The Role of Ether in Multi-Collateral DAI
Governance of MakerDAO needs to consider special role Ether has as collateral for DAI
1 DAI = $2–$3 of ETH
DAI tends to be over-collateralized by 200% to 300%. That means that for every DAI that has been generated, there is at least 2$–3$ worth of ETH locked up in a CDP. This is a very strong lockup-force, as demand in DAI turns into 2–3x demand for ETH-in-CDP lockup.
DAI Collateralization Ratio:
Leveraged Ether Lockup
We can clearly see these effects take place. Lockup of Ether is almost always at an all-time high. This is partly product of the decreasing ETH price, which requires more Ether to be locked-up, in order to keep DAI collateralized.
There is currently over 1.6% of all Ether inside of MakerDAO CDPs, which represents perhaps the largest single pool of Ether currently in Ethereum.
This is all a result for the demand for DAI, which constantly seems to be growing.
Supply of DAI:
1.6% of Ether is a ton of Ether. Removing 1.6% of all Ether from the secondary markets, and putting it into MakerDAO, theoretically, helps prop up the value of Ether. All Ether locked in use-cases like MakerDAO, is Ether that cannot move to the secondary market. Therefore MakerDAO, in part, ensures Ether’s value by keeping it off secondary markets.
Using DAI is Using 2–3x ETH
Because the 200%–300% collateralization of DAI, when you transact 1 DAI between two people, it’s as if you are transacting $2–$3 of Ether. Because there is $2–$3 worth of Ether locked in the purpose of creating that 1 DAI. For two people to be able to transact in a stable currency, it requires 2–3x the value of Ether to do so.
Using Dai is using Ether.
Dai is Ether in it’s stable form. It’s a Meta-Ether. DAI is stable transaction layer, on-top of Ether.
When Ethereum moves to Proof-of-Stake, the security of the network is directly tied to the value of Ether. Ether must be valuable, for Ethereum to be secure. The more valuable Ether is, the harder it will be to attack the network, and the better we can all sleep at night.
Because 1 DAI = $2–$3 of Ether, DAI strongly contributes to the value of Ether, and therefore the security of PoS Ethereum.
Multi-Collateral DAI Needs to Retain Ether as the Primary Collateral.
As new assets come to Multi-Collateral DAI, Ethereum will begin to lose share of the collateral that backs DAI. Transacting in DAI will no longer equate to transacting in 2.5x of Ether. Instead, it will be something like 2x Ether and .5x DGX, or OMG, or other assets that are allowed to back DAI.
As more and more assets become approved to lockup for DAI, Ether loses its privileged position as the main currency that backs DAI. While this is good for MakerDAO, and DAI, because more assets can create more DAI, which makes more fees for MakerDAO, this is bad for Ether, as it is no longer required for DAI creation.
Therefore, less Ether is needed to lockup in MakerDAO. More Ether is available on the secondary markets. The Ether price is not as high. The security of Ethereum is not as great.
Take, for example, a version of Multi-Collateral DAI that has 0% ETH collateral. Or a USD-backed stablecoin. If non-Ether DAI or a USD-backed stablecoin became the predominant method of exchange on Ethereum, then the use and value of Ether would fall. The value of Ether could very well suffer the velocity problem, where the value of ETH is only a function of the cost of gas.
When we see DAI integrate into things like Augur, and other coming DApps, we will see DAI push out demand for ETH on those same platforms. If DAI begins to push out ETH as the main method for transacting value in DApps, and there isn’t at least 1$ of ETH for every DAI, then success of DAI comes at the cost of the security of Ethereum.
I propose a few guidelines for consideration, as MakerDAO proceeds with Multi-Collateral DAI
1 DAI should have minimum 1$ of Ether collateralized
This prevents transacting in DAI from leeching value from transacting in Ether. If there is always a 1:1 USD ratio of DAI to Ether, then when a user transacts in DAI, then Ether retains this value.
Ether should be the most significant source of collateral
MakerDAO should give Ether a privileged position as a collateral type. Because MakerDAO is on-top of Ethereum, it requires Ethereum to be secure for it’s own well being.
Ether should have the lowest required collateral
MakerDAO should incentivize Ether lockup above all other collateral types. One mechanism for this is to ensure that Ether has the lowest (or at least, tied for lowest) collateralization limit. This shouldn’t cause much problems either, as Ether will likely be one of most liquid and least volatile assets in MC-DAI.
Other assets like tokenized gold or tokenized real-estate will be far less volatile, but also far less liquid.
Ether is likely to be much less volatile in the future, in the same way that Bitcoin is the least volatile of all other cryptos: growth in on-ramps, liquidity, market capitalization all help slow the price of Bitcoin. The same is true for Ethereum.
Ether is likely to deserve a more advantageous position as a collateral type, and I believe we should be ready to give it one.
Promote DAI above all other Stablecoins
All other stablecoins have 1 USD backing it. If other stablecoins became the main method of stable-transacting on-top of Ethereum, then the use-case for Ether is reduced, and the security of Ethereum is weaker.
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A comparison of how MakerDAO was able to extract different qualities of Bitcoin, and place them exclusively in one of its two tokens, DAI and MKR.
If (…when) crypto enters a bull market, and Ether price appreciates, CDP holders will have to option to generate more DAI. I claim the most likely thing they are going to do is purchase more Ether, causing a feedback loop.
There is a link between the volatility of cryptocurrency prices, and the rate at which MKR gets burned. The more volatile the prices, the more MKR is burned. This should help as a large buffer for absorbing price shocks in the long term
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