’s main function is to underpin MakerDAO’s stablecoin, Dai. Dai is described as a decentralized, permissionless, collateral-backed cryptocurrency soft-pegged to the US dollar. Dai is held in cryptocurrency wallets or on trading/exchange platforms and is supported on Ethereum’s blockchain. MKR is MakerDAO’s secondary token, serving as the administration token of the MakerDAO ecosystem. MKR is needed for paying the fees accrued within MakerDAO’s ecosystem. The dual token concept was created to align incentives to better help maintain price stability and address the prior issues surrounding an open, decentralized stablecoin.

MKR Token

MKR is destroyed when the Maker Protocol’s system surplus exceeds a minimum threshold, resulting in excess Dai being auctioned for MKR which is then destroyed. Inversely, when the Maker Protocol is running a deficit and the system debt exceeds a maximum threshold, MKR is created and auctioned for Dai in order to recapitalize the system.

Through its governance token, MKR, users can vote and manage the DAO concerning the following topics and more:

  • Add a​ ​new​ ​collateral asset ​vault
  • Adjust risk parameters for existing vaults
  • Modify​ ​the DAI Savings Rate
  • Trigger Emergency Shutdown

Value accrues back to MKR through buybacks from revenues, liquidations, and excess reserve assets. The  Maker surplus is the amount of money in excess if every debt was instantly repaid. The surplus increases with time as fees on debt accrue and when liquidations net a profit for the system. The system aims to keep a buffer of 250M, and when the surplus surpasses this buffer the exceeding amount is used to buy back and burn MKR. Whenever the DAO has expenses, these are paid by pulling DAI from the surplus.

MKR revenues May 2022 MKR revenues. Source

It is also worth mentioning the stability methods in place to keep DAI at a $1 peg:

  • Arbitrage: Bots use simple buy and sell scripts to quickly capture any profits resulting from DAI being above or below $1.
  • Auctions: “Keepers” are third-party bots that take part in buying up discounted tokens when collateral levels become dangerously low. There are some really interesting functions in place that Keepers participate in to ensure the health of Maker reserve levels that you can read more on here.

DAI outstanding April 2022 Source

Dai provides a solution to counterparty risk by creating an over-collateralized stablecoin in which its solvency is not reliant upon trusted third parties. All Dai is backed by Ether that is held in public, transparent smart contracts on the Ethereum blockchain. This allows any user to verify the system’s health/backing in real-time, unlike the legacy financial market. Additionally, users can transact with one another in a peer-to-peer (P2P) fashion anytime and from anywhere without the need to trust a bank or counterparty. 

One big obstacle is Dai volatility. Even though it is considered a stablecoin, price fluctuations in Dai can meaningfully change in as little as an hour. The incentive structure between MKR stakeholders and Dai is still new and inefficient enough that the Dai-US dollar pair can fluctuate ~5%. This doesn’t sound like much but can dissuade users who may opt for a more consistent stablecoin.

However, since Q4 2020 DAI’s price has become increasingly stable. Since December 2020, DAI’s price stability around $1 has coincided with tremendous growth in supply due in large part to Uniswap's new liquidity mining program. In December 2020, Uniswap began offering UNI as a reward for staking with one of the pairs being UNI/DAI.  This led to growth in DAI’s supply as more DAI was created to take advantage of the rewards. Since then, DAI supply has continued to grow and the price has become increasingly stable.

DAI vs price Image credit: CoinMetrics

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


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