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DAI – finally some stability

DAI has been in the news a lot lately. We covered DAI’s monetary policy a while ago, as well as arbitrage strategies around DAI.

DAI is exciting for a variety of reasons, including the fact that it is foundational to the DeFi stack.

DAI prices kept falling below the Dollar for the longest time, as Ethereum prices started increasing in line with the broader crypto market over the past couple of months. There has been selling pressure on them, with the result that it has been a struggle to keep the price of the stablecoin pegged to the Dollar. There have also been rumors of internal misalignment within the team, in addition to the DAI trading a discount to its fair value due to rapid supply expansion. The high inventory levels saw it being sold at a discount to $1, with the discount sometimes as high as 2-3%.

This is the key point; 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, effectively the borrowing costs, are high enough and offset the profit potential from a leveraged ETH position. In order to counter the supply overhang, MKR holders agreed to raise the stability fees. However, most of the early fee hikes which started in February and continued until April proved futile, as the supply kept increasing and price discount widening. The succession of hikes resulted in the stability fees reaching as high as 19.5% from 0.5% at the beginning of this year.

Perhaps aided by the rally in ETH prices, resulting in users de-leveraging their ETH bets by paying back DAI, or due to the prohibitively expensive stability fees of close to 20%, it’s price peg travails seem to be easing up. This has resulted in supply contraction and subsequent price stability, at least in the short term, exactly as it would have done in traditional financial markets, in response to a Central Bank’s open market operations.The current DAI supply is 16% below the peak supply of 93 million DAI outstanding in mid-March.  

Stability Fees Graph
Source: Diar.com
DAI Price Premium/Discount
Source: coinmetrics.com
DAI Supply as a % of Peak Supply
Source: coinmetrics.com

DAI will continue to play a critical role in the growth and adoption of DeFi for years to come. The recent listing of DAI on Coinbase should help push DAI awareness further. On the roadmap front, the launch of Multi-asset Collateral will diversify the risk away from ETH and allow users to borrow against a wide range of collateral assets. In tandem with the launch of Multi-asset collateral, MakerDAO also plans to launch a DAI savings mechanism where users can deposit their DAI tokens and earn interest on them, mirroring a traditional banking operation. This would put them in direct competition with key DeFi players such as Compound and Dharma that are using DAI to create lending markets.   

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