ON–039: DeFi (Part 2)

Coverage on BAL, MKR, SNX and YFI.

Sep 18, 2020

④ MakerDAO

Contributors: Marko Štemberger & Vishesh Choudhry

  • Liquidity mining schemes influencing the DAI peg. Observe the following moves in the diagram below:

    1. This period was most influenced by Sushi and other forks “Food DeFi” farms. These farms consist of Uniswap and later Sushiswap LP tokens including WETH/DAI. As a result, DAI was pulled from stablecoin nominated AMMs into WETH nominated AMMs. At the end of the period, MakerDAO executes the 60M debt ceiling increase for USDC-A, allowing for new supply to be minted.

    2. SAFE farm starts, which includes Balancer DAI/SAFE 98/2 pool as one of the four pools. The pool managed to pull a large amount of newly issued DAI and DAI from other venues (~155M at one point), which decreased DAI available in stablecoin and WETH nominated AMMs, pushing the price above $1.04.

    3. MakerDAO executes emergency executive vote to increase USDC-A vault debt ceiling and lowers the collateral ratio to 103%. Around the same time, the price of SAFE tokens suddenly decreases, rendering the high yield. DAI from SAFE farm and newly issued DAI is allocated to mostly stablecoin AMMs, decreasing the DAI price premium.

    4. Additionally, it is expected that MakerDAO governance will further increase the USDC-A debt ceiling & decrease the liquidation ratio to 101% on Friday. The change theoretically limits the DAI price premium to $1.01, given there is sufficient debt ceiling available for new issuance, which currently offers certain level of calamity for DAI short positions.

Liquidity mining remains a large factor in allocation of DAI across different trading venues and platforms. The chart below shows DAI balance in stablecoin nominated AMMs (Curve & Swerve), balance in ETH/DAI pools (Uniswap & Sushiswap), balance in Balancer DAI/SAFE 98/2 pool, and lastly log DAI price from Coinbase USD pair. The above explained dynamics, caused by different farms, have caused several DAI cash flows between different contracts in addition to newly issued dai, which is visible on the chart. As visible, the DAI price premium decreases as the allocation of DAI in stablecoin AMMs increases. Increased supply of DAI in ETH/DAI pools does decrease the price, but is limited in effect due to additional trading fees, network fees and volatility of ether.

Lastly, DAI allocated in pools which consist of highly volatile assets and do not have another stablecoin or at least ether nominated liquid market, does not help decrease the DAI price premium, as arbitrage is not possible with this liquidity. Example of such a market is the current Balancer DAI/SAFE pool, which visibly negatively affected the price of DAI. Observe how the first red bar visibly lowers liquidity in WETH & stablecoin nominated AMMs, which causes the above $1.04 price spike. In the following bars, we have a total increase across balances which is ultimately a result of USDC-A DC increase, while on the fourth red bar, it is one again visible how DAI flow from SAFE pool to other pools, mainly stablecoin nominated pools, positively affected the price.

Source: Etherscan
  • ETH liquidation risk. The current ETH spot price is ~$387. About 160M Dai minted from ETH-A vaults is  250% collateralized or lower. In the event that ETH price were to fall to $303, ~12M Dai would be liquidated. At $280, that number increased almost tenfold to 105M Dai liquidated. Given the aforementioned tendency for Dai liquidity to frequently dry up as a result of yield farming, this liquidation wall presents a significant risk for a few reasons:

    1. Liquidations result in further removal of circulating Dai pushing price upward reducing the price efficiency of Dai auctions

    2. If Dai liquidity is not enough to meet this amount then said auctions may not receive sufficient bids resulting in potential losses for MKR holders and vault owners (vis a vis March 12th events). This mentioned liquidation risks are currently less severe as usual due to aforementioned changes to USDC-A vault type.

Image 2020-09-18 at 9.55.37 AM
  • WBTC liquidation risk. The top 5 vaults account for ~46M Dai or 84% of the Dai supply minted from WBTC. With two of these vaults being <280% collateralized, there is a liquidation wall for WBTC at ~$9.1k. This is presumably a lower risk scenario than for ETH, given that it’s a smaller nominal amount of Dai and that ETH is a more volatile asset than BTC.
  • Dai Supply Issuance. Dai supply has grown significantly in spite of increased fees, particularly from USDC vaults.

    • The outstanding Dai supply has grown from ~200M in July to ~400M in August to over 620M in September of 2020. Of this, 57% was generated from ETH-A collateral, 32% from USDC-A, and 8.8% from WBTC-A. 

    • This is in spite of the fact that stability fees have been increased with USDC-A, BAT-A, and WBTC-A vaults sitting at 2% (ETH is still 0%). 

    • Recently, 3.5M was also minted from PAX-A (2% stability fee) and even 6.4M from USDC-B (alternate risk parameters) at a 48% stability fee. The remaining collateral types (TUSD, ZRX, KNC, USDT, Mana) account for <1% of the Dai supply. 

    • Dai issued from ETH remained net stable in the last month, whereas Dai issued from WBTC fell ~30% and that from USDC-A increased by 1400% following a series of debt ceiling increases.

    • Spikes in Dai generation are often correlated with the emergence of new yield farming opportunities, so it is reasonable to assume this is a prime driver of demand as of late.

About the editor: Spencer Noon is Head of Investments at DTC Capital.