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In the real world, interest rates are one of the most central figures in an economy. This is also true in the DeFi world, where Dai's stability fee plays the role of interest rates in the real world. As more DeFi projects began to integrate Dai, the situation became more and more complicated.

This article introduces MakerDAO, an infrastructure in the DeFi (decentralized finance) field, and an overview of Dai, and takes Dharma, a secondary lending market built around Dai, as an example to discuss its business model and its interaction with Maker itself, especially It has reference significance for the setting of stability fees and systemic impact.

MakerDAO’s current commitment to the world is to keep 1 Dai pegged to 1 USD (Dai is the stable currency issued by MakerDAO), and increase the degree of decentralization of Dai over time.

Whether this promise is fulfilled depends on whether Maker's credit system is as effective as it is supposed to be. Maker’s credit system includes the interest rate paid by borrowers (stability fee), the interest rate or yield earned by lenders (the upcoming Dai Deposit Rate), liquidation ratios, and a debt ceiling.

By actively regulating these parameters, Maker has successfully withstood a drop of more than 80% in the price of ETH. ETH is currently the main collateral for Maker.

But is that enough?

How does the rise of other decentralized credit protocols and applications - such as [Dharma's Lever] (a digital currency lending platform) affect Dai's peg to the US dollar?

How should the community vote on interest rates?

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How important is Maker?

First, Maker has been growing, and growing fast. .

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Source: https://mikemcdonald.github.io/eth-defi/

Now, let's add the ETH locked by Maker:

We can see that the collateral value of other major projects in this space is only a small fraction of the collateral value of Maker, which is staggering in size.

Last year, Maker had to adjust its debt limit from 50 million Dai to 100 million due to increasing demand to borrow Dai. Nine months later, Dai in circulation is once again approaching the new debt ceiling.

So why is Maker so popular?

By implementing a stability fee of 0.5%-2.5%, Maker provides the cheapest credit channel for stablecoins. This is especially important for investors looking for leverage: instead of lending WETH and taking the risk of price fluctuations on the principal, why not lend Dai to trade other coins? .

Driven by this demand, Maker has grown to become the most dominant platform in DeFi (and Ethereum). As more capital is at stake, and more integrated Dai projects are launched, it becomes increasingly important to understand how best to set Maker parameters.

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Current credit application scenarios of Dai

In the field of permissionless lending, there are several major projects:

MakerDaoDharmaCompound

(dYdX offers margin trading, but the funder is a designated partner, so not included)

image description

Source: [https://loanscan.io/]

The demand for Dai is driven by several factors, chief among them the convenience of leveraged investing (e.g., investors or traders who are reluctant to trade with their ETH holdings can instead lend Dai to trade). Dai has received attention mainly because Maker is a low-cost credit tool, even offering a 0.5% loan interest rate at one point.

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The downside of cheap credit costs

Take Coinbase as an example.

Among Coinbase trading pairs, Dai currently only has USDC trading pairs, while USDC itself has trading pairs such as BTC, ETH, BAT, ZEC, MANA, DNT, CVC, LOOM, and GNT.

In order to use the borrowed Dai, leveraged traders will have to sell Dai for USDC in order to take a position in a range of tokens to choose from. Such a situation led to continued selling pressure on Dai on Coinbase.

The same can be seen on KuCoin, where USDT has 26 trading pairs, while Dai only has 4 pairs. Here, USDT is trading at a higher price than Dai.

Therefore we can foresee:

In a bear market, Maker can guarantee that Dai will be pegged 1:1 to the U.S. dollar stably at a volume of 90 million U.S. dollars. When the bull market comes, the demand for Dai will increase exponentially, which is likely to put more pressure on the peg between Dai and the US dollar.

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raise interest rates

The Maker Foundation, keenly aware of the selling pressure on Dai, recently passed a community vote to increase the stability fee to 3.5%.

So far, on Coinbase, this rate increase has proven to be effective, and the price of Dai has a certain steady upward trend.

However, Dharma Lever offers a 0.1% lending rate, which is lower than any rate in Dai’s history.

Cheaper Dai on Dharma could exacerbate the aforementioned downward price pressure. However, Dharma allows Dai to be used as collateral to lend ETH, which will reduce the liquidity of Dai and slow down the sensitivity of Dai's price to sales. .

Fortunately, there is a loan limit of $25,000 for a single user on Dharma, and Dharma has just been launched, and its low interest rate is more like an opening promotion and will not last long. In the long run, the interest rate on Dharma will approach Maker's own interest rate. Therefore, for Maker, the amount of Dai affected by Dharma is currently negligible.

Additionally, the amount of Dai loaned on Dharma is limited by how much people are willing to lend. This means that as long as the Dai lending yield (0.1%) is less than the interest rate (3.5%) that Dai will bear when lending Dai, there is no need to worry about Soros-style attacks where people open a large number of CDPs to lend Dai and then lend on Dharma.

Moreover, Maker's upcoming Dai savings interest rate (that is, like a bank, users will earn interest for holding Dai) will also make users reluctant to sell and ease the pressure of selling.

Dharma is not the first credit agreement, nor will it be the last. In the future, when more projects and platforms allow Dai to be borrowed and borrowed at a lower cost, how should the Maker community respond? How will interest rates converge? How should the community think about Dai for other DeFi credits when deciding the best parameters to set for Maker agreement relationship?

