The Importance of Debt Ceilings within MakerDao’s Collateralized Stable-Coin System
I’m excited to see some buzz surrounding one of Ethereum’s oldest and most important projects — MakerDao. This project has been in development for over three years, and this last December they finally rolled out a working product — Dai ⬙ It’s been almost 4 months and Dai has remained stable through this enormous 70%+ market-crash, a true trial by fire.
As fun as it is to talk about how Maker works, this post will not be about that. Instead I am hoping to address a specific point to those who will be voting within Maker’s DAO. Mainly that any collateral could be valid, no matter how inherently risky.
MakerDao is a Decentralized Autonomous Organization(DAO). This means that this entity is managed by a decentralized group of people, holders of the MKR token. Voters will decide primarily on what types of collateral will be accepted on the platform, as well as the surrounding parameters and rules for each asset.
- Dai is a stable-coin which is soft-pegged to $1 USD.
- Dai is regularly backed by upwards of 220%+ in collateral assets.
- Dai is a standard ERC-20 token, and can be stored on your Ethereum wallet.
- Dai is the leading fully decentralized stable-coin.
If you’re unfamiliar with how Maker works i’ll direct you to the three sources below, check those out before reading any further.
I want to address a very specific point for the understanding of voters who will be participating in this DAO. One key concept to understand as a voter in the Maker system is that the more assets we support on the system, the better, and that risk needs to be looked at and understood very carefully.
Currently, Dai is only backed by a single asset, Ethereum. This test version of Dai is exposed to the most amount of risk it will ever be exposed to since there is a single point of failure. If Ether’s price falls quick enough, there wouldn’t be any valuable collateral to support the Dai ~ $1 peg. The system would become insolvent. However, if you give Dai more than one leg to stand on the risk of insolvency during a black swan event drastically decreases. This is called a Diversification Benefit.
Each potential collateral type will have to have various parameters configured to it such as:
- the stability fee imposed on CDPs of the corresponding CDP type, expressed as a per-second fraction of the CDP’s outstanding dai.
- the maximum total (“ceiling”) dai issuance for the corresponding CDP type.
- the minimum required collateralization ratio (value of collateral divided by value of issued dai) for CDPs of the corresponding CDP type.
- the penalty imposed on liquidated CDPs of the corresponding CDP type
All of these parameters give MKR voters a chance to fine-tune all types of assets, so that they can appropriately exist in the Maker system in a way which doesn’t expose the Maker system to too much risk. In theory though, any collateral could be valid.
In this post I only want to focus on one parameter, the Debt Ceiling
There will come times where we will be voting-in riskier assets onto the platform. One key controller of Maker’s overall risk is the Debt Ceiling assigned to each type of collateral asset.
Currently, the single collateral system is set-up with a 50 Million Dai debt ceiling. This means that only 50 million Dai could be minted against Ether.
It was written in the Digix/MakerDao partnership announcement that the DGD gold debt ceiling would be eventually set to as high as 3 Billion.
Let’s play with a make-believe portfolio for Maker now versus 1 year from now:
In a rush, so these graphics aren’t exactly meant to impress, only to illustrate a point.
As you can see, to the left is a snapshot of today’s risk profile in terms of collateral type, debt ceiling, and % of total debt ceiling across all collateral types. It’s 100%, since there is only 1 collateral type.
Next, is a snapshot of what our risk profile might be by this time next year, after the launch of Multi Collateral Dai. As you can see, there are now three points of failure. Two of which, Ether and OMG, are correlated assets. However, the massive debt ceiling which would be assigned to Digix Gold offsets the risk for accepting more volatile assets like Ether and OMG.
Some time later, our portfolio may look something like this — multiple assets within multiple asset types. The more the merrier. As you may have noticed, crypto is not the only collateral type that Maker will eventually accept. Eventually we will have more uncorrelated categories of assets like Real Estate, Equities, Government Bonds, Commodities, etc…
Here is the table of the numbers from the third pie chart.
In this portfolio example crypto-assets account for 33.67% of the risk in the MakerDao system. This is largely due to the Debt Ceiling parameter. As a Maker token holder, you have the right to vote on this number, along with several others.
Riskier assets are presumably given far smaller caps (and far higher stability fees) so that they don’t expose the overall system to too much risk. Riskier assets are not inherently bad, in fact they could produce a lot of revenue through heightened stability fees, in order to pay MKR holders for taking on this risk.
The overarching point of this post is to explain that any collateral could be valid. So long as it has the right set of parameters.
Edit: UPDATE, Rune Christensen made a comment on Reddit in response to this post and i received permission to append it below :) Cheers!
— Rune Christensen, Founder of MakerDao, (Source: Reddit; Rune4444)
“Great post. There’s a point that I want to clarify that I now realize hasn’t been properly communicated. The announcements of specific collateral types are done for PR reasons, and doesn’t give them special risk status in the system. The fact that we are confident in saying that OMG will be included as collateral, and DGX will be included at a very high debt ceiling, is because the broader risk framework that we’re working on will have these included, alongside many other tokens. In fact almost every single major ERC20 token that currently exists on Ethereum will be included as collateral, except for scams.
The point you make is very important, that just because a token is included in the collateral portfolio doesn’t mean all that much, because what really matters are the risk parameters, and e.g. the debt ceiling it gets will be highly dependent on how stable and correlated it is. This is why it’s safe to include a lot of tokens, even controversial ones that some consider to be bad, because we can fine tune the exposure of the system to these tokens based on our risk assessment model. So a token that’s “10 times worse” than another token, would also have e.g. 10 times less debt ceiling, to put it in very simplified terms.”