The crypto industry is young, and in emerging tech, a handful of companies often lead the charge. For those holding equity in these companies, this is generally considered something to be encouraged. For everyone else, it is not.
The recent rise of decentralized finance has been no different, and the company holding the torch is MakerDAO. When market conditions are favorable, these powerful companies can be trailblazers for the industry. However, if they face an existential threat, they can drag the entire sector down with them.
To say that the COVID-19 pandemic is a black swan now seems like an understatement. With one beat of its wings, the black swan felled markets, economies and created unemployment at the speed the likes of which the world has never seen. The steady spread of the virus, along with the mixed responses from companies and governments alike, created widespread uncertainty — kryptonite for the global markets.
Crypto prices also plummeted, with some arguing that the level of institutional investment causes an unavoidable connection to mainstream financial assets, while others argue that in a time of crisis, nervous investors simply sell everything. It was only a matter of time before the shockwaves from the growing financial crisis got to MakerDAO.
Crash: MakerDAO feels the heat
On March 12, Ether (ETH) prices dropped over the cliff edge, slipping 30% in 24 hours. Suddenly, MakerDAO’s decentralized protocol was left with millions of dollars in debt from under-collateralized lending. It looked as if the company had been dealt a fatal blow. The firm briefly considered an emergency shutdown.
Dai (DAI), Maker’s in-house stablecoin, is priced against the dollar. Dai is minted by users taking on collateralized debt positions, where collateral is deposited in an Ethereum smart-contract, with a percentage of the asset’s value being paid out in Dai. The collateral then gets released once the tokens are repaid, and the Dai are destroyed. Loans that can’t be supported by their collateral are placed into liquidation proceedings, in which the collateral is auctioned for Dai to repay the debt. But the price drop allowed bidders to win liquidation auctions for 0 DAI — further worsening Maker’s crisis.
As March 13 rolled around, the company had time to assess the damage from the day before. It seemed like MakerDAO bosses saw a glimmer of hope and called for a community vote ahead of the company’s first-ever debt auction.
At the time of the auction, MakerDAO’s financial woes had widened to around $5 million in under-collateralized debt. A blog post from Maker laid bare the sorry state of affairs at the firm:
“The MakerDAO had a +500k$ surplus before the price drop, and now has a -4M$ surplus that needs to be filled. The protocol covers this issue, the solution being to trigger an MKR mint and auction, the DAI raised being used to fill the surplus debt. During normal operation, MKR is burned when debt from vaults is reimbursed, this would be the opposite mechanism.”
Commentators circle, but most are optimistic
The crypto community often bays for blood when companies make mistakes. However, it appears that MakerDAO has garnered itself a soft spot in the hearts of the industry’s commentators nonetheless. In other cases, while technical flaws and sudden losses can create calls for boycotts of companies and cause people to take sides, the response from other crypto figures toward Maker has been largely supportive.
Alex Melikhov, CEO of EOSDT, a DeFi company, explained to Cointelegraph that MakerDAO’s recent troubles are of a technical nature, rather than economic: “These circumstances showed off the lack of redundancy in the MakerDAO’s system and weaknesses in the Ethereum network capacity.”
Although Melikhov’s analysis of the debt debacle laid blame on the technical side of the operation, he also had some pointed criticism of the proprietary oracle MakerDAO uses for price feeds, which did not hold up under the deluge of pending transactions:
“As a result, the on-chain prices in the system were remaining outdated in a period of significant price movement — $166/ETH on-chain instead of $133/ETH on the market.”
According to Melikhov, this created something of a “perfect storm” for MakerDAO. The firm’s keepers weren’t interested in buying ETH at a 20% market premium — a stark change from the usual 3% discount. Meanwhile, Kain Warwick, founder of Synthetix and CEO of blueshyft, struck a more optimistic note, arguing that while the price drop exposed underlying issues in DeFi, Ethereum’s fundamental qualities are still strong:
“This recent downturn has been a macro trend driven by uncertainty, so this short-term price action on ETH doesn’t reflect the long-term viability of the network. We've definitely seen some teething problems over the last 24 hours as protocols have experienced shocks due to the price action.”
The question of security looms large over the DeFi sector. Stani Kulechov, the founder and CEO of Aave, another fellow DeFi company, recently opined that “we used to have nerds attacking the system, now we have nerds with money.” MakerDAO’s Gustav Arentoft echoed the issues of security on stage at London Blockchain Week:
“It’s a difficult field. We have bigger responsibility when building the system, as the code is completely public. We have limited time to build the system. Hackers have unlimited time to research the code and create hacks. And that’s the hardest thing to beat.”
Messari founder and CEO Ryan Selkis also expressed skepticism about the level of security in January — prior to any hacks or particular technical flaws being exposed — stating it is “impossibly optimistic to say there won’t be a confidence shaking bug before DeFi gets big.”
Maker deals with the situation
MakerDAO’s all-important debt auction drew to a close on March 23, with a total of $4.3 million worth of under-collateralized Dai that was bid across two phases. While there was initially some criticism about Maker’s lack of decisive action at the time the firm was mulling over an emergency shutdown, the community was mostly optimistic about the firm’s handling of the situation.
To begin with, it looked like the auction was going to be a flop. As 20 minutes elapsed, only two bids had been made. One community member wrote: “I can’t wait to tell my grandkids about this.” Maker’s last gasp was in danger of falling flat.
However, several days prior to the auction, a “backstop syndicate” had been formed. The syndicate would swoop in and act as a last-resort buyer if the price fell below 100 DAI. The syndicate was made up of community members, along with Framework Ventures’s Michael Anderson, reversing his previous position on MakerDAO. Anderson told Cointelegraph that his decision was to ensure the stability of DeFi as a whole, again showing how intricately linked the fate of the sector is to its largest company.
Maker takes important step toward further decentralization
In a recent interview with Cointelegraph, Gustav Arentoft, European business development representative at MakerDAO, explained that DeFi projects will often have a thorny relationship with the concept of decentralization in their early stages, stating that if projects are decentralized from day one, they open themselves up to a lot of attack vectors in the system.
Arentoft also explained that while MakerDAO fully supports decentralization in the sector, it is taking the approach of gradual decentralization. He told Cointelegraph that decentralization in DeFi does not need to be a binary position: “I don't personally believe that it’s binary in the sense that you are either decentralized or you're like traditional finance.”
But as the dust settles from the debt crisis, MakerDAO is handing over governance for the smart contract that underpins the firm’s protocol to MKR token holders. As the driving force of the whole DeFi sector, the move is a significant step toward decentralized governance.
Although the three-month transition of power to the community has been finalized, the foundation urged the Maker community to “remain deeply engaged and continue to vote smartly and often,” stating that voter apathy could threaten the project:
“While voter apathy can threaten any election process, it can do harm to a project’s decentralization efforts. Without enough community passion and well-intentioned participation, a community-governed system can become vulnerable and struggle to succeed.”
Chief Executive of the Maker Foundation Rule Christensen said that the company was fast moving toward complete decentralization:
“By completing its commitment to transfer the MKR token contract to MKR holders, the Maker Foundation continues to move toward a completely self-sustaining MakerDAO. And it’s just the beginning. We will continue to ready the community for complete decentralization in the weeks and months ahead.”