Coronavirus and blockchains: the crisis of MakerDAO

Coro­na­vi­rus pan­de­mic stres­ses world sys­tems on all levels — from indi­vi­du­al human bio­lo­gi­cal immu­ni­ty and men­tal wel­l­be­ing to poten­tial­ly geo­po­li­ti­cal order. Block­cha­in eco­stems, still a tiny ele­ment of the glo­bal eco­no­mic sys­tem, expe­rien­ces this as well. Two weeks ago the Black Thurs­day hap­pe­ned, with all stock inde­xes plum­me­ting to the levels not seen in deca­des. Cryp­to­cur­ren­cies got hit even har­der, loosing clo­se to 50% in some instan­ces, in a move­ment cor­re­la­ted with stock mar­kets» loses. This coupling sug­ge­sts that cryp­tos still have not beco­me  alter­na­ti­ve cur­ren­cy, a save heaven for the time of tur­mo­il, but rather are sill regar­ded as inve­st­ment instru­ments, and rather riskier ones.

Łukasz Jonak, Ana­li­tyk DELab UW

Pri­ce of Ether during the ini­tial pha­se of Coro­na­vi­rus pandemics
DAI and Decentralised Finances

The pande­mic stres­ses not just the first-order cryp­to mar­kets, but also the finan­cial eco­sys­tems built on top of cryp­to block­cha­ins. Decentra­li­sed Finan­ces (DeFi) move­ment has been the most exi­ting and dyna­mic recent deve­lop­ment on Ethe­reum block­cha­in. It is an eco­sys­tem of finan­cial servi­ces allo­wing users to uti­li­se the­ir (cryp­to) money in the simi­lar man­ner to the tra­di­tio­nal world of finan­ces. Users can exchan­ge dif­fe­rent kinds of cur­ren­cies (tokens), save and lend money with inte­rest rates even higher com­pa­red to the lega­cy sys­tems, they can tra­de deri­va­ti­ves, inc­lu­ding the syn­the­ti­cal ones, cor­re­spon­ding to the „real world” assets such as gold, they can bor­row, and spe­cu­la­te using leve­ra­ge, if they fell adven­tu­ro­us. Vario­us servi­ces com­ple­ment and sup­port each other; when you invest in liqu­idi­ty pools of cryp­to swap­ping servi­ces (ear­ning the per­cen­ta­ge of trans­ac­tion fees on cryp­to pairs) you actu­al­ly make the ope­ra­tion of the­ses servi­ces possi­ble, pro­vi­ding liqu­idi­ty neces­sa­ry to exchan­ging cur­ren­cy for other users. And the cru­cial thing abo­ut all this eco­sys­tem is that it works in decen­tra­li­sed man­ner — the­re are no banks, bro­kers, cen­tral finan­cial poli­cy making agency.

Very impor­tant ele­ment of DeFi is Maker­DAO foun­da­tion and its pro­duct: DAI sta­ble­co­in, living on top of Ethe­reum block­cha­in. Whi­le Ethe­reu­m’s nati­ve cryp­to­cur­ren­cy, Ether, is very vola­ti­le, DAI’s pri­ce is con­stant: o unit of DAI costs aro­und one dol­lar. The exi­sten­ce of sta­ble coins (the­re are other than DAI as well), pro­vi­des sta­bi­li­ty needed for the ope­ra­tion of all the other servi­ces of DeFi ecosystem.

The spe­cial thing abo­ut DAI is its decen­tra­li­za­tion — its sta­bi­li­ty is not con­tin­gent on any cen­tral enti­ty and arran­ge­ment, for exam­ple, a basket of tra­di­tio­nal cur­ren­cies kept in a bank exter­nal to the block­cha­in sys­tems. What sta­bi­li­ses DAI is the way the cur­ren­cy is being issu­ed on the block­cha­in. DAI is bac­ked by the vola­ti­le Ether loc­ked in the sys­tem as col­la­te­ral when users want to generate/borrow some DAI. If you want to gene­ra­te 100 DAI you need to com­mit at least $150 worth of Ether. You get it back when you return the 100DAI to the sys­tem. This way all the DAI in cir­cu­la­tion is secu­red by a safe, exces­si­ve amo­unt of Ether.

The perfect storm

The­re is a num­ber of mecha­ni­sms guar­ding the sta­bi­li­ty of DAI. Auc­tions of loc­ked Ether take care of situ­ations when the pri­ce of Ether falls to the levels insuf­fi­cient for it to back DAI any­mo­re. Sta­bi­li­ty and saving fees regu­la­te the sup­ply and demand of DAI, depen­ding on how much it devia­tes from its dol­lar peg. The­se mecha­ni­sms are desi­gned to with­stand serio­us mar­ket per­tur­ba­tion and attacks. Unfor­tu­na­te­ly, the Black Thurs­day cre­ated a per­fect storm for Maker­DAO and DAI, one that the sys­tem bare­ly survived.

