How Bitcoin trading frenzy almost depleted a vault in MakerDAO

Bitcoin’s dizzying surge to above $69,000 on Tuesday almost upended the backing for MakerDAO’s $4.3 billion DAI stablecoin.

That’s because one of the Maker vaults containing collateral that backs DAI was minutes away from being depleted amid the frenzied market action.

MakerDAO’s USDC PSM was the vault in question. PSM, which stands for “peg stability module,” is a tool used by the protocol to mint DAI in exchange for supported stablecoins such as USDC.

In the end, MakerDAO was able to collateralise the vault adequately with a fresh supply of USDC, but the PSM reserves have diminished to less than $320 million, according to a governance post on Friday by the DAO’s risk unit BA Labs.

The DAO, or decentralised autonomous organisation, is now considering an accelerated proposal to make temporary changes to the protocol that will help the DeFi lender navigate periods of excessive demand for DAI, as was the case during Tuesday’s market volatility.

The situation is so pressing that approved changes will be ratified by an executive vote rather than by the normal multi-step governance process.

DAI demand shock

DAI’s total supply is down to $4.38 billion from $5 billion at the start of the week, data from Makerburn shows.

That decline is due mainly to excessive DAI minting by crypto traders who were looking to place optimistic bets on Bitcoin’s price.

“The Bitcoin price spike caused the PSM to suffer because Maker guarantees a fixed borrowing rate,” Pablo Veyrat, co-founder of stablecoin protocol Angle Protocol, told DL News.

“Anyone looking to long Bitcoin–USD at a fixed rate over time is incentivised to do this directly with Maker,” he said.

The traders were borrowing DAI from MakerDAO and swapping directly to Bitcoin to profit from BTC’s price climb. That depleted the PSM faster than it could be replenished.

The USDC PSM isn’t Maker’s only USDC vault. The DeFi lender also has $1.1 billion worth of USDC in its real-world asset vaults, but those funds cannot be redeemed quickly to cover any shortfalls in the PSM reserves.

A depleted USDC PSM could cause DAI to depeg from the US dollar, but Veyrat said that would be only temporary.

“It wouldn’t have been bad in the sense that it would have come back to peg and all people closing their Bitcoin long would have had to rebuy DAI — by putting USDC in the PSM — and repay their debt,” Veyrat said.

BA Labs’ proposal

The BA Labs proposal recommends four broad temporary changes to the Maker protocol.

One is to make it more attractive to save DAI rather than to borrow it by raising the DAI savings rate, or DSR — interest paid to DAI holders who lock the stablecoin on the protocol — to 15% from the current rate of 5%.

On top of the rate bump for holding DAI, the proposal also calls for an increase in the protocol’s stability fees for borrowing the stablecoin against accepted collateral. Maker’s stability fee is the interest rate charged for borrowing DAI.

BA Labs said the measure was appropriate given that MakerDAO’s borrow rate was lagging other DeFi lending rivals whose rates have surged lately.

Other changes include adjusting the intervals for increasing the debt ceiling to 12 hours from 24 hours. That would allow the protocol to more rapidly accept more collateral to back the DAI.

Also, BA Labs recommended a decrease in the time lag for approving governance actions after execution to 16 hours from the current 48 hours.

These changes would be temporary. Should the DAO approve them, the protocol will revert to its normal settings once the crypto market volatility peters out.

Osato Avan-Nomayo is our Nigeria-based DeFi correspondent. He covers DeFi and tech. To share tips or information about stories, please contact him at osato@dlnews.com.