Made possible with the support of Beanstalk Farms

MakerDAO (DAI)

I suggest avoiding MakerDAO and DAI until you fully understand the existential risks and are able to work around them.

Chris Blec

DAI, created by MakerDAO, promotes itself as “a stable, decentralized currency that does not discriminate.”

This may have been true a short time ago. However, this is a promise that MakerDAO can no longer make.

The USDC Peg Stability Module

In 2020, MKR tokenholders voted to implement Peg Stability Modules (PSMs). PSMs are specialized DAI vaults that allow the direct exchange of 1 token (usually a centralized stablecoin) for 1 DAI, regardless of DAI’s market price. The idea is that this would build up a very stable collateral base for DAI and strengthen DAI’s peg to $1 USD.

One of the first PSMs to be established was the USDC PSM, allowing for 1 DAI to be traded for 1 USDC (and vice versa) for little to no cost and at any time.

Fast forward to 2022, and DAI’s collateral is now approximately 75% USDC and a few other centralized stablecoins.

The problem here is that USDC is run by a company called Circle. Circle is a centralized, custodial and highly-regulated entity that has strict control over the USDC token.

If Circle chose to, it could blacklist all of the USDC tokens that collateralize DAI.

With DAI’s collateral frozen, DAI would quickly depeg. All DAI in the market would rapidly become worthless. Catastrophic destruction would follow.

Coinbase’s Custody of PSM Funds

Unfortunately, it gets worse for DAI.

Not only does Circle have blacklist power over the majority of DAI’s collateral, but in 2022 MKR tokenholders voted to hand over custody of one-third of the USDC PSM to Coinbase in exchange for a 1.5% APY return.

With the USDC in Coinbase’s custody, MakerDAO will not be permitted to access it without first asking for Coinbase’s permission. Of course, Coinbase can always say “no”. If it does decide to withhold access to the collateral, DAI will suffer in the same way that it would under a blacklist.

After witnessing multiple exchange collapses in 2022, no sane crypto user would assume that Coinbase is immune from catastrophic failure. However, if it does go down the way that other exchanges have, it will take DAI down with it.

Real World Asset risks

On top of all of this is MakerDAO’s commitment to building a trove of opaque real-world asset (RWA) collateral.

One of the clear benefits of DeFi is the ability to transparently show at any given moment that there is a treasury of funds backing each and every token. MakerDAO has lost this ability with RWA. It is simply not possible to have RWA collateral represented transparently on-chain.

A real-world economic catastrophe could cause one or more of MakerDAO’s RWA partners to fail. Since there is no automated liquidation mechanism possible with these collateral types, MakerDAO would be left high and dry and DAI could become undercollateralized.

Legal Unknowns

As of now, DAI itself is inherently a censorship-resistant protocol. It is not possible to censor an individual DAI transaction or a specific wallet. There is no function in the DAI smart contract that permits this.

DAI is also permissionless. Anyone can open a vault, generate DAI and send it to anyone else for any purpose that they choose.

This is a clear benefit of decentralization and something that we celebrate with protocols like Bitcoin that are unstoppable by nature.

This would be a huge benefit of using DAI… if it were unstoppable by nature. However, with the majority of its collateral at the mercy of highly regulated custodians, it absolutely is not unstoppable.

Therefore, it can be assumed that if DAI is used for illicit purposes, the day may come when state actors force DAI’s regulated custodians to freeze the collateral and, in essence, destroy DAI.