MakerDao's concerns are not just about the exposure to RWA

Author: Alex Xu

This issue of Clips focuses on the recent hot topics of RWA leaders and the DeFi blue-chip project MakerDao. The author attempts to analyze the internal and external driving forces behind the rise of MKR and evaluate its advantages, challenges, and long-term risks based on Maker's business.

The following article reflects the author's views as of the publication date, which may contain factual errors and biases, and is intended for discussion purposes only. Corrections from other investment research peers are also welcomed.

1. MKR Price Rebound: A Result of Multiple Resonating Factors

Recently, the secondary market prices of older DeFi projects have shown a clear rebound, with Compound and MakerDao experiencing the most significant increases. Although Compound's surge is partly attributed to founder Robert Leshner's second venture into the RWA space, this event has limited impact on Compound's fundamentals; the rise of Comp is more of a "dry pull," and the analytical value is minimal.

The rise of MKR, on the other hand, is driven by a combination of internal and external factors, including a fundamental business reversal and the gradual fermentation of the long-term vision of the Endgame plan.

Specifically, the driving forces behind MKR's recent rise include:

1. The protocol's monthly spending has decreased, with monthly expenditures dropping from previously around 5 to 6 million dollars to about 2 million in June.

Maker's token transfer payment statistics, image source: https://makerburn.com/#/expenses/accounting

2. Converting collateral from non-interest-bearing stablecoins to government bonds or interest-bearing stablecoins has significantly improved financial income expectations, reflected in a decrease in PE. According to makerburn statistics, MakerDao's projected annual income from RWA alone is nearly 71 million dollars.

Maker's RWA asset list, image source: https://makerburn.com/#/rundown

3. Founder Rune has been selling other tokens like LDO in the secondary market while continuously repurchasing MKR for several months, boosting market confidence.

4. Through governance, the threshold for repurchasing funds from the project surplus pool (System surplus) has been lowered from 250 million dollars to 50 million dollars. Currently, the available funds in the surplus pool amount to 70.25 million dollars, with around 20 million available for repurchase. However, according to Maker's current repurchase mechanism, it has changed from repurchase and destruction to "repurchase for market making," so the actual amount of MKR repurchased will be 20 million divided by 2, and the remaining 10 million Dai will be used to provide liquidity with MKR on Uniswap v2, existing as treasury assets in LP form.

Maker's system surplus data, image source: https://makerburn.com/#/system-surplus

Additionally, since last year when Maker's founder Rune Christensen proposed the Endgame Maker transformation plan, its grand narrative has led many investors to start believing in and buying MKR after its performance and price rebound.

The ultimate goal of MakerDao's Endgame is to achieve its vision of a "world fair stablecoin" by optimizing the governance structure and funding sub-projects.

Moreover, the recent narrative around RWA seems to be quite popular in the market. Although there are not many projects with launched tokens specifically around this business, the discussion has clearly heated up, gaining the favor of many investment institutions.

In summary, this wave of MKR's rise is the result of a combination of internal and external factors, with internal factors being primary. As for the push from the RWA narrative, the author is more inclined to believe that MakerDao's practical results and relatively good performance in the RWA business have driven the development of the crypto market's RWA narrative, rather than the other way around; the causality here has been inverted.

2. The Essence of MakerDao's Business

So, how should we view the long-term impact of the above factors on MakerDao? Can these positive factors propel Maker to the next level and realize its grand vision of creating a "world fair stablecoin"?

The author finds it difficult, and this needs to start from the essence of MakerDao's business.

MakerDao's core business has never changed, and it is fundamentally consistent with projects like USDT, USDC, and BUSD, which is to promote its own stablecoin and obtain "seigniorage income" from the issuance and operation of the stablecoin.

Seigniorage can be broadly understood as the income obtained by the currency issuer through issuing currency. Different stablecoin projects have various ways of obtaining seigniorage income. For example, another decentralized stablecoin project, Liquity, charges a fee of 0.5% when users mint its stablecoin LUSD. For Tether users, a fee of 0.1% or $1000 is required when depositing or withdrawing dollars.

Additionally, Tether actively allocates the dollars deposited with it to purchase liquid government bonds, reverse repos, or money market funds to earn financial income on the asset side.

One of Dai's previous main sources of income was the borrowing interest (stability fee) paid by users when obtaining Dai through collateral. Later, it adopted a method similar to Tether's, replacing its PSM module's USDC and other stablecoin collateral with yield-bearing assets, such as government bonds or USDC savings accounts at Coinbase.

However, the core of the stablecoin business lies in expanding the demand side for stablecoins. A stablecoin can only obtain sufficient collateral assets if it maintains a high issuance scale, thereby utilizing allocatable assets to generate financial income.

Moreover, the main difference between Dai and USDT and USDC is its decentralized positioning. "Dai has stronger censorship resistance and less regulatory exposure compared to USDT and USDC" is Dai's most important differentiated value. However, replacing a large portion of Dai's collateral with RWA assets that can be seized by centralized forces essentially undermines the difference between Dai and USDC and USDT.

