Editors Note: This article comes fromBlue Fox Notes (ID: lanhubiji)Editors Note: This article comes from
Blue Fox Notes (ID: lanhubiji)
, author: HasuSuzhu, from medium, translated by the Blue Fox Notes public account SL, and published by Odaily with authorization.
Foreword: At present, there are more than 2 million ETH mortgaged on Maker, which is equivalent to more than 2% of the total supply of ETH, and nearly 300 million US dollars. It is far larger than DEX. It is one of the best-developed projects in the Ethereum system and a DeFi masterpiece. The author believes that, unlike other stablecoins, Dai is not driven mainly by professional arbitrage, but more by staking assets to achieve asset circulation and leveraged transactions, which is insightful. Blue Fox Notes believes that due to the decentralized nature of Dai, with the increase of future application scenarios, its demand motivation may come from more aspects. In the long run, Dai also has the opportunity to expand, but there will indeed be a balance, because Dai Be steady.
The least known thing about a stablecoin is how it came to be. Who created the USDT, USDC or Dai that everyone bought on the exchange? We will see how professional arbitrageurs expand and shrink the supply of stablecoins according to market demand. How is Dais model different, and why is there a lack of a professional arbitrageur model, which makes Dai fundamentally difficult to scale.
There is a common misconception about Dai that it can scale to any size due to the demand for the stablecoin pushing the price above $1, which leads arbitrageurs to lock up ETH or other assets in CDPs, thus creating more Dai. This logic is often used to support the statement that the higher the demand for Dai, the higher the demand for Ether, but both are false.
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We consider a stablecoin to be scalable if its supply can quickly reflect its demand. To do this, stablecoins rely on the existence of professional arbitrageurs who respond to market signals and keep supply and demand in balance.
Professional arbitrageurs need a closed cycle. The faster and more efficient the cycle, the closer supply can move in the direction of demand. As an example, look at Tether (USDT), which is collateralized with fiat currency.
When market demand pushes USDT’s price to $1.02, the market signals to arbitrageurs that it’s time to work. Arbitrageurs will send 1 USD to Tether Inc. and receive 1 USDT at the same time. Since USDT is worth $1.02 in the market, this gives the arbitrageur a $0.02 profit. When the price of 1 USDT drops to $0.98, arbitrageurs will buy USDT, send it to Tether Inc. and redeem it for 1 USD. Both cycles ended in profit.
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Professional Arbitrage on Dai is Nearly Impossible
Since there is no way to implement a closed cycle on Dai, making arbitrage more difficult.
When market demand pushes the price of DAI to $1.02, you can buy $1 worth of ETH (or any other asset that can be used as collateral) for $1 and lock it in DCP. The problem, however, is that for every $1 of ETH locked, Maker will give you less than $1 of Dai. Because it uses over-collateralization. The current mortgage rate is 150%, so 0.66 Dai can be generated by mortgaging 1 dollar of ETH in CDP (this mortgage rate will change, but it will never be close to 100%).
Now, you can sell 0.66 Dai for the same 2% premium, but your ETH is still locked. The fundamental difference between Tether arbitrage and Dai arbitrage is that for Dai arbitrage, you need to find a way to make a profit by closing the CDP after some time. The only way to make a profit is to buy back Dai at a lower price (compared to the selling price).
So while youre waiting for the Dai price to drop, youre in an awkward situation:
1. You have no way of knowing when, or if, it will drop again.
2. Since you cannot complete all the steps of this cycle immediately, you are stuck in waiting and pledged ETH. You want to remove the risk by shorting ETH, but that incurs additional borrowing costs.
3. You need an additional capital cost to lock up the portion of Dai that is not used to borrow Dai, at least 33% (because you only loaned out $0.66 of Dai from $1 of ETH). This cost is the risk-free rate in dollars.
4. Closing a CDP requires additional costs
USDT and other fiat-collateralized stablecoins allow for a closed arbitrage cycle because the collateralization ratio is 100%, rather than over-collateralized. Arbitrageurs can use 1 USD to create 1 USDT, and then sell the USDT to complete the arbitrage. Arbitrageurs don’t need to worry about dollars being “locked” in Tether’s bank account. Those dollars are now someone elses problem. The existence of commitment arbitrageurs allows USDT supply to respond closely to demand. (Blue Fox Notes: One risk not mentioned here is the risk of centralization.)
