Over 2018 and 2019, leading decentralized finance protocol MakerDAO was having trouble growing. The protocol, which offers users decentralized loans paid in the U.S. dollar stablecoin Multi-Collateral Dai (DAI), saw value locked in its contracts stagnate at $300 million.
This has begun to change over recent months. There is now nearly $2 billion worth of an assortment of cryptocurrencies locked in MakerDAO's contracts, driving up the amount of DAI in circulation.
What is MakerDAO?
MakerDAO is a decentralized autonomous organization that allows holders of certain cryptocurrencies to request overcollateralized loans. The loans are paid out in DAI, a decentralized stablecoin that is pegged to the value of one U.S. dollar through monetary policy levers. Users can generate DAI by depositing cryptocurrencies accepted by the protocol, which currently includes Ethereum, USD Coin, Wrapped Bitcoin, and Basic Attention Token.
MakerDAO's monetary policy is controlled by holders of the Maker (MKR) token, who dynamically adjust a variety of levers to ensure DAI trades around $1.00. These levers include but are not limited to the interest rate (stability fee), the DAI Savings Rate, and the global debt ceiling.
Total Value Locked in MakerDAO Pushes $2 Billion
The total value of cryptocurrencies locked (TVL) in the DeFi protocol currently sits at $1.83 billion, data from DeFi Pulse shows.
As can be seen in the chart below, MakerDAO's TVL has grown dramatically since the start of 2020. On January 1, the metric sat at $350 million, 19.1% of the current value. On June 1, MakerDAO's TVL sat at $510 million.
The growth of MakerDAO's TVL comes as a result of two trends.
First and foremost, the rise of yield farming has increased the demand for DAI dramatically. Yield farming, the term prescribed to using cryptocurrencies to earn passive returns, has largely involved DAI. All mainstream yield farms, from Compound to Yearn.finance, have centered around stablecoins. Demand for DAI, along with other stablecoins, has skyrocketed. For MakerDAO in particular, this meant that investors were depositing collateral into this system to obtain DAI loans.
DAI has been an attractive asset to use in DeFi in particular due to it being relatively limited compared to USD Coin and Tether's USDT, its primary competitors. Take the example of Yearn.finance's Vaults, which currently offer 13.5% annualized growth on DAI deposits and only 0.94% annualized growth on USDT deposits.
To respond to this increase in demand, MKR holders have introduced a number of monetary policy measures. The global debt ceiling has been raised to 1.416 billion DAI while new vaults have been introduced for Chainlink, Loopring, Compound, Tether's USDT, Paxos, Kyber Network, and Wrapped Bitcoin. This has resulted in a strong uptick in DAI in circulation, driving down the premium to 1%.
Secondly, faith has been restored in the MakerDAO protocol after the controversy in March where users had their loans liquidated and received none of their collateral back.
During the "Black Thursday" crash in March, a combination of a rapid decrease in Ethereum's price and a congested blockchain allowed MakerDAO users to liquidate collateral of defaulted loans at $0 as opposed to their ticket price. This event caused DAI to trade 2-3% above peg for extended periods of time.
This persistent de-pegging of DAI, crypto-asset fund ParaFi Capital explained, was a result of users losing faith in the MakerDAO protocol. In a MakerDAO forum post about the matter, the fund explained:
"We believe this lack of stability and liquidity is translating into uncertainty around using DAI as a decentralized stablecoin in many DeFi protocols. Anecdotally, we have heard a handful of DeFi teams express frustration over DAI’s lack of liquidity/stability, with some opting to use USDC instead. We see this as damaging to DAI’s network effects in the long run."
The ongoing influx of capital into the Ethereum-based application is a testament to a return of faith in the project.
Centralization Concerns Abound
While the implementation of the monetary policy changes helped to stabilize DAI, there are concerns about the fact that the stablecoin is now backed by largely centralized assets.
MakerBurn.com, a data site tracking MakerDAO, reported on October 3 that 358 million out of the 866 million DAI in circulation were generated through deposits of USD Coin. Furthermore, dozens of millions more DAI have been generated through the use of Wrapped Bitcoin, USDT, and Paxos Dollar, which can be frozen by admin addresses.
This means that more than half of all DAI in circulation has been generated through the use of cryptocurrencies that can be deemed worthless or frozen by a central party. The issue is systemic for MakerDAO as DAI is fungible — DAI is all identical, regardless of what token it was generated with.
Tyler Reynolds, a cryptocurrency investor that works for Google's payments team, expressed his concern about the USDC backing DAI:
"They destroyed their sole value proposition — a decentralized, uncensorable dollar backed by equivalent liquid collateral. SAI was excellent. MCD w only non-custodial assets would’ve been great. Custodial DAI is a strictly weaker option than USDC/USDT."
John Paul Koning, a monetary economist and analyst focused on Bitcoin, echoed the concerns over this fact:
"At this point, I suppose you'd have to be pretty much indifferent between owning Dai or USDC, no? Same stablecoin, different name?"
These concerns are especially poignant as the organization Tether has been actively censoring payments made in USDT in response to recent hacks and bugs, such as the $32 million in USDT theft from KuCoin.
While Tether censored these transactions to ensure users did not lose funds to malicious actors, some fear governments looking to attack DeFi and Ethereum could convince Tether or the creators of USD Coin to censor even more transactions.
MakerDAO now lies at the center of these worries as it becomes increasingly dependent on trusting that the actors behind centralized collateral do not arbitrarily freeze or censor transactions pertaining to DAI loans.