Of course, Dai is still the largest decentralized stablecoin, with a market cap of 4.3 billion, significantly ahead of Frax (nominal market cap of 1 billion) and LUSD (290 million market cap).

3. Sources of Dai's Competitive Advantage

In addition to actively attempting to align with RWA on the asset side, Maker's overall operation of Dai in recent years has felt lackluster. It still firmly holds the competitive advantage of being the first decentralized stablecoin in two ways:

1. The legitimacy and brand of being the "first decentralized stablecoin": This has allowed Dai to be integrated and adopted by many leading DeFi and CEX projects earlier, significantly reducing its liquidity and business public relations costs. For example, in Curve, Dai is one of the tokens in the historically oldest stablecoin liquidity base pool (basepool) 3pool, which is implicitly recognized as the base stablecoin by Curve. This means that Maker, as the issuer of Dai, does not need to spend a dime on Dai's liquidity on Curve. Moreover, Dai also enjoys indirect subsidies provided by other liquidity bribers (when these projects procure their own tokens to provide liquidity to 3pool).

Curve's 3pool stablecoin pool, source: https://curve.fi/#/ethereum/pools/3pool/deposit

2. The network effect of stablecoins: People tend to use the stablecoin with the largest network scale, the most users, and the most familiar scenarios. In the niche category of decentralized stablecoins, Dai's network scale still leads the followers.

However, Dai's main competitors are not Frax and LUSD (who are also in a difficult situation); when users and project parties choose stablecoins to use and cooperate with, they often compare them with USDT and USDC. Compared to them, Dai is at a clear network disadvantage.

4. The Real Challenges for MakerDao

Despite the dense short-term positive factors for MakerDao, the author remains pessimistic about its future development. After discussing the essence of Maker's business as stablecoin issuance and operation, as well as the competitive advantages that Dai currently possesses, let us face the real problems they are encountering.

Problem 1: Dai's Scale Continues to Shrink, and Application Scenario Expansion is Long-term Stagnant

Data source: https://www.coingecko.com/en/coins/dai

Dai's current market cap has dropped nearly 56% from its previous peak and shows no signs of stopping. Meanwhile, USDT has reached a new high in market cap even during the bear market.

Data source: https://www.coingecko.com/en/coins/tether

Dai's previous growth in scale came from the mining boom of the DeFi summer, but where will the growth driver for its next cycle come from? It seems difficult to find strong scenarios for Dai within sight.

Maker has indeed thought about and planned how to expand Dai's use cases for broader acceptance. According to the design of Endgame, the first measure is to introduce renewable energy projects as the underlying assets for Dai, making Dai a "clean money." In the simulation of Endgame, this would give Dai a brand element accepted by the mainstream, and it would impose a higher "political cost" on real-world administrative forces when attempting to seize or confiscate Dai's clean energy projects. In the author's view, increasing the "green" content of collateral to enhance Dai's acceptance is clearly an overly naive idea. People may support environmental protection in thought or slogan, but in actual actions, they will still choose the more widely accepted USDT or USDC. Promoting decentralized stablecoins in the highly decentralized web3 world is already so difficult; how can we expect real-world residents to use Dai for "environmental protection"?

The second measure, which is also a key focus of Endgame, involves Maker incubating sub-projects (subDAOs) around Dai, developed by the community. On one hand, subDAOs take on the governance and coordination work currently concentrated on MakerDao's main line, transforming centralized governance into governance by segments and projects. On the other hand, subDAOs can establish separate business projects to explore new sources of income and provide new demand scenarios for Dai. However, this is also the second significant challenge Maker faces.

Problem 2: How Can SubDAO Projects Successfully Start Up While Providing Value to MKR and Dai?

The numerous subDAOs that Maker will incubate in the future will use their own new tokens to incentivize Dai's liquidity mining to enhance Dai's usage. Meanwhile, MakerDao will provide Dai loans to subDAO business projects at low or zero interest to help them complete early-stage launches. In addition to low-interest financial support, subDAOs also inherit MakerDao's brand credit and community, which is crucial for the startup phase in DeFi. Compared to relying on introducing environmental projects to enhance Dai's adoption, the subDAO plan sounds more executable and has precedents in the DeFi field. For instance, Frax has developed its own Fraxlend, supporting borrowing Frax with various collateral to provide usage scenarios for Frax.

Fraxlend asset lending list, image source: https://facts.frax.finance/fraxlend

However, the problem is that, in the context where the "low-hanging fruit" in the DeFi field has already been picked by entrepreneurs, developing a subDAO project that fits market demand is not easy. More importantly, these subDAOs need to shoulder the responsibility of delivering value to Dai and MKR while developing their projects, as they need to allocate additional project tokens to Dai, ETHD (the re-packaged version of the LST token planned in Endgame, used as collateral for Dai), and MKR as incentives. With such a "tribute task" in place, they also need to complete the task of meeting user needs and defeating competitors, which is undoubtedly challenging. For instance, the lending product Spark incubated and launched by MakerDao, after deducting the 20 million Dai directly minted by MakerDao, currently has an actual TVL of just over 20 million.

Image source: https://app.sparkprotocol.io/markets/

5. Other Concerns for MakerDao

In addition to the two challenges mentioned above, MakerDao faces other concerns.

