Explained: MakerDAO’s plan to break the dollar peg

MakerDAO, the protocol that issues the Dai stablecoin, has passed a governance proposal beginning the transition to its “Endgame Plan.” This plan fundamentally changes many aspects of MakerDAO.

Here’s a breakdown of the proposal’s main points:

Clean Money

In October of 2021, MakerDAO founder Rune Christensen unveiled his new vision for what Maker was to become, and it all centered around a concept he called Clean Money. It was a way to take the collateral backing Dai and use it to tackle catastrophic climate change. This was to be the vision that would unite the Maker community and bring its together with a common purpose.

This isn’t actually a new belief within the MakerDAO community, with its sustainable finance principle, passed in 2018, saying: “that governance of the collateral portfolio take long-term societal, environmental, and sustainability impact into account.

The Maker project as a whole must keep the principles of sustainable finance as a core value, and always include negative externalities as a key factor in risk assessments of collateral. This means that Maker will be biased towards, for example, renewable energy that provides a long-term global benefit, while being biased against funding fossil fuels and other assets that create long-term risk.”

Rune hoped that “within a year we can allocate 3 billion or more of our USDC exposure into ESG corporate bonds protected by a world-class trustee in the UK or another Super Country.” One year later, MakerDAO has invested $0 of its collateral into ESG corporate bonds protected by a world-class trustee in the UK or another Super Country.

USDC and “real world assets”

USDC is specifically referenced by Rune because it represents one of the largest potential risks to the Dai stablecoin. According to makerburn.com 81% of Dai in circulation was minted from ‘stable collateral,’ dominated by USDC. This does somewhat exaggerate the scale of the problem though as, unlike other vaults, the stablecoin vaults are not over-collateralized. USDC and USDP together make up approximately 42% of the total collateral locked for Dai. These stablecoins are such a meaningful risk to Dai because the issuers can choose to blacklist those tokens and make them valueless at any time, but many parts of Maker either explicitly or implicitly assume they will continue to have the value of a dollar. This was one of the motivators behind trying to reduce that exposure in favor of US Treasuries.

Besides the stablecoins, Maker has increasingly relied on other real-world assets, bridged assets, and other assets that could come under pressure from regulators and law enforcement.

Maker’s critics have suggested for years that this represents an untenable situation, with these assets fundamentally undermining Maker’s goal to be a censorship-resistant stablecoin.

Rune hoped when he announced the Clean Money initiative that Maker would be able to shift assets from USDC into other bonds that would increase the yield that it was earning. This would arguably make it harder for regulators or law enforcement to quickly disable Dai.

Maker’s Endgame Plan

The Endgame Plan is a fundamental re-working of many parts of the Maker protocol that changes some of the expectations people have of it.

One of the changes is an intent to create a variety of MetaDAOs – smaller communities that own parts of Maker functionality or growth. Nominally MetaDAOs are supposed to help manage some of the political and interpersonal issues that Maker governance has struggled with, but they’re incredibly complex. Each MetaDAO will have its own treasury, which the MetaDAO will not control, and will instead be under the control of the Maker Core DAO.

Each MetaDAO will also have its own token, operate its own front end, and will have yield farming. MakerDAO will be moving from a two-token system (plus collateral) to a many-token system, with a complex system of token economics that will hopefully allow MetaDAOs to create their own value while still returning value to Maker Core.

The intention is for there to be GovernorDAOs who “are responsible for organizing the Decentralized Workforce of Maker Core,” CreatorDAOs who “focus on growth and innovation in the Maker ecosystem,” and ProtectorDAOs who focus on “intermediating Maker Cores interaction with the physical world.” The plan is to start with two of each for six MetaDAOs in total.

At all times, Maker Core, which will still be managed by MKR holders instead of MetaDAO token holders, will maintain control of all the MetaDAOs and their treasuries. The votes in MetaDAO are signaling and will still require Maker Executive Votes to be executed.

The ability to create sustainable communities and values surrounding managing individual aspects of a broader community has yet to be proven and will likely be an ongoing challenge for the MakerDAO community. Many DAOs see very low participation and even Maker’s recent important governance vote to see if the pre-Endgame Maker Improvement Proposals (MIPs) should be passed only saw approximately 16% of governance token voted.

