Overview of MakerDAO: DeFi, DAI & Declining Economics

By Zacharias | RekTimes | 3 May 2022

2 May 2022: One of the largest dAPPs and the first decentralized finance (DeFi) applications to earn widespread adoption, MakerDAO is an open-source Decentralized Autonomous Organization (DAO) that runs on the Ethereum blockchain.

MakerDAO has recently experienced a decline in overall market share of DeFi, as DAI and MKR have both declined in market cap since 2021.

Top Things to Know:

MakerDAO is governed by holders of the platform’s native MKR token, with one token being worth one vote

DAI is the native stablecoin of the Maker protocol and is pegged to the USD through management of the DSR to manipulate supply

Maker Vaults are created with a minimum generation of 5,000 DAI which is generated by staking collateral, the value required is typically between 150%-175% of the desired value of DAI

MakerDAO Ecosystem

MakerDAO governs the Maker protocol, which is designed to facilitate lending and borrowing on a decentralized platform. Loans are received and paid in DAI tokens.

Governance of the MakerDAO platform is decided under a proof-of-stake, proportional voting system. Maker’s native token (MKR) is used as the governance token, with one MKR equalling one vote. MKR must be transferred to the voting contract and locked up in order to receive voting power, which can be withdrawn at any time.

Voting requires a single transaction, typically costing a few cents per vote but variable based on network congestion. A linked-wallet Voting contract requires four transactions for a total cost of 1M gas.

The Maker token currently has a value of $1,425 and a supply of just under 1 million tokens for a market capitalization of 1.42 billion USD. The market cap of MKR has plummeted 4.5 billion USD over the past year.

DAI Stablecoin

The DAI stablecoin is a decentralized, unbiased, collateral-backed cryptocurrency whose value is soft-pegged to the US Dollar. DAI is generated by depositing collateral into a Maker Vault, with a minimum of 5,000 DAI in order to create a vault. Rules governing vault economics are determined through voting by MKR holders.

DAI currently has a market cap of 8.82 billion USD and an equivalent supply due to its nature as a stablecoin. DAI’s market cap is down roughly 1.8 billion dollars from its peak in mid February due to a combination of increasing competition, lack of investor enthusiasm, and weariness of recent market volatility.

Economics of MakerDAO

According to MakerDAO, the largest responsibility of Maker holders is to ensure the stability of the DAI peg and the Maker protocol.

This is accomplished by modifying risk parameters for accepted collateralizable assets, adjustments to the burn protocol, deciding whether to allow a new asset, and by participating in recapitalization if necessary.

Maker Vaults

Maker Vaults are where collateral is stored and secured that represents the value behind the DAI stablecoin.

The value of required collateral is typically between 150%-175%, making DAI over-collateralized. Falling underneath this requirement results in steep penalties and possible liquidation.

For Ethereum, this value is currently set at 170%. This is designed to help insulate DAI from a rapid loss of backing value due to the volatile nature of some cryptocurrencies. Maker Vaults are capable of accepting any Ethereum based asset that is approved by Maker holders, who also determine risk parameters.

Protocol Peg Mechanism

The pegged value of DAI is maintained at 1 USD by managing the circulating supply of DAI utilizing variations in the DAI Savings Rate (DSR). The DSR is an interest rate value determined by community vote and applied to DAI that are staked in the DSR Contract.

If the market price of DAI is above the peg, the MKR holders can vote to decrease the DSR in order to make staking DAI less valuable and increase supply. If the price of DAI falls below the peg, MKR holders can vote to increase the DSR and encourage staking to reduce supply.

Recapitalization is facilitated through an exchange of DAI and MKR, where the value of one is transferred into the other and the tokens are burned.

MKR is burned when there is a system surplus over a minimum threshold and created when system debt crosses a minimum threshold. MKR is burned by auctioning off excess DAI in exchange for MKR, with the collected MKR being destroyed. MKR is created to be auctioned for DAI in order to recapitalize the system.

Recent Governance Action

In light of a declining market cap and investor confidence, the Maker community has moved forward with several recent design proposals in hopes of slowing the market cap decline and maintaining/attracting investors.

The burn functionality and burn reward system of Maker were recently disabled by a community vote with replacements under consideration. These replacements vary widely, although the most common are centered around reinstating the removed system either under the same or a reduced burn rate while a new system is designed.

Proposal MIP69 Implementation

In order to improve the liquidity of the DAI system, proposal MIP69 is currently being implemented. This proposal allows for the instant withdrawal of DAI from L2 to L1 by eliminating the need to wait for fraud proofs.

When an instant withdrawal is initiated the transferred DAI is eliminated in L2 and minted in L1. Although fees on these withdrawals were initially considered to prevent abuse, they were eliminated in later updates to this proposal.

stkMKR Token Proposal

A proposal that is still in consideration is to replace the governance token MKR with a new token that represents MKR staked in governance (stkMKR).

StkMKR holders would receive MKR tokens purchased through surplus auctions and the prior burn system would also be reimplemented and paid in MKR. Withdrawing stkMKR requires waiting for a preset unbonding period before MKR is returned to the token holder. Theoretically, this will improve governance security and protocol resilience.

Summary

MakerDAO and, by extension, the MKR token and DAI stablecoin, have experienced a troubling economic decline. The market capitalization of both tokens have fallen dramatically in recent times as investor confidence has been eroded by erratic markets and a lack of forward innovation.

The annual yield from staking DAI has fallen and many investors no longer deem it worth providing a much higher valued collateral that can be staked elsewhere for higher returns.

MKR holders and governance have introduced a number of proposals such as reinstating the removed burn rate (whether the same or a modified function), increasing L2 liquidity, and replacing the primary governance coin with enhanced incentives for holders. These proposals are aimed at reversing this trend and regaining the Maker Protocol’s place at the forefront of the DeFi space.

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