MakerDAO governance leaves the foundation

$25m drained from Lendfme plus big DEX moves

On Saturday, crypto fund ParaFi Capital posted a 900-word piece on Maker’s online governance forum entitled [Action Required] State of the Peg. The post argues that Dai is in a “perilous and dislocated state at $1.02-1.03” that demands “emergency action” outside of the newly implemented MIP process.

We discussed why Dai is trading above its peg last week, but the campaign to return it to $1.00 picked up considerable steam over the weekend with several prominent DeFi voices replying in agreement with ParaFi Capital, including Scott Lewis at DeFi Pulse/DEX.AG and Tom Schmidt at Dragonfly Capital, a major MKR holder.

While a 2% premium may seem small, Tom Schmidt explains how that can make a big difference:

“We’re (anecdotally) speaking with a few teams that are considering switching to USDC away from Dai, and we see this switch already happening through on-chain data. dYdX posted its first day 1 with more USDC-WETH volume than DAI-WETH volume last week. Currencies, even fully-backed ones like Dai, still rely on network effects and strong narratives, which can often unwind just as quickly as they grew.

With this in mind, it’s important to think about the problem itself, which is that ~6-10MM more Dai needs to be minted in order to re-peg. So, where is this going to come from?”

The Maker forums are typically populated by the Maker team and core members of the community; most attend Maker’s weekly Governance and Risk meetings on Zoom. Some in the community reacted defensively, diminishing the seriousness of the situation. They argued macro volatility justified the drift from the peg and that rushed solutions could endanger Dai’s long-term sustainability.

Others in the community, like the pseudonymous LongForWisdom and Maker Founder Rune Christenson, were more open to solutions to restore the peg and increase Dai liquidity, namely slashing stability fees and expediting collateral onboarding.

Just this afternoon, Maker’s Head of Risk Cyrus Younessi posted four polls to gauge the community’s feeling on how to proceed:

  1. Are you in favor of adding LINK as a collateral type to MCD?

  2. Are you in favor of adding ETH with a lower liquidation ratio as a collateral type?

  3. Are you in favor of adding additional fiat-backed stablecoins (such as PaxUSD) as a collateral type?

  4. Are you in favor of significantly reducing the stability fee and liquidation ratio for USDC?

LINK looks like it will be fast-tracked for inclusion and # 2 seems like an odd fix, but Rune’s initial reply to ParaFi Capital may be the most prescient:

I think it would make sense to set all SFs to 0 (temporarily) and onboard as many new collateral types that the community has shown interest in, and that the domain teams state can be easily onboarded (so only erc-20’s). Taking such decisive action would hopefully have the effect of overshooting, taking the dai price below 1 USD, and from there the peg can then be stabilized from below, by increasing the DSR and the stability fees.

It’s clear that Rune sees a fully implemented Multi-Collateral Dai system as the key bulwark against the liquidity crunch that Dai finds itself in the long-term and the quickest way to restore Dai in the short-term. But never waste a crisis.

Important: Dai has been trading at ~ $1.015 on dYdX and Coinbase pro for most of the day. If it dips below $1.01, it may assuage fears of a Dai spiral.

Related: Popular currency blogger JP Koning’s latest in Coin Desk argues that Maker should consider negative rates.

How did we get here?

These are tough problems to solve. There are real long-term risks to account for, and there should be push back to short-term fixes for an ecosystem that hopes to be around for decades.

Taking a step back, the MakerDAO ecosystem features 3 pretty different interest groups:

  1. Dai holders

  2. CDP/Vault owners

  3. MKR holders

While there is large overlap in these constituencies right now, they will trifurcate in the future as the system develops. As Scott Lewis pointed out, CDP/Vault holders are much more sophisticated than Dai holders, which may be acquiring Dai to save in a stable currency, rather than opening a CDP to take a levered bet on the price of ETH.

Meanwhile, MKR holders, are the ones with decision-making power. It’s up to them to balance the interests of all three and create a sustainable and secure Dai ecosystem.

There is perhaps a more important constituency that MKR holders should consider: companies/projects building on top of Dai. Two companies come to mind: PoolTogether and Dharma.

Both are building consumer-facing products that leverage Dai but (almost) completely abstract away Dai/Ethereum. With other stablecoin options, it’s a simple choice of what works better and “better” typically means more liquidity – something that benefits all Maker stakeholders.

Related:

imToken exploited on Lendfme for $25m, Uniswap for $300k

A lot to still unfold after the largest attack ever in DeFi. There are good technical and Twitter explainers or articles from The Block and Coin Desk. The tldr is that imBTC is an ERC-777 token and there was an exploit unique to ERC-777 on Uniswap and Lendfme (or DForce) that allowed an attacker to reenter when withdrawing and essentially allows you to withdraw more than you supply.

