MakerDAO: the temptation of traditional finance

MakerDAO: the temptation of traditional finance

The protocol recently decided to invest the reserve of its stablecoin, the DAI, in traditional assets such as US government bonds. A decision that is far from unanimous in the community.

👉 First of all, what is MakerDAO?

MakerDAO is the decentralised autonomous organisation (DAO) that manages DAI, the fourth largest dollar stablecoin on the market ($5 billion capitalisation). The protocol was launched in 2018 on the Ethereum blockchain.

Unlike centralised stablecoins such as USDT ($65 billion) and USDC ($63 billion), DAI is not based on a traditional dollar reserve.

Its value is "backed", i.e. supported, by crypto-assets, which is not without consequences: to ensure the stability of the reserve, an over-allocation mechanism is needed in case crypto-asset prices fall.

An example: you need to send $1,000 worth of ethers to generate 500 DAI. In the event that ether falls by around 50%, the collateral is liquidated on the markets, but the DAI remains stable. Pretty clever 🤓.

In recent months, and in response to the continuing depreciation in crypto prices, the DAI's reserve has been fed mainly by other stablecoins (USDC, GUSD, USDP). Currently, the DAI is thus "protected" by around $7.7 billion worth of cryptos placed as collateral by the community, which is remunerated for this.

Maker is remunerated by the Gemini exchange platform with 1.25% on the GUSD (Gemini's dollar stablecoin) it holds if its balance is maintained above $100 million. According to the latest figures, Maker holds $500 million in GUSD.

As a sign of the trend, Maker is also in talks with platform Coinbase for a $1.6 billion loan in USDC against a 1.5% yield.

All these decisions were voted on by the community, i.e. the holders of the MKR governance token, whose price is hovering around $600.

Basically MakerDAO had not planned to put its reserve to work; its objective is to maintain parity with the dollar. But that was without taking into account the new macroeconomic environment and the very strong competition from other stablecoins...

👉  A problematic dependence on the USDC

Since 2020, most of Maker's reserve has relied primarily on the USDC stablecoin (nearly 50%) issued by American company Circle. "This stablecoin has the advantage of being highly liquid and regulated in the United States, but its weight has become too great and its returns are limited with the new market conditions," concedes Sébastien Derivaux, who is responsible for risk management at MakerDAO.

According to financial analysis firm Kaiko, the remuneration on the USDC in the Aave lending protocol has fallen from 2.3% to 0.6% in the space of just 15 months. As a result, MakerDAO saw its least profitable quarter since at least 2020 between July and September.

To adapt, the organisation is exploring other options such as investing in traditional finance assets (the word is out 😬 ). "There are other ways of finding returns," confirms Sébastien Derivaux.

This decision also comes at a time when the USDC is particularly exposed. This summer, several of its addresses were frozen after US sanctions against Tornado Cash, a tool that anonymises cryptocurrency transactions. 

👉 US government bonds

But back to the "real world" assets Sébastien Derivaux is talking about. At the beginning of October, the Maker community decided to invest $500 million in US Treasury bonds with a short maturity, i.e. "1 year".

Why? Because interest rates have soared and MakerDAO can take advantage of this. The yield on US bonds has risen from 0.04% to 4.7% in just over a year! A system that its competitor  Circle (which issues USDC) has understood well and has already been using massively for months.

Maker has also set up other arrangements. "We lend DAI to projects such as those of Société Générale ($30 million) or the American Huntingdon Valley Bank ($100 million)," explains Sébastien Derivaux.

"The aim of these investments is to finance projects that demonstrate that DeFi has a positive impact on society, he continues. "We could eventually diversify into corporate bonds," explains the Frenchman, who concedes, however, that this will take time.

And so much the better, because this gradual shift towards traditional finance and its "centralisation" is not to everyone's taste. "Maker goes where the yields are, and at the moment they're in US government bonds," explains one industry expert.

"People were starting to leave DeFi, so we had to be able to remain attractive," stresses Sébastien Derivaux. And traditional financial products are part of the solution, at least for the next few months. At least for the next few months.

