Weekly (almost) Narrative on MakerDAO – 15 May 2019
In the last weeks, the community voted on and implemented an additional increase in the Stability Fee bringing the new fee to 19.5% per annum. The community has also stepped-up the polling frequency for another executive vote. At present and pending an executive vote, the Stability Fee looks to be remaining the same. The overall price* of DAI has significantly rallied to its soft peg target of 1.0000. During the last week, the total outstanding DAI has now expanded to just slightly above 85.4mm DAI. This expansion is largely expected to the attributed to the rally in the underlying sole collateral of ETH which is now above $5 for every 1 DAI.
The above being said, as the DAI price* continues to hover above the target of 1.0000, we can draw an initial conclusion that most of the market maker inventory has been cleared out; therefore, it is reasonable to believe the supply overhang (e.g. difference between Demand and Supply) has ceased growing and is basically zero. As the supply overhang has disappeared, a new risk appears that might cause the price of DAI to continue to elevate above 1.0000. As now, the expected primary sellers of DAI at 1.0000, the market makers (which previously had outlined their desire to sell at 1.0000) no longer have excess inventory. As such, the remaining sellers will not have large inventory to sell which could cause a squeeze on the price upward.
As the 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). Historically speaking during times of an ETH rally, CDP owners that are borrowing for purposes of leverage would be minting new DAI to the point of price degradation. As we are not seeing this today, we can infer that on a blended basis the Stability Fee is more or less correctly priced. When the credit bubble does “pop”, we are going to need to poll & vote to decrease the fee urgently. A “pop” would be determined by large CDPs deciding to wipe millions of DAI instead of a few thousand. This event could be masked right now as the underlying collateral ETH is experiencing a rally. Specific vigilance on this point is recommended.
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.
With the upcoming introduction of the DAI Savings Rate, we need to start polling for / forecasting where to start the DAI Savings Rate. As it is strongly recommended to treat the introduction no different than another other new market force, it is strongly advised to roll-out the DAI Savings Rate slowing starting at 100bps.
In doing so, we need to also look to the future to understand where we want to go, as we embark on how to get there. The following is a combination of recommendations and forecasts together. As we introduce the DAI Savings Rate as a portion of the Stability Fee, we will want to decrease the Stability Fee by more or less the same that we implement for the DAI Savings Rate (e.g. offset the two market forces). In doing so, we will inherently mix signals (e.g. which signal caused the change in the outstanding DAI and the expected change in the price). This is guaranteed to happen on the first introduction as without doing both at the same time we will not have a market force offset which would then cause the DAI price to shift upward or downward. Thereafter, it will be recommended to increase one and not change the other to determine the potency of one change versus the other. For example, after we have introduced the DAI Savings Rate at 100bps, the following change should be a decrease in the overall Stability Fee, which should then logically create more supply. Thereafter, we need to increase the DAI Savings Rate to the point where we re-establish market harmony as seen in the DAI price. This process should repeat over and over until we have identified the market correlation between “incentives” to the DAI Savings Rate and the “penalty” with the Stability Fee overall. What we will find should be a world where the DAI Savings Rate will increase until we get exponentially more interest from alpha-seeking investors. From there, we will be able to start backing down both the DAI Savings Rate and the Stability Fee together. It is expected that when we start that decline of both the DAI Savings Rate and the Stability Fee together, we will probably be able to maintain the same ratio and see similar results (e.g. going from 10% DAI Savings Rate and 15% Stability Fee to 5% DAI Savings Rate and 7.5% Stability Fee, maintaining the proportions). Granted it is not recommended to make that massive of a change at once. The objective here is to use market forces, incentives / penalties to have a desired outcome.
In doing so, we will find the true “sweet spot” market fit for DAI and Maker as a whole. That market fit being a scenario where the DAI Savings Rate is higher than most banks (and stable and decentralized) and the Stability Fee as a whole is lower than most banks. For the record when we find that sweet spot, the outstanding DAI will be “much” more than where it is today.
In general, all participants want the rate to come down and have supply and demand be in harmony. Today they are not. It is conceivable they will not until the DAI Saving Rate is implemented. Please don’t rely on a “cheap” rate from Maker any time in the near future as the above referenced iterations will take months to achieve.
It is expected that the DAI Savings Rate contract will be an essential metric to gauge and estimate demand changes. As such, it is essential for future PID algorithm optimization to gather as much demand side information as possible, hence the logic to start slow and iteratively determine the market correlation.
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 throttling might also occur via different Stability Fee percentages tied to a specific collateral type. 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.
In a continuation of the last narrative, it is recommended to establish a workgroup to start the logic on a PID Control System** tool to help with signaling. As outlined prior, it can be reasonably forecasted that over a period of time upcoming to see that control system move from signaling humans that vote to one where the PID tool would implement those changes and have humans vote on the tuning variable or to veto all-together. What becomes interesting is not only the frequency of when that PID tool should be run (e.g. weekly? daily? hourly?) but also if we should run the optimization when DAI is being minted or burned. A solid argument could be made that the DAI minting and destruction process can directly cause price change in the market and are likely targets for when the control inputs to the system could be modified. Further, minting 3000 DAI has a clearly different impact on the market than minting 3mm DAI, especially if the intent of such DAI minting is to sell for a FIAT off-ramp, thus degrading the DAI price. Therefore in a multi-collateral dai world, it is recommended to include whether or not the intention of the collateral used on or off-chain as a metric of consideration (e.g. lending against real-estate).
The PID should start as purely an informational tool (off-chain but pulling chain data for computation) for the governance calls to continue to allow humans to vote based on the output. Thereafter, it is recommended to use resources to optimize that algorithm to the point where it could be put on-chain. Thereafter, the governance team and community as a whole should then be voting on the tuning of the algorithm while always retaining the ability to veto the output.
- – price being determined by USD fiat offramp via USDC – DAI (at pro.coinbase.com)
** – 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.
Data points: Top 250 MKR holders = 683279.482 1d delta: 180.788 and 1wk delta: -456.209 | Live Stability Fee: P/E (diluted) 39.40 – P/E (w/o dev fund) 29.05 | Forecasted 50bps Stability Fee (MKR burn portion): P/E (diluted) 1563.22 – P/E (w/o dev fund) 1151.84