DAI’s $4 million debt bubble and lessons learned.
The Maker Protocol was put under extreme stress during the Black Thursday market crash. DAI is a dollar-pegged stablecoin backed by crypto. Borrowers mint DAI by depositing 150% collateral (in ETH or BAT) to a “vault”.
Usually, when the price of ETH falls so that a vault is no longer fully overcollateralized, a “Collateral Auction” can trigger. Under the system, other users can initiate the liquidation process by calling the smart contract, and then competing for the vault’s collateral by bidding in DAI. The auction works so that the winners end up receiving a discount on the underlying collateral, and the outstanding debt is reimbursed to the protocol.
When the price of ETH fell dramatically, many vaults suddenly became available for liquidation, which is expected. However at the same time the price of gas (Ethereum’s network fee unit) surged, making it difficult to submit transactions to the blockchain.
These chaotic conditions caused there to be nearly zero Collateral Auction activity. One user took advantage of the lack of competition by triggering liquidations and bidding $0 on the underlying ETH of several vaults. Without higher bids, over 2-3 hours the user was able to liquidate multiple vaults for free.
As a consequence, the dollar-pegged stablecoin now had $4 million not backed by underlying assets. “Some vaults were liquidated with 0 DAI coming back in the system, resulting in a net loss for the system,” wrote a MakerDAO community member.
To resolve the problem, MakerDAO conducted an auction of MKR in exchange for DAI in order to recapitalize the under-collateralized $4 million debt.
This was an important stress-test of DAI, with lessons learned. After the event, the community was quick to propose and vote on a set of parameter changes to prevent a similar situation from occurring in the future.
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