The central bank stabilizes MakerDAO, once again overturning the governance paradigm (Part 1)

Author: CYC Labs

Undoubtedly, MakerDAO has successfully updated the paradigm of the entire industry as the "central bank" on Ethereum. This article will discuss MakerDAO's proposals and what insights it brings to the industry. Which governance areas does it focus on? This is the first part of the series; to read the second part, please click here.

On-chain central bank MakerDAO, a simple and effective debt auction mechanism

MakerDAO is referred to as the "central bank" on Ethereum because its operational mechanism is easy to understand. Users stake ETH on MakerDAO, and MakerDAO issues a corresponding amount of DAI. This process is somewhat similar to how central banks issued fiat currency based on gold reserves during the gold standard era. The price of DAI is pegged to the US dollar, and MakerDAO adjusts supply and demand by controlling lending rates to maintain the peg between DAI and the dollar. To avoid the risk of price fluctuations, users must over-collateralize when borrowing DAI against ETH, borrowing different amounts of DAI based on the collateralization ratio. When the price of the collateral falls to a certain level, it will be liquidated at a price slightly below the market price to prevent losses for the platform.

MakerDAO and the governance token MKR:

• Voting governance role: In addition to the stablecoin DAI, as a DAO project, MakerDAO also provides MKR as a stake and governance token. Anyone holding MKR effectively joins the Maker DAO organization to some extent, gaining partial rights to manage MakerDAO and vote on proposals. Of course, currently, anyone can submit proposals, but voting rights can only be exercised by holding governance tokens.
• As interest payment: Additionally, when users redeem Ethereum from MakerDAO, they need to pay MKR as interest for borrowing DAI. When forced liquidation occurs, MKR must also be paid as a penalty fee. During the debt auction, the system will mint new MKR (increasing the circulating supply of MKR) and sell it to users participating in the auction with DAI. In surplus auctions, successful bidders pay MKR to purchase surplus DAI. The repurchased MKR will be burned, thereby reducing the total supply of MKR, making the overall token economic model of MKR deflationary.

Debt auction mechanism:

• When collateral > debt + liquidation penalty: The collateral is auctioned to pay off the debt and liquidation penalty, and the remaining collateral is returned to the original owner.
• When collateral < debt + liquidation penalty: The collateral is fully auctioned, and the remaining debt will be covered by the Maker protocol's buffer DAI. When the DAI in the protocol exceeds the upper limit of the buffer pool, such as during unexpected events like the 312 incident, a surplus auction will be conducted. During the surplus auction, bidders use MKR to bid for a fixed amount of DAI, with the highest bidder winning. Once the surplus auction ends, the Maker protocol will automatically burn the MKR obtained from the auction, thereby reducing the total supply of MKR.

Buffer: The Maker buffer can act as a cushion to avoid excessive issuance of MKR in the future due to insufficient collateral auctions and rising DAI deposit rates.

Active and passive governance proposals, clarifying governance content

The governance framework itself can be divided into two main parts:

• Governance proposals (active), duration 3-7 days: Symbolic voting used to gauge community sentiment on specific models or data sources. (e.g., considering new tokens as collateral, accepting them into the portfolio, and deploying their risk parameters)

Image source: MakerDAO Forum

• Execution proposals (passive), longer duration: Used to approve risk parameters determined by models and data accepted by governance proposals. Execution votes will lead to changes in the state of the DAI credit system and occur quarterly. (e.g., voting on risk parameters for newly accepted collateral types)

Image source: MakerDAO Forum

Governance iteration, business becoming more specialized

• Early stage: Core Unit leads, managing community affairs.
• MakerDAO Foundation leads: Sustainable decentralized governance, further decentralizing governance.
• Community governance: As MakerDAO Foundation CEO Rune Christensen steps down, the transition to community management begins, moving towards decentralized governance.
• Monetails sage (RWA): A company named Monetails uses Maker to support their lending platform, extending the community's development to CeFi.

MakerDAO milestones: MakerDAO Foundation (2015-2021)