In a note published in mid-October, analysis firm Kaiko explains that this decision is "good in the short term", but also stresses that it has an impact on the decentralised dimension of the DAI and raises questions about the long term.

To reassure the community, this pivot towards decentralised finance is supposed to be temporary. Investments in "real world" assets should be limited to 25% of the reserve within three years. "However, this date is not set in stone. It could be pushed back depending on regulatory developments and market conditions", Sébastien Derivaux concedes.

In the long term (if all goes according to plan), Maker's reserve should consist solely of ethers, the cryptocurrency at the heart of the Ethereum ecosystem. "The aim is to make as much profit as possible to acquire as many ethers as possible and dispense with traditional finance," explains Sébastien Derivaux.

"Holding ethers or any other decentralised asset is the only way to resist regulation because reserves will be beyond the reach of any sanction," Kaiko points out.

To date, traditional assets account for two-thirds of Maker's revenues, valued at just under $1m a month ($4m in the third quarter, according to analyst firm Messari).

👉 The centralisation dilemma

So what to do? "I hear the criticisms," says Sébastien Derivaux, but no one has yet found an entirely decentralised solution. If there was one, we would obviously have chosen it."

Projects that have remained exclusively in the decentralised universe are not at their best. One of the most striking examples is the RAI stablecoin. Currently, its holders are exposed to negative returns of 6% 🫤.

"What is happening at Maker is, in my opinion, an illustration of DeFi at a crossroads," analyses Stanislas Barthélémi, crypto expert at KPMG. "We end up with two contradictory trends: on the one hand, a DeFi that wants no connection with traditional finance and risks being marginalised, and on the other, a TradFi-DeFi hybridisation that creates risks vis-à-vis regulators and reinforces the centralised nature of DAI", he stresses.

For him, this vagueness is maintained by co-founder Rune Christensen: "He has put to the vote a proposal that is ideologically pure in the long term (doing without real-world assets and de-anchoring with the dollar to avoid censure from Washington), but which is not simple, if not impossible, to implement and clashes with reality."

👉 Governance ill-suited to the challenges?

Would Rune Christensen have too much power? What is certain is that the project is not sufficiently decentralised in practice, notably because of the non-participation in votes of many members - venture capital funds and exchange platforms that refuse to take a position for legal or neutrality reasons.

During the last major vote organised by the community at the end of October, Rune Christensen's voice represented 74% of the votes cast 😵💫. We've had better decentralisation!"

"MakerDAO is one of the oldest DAOs and has actually been operating in this form since 2020, but the governance models are still too simplistic to be resistant to attacks from inside or outside what are known as DAOs, so it's a term that needs to be put into perspective," analyses Stanislas Barthélémi.

The symbolic case of MakerDAO was the subject of an analysis by Vitalik Buterin, co-founder of Ethereum, in a long blog post published on 5 December. "The protocol and its financial reserves have not been attacked because the majority of MKR tokens are held by a fairly small group who are not prepared to sell because they believe in the project. This is a good model for launching a stablecoin, but not for its long-term management and development. For decentralised stablecoins to work in the long term, they need decentralised governance."


👉 Towards a new system?

The Maker community spoke out on 31 October in favour of the "End Game" proposal put forward by Rune Christensen. This plans to reorganise Maker into a series of "MetaDAOs" that will autonomously develop their own business models.

These MetaDAOs will operate in parallel with the main protocol and should have their own governance token.

"MakerDAO had become too complex, so we had to break it up into several sub-parts", explains Sébastien Derivaux. "We'll keep the Maker Core structure above, which will look after supervision, while the MetaDAOs will focus on more concrete applications," he continues.

This new organisation will enable new economic incentives to be put in place to attract more users. "Yield farming mechanisms (returns from cryptocurrencies) will make their arrival", confirms Sébastien Derivaux.

In any case, all these changes are not without consequences for the project and its future. According to our information, a schism in the community that would result in a "fork" (separation of opponents who would retain the operation of the historical protocol) cannot be ruled out.

Even in DeFi, the temptation of traditional finance can come at a price.

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