Weekly Narrative on MakerDAO – 19 April 2019

2019-04-19

General:

Last week, the community voted on and implemented an additional 400bps increase in the Stability Fee bringing the new fee to 11.5% per annum. The community has also stepped-up the polling frequency for another executive vote. At present and pending an executive vote to implement a new fee structure, the Stability Fee looks to be increased by an additional 300 bps. General concern continues to permeate as the price* of DAI still remains below its soft peg target of 1.0000 . During the last week, the total outstanding DAI has now contracted just slightly below 90mm DAI which demonstrates the previous increase had the net one week contraction of ~3mm DAI. While the average price* still remains below 1.0000 it should be pointed out that thin trading volume exists on Coinbase Pro (with a ~$200,000 theoretical purchase, DAI would be trading at 0.99 to 1.00 USD).

The above being said, as the price continues to lag below the target of 1.0000 and the overall supply has slightly contracted ; therefore, it is reasonable to believe the supply overhang (e.g. difference between Demand and Supply) has ceased growing. A removal of the *excess* Supply is still needed.

As a community cadence is up which is an excellent sign, prudence and restraint are needed to keep the vigilance but remove the intensity of upcoming changes. Further, we need to start the poll to take our foot off the throttle and include Stability Fee reductions as possible candidate(s). When the credit bubble does “pop”, we are going to need to poll & vote to decrease the fee urgently.

Demand:

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. 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 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.

Some have voiced their concern regarding the introduction of the DAI Savings Rate as being directly contrary to the interests of MKR holders as that portion of the Stability Fee is then allocated to DAI DSR holders instead of MKR. That concern is legitimate and should force the entire MKR community to adopt a set of objectives / priorities:

DAI soft peg to 1.000000

DAI stability maintaining the above with the pursuit of minimal statistical variance
By derivative only, what is the best interest for MKR holder

To that end some have stated their concerns that certain actions look to be self-serving as MKR owners. Again, no one can really prove a negative however, it should be our combined effort of having a stable system that **by derivative** generates MKR appreciation rather than by direct causal actions.

Debt Ceiling:

As the current outstanding DAI is now just below $90mm, 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 (mostly surrounding how to unwind using the debt ceiling as a policy tool). The ideal solution is set the Stability Fee (and the “coming soon” 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.

Recommendations:

Observe the market price* and compare the supply numbers from Maker’s internal trade desk (and any other trade desks). On the assumption the most recently polled increase of an additional 300 bps passes and is implemented thus bringing the overall Stability Fee to 14.5% per annum, it is recommended to monitor the system and stand down on further rate increases until the ecosystem as a whole has had the opportunity to truly digest the material Stability Fee increases. With the supply recently declining, the risk associated with further increases to directly cause supply destruction instead of inhibiting supply growth is not justified.

It is further recommended to keep a rolling vote & poll to continue the communication to the community related to Stability Fee changes. Further, while not implemented yet, we should start the polling to form rough consensus on what portion (e.g. how many bps) of the Stability Fee to allocate to the DAI Savings Rate. As we do not yet know the full extend of the DAI Savings Rate on demand; although solidly believed to be a potent tool, it is recommended to start at no more than 100bps and only increase in 25bps increments. Gathering demand side data is essential for future algorithm optimization. It is expected that the DAI Savings Rate contract will be an essential metric to gauge and estimate demand 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.

Forecast / Prediction:

Unless you are the weatherman, forecasts are notoriously difficult. However, there are some aspects that are reasonable to predict. When Multi-Collateral DAI is released and the DAI Savings Rate is available for general usage, please keep good records on any interest earned / allocated and pay your taxes accordingly. This one is simple but needs to be stated ! Nothing will harm a community more than being targeted by tax authorities.

With the Stability Fee now set in the low double digits, it is clear there is a desire to mint additional DAI that would otherwise surpass the debt ceiling. Thus far, quantifiable demand (or lack thereof) has degraded the price, thus the community took and is taking actions to focus on price not purely the mass deployment of DAI. With the DAI Savings Rate as a tool to directly stimulate demand, it is widely expected that the total outstanding DAI will slingshot much higher than it is today. Further, the overall Stability Fee is forecasted to drop significantly over time. Unfortunately, until such time as we have the DAI Savings Rate in a collateral rising environment the Stability Fee is expected to continue to increase. Short term leverage will be justified well into the 20+% area.

Historically speaking system that convert variable input to a flat output took many iterations and human oversight before large scale adoption (e.g. autonomous cars / ship navigation systems / early thermostats to name a few). The oversight aspect is typically because humans want to have other humans accountable for any possible damages incurred. With MakerDAO, we can reasonably forecast that after twelve months of monitoring Multi-Collateral DAI, a feedback control system could be implemented to provide recommendations to the governance team for recommendations**. After an additional twelve months of monitoring, we could see a system (probably a PID tuned***, and supply leaning, control system) that is implemented that would modify the DAI Savings Rate and Stability Fee once per day with the governance team having a reoccuring veto to minimize external gaming of the system. It should be noted and reminded to the community how long humans used bicycles before getting on a Segway even though we understood feedback algorithms and how to ride a bicycle. For certain, many folks broke bones while the Segway was being developed. While financial in nature, the possible damage using feedback control systems for monetary policy are just as real. Summary: there are some lessons learned from the WOPR in “War Games” (1983). That said, it remains a viable objective that while retaining a veto structure to keep control with humans, a PID tuned feedback system could get the overall Stability Fee to around 2% per annum and keep it there.

* – price being determined by USD fiat offramp via USDC – DAI (at pro.coinbase.com)

** – feedback inputs would be DAI Savings Rate balance / Overall Supply Balance / computation of arc point elasticity for each / others

*** – PID (proportional / integral / derivative) Control System. It is expected that the DAI Savings Rate will be a potent (and more so than the Stability Fee impact on Supply) tool, as such it will be supply leaning (much like an autonomous car that has an alignment issue and drifts to the right, the control system for Maker will unlikely be symmetric between supply and demand).

NOTE: Not a part of the Maker foundation, just my $0.02 and not intended as advice in any capacity.

Posted in Digital Assets, Investing