• March 26, 2015: MakerDAO and its first stablecoin are launched. The initial concept of DAI (then called "eDollar") was described in a Reddit post.
• November 2015: The MakerDAO team attends DevCon1. MakerDAO co-founder Nikolai Mushegian details the components of Maker. This was an early introduction of organizations and protocols to the broader Ethereum community.
• May 2017: ProtoSai goes live. MakerDAO developers launch and begin using the first version of DAI, called ProtoSai. This marks the first limited issuance of the DAI stablecoin system and is a precursor to the public launch of single-collateral DAI (SAI) months later.
• December 10, 2017: The Sai white paper is released. The original **white paper describing the DAI stablecoin system clarifies the final design of SAI and provides a roadmap for the future, including the ultimate goal of multi-collateral DAI.
• December 19, 2017: Sai is launched. Single-collateral DAI goes live; it will eventually kick off the now-popular DeFi movement.
• June 21, 2018: Foundation proposal released. This proposal was later updated to propose the core principles of sustainable decentralized governance.
• November 18, 2019: Multi-collateral DAI goes live. The launch of multi-collateral DAI allows anyone to generate DAI based on digital assets approved by Maker governance.
• March 25, 2020: MKR token contract transferred to Maker governance. Since MKR holders now fully control the MKR contract, decentralized governance is the only way to change MKR token authorization.
• May 2, 2020: MIPs framework approved. The Maker Improvement Proposals (MIPs) framework, including MIP0 and two MIPs, is approved.
• March 25, 2021: Core unit framework approved. The core unit framework paves the way for decentralized management of all Maker Protocol teams and activities.
• May 3, 2021: Maker Foundation returns assets held in the Dev Fund to the DAO. Returning 84,000 MKR to the DAO is another key step towards further decentralization.
• June 2, 2021: Liquidations 2.0 module launched. Liquidations 2.0 has been activated for all collateral types approved by Maker governance to be accepted in the Maker protocol.
• July 20, 2021: Rune Christensen announces MakerDAO is fully decentralized. The global Maker community is now responsible for all aspects of the Maker protocol and DAO.

Popular proposals, mainly focusing on tokens, financing, and governance

Foundation dissolution, handed over to community governance

Governance direction: The beginning of decentralization

Proposal date: Jul 20, 2021

Proposal proposer: Rune Christensen, Maker Foundation CEO

Summary: The decentralized autonomous organization MakerDAO officially moves towards complete decentralization. Maker Foundation CEO Rune Christensen stated that after years of development, MakerDAO has achieved self-sufficiency, and to fulfill its commitment to the community, the guiding Maker Foundation will also officially dissolve in a few months.

Comment: The beginning of community governance. The 312 incident caused significant losses for MakerDAO, leading many investors to express dissatisfaction and take legal action. Additionally, $500 million in development funds will be handed over to the community.

Clean Money

Governance direction: MetaDAO, token engineering

Proposal date: Oct 21, 2021

Proposal proposer: Rune Christensen, Maker Foundation CEO

Summary: Clean Money proposes principles for sustainable finance, although the MakerDAO community was born in 2018. Notably, it finally mentions the Sagittarius engine token model.

Comment: The biggest issue in Maker governance is the difficulty of participation, lack of transparency, and governance apathy, which exacerbates the general perception among the broader and less informed MKR holder community. There are noticeable reactions regarding the inefficiency and even corruption of the MakerDAO governance core unit (CU). Therefore, Rune once mentioned the concept of clean money to reduce bureaucratic internal political structures.

Sagittarius engine

Governance direction: Token engineering

Proposal date: Oct 21, 2021

Proposal proposer: Rune Christensen, Maker Foundation CEO

Summary: The proposal learns from current DeFi models and changes the existing core unit reward model to attract funds from the market, achieving more MKR locking and low-interest borrowing. Long-term MKR lockers receive more benefits, and users can collateralize locked MKR to borrow DAI at favorable rates and liquidation conditions.

Comment: The main goal is to provide high actual APY for long-term locked MKR, directly locking liquidity, as seen in the small diagram. Borrowing DAI through collateralized MKR is related to parameters and collateral time. However, the community generally has concerns about the proposal, believing that the SE model is too complex. It did not pass.

gbMKR (government-boosted MKR)

Governance direction: Token engineering

Proposal date: Jan 21, 2022

Proposal proposer: ParaFi Capital

Summary: Currently, any MKR holder can participate in governance voting. This proposal suggests that long-term locked MKR holders receive "gbMKR (governance-boosted MKR)" for governance participation (up to four years), while also granting gbMKR holders higher returns.

Comment: It is somewhat similar to Curve's boost mechanism, using gbMKR to replace MKR in governance voting. It is generally believed that the basic incentive measures are inadequate, seeking simpler solutions.

Rights of gbMKR holders:

• Default unlocking will compensate some MKR to other gbMKR holders.
• Grant gbMKR holders zero or negative interest rates for borrowing DAI.
• Some protocol income (stability fees, liquidation income) will be given to gbMKR holders.
• Repurchase MKR with stability fees and provide it to gbMKR holders.
• gbMKR will be added as MakerDAO collateral with 0% stability fees and lower collateral rates.

sktMKR

Governance direction: Token engineering

Proposal date: Mar 14, 2022

Proposal proposer: Risk Core Unit Team

Summary: Obtain sktMKR by staking MKR, where sktMKR has voting power, and the longer the time, the higher the voting weight. However, redeeming MKR has its limitations and requires waiting for a certain unlocking period. The sktMKR redeemed will be directly burned.

Comment: This model draws on the token model scheme of Cosmos. Additionally, an extra governance token is added to address governance attack issues.

Image source: MakerDAO Forum, staking MKR for sktMKR

Image source: MakerDAO Forum, sktMKR is directly burned upon retrieving MKR. There is an unbinding period, and MKR can only be retrieved after the unbinding period.

