Valuation Outlook, MakerDAO’s Opportunities And Risks in The New Cycle

February 8, 2023 - Around 10 mins mins to read

MakerDAO is the first DAO organization established on Ethereum, and it is also one of the most successful applications of Ethereum. Even in a bear market, the amount of assets locked in this agreement has been ranked first for a long time, and it was not until recently that Lido surpassed it briefly. Lido has received a lot of attention under the expectation of ETH 2.0 and Shanghai upgrades, and the currency price has also performed very well.

In this bear market, although MakerDAO is also a constant topic, it first cooperated with Coinbase on lending and then passed a series of external credit loan proposals. It is constantly trying to increase the income of the balance sheet in various ways, but the performance of the currency price has not been stable. Good, then why such a high TVL did not bring benefits to the token?

There have been many articles about analyzing MakerDAO on the market before, but after its continuous development, it has undergone a lot of adjustments, some of which may bring it higher income and may also cause many new problems, such as its Mixed reviews of RWA real-world asset investment strategies. And behind the large-scale foreign investment, where is the source of its funds?

How to look at the above-mentioned issues is also the purpose of this article. We will combine its various businesses and data to look at the potential of this project in the new cycle in the future.

Valuation Outlook, MakerDAO's Opportunities and Risks in the New Cycle

How MakerDAO Profitable

For the convenience of readers who are not familiar with MakerDAO before, here is a brief introduction to its mode of operation.

MakerDAO is an overcollateralized stablecoin. Users can mortgage the assets supported by the protocol to obtain the decentralized stablecoin dai anchored to the US dollar.

In MakerDAO, each position is called Maker Vault. The value of min the collateral ratio in the Vault represents the liquidation ratio, which refers to the ratio of the over-collateralization you need for the current collateral.

Taking ETH as an example, the current liquidation ratio of ETH is 170%. If you want to lend 5000 DAI, you need to mortgage the eth with a value greater than $8500. If it is lower than this amount, you will face the risk of being liquidated and liquidated.

Stability Fee Stability Fee

The current fee for pledged ETH to lend DAI is 0.50% annually.

If you need to close the position and take out the mortgaged assets, you need to repay the borrowed DAI and the stability fee at the same time

According to the current TVL, it is expected to earn 20 million DAI a year.

Liquidation Fee

If the user’s collateral price in the agreement drops sharply, but the user does not close the position or increase the mortgage funds in time, when the minimum pledge rate falls below, the Keepers liquidator in the ecology can send a request to the contract to liquidate these insufficient collateral Positions, at this time, the system will auction these collaterals at a discount, and the liquidator can use DAI to bid to participate in the auction of these collaterals, which usually has a 3% arbitrage space.

Taking ETH as an example, the current liquidation fee in MakerDAO is 13%. If you pledged ETH position falls below the minimum pledge rate and is liquidated, an additional 13% of assets will be deducted as a penalty. Part of the fine becomes the source of the liquidator’s profit, and the rest belongs to the MakerDAO agreement. Last year, MakerDAO’s liquidation fee income was approximately 27.6 million DAI.

The keeper’s liquidator is actually a kind of arbitrage robot on the chain. Anyone in MakerDAO can become a liquidator to participate in the auction. The team also provides open-source robot code.

Because of the existence of arbitrage space, a large number of liquidators are encouraged to keep monitoring the system so that high-risk positions can be liquidated in a timely manner so that DAI has enough assets to maintain its value anchor. Make sure the DAI collateral value in the system is higher than the DAI issuance.

MakerDAO system surplus and expenditure

The money earned by the agreement will be stored in the system surplus pool, which is MakerDAO’s treasury. These funds will be allocated for the buffer (Maker Buffer) first, and then used for repurchasing and destroying mkr and providing operation teams, etc. expenditure. The specific rules are as follows

Buffer Gold Maker Buffer

As we mentioned earlier, if the mortgage rate of a certain position is insufficient, the collateral will be liquidated and auctioned. But when there are some extreme market conditions, or encounter other liquidity problems, such as 312. When the value of the collateral drops sharply and cannot be liquidated in time, the final auction price of certain position collateral may not be able to cover the debt. Bad debts will arise, and at this time, the buffer pool funds will be called to repay these debts to ensure the value of DAI.

The current setting of this pool is 250 million DAI. When the system surplus exceeds $250 million, MakerDAO will start the surplus auction voting, and auction the excess DAI in the market. Bidders can use MKR to bid, and the highest bidder wins. Once the surplus auction is over, the Maker Protocol will automatically destroy the MKR obtained from the auction, thereby reducing the total supply of MKR. (That is, through this mechanism, buy back and destroy MKR to the market)

On the contrary, if the debt generated is too large and the funds in the buffer pool cannot cover the loss, MakerDAO will trigger the debt auction (Debt Auction) mechanism. During debt auctions, the system mints new MKR (increasing the amount of MKR in circulation) and sells it to users who use DAI to participate in the auction.