It is against this background that we propose the following thinking directions for the Maker and DeFi communities to better inform governance decisions.

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How DeFi sets lending rates

Dharma, as a venture-backed business (which is not yet profitable in the form of token issuance), must generate returns for investors, and Dharma may end up having to collect fees on loan origination.

This means that Dharma charges a small fee on top of the base cost of the Dai it acquires.

This presents a dilemma: if Dharma charges a small price difference on top of the stability fee, users will have no incentive to borrow from Dharma, but will borrow directly from Maker. Because the collateral rate is the same, and the interest rate is lower.

With that in mind, here are the main factors DeFi projects should consider when setting lending rates for Dai:

1. Any borrowing rate will be highly dependent on community-voted stability fees, should a project like Dharma acquire a significant stake in MKR to participate in governance, or at least actively communicate its preference? **2. Since the borrowing rate needs to be higher than Dai's deposit rate, should Dharma consider supporting other collateral?

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How to set the collateral ratio of DeFi

Currently, the collateralization ratio of all DeFi credit platforms — whether Dharma, Compound or Maker — is set at 150%.

, but this is not necessary for Dharma. The reason why the mortgage rate is set as high as Maker is because it cannot take the risk of systemic collapse. But Dharma could theoretically allow users to set their own mortgage ratio.

Then the following questions should be considered:

1. How should Dharma users set the collateral ratio to compete with Maker's own products with a better combination of collateral ratio and yield?

(For example, a borrower may evaluate whether a loan with a 125% mortgage rate and 3.6% APR is more appropriate than a loan with a 150% mortgage rate and 3% APR)

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How to Set Maker Stability Fee

Choosing the right stability fee (which may need to flexibly adjust to demand and supply over time) is critical for Maker and DeFi projects that provide Dai credit, and it has the following implications:

1. Determines how much MKR will be destroyed for each Dai borrowed; 2. Determines the upper limit of the Dai savings rate 3. Affects the interest rate of all other platforms that borrow and lend Dai

Given that we are in the early days of Maker, setting fees is mostly a range in a general direction, rather than a quantitatively precise action (i.e. raise the stability fee a bit if demand for Dai is too high).

Over time, as DeFi matures and becomes a real financial solution in the future, we suggest that the Maker community also pay attention to the lending rates in the traditional financial field. Some key questions are:

1. Should Maker compare its stability fee to the secured lending rates offered by major banks?

2. Should Maker make Dai’s interest rate lower than that of traditional banks, making Dai more attractive in the field of high demand for cross-border stablecoins?

3. Should Maker charge a small premium to protect the interests of MKR holders?

4. Should the stability fees and collateralization ratios be different for different collateral types under multi-collateral Dai to reflect different levels of liquidity and volatility?

A rough statistic is that 3,598 Dai have been lent out of 898 CDPs in the past 7 days. The average loan value per CDP is around $4,000.

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How to Set Dai Savings and Lending Rates

Lending is a prerequisite element of Dharma (if no one lends, no one can lend). Hence, when rates on Dharma can be personalized, competitive pricing may be given to attract lenders.

Instead, the Dai Savings Rate exists primarily to encourage people to hold Dai, thereby limiting the amount of Dai in circulation in the market. In fact, since the DSR (Savings Rate) is funded from the Stability Fee (which will eventually be returned to MKR holders through destruction), a low deposit rate is in the best interest of MKR holders.

This is a great incentive because all projects, including Maker, want the deposit rate to be as low as possible without affecting Dai's peg to the dollar.

As the two rates are likely to converge over time, key factors for stakeholders to consider include:

1. How much higher should the lending rate be for a project like Dharma than the Dai savings rate?

2. Should Dharma actively participate in Maker governance to ensure that DSR is low enough that Dharma can command a premium on lending rates while maintaining an attractive lending rate? ?

3. If it is too costly for Dharma to acquire enough MKR stake, can they vote in their favor by borrowing MKR? Is it ethical to do so?

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How to Set the Debt Ceiling

in conclusion

in conclusion

All in all, we are seeing the rise of borrowing and lending Dai in a trust-minimized way outside of Maker itself, which is a boon for the broader Maker ecosystem.

Platforms like Dharma increase the utility of Dai by allowing users to stake Dai as collateral and generate yield by lending Dai (before Maker introduced the Dai Savings Rate). Increasing Dai’s utility and increasing Dai’s counter asset can help increase the incentive for people to hold Dai, which may reduce pressure to sell. Beyond credit protocols, we expect to see more decentralized financial products backed by Dai-based DeFi institutions in the near future.

However, the rise of these platforms has also complicated governance considerations for the broader DeFi community. The Maker rate decision will have a significant impact on all third-party platforms seeking to provide borrowing Dai and related services. Setting an interest rate that is too high may discourage other Dai credit platforms.

Taken together, we believe that the governance of Maker stability fees and savings rates will increasingly be influenced by emerging protocols for borrowing and lending in Dai. Ultimately, in order for the credit market to continue to grow steadily, the experience of the traditional credit market is likely to have reference and influence on the decision of Maker's interest rate.