A16Z proposal innovates MakerDAO's token economic model

Governance direction: Token engineering

Proposal date: Mar 22, 2022

Proposal proposer: a16z

Summary: The earliest MakerDAO proposal allowed anyone to submit proposals, but only voting holders could vote. a16z also identified the problem, which could easily lead to governance attacks.

Comment: The proposal mainly organizes past proposals to empower tokens more, including incentives and governance.

Image source: Talkchain

1. Add practical functions to MKR tokens

Summary:

• Require Maker tokens to be used as collateral for other RWA collateral vaults.
• Provide additional allocation benefits for those willing to collateralize Maker tokens.
• Encourage participants to stake Maker in Maker DAO liquidation auction activities, aligning participants' interests with the DAO.

Comment: Incentivizes token holders to stake, achieving a positive cycle. Additionally, integrating RWA helps stablecoins expand their application space.

2. Adjust governance to align with Maker holders' interests

Summary: MakerDAO sets up a community bonus to reward ordinary voters and representatives. However, the entire community bonus distribution lasts 18 to 36 months, distributed based on contribution levels.

Comment: The entire governance incentive mechanism references gbMKR, encouraging the community to participate in governance together.

3. Increase MakerDAO's surplus buffer reserves

Summary: The surplus buffer reserves do not need to be a fixed value and should be flexibly adjusted, currently maintaining around $250 million. Additionally, establish a retained earnings management system to maximize community growth, such as compensating operational and strategic contributors or distributing surpluses to token holders in specific ways to achieve specific goals.

Comment: Enhance financial flexibility through community voting, including setting surplus buffer reserves and establishing a retained earnings management system. Focus on MakerDAO's core pain points to avoid large-scale losses from black swan events as much as possible.

Société Générale proposes to MakerDAO: $20 million refinancing for its bond token

Governance direction: RWA

Proposal date: Oct 21, 2021

Proposal proposer: Societe Generale-Forge

Summary: A number of digital asset subsidiaries of the French financial services giant Société Générale (SG) proposed to the governance forum of the decentralized autonomous organization MakerDAO, hoping to use the bank's security token OFH as collateral to apply for a $20 million DAI loan.

Comment: An example of combining TradFi and DeFi using RWA.

Monetalis Clydesdale: Liquid Bond Strategy & Execution

Governance direction: RWA

Proposal date: Feb 11, 2022

Proposal proposer: Allan Pedersen, Regular

Summary: $500 million DAI is used to purchase U.S. Treasury bonds as collateral. The proposal installs an RWA vault that will acquire USDC through PSM and invest it in approved bond strategies.

Comment: Another example of RWA.

Real World Finance

Governance direction: RWA

Proposal proposer: Christian Petersen, Real World Finance Core Unit

Summary: Utilize RWA to expand CDPs (Collateralized Debt Positions).

Comment: The proposal suggests that DeFi protocols should utilize real-world assets to scale.

Aggressive Growth Strategy

Proposal date: Mar 16, 2022

Proposal proposer: Sam MacPherson, Protocol Engineering Core Unit Team

Summary: The proposal suggests financing for MakerDAO:

• Issue debt to increase surplus buffer funds
• Exchange equity for financing, accepting investments from large VCs
• RWA

Comment: Can be seen as supplementing the RWA protocol content with more specific measures.

The Endgame (Part 1 & 2)

Governance direction: MetaDAO

Proposal date: May 31, 2022

Proposal proposer: Rune Christensen, Maker Foundation CEO

Summary: Introduces MetaDAO and its applicable scope.

Comment: The proposer of the Endgame Plan is the former CEO of MakerDAO Foundation, who previously proposed the clean money proposal. The Endgame Plan can be seen as a supplement to clean money. MetaDAO combines the advantages of sub and pods, issuing tokens while bringing organizational governance closer to a minidao format.

The Endgame Decentralized Workforce (Part 3)

Governance direction: MetaDAO

Proposal date: Jun 11, 2022

Proposal proposer: Rune Christensen, Maker Foundation CEO

Summary:

1. Top-down (classic).
2. Bottom-up (D2D).
3. D3M (Direct Deposit Model) suitable for Matadao.

Comment: Introduces three budget labor mechanisms, each acting on different labor forces.

Summary

MakerDAO governance proposals can be summarized as:

1. Token engineering: Key elements of MakerDAO's token governance

• Rewards can be used for delegation and direct voting. Is it representative, and is governance minimized?
• Rewards are related to the performance of the protocol. Do they contribute to the long-term development of the protocol and solidify its position?
• Rewards encourage longer-term thinking. Are the interests of the protocol and token holders aligned?

2. RWA (real-world asset): Financing

• Issue debt to increase surplus buffer funds
• Integrate RWA
• Exchange equity for financing, accepting investments from large VCs

3. Endgame Plan: MetaDAO governance structure and labor distribution salary settlement.