In the extreme market on March 12, 2020, due to transaction congestion, the sudden drop in liquidity led to the superimposition of dai premiums, etc., causing a large number of liquidators to stop participating in the market, resulting in 5.67 million DAI loans undercollateralized.

So on March 19, MakerDAO launched its first debt auction since its launch. The auction lasted until the end of March 28, and finally 20,980 MKRs were auctioned at an average price of 296.35 DAI. A total of 5.3 million DAI was raised, and the refinancing was successfully completed with mkr. Among them, the investment institution Paradigm stated that it bought 68% of the MKR in this auction.

In response to the problems in 312, MakerDAO subsequently launched the liquidation 2.0 module, which further improved the auction mechanism and replaced the 1.0 English auction system with the Dutch auction system.

On May 19, 2021, the value of cETH dropped by 45% on that day, the 2.0 system processed positions worth $41 million, completed 177 auctions to liquidate debts, and generated $5.1 million in liquidation costs. At the same time, only two Liquidation losses totaling $12,000. It can be seen that the new liquidation system has been well stress tested.

Dai Savings Rate (DSR)

DSR is a system-global parameter that determines the benefits that DAI holders can earn based on their deposits. When the market price of DAI deviates from the target price due to market changes, MKR holders can vote to change the DSR to maintain the stability of the DAI price:

If the market price of DAI exceeds $1, MKR holders can choose to gradually reduce the DSR, thereby reducing demand and thereby reducing the market price of Dai to the target price of $1.
If the market price of DAI is below $1, MKR holders can choose to gradually increase the DSR to stimulate demand and increase the market price of DAI to the target price of $1.

MakerDAO team operating expenses

The team currently has more than 100 employees maintaining the system. Last year, various expenses totaled more than 45 million dai.

Value-added logic of MakerDAO token

The following are the main risk parameters for Maker vaults:

Debt Ceiling: The debt ceiling refers to the upper limit of the total amount of debt that can be generated by collateral. Maker governance imposes a debt ceiling on each type of collateral to ensure sufficient diversity in the Maker protocol’s collateral portfolio. Once collateral reaches the debt ceiling, it is impossible to incur more debt unless existing users repay some or all of the vault’s debt (thus freeing up debt space).
Stability Fee: The stability fee is the annual interest calculated based on the amount of Dai generated by a treasury (for users who generate Dai, the stability fee rate is equivalent to the annualized interest rate of the payment; for the Maker agreement, Stable rates are the comparable
annualized rate of return). The stability fee can only be paid by DAI, and sent to the Maker buffer.
Liquidation Ratio: A lower liquidation ratio means that Maker governance has lower expectations for collateral price volatility; a higher liquidation ratio means higher expectations for price volatility.
Liquidation Penalty: A liquidation penalty is an additional fee charged to users based on the total amount of outstanding Dai in the vault when liquidation occurs. The liquidation penalty is designed to incentivize vault owners to keep the collateralization ratio at an appropriate level.
Collateral Auction Duration: Collateral Auction Duration is specific to each Maker Vault. The debt auction period and surplus auction period are global system parameters.
Auction Bid Duration: The minimum amount of time before and after a single auction ends.
Auction Step Size: This risk parameter is designed to incentivize early bidders in the auction and prevent the proliferation of too low a step size.

MakerDAO has an excellent economic model design. As a governance token, MKR can participate in voting to manage various parameters of the MakerDAO system, which determines the use and distribution of PSM pool funds and profit pool funds. At the same time, when the protocol surplus exceeds 250 million, it will start to repurchase and destroy MKR so that MKR will enter deflation mode so that token holders can increase their value and benefit. On the contrary, if MakerDAO has bad debts, it will issue additional MKR to fill the debt, and the value of MKR will be diluted.

Exploration of new business lines

In order to solve the above problems, MakerDAO initiated and passed a number of investment proposals in the past six months, with the purpose of diversifying the risk of centralized stablecoin assets in the balance sheet and, at the same time, obtaining more benefits, which also increased the RWA reality. Investment in the real-world asset.

In July 2022, MakerDAO voted to approve a proposal to provide a loan of up to $100 million to the Huntingdon Valley Bank, a Pennsylvania chartered bank established in 1871, which is expected to yield a net annual rate of return of 3%. Became the first DeFi protocol to provide loans to traditional US banks.

Meanwhile, a proposal for a. $30 million line of credit to. Société Générale was approved in July.

Conclusion

In addition to monthly and weekly fixed risk management meetings and financial reports. Every investment and expenditure, every parameter adjustment, will also produce a detailed evaluation report. It is a learning case for many project parties. Of course, this is inseparable from manpower and material resources, which is also one of the sources of the high operating costs mentioned above.

So they also recently passed a new proposal to split MakerDAO into sub-daos called metaDAO, such as letting a sub-dao be responsible for investing in real assets and independently managing Vaults of real assets. Each metaDAO can find its own governance tokens and reserve at least 40% of the tokens for MKR to dig pits. It is expected to reduce expenses by half, but no more implementation details have been seen so far. We look forward to exploring more successful and effective governance models for the industry in the future.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your own research before investing.

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Harold

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