Besides breaking up the current organizational structure of Maker, the Endgame Plan also intends to fundamentally change the type of collateral and stance that MakerDAO takes.

Rune now believes that a “physical crackdown against crypto can occur with no advance notice, and with no possibility of recovery even for legitimate, innocent users. This violates two core assumptions that we used to understand RWA risk, making the authoritarian threat a lot more serious.”

This was the motivating factor behind many of the changes that he hopes to have incorporated into Maker. Broadly, these changes are motivated by a desire to have Maker become more censorship-resistant and harder for regulators to pressure. This is clearly noted by the three phases that Rune describes for Maker.

The first is called “Pigeon Stance” and is basically where Maker is now. During this phase, which is intended to last the first two and a half years, Maker is focused on earning income and storing ether for the next phase.

After two and a half years, unless delayed or begun early, the goal is to enter “Eagle Stance” and reduce the seizable assets to less than 25% of the total. If necessary, this is when they intend to break Dai’s peg to the dollar to achieve this goal.

Finally there’s “Phoenix Stance,” which is only meant to be activated in times of global instability or if an attack on collateral is expected. Remember, this can come at any time with zero warning. In this phase, all remaining seizable assets are sold to acquire more staked ether.

The other change related to stages is trying to increase the amount of staked ether that the protocol controls, in the hope that it will continue to increase the amount of ether the protocol controls.

Finally, historically the assumption has been that if vaults cannot be liquidated for sufficient value to cover the debt, and the protocol surplus was not adequate, then MKR would be sold off into the market to keep the protocol solvent. It has always been possible for that process to be interrupted by governance, but the explicit assumption is now that this backstop is entirely optional and “the possibility of passing on a loss to Dai holders through a haircut to the target price becomes explicitly possible.” This means while MKR holders will still have the ultimate say over the protocol, they’ll no longer be the ones assumed to be diluted to make others whole.

What’s actually changing?

Having said all of that, the initial pre-Endgame MIPs do not make all of those changes. They create an emulation of the vault that will be controlled by the protocol and which will be used to hold stEth. It broadens the mandate for some core units, changes the collateral onboarding process, and removes some older MIPs. The process for launching the first MetaDAOs is beginning.

The rest of the plan is still to come, but in a sense, it does start the clock. The Endgame Plan expects that in three years it will be time to move to “Eagle Stance” and potentially break the peg to the dollar, however, MKR token holders are still in a position where they can choose to indefinitely delay that transition. They’ll find this appealing due to the additional income from purchasing bonds and custodying USDC with Coinbase to earn yield, especially if the assumptions around them needing to provide a backstop are gone.

MKR holders may end up incentivized to extend the “Pigeon Phase” indefinitely and continue to find ways to continue to increase the yield because it will primarily benefit them.

Consequences of peg breaks

If MakerDAO does choose to enter the “Eagle Phase” and break the peg then it will have second-order effects across the ecosystem. Any protocol that implicitly or explicitly assumes that Dai will be worth a dollar would have problems with this type of peg break, and so over the next couple of years it will be increasingly important for every protocol to make sure that assumption is not baked anywhere into the protocol. It’s also vital to have adequately tested and hardened solutions to manage a sudden peg break from Dai (a thing that most protocols should already have for all stablecoins).

A previous peg break was the motivator for onboarding so much centralized collateral in the first place. Having Dai pegged to the dollar is one of the reasons that it has so meaningfully outperformed its competitors like Rai that allow the peg to float. Rai currently has a market cap of less than 0.25% of Dai. Shifting back towards a conception of Dai where the peg can break and with this type of change in collateral will also affect demand for Dai, which may have feedback loops as the protocol tries to adjust its collateral.

What’s it mean?

I’ve referenced Rune’s communications repeatedly here, and that’s in large part because he’s been by far the largest voice advancing this change to the protocol.

He’s correctly identified a risk to the protocol, came up with what he believes is a solution, and passed the signaling vote. But the very structure of the “Pigeon Phase” he designed may disincentivize MKR holders from dealing with the problem he identified, by allowing them to profit from inaction. A “solution” that disincentivizes solving the problem is not a solution.

Then if the “solution” is advanced nonetheless, it will permanently alter the demand for Dai and its place in the ecosystem, and potentially harm or break other protocols.

All with less than 20% of voters expressing their opinion.

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