We think Dai arbitrage is very expensive, but is it profitable? The mortgage ratio of ETH and Dai is fixed at 1.5:1, so 1ETH currently creates 0.66Dai. If the price of Dai is $1.50 or higher, $1 of ETH will create $1 of Dai. At this time, you can sell Dai and forget about your CDP—just like you use USDT. In addition, you even have an extra option to buy back your own ETH in the future. So pure arbitrage is profitable when Dai is at $1.5, but there is no guarantee that the cycle will close in the foreseeable time window.
Of course, this is purely hypothetical - people wont push Dai to $1.50, not even $1.10. Because it’s cheaper to use other stablecoins, or because of regulation, this can’t be the case — shorting out volatile assets like Ethereum or Bitcoin. As a result, the price of Dai, even in high-demand scenarios, has a lower ceiling, which causes the professional arbitrage window to never open.
No arbitrage = no scaling
Now one could argue that the same premium would lead to more natural demand for CDPs, leading to a degree of arbitrage, and that would be true. Natural CDP creators are incentivized to arbitrage at the marginal price, especially those who already have a CDP and can generate more Dai with less effort. But at this price level, there is a natural ceiling to demand for CDPs that does not exist when closing the arbitrage cycle becomes possible.
Why is the natural arbitrage of CDP creators not enough for Dai to scale? Remember, the faster a stablecoin iterates through this cycle, the closer the supply will be to demand. An important part of the stability is getting the token price up to $1. However, an important part of scalability is getting the token price down to $1.
Whenever the token price exceeds $1, the need to buy Dai decreases as potential buyers have to expect the price to return to normal. At this time, fast arbitrageurs will pull the price down to $1, and the faster the demand will rise again, causing the demand to further increase until it reaches the natural upper limit.
Professional arbitrageurs attempt to generate risk-free profits, denominated in dollars, on a limited balance sheet. Dai does not give them the opportunity to realize arbitrage. The difference becomes apparent when a buy order for 25 million tokens is placed at a small premium. For Dai, none of them will open a CDP to create more Dai. In contrast, if USDT had the same buy order, this would immediately result in an increase in supply, and arbitrageurs would be able to sell the added supply to the buy order.
Because Dai does not allow professional arbitrage, even if it has a cycle, it is slow. Although for USDC or USDT, once buyers purchase more than 1 USD, the new supply will be triggered, and the generation of more Dai depends on the vague demand for more debt on the CDP side. What does this mean for Maker?
However, Maker is not primarily about stablecoins.
Dais inability to scale has little effect on Maker, since thats not its goal. Maker is decentralized and is indeed a very effective lending service, similar to the centralized lending service BlockFi, whose main purpose is tax arbitrage:
BlockFi lending allows you to use crypto assets as collateral, and then get borrowed in US dollars on your bank account. Borrowing and lending through your crypto assets allows you to achieve liquidity, at the same time, there is no capital gains tax event, and depending on the use of funds, interest can be deducted from asset gains or other investment income.
——From BlockFi
Two other prominent use cases are long-term leverage for ICOs and financial/payroll management. The basic idea is to always generate liquidity ahead of future liquidity events - spending money that you expect to receive later. Either sell the ETH after the tax deadline, or sell it at a higher price sometime in the future.
We believe Maker is an excellent service with many unique features. On the plus side, it offers less friction, lower fees, and less counterparty risk than centralized competitors; on the minus side, lower max leverage, lack of standard add-ons Margin, and steeper liquidation penalties. The demand for Makers core product is lending, which will determine the Dai supply and nothing else.
If the price of Dai exceeds $1, this generally incentivizes people to take on more debt, especially those who have opened CDPs. But it does not incentivize anyone to arbitrage the difference through a CDP unless that person is indifferent to the debt. Since all the money locked in the CDP is only from natural borrowing demand, there is also a natural ceiling here, which is the total amount of peoples demand for lending, and thus the amount of Dai.
