Weekly Narrative on MakerDAO – 13 April 2019
Last week, the community continued to monitor the 400 bps increase in the Stability Fee from two weeks prior, bringing the current Stability Fee to 7.5% per annum. General concern continues to permeate as the price* of DAI still remains below its soft peg target of 1.0000 . A recent MakerDAO poll indicated strong support for a further 400bps rate tightening. Upon its approval the new stability fee will be 11.5% per annum.
During the course of the week, we saw a slight contraction in the DAI outstanding now hovering slightly below $92.9mm.
The above being said, the price continues to lag below the target of 1.0000 ; therefore, it is reasonable to believe the supply overhang (e.g. difference between Demand and Supply) has almost ceased growing, at best it has been brought to a crawl. A removal of the excess Supply is needed.
We need to start the research for the Stability Fee impact on Demand and then expand that research into its fundamental parts of DAI Saving Rate and the Stability Fee overall (w/ specific emphasis on determining when the partial derivative of profit with respective to stability fee equal zero). By doing so, we will be tweak these metrics to forecast expected Demand increases and Supply decreases for when future credit bubbles occur.
As empirically perceived, the DAI credit bubble continues to persist after a period of low credit with lagging demand. As the Maker community is committed to a soft-peg for DAI and using market forces related to the Stability Fee to cause the enforcement of such policy, it is expected that the community will continue to tighten its policy until such time as the supply begins to have a continual supply contraction. The point (via the Stability Fee) in which unit-elasticity is exceeded must be determined. Once crossed, it is imperative to loosen the monetary policy to avoid an accelerated contraction of DAI (e.g. a death spiral). The sole purpose of the recent Stability Fee raise is / was to reduce the supply overhang to put Supply and Demand back in “more or less” alignment. By doing so, the soft-peg should be restored. Make no mistake, the aggressive policy to remove supply via substantial rate increases includes systemic risk. This risk is somewhat hedged provided the community accepts a “loosening when determined” policy.
It is important to note that many market makers that are holding inventory (and some with material inventory) have already placed their sell orders in or around 1.0000 .. This is important as upon the tightening of supply, there is somewhat a known quantity of DAI to digest. Once they have sold, the system should revert back to more or less organic buyers and sellers that don’t have large exit orders. The concern here is further outlined from the above that if we have an accelerated contraction of DAI, we may find ourselves on the opposite of this problem with a price above 1.0000 and not enough Demand to cause the creation of new DAI (thereby making the then problem worse). As such, vigilance to not overshoot the Stability Fee and the commitment to soften after passing the contraction point is needed.
Debt Ceiling:As the current outstanding DAI is now just below $93mm, the community should start a discussion to form rough consensus around a new debt ceiling as it is a question of when / not if the total outstanding DAI reaches the $100mm level. Many of the discussions in the last week circulated around using the debt ceiling as a policy tool to help establish DAI back to 1.0000 .. While this would help produce a short-term solution, it would also start to insert a new level of complexity (and thereby uncertainty) and should be discouraged. The ideal solution is set the Stability Fee (and one day hopefully soon the Dai Savings Rate) to the optimal rates and use purely market forces to stabilize the system. As outlined in the call, should we see a surge in the value of the underlying collateral, as the system presently does not have the tools to allow the throttling of newly issued DAI, the only way to discourage the creation of that DAI will be via increasing the economic costs (the borrowing rate) to mint DAI.
Observe the market price* and compare the supply numbers from Maker’s internal trade desk (and any other trade desks). In parallel, prepare the community for a continual series of 50bps rate increases to continue to tighten the perceived supply demand imbalance. Further, it is recommended to continue these rate increases on a predictable and well-communicated cadence until such time as we see the excess liquidity begin and continue to contract in an orderly manner. Once we are able to effectively value the demand side, it is expected to see a trend when / where supply and demand would match. It is further recommended to keep a rolling vote & poll to continue the communication to the community related to Stability Fee changes. This has the dual benefit of both forward guidance to the community and actually implementing that guidance.
Until such time as the DAI Savings Rate is implemented and the DAI credit bubble is brought under control, it is recommended to poll and implement weekly Stability Fee changes.
Further, when Multi-Collateral DAI is released, it is recommended for each of the risk teams to evaluate the concept of throttling newly issued DAI (on a hourly / daily / weekly / monthly basis) until such time as each collateral class has reached a threshold of stability via a frequently updated per collateral debt ceiling. This serves the dual purpose of not allowing too much DAI to be minted and potentially move the overall DAI price off its peg, but also limiting the maximum amount of risk exposure any one given Maker Risk team should be allowed to embrace on behalf of the MKR token holders as a whole.
*price being determined by USD fiat offramp via USDC – DAI (at pro.coinbase.com)
NOTE: Not a part of the Maker foundation, just my $0.02