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DAI monetary policy - mirroring traditional central banking

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Satoshi&Co Daily Crypto Newsletter

April 15 · Issue #160 · View online
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(TLDR: this article assumes you have a basic background on stablecoins. DAI, perhaps uniquely, is a crypto-collateralized stablecoin. Do check out our comprehensive stablecoinwatch section for more background on this exciting area on cryptocurrencies).
Source: xkcd
Source: xkcd
Arguably the most important and the biggest component of the DeFi ecosystem, the MakerDAO project seems to be caught up in a strange problem. After weathering concerns over price stability in a downward-trending ETH market through 2018 (DAI maintained its $1 peg when ETH crashed all the way from $1200 to $100), DAI now has to contend with a new quandary where the price has persistently traded at a discount to its pegged price of $1. The graph below illustrates DAI’s trading discount based on various price oracles. For instance, on, some of the most popular trades have been those that sell DAI for USDC or TUSD or some other stablecoin, with the DAI being sold at a slight discount to the dollar.
How exactly does DAI maintain the dollar peg? CDP borrowers can buy DAI if the price is below $1 to close the CDP and get their ETH back. For example, let us consider a case where you might borrow 100 DAI tokens by depositing $200 worth ETH in a CDP (200% collateralization). In order to close the CDP and get back your ETH, you will have to payback the borrowed DAI and also pay the accrued stability fees for the tenure. If the price of DAI is trading below $1, say 98c, borrowers can buy DAI from the market for less than a dollar each and redeem their ETH from the CDPs, thereby making a profit of 2%. In cases where the price of DAI is above $1, say $1.02, users are incentivized to borrow DAI by collateralizing ETH and sell the borrowed DAI on the market for a 2% profit. These potential arbitrage opportunities are expected to keep the peg as close to a dollar as possible.
However, when DAI is persistently trading above or below its $1 peg, the MKR ecosystem makes changes to the protocol to incentivize users to restore the price to $1 again. Stability fees is one parameter that can be tweaked to increase or decrease the supply of DAI, akin to how central banks use interest rates to infuse or suck liquidity out of the system. When there is too much liquidity in the system, increasing the stability rate will make borrowing DAI more expensive and incentivizes users to payback loans faster. This results in liquidity shrinking and the price of DAI going up.
When DAI was faced with the problem of trading below its peg, the Maker governance body (a loose affiliation of early stakeholders) brought forth a proposal to increase the stability fees from 0.5% to 1.5%. This was voted in by MKR holders with the aim of reducing the overall liquidity of DAI, albeit for a short while. However, DAI prices very soon readjusted to the new normal and started trading at a slight discount again. This led to new proposals for further rate hikes, which resulted in the stability fee increasing from 1.5% to 7.5%, across three successive hikes. Ideally, a high stability fees of 7.5% should deter users from borrowing new DAI and increasing supply, but it failed to have an impact on DAI’s price. DAI’s price seemingly moved closer to $1 after increasing the stability rate to 7.5%, but the price retracted back when the prices of ETH surged in the mini rally a few days ago. In a bullish ETH environment, traders are incentivized to borrow more DAI as it allows them to gain leveraged exposure to ETH. DAI liquidity is more likely to contract when the stability fees are high enough and offset the profit potential from a leveraged ETH position. In order to counter this, MKR has announced another rate hike, this time to 11.5%.
We are just scratching the surface here with this line of reasoning. There are angles to be explored around velocity of DAI, total secondary DAI trade volume to primary issuance, and other such concepts that lend themselves directly from traditional macroeconomics and monetary policy. It will be interesting to whether the rate hike to 11.5% will finally lead to price stability, especially when previous attempts at stabilizing the prices have been proven futile. Moreover, if the impending rate hike is not sufficient to maintain the peg, Maker could be forced to look for alternatives such as imposing a temporary supply constraint on DAI issuance to rein in the surging demand for DAI tokens. 
Meanwhile in Crypto Wonderland....
“Binance to Delist Bitcoin SV”
Binance, the largest cryptocurrency exchange by volume, has decided to delist the BSV cryptocurrency. The news follows recent legal threats stemming from Craig Wright’s team of litigators who are demanding an apology from various prominent digital currency enthusiasts. The first person to receive a letter was an online persona known as Hodlonaut, the creator of the Lightning Torch. According to the letter, Hodlonaut called Wright a fraud and the team is expecting an apology or plans to sue for libel.
“UK-based Blockchain Startup Raises $3.9 Million”
United Kingdom-based blockchain startup has raised $3.9 million through a platform owned by the London Stock Exchange (LSE), fintech news Finextra reported on April 15. Known as Twenty Thirty or 20|30, the startup has reportedly secured 3 million British pounds (GBP) by selling tokenized shares on LSE-owned equity trading platform Turquoise. In July 2018, 20|30 became one of 29 firms that were approved by the Financial Conduct Authority (FCA) to start testing within its fourth cohort of a regulatory sandbox. With FCA approval, 20|30 became authorized to issue equity tokens on the Ethereum (ETH) blockchain, with the firm announcing that LSE’s Turquoise will be the first platform to pilot the sales of its tokenized shares.
“Mitsubishi to Launch its Own Crypto”
Mitsubishi UFJ Financial Group Inc. plans to put its original digital currency into practical use by the end of this year, according to President Kanetsugu Mike. The major banking group hopes to enable other enterprises, such as retail stores, to use the digital currency, called “coin,” as their own currencies and bearing their own respective corporate names. If businesses in different sectors use the currency, Mitsubishi UFJ “will be able to connect economic blocs,” including customer bases of such firms, Mike said in a recent interview. With competition for cashless payments intensifying, as seen in moves to issue new digital currencies, Mike voiced confidence in differentiating his company from others by providing a payment infrastructure that will enable many companies to participate.
“BitMEX Mulling Over Issuing Bitcoin Bonds”
In a recent interview, Arthur Hayes, Co-Founder and CEO of crypto derivatives exchange BitMEX, talked about his company, and in particular, mentioned that he was looking into the idea of BitMEX issuing some kind of short-term Bitcoin bond. The BitMEX CEO’s comments during an interview with cryptoasset analyst and trader Luke Martin (“@VentureCoinist” on Twitter) on the “Venture Coinist” podcast. Perhaps, the most interesting part of this highly informative and interesting interview was when Hayes started talking about the idea of creating a future “where the highest quality exchanges and miners… issue short-term Bitcoin bonds.”
Crypto Twitter Pick
Dovey Wan 🦖
Not all inflation are created equal

Treasury reward is NOT an issue if the team is tranperant and reasonable abt it. However hidden founder reward and outrageous treasury inflation can be even worse than the fiat style robbery

h/t @ceterispar1bus
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