Couple of things happened:

  • Ether pri­ces drop­ped shar­ply, fol­lo­wing the gene­ral mar­kets» panic,

  • Users fled to the sta­ble DAI, incre­asing demand for it and con­se­qu­en­tly, its pri­ce, thre­ate­ning to detach it from the dol­lar peg,

  • The traf­fic on the Ethe­reum block­cha­in incre­ased, making it lon­ger for some of the trans­ac­tions to go through,

The results were near­ly cata­stro­phic. If Ethe­reum trans­ac­tions slow down, eve­ry­thing on the block­cha­in, inc­lu­ding MakerDAO/DAI mecha­ni­sms, slows down. The servi­ces pro­vi­ding sys­tem with the infor­ma­tion abo­ut cur­rent pri­ces (so cal­led «orac­les») could­n’t do it on time. The users who wan­ted to add Ether to the­ir deva­lu­ed col­la­te­ral and avo­id the­ir loc­ked Ether auc­tio­ned could­n’t do so. The auc­tions them­se­lves, desi­gned to main­ta­in DAI col­la­te­ri­za­tion when Ether pri­ce falls, could­n’t go thro­ugh. Wha­t’s wor­se, some rogue agent abu­sed the crip­pled auc­tion sys­tem and was able to win some of them, buy­ing auc­tio­ned Ether for the equ­iva­lent of zero dol­lars, or clo­se to it. This costed some users all the­ir loc­ked col­la­te­ral and cre­ated dan­ge­ro­us, over $4 mln defi­cit in the sys­tem, under­mi­ning the strength of DAI as a cur­ren­cy and sta­ble coin.

Saving DAI

The Maker­DAO foun­da­tion scram­bled to address and con­trol the situ­ation. Fol­lo­wing the Black Thurs­day and thro­ugho­ut the next week, the team held daily calls during which vario­us coun­ter­me­asu­res were discus­sed. If you replay the recor­dings of the­se meetings (they are ava­ila­ble on the Maker­DAO youtu­be chan­nel), you’ll noti­ce they were punc­tu­ated with a mixtu­re of dis­be­lief abo­ut what was hap­pe­ning, wor­ry, the reso­lve to fix the sys­tem, and, even­tu­al­ly, exhau­stion. The sta­kes were high, the­re was a risk that emer­gen­cy shut­down of the enti­re sys­tem would be trig­ge­red, anni­hi­la­ting all the DAI in cir­cu­la­tion, leaving cur­ren­cy users with a loss of some of the value of the­ir hol­dings, and thre­ate­ning the exi­sten­ce of the who­le DeFi ecosystem. 

A num­ber of solu­tions were pro­po­sed: the incre­ased dura­tion of col­la­te­ral auc­tions gave legi­ti­ma­te bid­ders chan­ce to par­ti­ci­pa­te and out­bid mali­cio­us «0‑bid» actors. In con­tro­ver­sial move, ano­ther, cen­tra­li­sed sta­ble­co­in, the USDC, was allo­wed to be used as col­la­te­ral, in pur­su­it of more sys­tem sta­bi­li­ty. A radi­cal adju­st­ments of key sys­tem para­me­ters (meaning sla­shing them to the mini­mums) were pro­po­sed in order to incen­ti­vi­se users to mint more DAI and incre­ase the amo­unt of the cur­ren­cy in cir­cu­la­tion. Final­ly, in order to cover sys­te­m’s defi­cit, the min­ting and auc­tio­ning of Maker­DA­O’s nati­ve token, MKR, was discussed.

DAI pri­ce off-peg

All of the­se pro­po­sals went thro­ugh the gover­nan­ce pro­cess, in which the MKR token hol­ders (meaning the users incen­ti­vi­se to act in the best inte­rest of Maker­DAO sys­tem) voted for each solu­tion. As of today the MKR auc­tions mana­ged to sup­ply sys­tem with funds eno­ugh to redu­ce the debt, USDC has been allo­wed to back min­ting new DAI (altho­ugh with mecha­ni­sms in pla­ce to disco­ura­ge its long-term uti­li­sa­tion in the sys­tem), the col­la­te­ral auc­tions star­ted to ope­ra­te with adju­sted parameters.

The situ­ation seems to be sta­bi­li­sed, altho­ugh Maker­DAO and DAI are not com­ple­te­ly out of the woods yet. The who­le orde­al seems to have under­mi­ned users» trust in the sys­tem. The bad debt has been cove­red, but DAI is still off peg, tra­ding a couple of per­cent abo­ve one dol­lar. The­re is still not eno­ugh sup­ply of DAI to dri­ve the pri­ce down, possi­bly becau­se the users are reluc­tant to mint new DAI by loc­king the­ir Ether in the Maker­DAO system. 

The Maker­DAO cri­sis high­li­ghts how the extre­me, black swan-like, situ­ations can expo­se all the vul­ne­ra­bi­li­ties of high­ly inno­va­ti­ve and still expe­ri­men­tal socio-tech­ni­cal sys­tems. For Maker, as well as the who­le block­cha­in world, the coro­na­vi­rus pan­de­mic pro­du­ced an extre­me stress-test situ­ation, if not stra­ight­for­ward exi­sten­tial thre­at. Only time will tell if the eco­sys­tem will be able to endu­re the­se cir­cum­stan­ces and, per­haps, for­ti­fy itself for the future.

Autor pro­jek­tu: Łukasz Jonak

Pro­jekt finan­so­wa­ne ze środ­ków pro­gra­mu „Dia­log” MNiSW

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