The craziest DAPP in the eyes of Vitalik Buterin: MakerDAO

TL;DR

• MakerDAO is a crypto lending credit tool that provides loans at a predetermined interest rate. It can collateralize various crypto assets and mint debts similar to banks. It can be called the "central bank" in Ethereum.

• The essence of MakerDAO is to do long ETH.

• The sanctions imposed by the US Treasury on Tornado Cash are the main reason why MakerDAO considered turning to ETH.

• MakerDAO still has a long way to go. It still needs to prove the correctness of its decision reversal at that time in the future. Let’s wait and see!

What Is MakerDAO

MakerDAO, as one of the oldest DeFi projects by far, is a crypto lending credit tool that provides loans at a predetermined interest rate. It can collateralize various ecrypto assets and mint debts.

MakerDAO, similar to banks, is called the "central bank" in Ethereum. In a banking environment, the borrower can take the house, car, accounts receivable, etc. as collateral for the loan.

If users want to borrow money from MakerDAO, they will first deposit Ether(ETH) as collateral in Maker's smart contract, and then this debt exists in the form of stablecoin DAI. Makers can use external market forces, incentive mechanisms and policy tool systems to maintain DAI pegging to US dollars in a 1:1 ratio.

It allows users to use their native stablecoin DAI to borrow, trade and earn savings. The stablecoin DAI is pegged to the US dollar in a 1:1 ratio. MakerDAO is often reminiscent of a bank, because it makes loans secured by cryptocurrency, but does not require documents, checks or a good credit history. Users can collateralize any of the 10 cryptocurrencies accepted by ETH or the platform and obtain a certain amount of DAI.

MakerDao uses a global system parameter to determine how much DAI holders earn from their savings. MakerDAO also has the governance token MKR. Whenever the market price deviates from the target price, the holder of MKR will mitigate the adverse impact caused by the price instability of DAI.

What Makes MakerDAO Special

In an interview with Vitalik Buterin, the host asked Vitalik Buterin: "What is the "craziest" Ethereum application you have recently encountered? Vitalik Buterin replied, "MakerDAO impressed me deeply.”

Why Is MakerDAO So "Crazy"?

MakerDao is the first DAO organization established on Ethereum. In the whole stablecoin market, DAI is the top star in the application scale of decentralized stablecoin, and in the DeFi field, MakerDao has a subversive role and significance. The extra-collateralized mechanism of MakerDao eliminates the risk of "printing money with nothing" and is a system that runs completely on the chain, without centralized custodial risk.

DAI is a decentralized stablecoin pegged to the U.S. dollar generated by the extra collateralization of the Maker protocol on the MakerDAO. The total supply depends on the value of the collateral in the Maker protocol. As of August 19, 2022, a total of 7144242600 DAIs were minted, ranking fourth in the total market value of all stablecoins, and is currently the largest decentralized stablecoin with the largest market value.

For loans to digital assets, the value of the loan must always be lower than the value of collateral to protect creditors from default risk or liquidation risk, which is closely related to the liquidity of collateral. In order to prevent this risk, the borrower can choose to deposit various collateralized assets (ETH, UNI, LINK, YFI, etc.) to mint debts. Various assets have different margin requirements according to their risk level. Large scale liquidation of assets with low liquidity and high volatility is more difficult. If the collateral is lower than the margin requirement, a larger buffer is required to ensure smooth closing of positions.

After the loan, DAI can be used for any purpose, but mainly for investment. If you want to repay the loan, you need to repay the same amount of DAI you received before, plus a little interest. If the ETH price rises during this period, users will benefit. Because the amount of collateral in ETH will increase according to its dollar price, the essence of MakerDAO is to do long ETH.

It is very simple to borrow assets from MarkerDAO. Users only need to have an active crypto wallet of MetaMask, Ledger, Coinbase, Trezor, WalletConnect or D'cent, and the balance is at least 40 dollars. However, the total amount of loans is always limited by the collateralized ratio of 150%. In other words, the loan amount cannot exceed 66% of the collateral. To put it simply, a borrower who deposits $1 will get 66 cents.

In general, MakerDAO is easy to use and clear for any user who has interacted with DeFi before.

Why MakerDAO Scrapped USDC

On August 8, 2022, the US Treasury Department launched the cryptocurrency mixer Tornado Cash which is added to the sanctioned List. All American individuals and entities are prohibited from interacting with Tornado Cash or any Ethereum wallet address related to the protocol. This is the first time that the United States has approved to impose sanctions on an on-chain DeFi protocol.

According to SlowMist’s analysis report, 74.6% of money laundering funds in security incidents in the first half of 2022 went to Tornado, which may be an important reason why the United States decided to ban Tornado.

Since the US Treasury Department imposed sanctions on Tornado Cash, the butterfly effect has begun to ferment.

On August 9, the founder of ShapeShift began to urge MakerDAO to release USDC as collateral to avoid risks.

On August 11, according to the tweet of banteg, the core developer of Yearn, MakerDAO is considering purchasing $3.5 billion ETHs to convert all USDCs from the peg stability module to ETH.

