Weekly Narrative on MakerDAO – 25 March 2019
Stability Fee: Last week, the community’s polling supported the push for a 400 bps increase in the Stability Fee. General concern continues to permeate as the price of DAI* still remains below its soft peg target of 1.0000 . Further, market makers as well as MakerDAO’s internal trading desk confirms that inventory levels remain materially elevated. During the Maker governance call it was also noticed that $200k DAI were being burned almost in real-time as the polling was coming to a close which confirms to some extent that CDP holders are aware of the changing environment related to the then proposed stability fee change. It was subsequently determined that the majority of such DAI burning was due to two CDP holders. The community has elected to aggressively pursue a rate tightening policy to help reduce excess liquidity in the market.
Even with the polling, some new CDPs were still minting new DAI. Possible explanations include they were simply unaware of the proposed rate change or even more concerning that their borrowing was still rate inelastic even with an imminent new rate vote.
Also it must be noted that some DAI holders have the intent to sell their DAI for USD via fiat offramps. This action directly causes price deterioration to which MakerDAO remains quite sensitive. The excess DAI liquidity, which stems from a perceived imbalance in supply and demand with market makers or other, is exacerbating the price deterioration as there is simply too much DAI. However, there does not yet appear a linear correlation between DAI contraction and the DAI price*. Once the temporary optimal rate** is found, it is expected to see DAI being minted at more or less the same as it is being burned. By derivative, the Maker “burner” wallet should be increasing at a somewhat a constant rate based on the DAI outstanding and the stability fee. During the recent week, the number of open / closed CDPs were disproportionately low, even after a rate increase. This metric points to CDP holder closing their position. The foregoing notwithstanding, the DAI price* still remains stubbornly below 1.0000, thus indicated too much DAI supply remains.
Given the observed impacts of the stability fee on the price, prudence and monitoring are advised. As the overall objective is to bring supply and demand into balance (which may be observed via the price* being as close to 1.0000 as possible), it is critically important to engage pragmatically and not overshoot any new rate change adjustments.
From a historic perspective, credit bubbles have and will always exist in monetary policy. As empirically perceived, there has been a credit bubble of DAI that continues to persist. 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. When the credit bubble does start the materially shrink, it is expected to see a rapid contraction of outstanding DAI (and by derivative the soft-peg being restored), as we will have then sufficiently passed rate sensitivity elasticity of 1. When this event occurs, it will be critically important to monitor and possibly soften the monetary policy accordingly based on the then market conditions with an attempt to restore demand unit-elasticity.
Recommendations: Observe the market price* and compare the supply numbers from Maker’s internal trade desk (and any other trade desks) for another week. In parallel, prepare the community for a continual series of 50bps rate increases to continue to tighten the perceived supply demand imbalance and to identify the rate sensitivity point in which CDP holders begin to close their CDPs at more or less the same rate as they are opened by others. 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 begins and continues to contract.
Start a post-mortem on what might have caused such a credit bubble with emphasis on what changes might be recommended in the future to make such credit bubble more difficult to create.
Debt Ceiling: As the current outstanding DAI is now below $91mm, 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. While not catastrophic if the debt ceiling is temporarily hit provided we are in an oversupplied DAI market, it would however start to artificially increase the price. Such prices increases should instead be caused by raw economic forces of supply and demand.
- price being determined by USD fiat offramp via USDC – DAI (at pro.coinbase.com) ** – short-term optimal rate should not imply a commitment to a specific price, rather it is the rate that works at that given time for the current circumstances.