To be clear, Uniswap (or more specifically, ConsenSys Diligence) publicly identified the re-entry attack a year ago during a smart contract audit and Uniswap never offered support for ERC-777 in v1 (even though imBTC had been listed on their official UI). Open Zeppelin even wrote a blog post in July about the ERC-777 reentrancy attack specifically.

DForce/Lendfme, on the other hand, should have been aware of this issue before they listed imBTC and their risk warnings should have gone to 11 after the first imBTC attack. And the same thing for imToken, which runs imBTC.

The incident highlights two key risk considerations going forward:

  • Listing assets is a core governance feature - Choosing not to have any say in what is listed – as Uniswap does – is also a governance choice, but the recent attacks (and bZx) show that the diligence that Maker applies to new collateral may be worth it.

  • Multi-asset pools increase complexity and risk exponentially – there is a 100x difference in the size of these attacks and that’s because all of the assets on the Lendfme platform participate in the same share-risk pool, as opposed to just the two asset-pools on Uniswap.

The incident is leading to a wider discussion on the safety and security of DeFi and increased calls for “composability audits”, but of course, who pays for these? And who watches them?

Liquidity providers bear the most risk in the current set up but there must be some type of diligence-as-a-service for the DeFi community. There may be something brewing. Regardless, the attack will lead to some thorny governance issues:

Click for poll results.

DEX activity heats up

In what was just a monumental news week, two huge announcements in the land of decentralized exchanges:

  • Gnosis launches new DEX with batched auctions – Targeting large trades in low-liquidity token pairs, Gnosis’s new design executes trades in 5 minute increments by conducting a series of auctions across asset pairings and finding the most efficient routes to execute. TokenTerminal has a nice explainer. Gnosis has been around for a while (originally conceived as a prediction market project) and their unique design shows how new projects can fill a specific liquidity gap. Perhaps most interestingly, the front-end of the Gnosis Protocol, Mesa.ETH.link is owned and operated by DxDAO, a decentralized collective built on DAOStack that plans to launch other (decentralized) DeFi protocols in the future.

  • dYdX launches BTC-USDC perpetual swap, offering 10x leverage – dYdX has been hard to classify in the current DeFi taxonomy. It’s the 3rd largest lending protocol after Maker and Compound, but also cracks the top 5 DEX’s by trade volume. Their latest launch reaffirms their core focus: margin trading. The Bitcoin derivatives space has seen a lot of growth over the last year and the timing could not be better after BitMex’s problems last month. dYdX is now out in front in the race to build the “Decentralized BitMex” (followed closely by Synthetix). In its pursuit, dYdX took a page from BitMex. BitMex recognized early on that Bitcoin was a good product to speculate on but it was even better collateral for a digital derivatives exchange. dYdX, meanwhile, is using USDC for margin deposits and settlement. USDC will be stable collateral and easy to liquidate. And, of course, this may be the most serious attempt to corner the “DeFi BTC” (alongside tBTC, renBTC, PieDAO, etc) market and is most direct overture at institutional DeFi. Also, talk about a back door way for Coinbase to compete with BitMex and other exchanges. This may be just as good of news for USDC as it is for dYdX.

Chart of the Week: Tokens during their time of day

Cool chart from Flipside Crypto on when tokens are used during a day to highlight time zone differences. Dai is pretty even, but USDT shows a heavy Asian bias.

Tweet of the week: ETH yields > USD yields?

I’m not convinced that this will be a long-term trend but the relationship between ETH yields from staking will have some type of affect on stablecoin yields, which may lead to discrepancies between stablecoin yields on competing PoS networks.

Odds and Ends

  • Black Thursday losses spur $28 million class-action lawsuit against Maker Foundation Link

  • Andreessen Horowitz aims to raise $450m for second cryptocurrency fund Link

  • First look at China’s digital currency DCEP Link

  • Stablecoins pass $9bn, adding $3bn in the last six weeks Link

  • 0xTracker tool shows how 0x API sources its liquidity Link

  • Ethereum addresses for all major DeFi protocols Link

  • Atomic Loans Raises $2.45M for Bitcoin Lending Mainnet Launch Link

  • Update on EIP-1559 Link

Thoughts and Prognostications

That’s it! Feedback appreciated. Just hit reply. Jam packed edition. Be on the lookout for exciting development this week. Written in Brooklyn (again) where I enjoy the mornings in Prospect Parks and dogs without leashes. Jake and Ben won 3-0 yesterday in Euchre.

Dose of DeFi is written by Chris Powers. Opinions expressed are my own. All content is for informational purposes and is not intended as investment advice.