MakerDAO partnership with Aave redefines the mechanics of stablecoin protocols
MakerDAO is back in the spotlight with its new feature release in partnership with Aave. This could have led to the recent price action of MKR which has surged more than 30% in the last 7 days, following the proposal’s implementation. The proposal consists of a new feature called Dai Direct Deposit Module (D3M) that allows Maker to directly interact with its secondary market by actively controlling the DAI supply according to its market demand. The effect will be better rates for its users and an increment in DAI supply. Such an increment should directly impact the MKR holders due to Maker auctions and token burns. We will show here some on-chain indicators about the current DAI growth and how the MKR holders are reacting to the D3M release.
Maker + Aave = Stable Rates
Periods of high demand in DeFi produce high spikes in stablecoin borrowing rates due to for example traders covering their positions. This negatively affects those users borrowing stablecoins because in those moments they have to pay higher costs than expected over their stablecoin loans. D3M aims to mitigate that cost by directly acting over the main DAI lending market (Aave) and stabilizing DAI interest rates.
When the demand for it is high, DAI will be minted and supplied over Aave to decrease its interest rates to keep them appealing and on price. Conversely, if demand is low DAI liquidity will be removed from Aave in order to increase its interest rate to competitive levels. This relationship is described in the next diagram:
These adjustments will align DAI users and MakerDAO by keeping attractive and predictive rates (chosen by the DAO as a 4% borrow rate target) which should incentivize broader usage. Maintaining the cheapest borrowing rate among the three major stablecoins is a key competitive advantage that will make DAI use increase, since for many users the cheapest borrowing rate is the major deciding factor when borrowing stables.
This mechanism, along with the current expansion of Aave towards other chains, is expected to improve the DAI utilization ratio and its peg while keeping Aave rates competitive. This usage increase of DAI potentially benefits MKR coin holders, since Maker’s auctions system will burn MKR and reduce its supply. Furthermore it benefits from the Aave liquidity mining program, by collecting AAVE tokens and earning governance rights in Aave Governance along the way.
Can DAI now be considered algorithmic?
In some sense yes, the D3M feature issues liquidity algorithmically which is directed towards secondary markets in a feedback loop that improves interest rates to drive up demand. That demand increase will accrue more fees and thus benefit the MKR holders with token burns. It is an excellent symbiosis that achieves incentives alignments between primary markets protocols, secondary markets protocols and both its users. A win-win-win scenario.
This feature should be familiar for those users that already know the inner workings of other algorithmic stablecoins. It resembles similar mechanisms such as the ones of FRAX (AMOs) or DOLA (FEDs) where they directly exercise expansionary and contractionary monetary policies. All these protocols are seeking ways to directly interact with secondary markets in benefits of both users and the main protocol. Further discussion could arise about the implications of stablecoin issuers taking advantage of market inefficiencies by directly acting over secondary markets.
DAI usage is in ATH and continues growing
The long-term perspective is supported by the fact that DAI usage continues to increase along with DeFi’s growth. The number of addresses with DAI can be used as a proxy of users. Currently this metric is at an all-time high surpassing the 400,000 addresses mark, more than doubling from 197,440 on November’s last year. This data only accounts for Ethereum data, so its multi-chain figures are slightly larger.
This increase in DAI usage can be measured as the amount of active loans taken in each protocol. Recently Aave gave in its top position to Maker, which currently stands as the leader with the largest amount loaned at $8.1b. This corresponds to the amount of DAI in circulation, which have doubled since May of this year when it was topping at $4b.
It seems that long term ‘hodlers’ of MKR are aware of the DAI growth and this protocol improvements and its number continues to increase. Over 20,000 addresses have been holding MKR for more than one year. The volume held by these addresses is around 190,000 MKR, which is almost 20% of the circulating supply:
These indicators showed that the increasing use of DAI continues to impact positively the long-term prospect for MakerDAO. The new feature will increment DAI usage even more and consolidate Maker as the market leader in decentralized stablecoins and one of the main legs of DeFi. If you are interested in reading further about D3M, be prepared about the level of DeFi knowledge and the amount of work that is behind a feature launch like this with thoughtful discussions, risk assessments, and even simulations.