On August 12, Rune Christensen, the founder of MakerDAO, the leader of the lending protocol, announced through the official discord that MakerDAO might choose to sell all the USDC exposures in the protocol, which might lead to the depegging of DAI from the US dollar, and we need to be prepared for this situation.

According to the data of Makerburn, 80% of the collateral assets behind the DAI are stablecoins and 60% are USDCs. Rune Christensen believes that depegging is an acceptable risk. Rune also mentioned that the recent sanctions imposed by the US Treasury on Tornado Cash, acrypto hybrid mixer, are the reason for the shift in consideration. The sanctions are more serious than he initially thought. After the sanctions, the consortium Centre behind the USDC froze the USDC funds in Tornado Cash's wallet.

In fact, as early as two years ago in the "March 12" period, MakerDAO's decision to accept USDC triggered a community dispute.

In the middle of March 2020, the market plummeted, and the ETH network suddenly burst, MakerDAO also experienced a flash crash. In order to avoid similar problems in the future, MakerDAO decided to accept the USDC token pegged with USD as collateral.

At that time, MakerDAO's acceptance of the USDC triggered many disputes in the community. After all, DeFi is essentially decentralized. Although the USDC is also the ERC20 token, it can be sent to other ETH addresses as long as the private key is mastered. However, it is ultimately up to Circle and Coinbase to redeem the USDC into real dollars. If the process involves AML and CFT's cash flow account, it will also be blocked.

MakerDAO's acceptance of USDC does seem to help reduce losses in the event of similar events in the future, but it actually adds more reflection to the word "decentralization" of decentralized finance.

Risks of MakerDAO

Death Spiral

Nowadays, Ameen Soleimani, founder of Tornado, stated that Circle's compliance with US sanctions was a watershed in the history of decentralized finance.

Tornado.Cash will be blacklisted by USDC, which means that the United States has frozen hundreds of billions of dollars of Russian assets, which represents the inherent responsibility of the centralized interaction project with the United States... Every DeFi agreement is considering reducing their USDC exposure.

For this potential transformation, if MakerDAO scraps USDC and buys Ether worth $3.5 billion, it will introduce ETH into its peg stability module.

However, Vitalik, co-founder of Ethereum, said that, “this sounds like a terrible idea with high risk. If ETH depreciates significantly, the value of collateral will also decrease accordingly, but the collateralized debt position (CDP) may not be cleared, posing risks to the reserve system of the whole system.

How to Solve the Dependence of MakerDAO on USDC?

Vitalik suggested that no single collateralized asset other than ETH should exceed 20% of the total collateralized asset. It is even limited to 20% collateralized assets in each jurisdiction; If we can't, we should limit the growth of DAI until we can solve the problem.

This is also the black swan event that everyone is worried about - whether ETH will encounter the "death spiral".

Investors familiar with the stock market, especially those who have experienced stock market disasters, may not be unfamiliar with the word "death spiral". Under the condition that almost all people are equipped with leverage, once the stock market suddenly plummets for any reason, it will cause a large number of automatic liquidation, leading to the sale of assets by closing positions, which further aggravates the decline of asset prices, leading to more automatic liquidation of closing positions... Thus, the spiral cannot stop falling, known as the "death spiral".

Theoretically, MakerDAO also has similar risk, although it does not seem to be a heavy risk.

But if the ETH 2.0 upgrade fails, or it is proved that the underlying idea is wrong one day, or it is replaced by an emerging public chain, or the entire industry suffers from some kind of black swan, which causes the ETH price to plummet, what will happen?

Although it seems unlikely at present, ETH is still the most promising king of the public chain. However, if the black swan incident occurs and a large number of ETHs are collateralized at MakerDAO at the time, then the "death spiral" of the stock market is likely to repeat on MakerDAO: ETH plummets, DAI smart contracts automatically close positions and sell a large number of ETHs, and a large number of ETHs are sold, leading to a further decline in ETH prices, this leads to more collaterals on MakerDAO being sold by contract……

DAO Governance

How to vote on community governance is a headache in the blockchain world and even in the traditional world, whether it is the presidential election in the real world or the proposal and vote in the blockchain world. The EOS blockchain, which has a large audience, also has a low voting rate, and MakerDAO is not immune.

MakerDAO can be said to belong to "oligarch" governance rather than real decentralized governance, which is not uncommon. The reason for this is that people generally have no interest in participating in governance or MKR's price makes the governance threshold for participating in MakerDAO too high.

Although for holders of a large number of MKRs, they can achieve "complete control" of the Maker protocol by combining with other MKR "whales", and even the first few MKR holders have enough MKR to unilaterally start the emergency shutdown mechanism, but it is actually not beneficial for MKR holders to use it to do evil. The development of MakerDAO is the common interest of MKR holders.

Conclusion

From MakerDAO to the whole DeFi industry, it seems that there is still a long way to go. Many choices in the direction still need to prove the correctness of the decision at that time in the future. As for the decision of MakerDAO to consider ETH as the collateralized asset reserve, we have to wait patiently to get the answer.

Author: Gate.io Observer: Byron B. Translator: Joy Z.

Disclaimer:

* This article represents only the views of the observers and does not constitute any investment suggestions.

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