🥊 DeFi's Heavyweight — Issue No. 41
/đź“°News
There wasn't much technical news to focus on this week in the blockchain world. Rather than weaving a narrative where there isn't one, or recounting less technical happenings that other outlets cover adequately, I've decided to focus this issue on the biggest player in Decentralized Finance ("DeFi") ecosystem: Maker. Link.In one sense, the Maker project is a very old idea. You have an asset, you don't want to sell it, but you need cash. What do you do? Take out a loan and use your asset as collateral. If you fail to make loan payments, your asset can be liquidated by the lender. This is what Maker allows holders of Ether to do, and many have, with nearly $300M worth of ETH locked in thousands of Collateralized Debt Positions (CDP). Link.
Though the basic premise of Maker is as old as money itself, the project is pushing boundaries on multiple other fronts. For one, enforcement of collateral positions, payment collection, and liquidation of delinquent loans is all handled in a fully decentralized way. It's all in the smart contract code. The loans themselves are made in DAI-- a stablecoin pegged to the US Dollar. DAI achieves its stability through the collateral mechanisms programmed into the contracts. Unlike other stablecoins, it's fully decentralized. There's no trusted organization holding dollars in a bank. Link.
Another way Maker is breaking new ground is in its governance. Anyone who owns the MKR token collects the interest charged on the loans and also has the right to vote for certain changes. The critical factors in the system, such as the interest rate charged when borrowers open new CDPs, are thus controlled by a Decentralized Autonomous Organization (DAO). Unlike DAI, the MKR token floats relative to the dollar. If CDPs ever become insolvent, more MKR is minted as a backstop. This mechanism incentivizes token holders to vote for parameters that keep the system stable. If they don't, their investment in MKR will be devalued by dilution. Just this week, token holders voted to raise the interest rates on CDP loans because DAI has been trading a few cents below one dollar. Link.
This brings up the most valid criticism of Maker I've seen to date: that the supply of DAI won't scale to meet demand. More precisely, DAI isn't minted when people want DAI-- it's minted when someone wants a loan on their Ether. This week's move to raise the interest rate, which should decrease the supply of DAI and bring its price back up to the peg, proves the point. Even as the community is embracing DAI as the unit of exchange for Ethereum economy, DAI is being destroyed, not created. This excellent post by Hasu and Su Zhu expands on this eloquently. Link.
That criticism aside, I find the Maker project fascinating. It feels like the best example to date of the enormous potential of programmable blockchains. Think about it... Maker is a fully decentralized lending platform that creates a fully decentralized, censorship resistant stablecoin as a byproduct. Its governance is managed by thousands of disparate token holders around the globe, all acting in their own self interest to produce an outcome that is desirable for the system as a whole. And so far, it's worked! To the tune of hundreds of millions of dollars in loans. This is amazing, and if you're like me, you might wonder if it's just the tip of the iceberg in terms of whats possible.
I will mention one aspect of Maker that actually does give me pause. What happens if Maker, or some other DeFi application, becomes too big to fail? More than 2% of all ETH is now locked in CDPs. What happens if there is a bug in the smart contract? Or what happens if there's a sudden drawdown in price, which leads to mass liquidations, which drives the price of Ether down even further. Could we be programming our way into a Decentralized Financial Crises? It's far too early to say, but as usual, one thing is certain: interesting times are ahead!