First, the stablecoins available for MakerDao to continue purchasing RWA are running low, making it difficult to continue increasing its holdings in U.S. Treasuries.

According to Makerburn statistics, there are currently about 912 million dollars left in stablecoins held within its PSM (USDC + GUSD). Among them, 500 million dollars in GUSD is already enjoying a 2% annual yield subsidy from Gemini, which, although far below the rates of other RWAs, will not see much short-term change due to complex factors (for example, Makerdao's PSM holds 89% of the total issuance of GUSD; if forcibly liquidated and sold for dollars, there would be significant price losses).

Image source: https://makerburn.com/#/rundown

Therefore, the flexible cash that Maker can use to continue buying yield-bearing assets is only 412 million USDC left in the PSM. At worst, it can exchange the 500 million USDC in Coinbase, which has an annual yield of 2.6%, for U.S. Treasuries. Thus, the total amount of funds Maker can use to increase its holdings in U.S. Treasuries is only about 900 million. In reality, to respond to PSM redemptions, the amount of funds Maker can use to buy U.S. Treasuries will not be too much. Otherwise, if users redeem large amounts of USDC with Dai, Maker will need to sell U.S. Treasury assets to redeem, facing transaction friction and bond price fluctuations that could lead to losses. Moreover, if Dai's market cap continues to decline, Maker's investable asset scale will also be further forced to decrease.

Second, whether Makerdao can continue to control costs remains a point of skepticism for the author. According to the current planning of Endgame, although it attempts to decentralize the governance process and power of the DAO from the "Maker center" to various subDAOs, it has set up complex roles, organizations, and arbitration departments within the governance units of subDAOs. The entire collaboration chain is the most complex among all the projects the author has come across, truly a "governance maze." Interested readers can visit the complete version of Endgame V3 for a brain-teasing reading experience. Additionally, the introduction of RWA business has caused an intersection between DeFi and traditional offline financial entities, along with the emergence of numerous high-paying outsourced jobs, compounded by the very serious issue of centralized governance power (in the Endgame plan vote passed in October 2022, 70% of the votes in favor came from voting groups related to Maker founder Rune), the issue of interest transfer within MakerDao has become the elephant in the room. For example, the largest RWA investment management vault of Maker is managed by a small institution called Monetalis Clydesdale, which oversees 1.25 billion dollars of Maker's funds, responsible for allocating funds to government bond assets and liaising with other traditional financial institutions. This company charges nearly 1.9 million dollars per year in service fees, and Maker was its only client at the time, while Maker's founder Rune Christensen is a major shareholder of the company.

Rune is a major investor in Monetalis, image source: https://monetalis.io/

Similar examples include Maker paying nearly 5 million dollars per year (Dai + MKR) to its risk management service provider Block Analitica. Ironically, Block Analitica is not only the provider of risk management services but also the evaluator of those services. This dual identity of athlete and referee has turned Maker's risk control services into a lucrative monopoly business. The remaining question is how Block Analitica and the interest groups monopolizing MKR governance will share the substantial profits obtained from Maker's treasury. Such incidents, combined with the grand plans of Endgame that even a16z found hard to support, will likely exacerbate the future siphoning of treasury funds. However, as the organization becomes more decentralized and delegated, the methods by which interest groups hollow out the treasury and share profits may become more covert and intricate.

Source: coindesk

Additionally, the stability fee rate for Dai has recently been raised from over 1% to over 3%, further shrinking the demand for users to engage in borrowing activities through MakerDao, which is not conducive to maintaining Dai's scale.

Finally, from Endgame to large-scale purchases of government bonds and RWAs, to the founder's high-profile repurchases in the secondary market, and initiating votes to significantly lower the threshold for withdrawing repurchase funds from the treasury, a series of combined actions have led to a noticeable short-term improvement in MKR's market cap, but they have also left many hidden dangers:

1. Insufficient retention of treasury surplus reserves, leading to a decreased ability to respond to bad debt risks.

2. Aggressively increasing exposure to RWA, significantly raising the risk of assets being seized by centralized institutions, further amplifying Dai's vulnerability.

3. The large, complex, and continuously modified Endgame plan has caused severe community division. In the roadmap released by Rune Christensen in May, there appeared "AI governance," the issuance of a "new brand" stablecoin and governance token (retaining the original Dai and MKR), and even MakerDao creating its own chain, among other "fantastic ideas."

6. Endgame is Not the Endgame

In the comment section of the forum article where Rune Christensen released the Endgame roadmap in May (The 5 phases of Endgame), apart from the usual praise and confused questions from other governors, two users' comments stood out:

"(We) have wasted precious money and energy on funding useless people and garbage, instead of investing in creating value for MKR and expanding Dai's scale. All funds and research should be focused on figuring out how to make Dai and MKR operate autonomously! Remove the bloated personnel and the complicated governance; that is the right path."

"Why do we think a globally pre-planned 'endgame plan' is better than solving current problems and making gradual improvements? This plan, aside from the blockchain part, is always very specific about 'what we do,' while there is very little related to 'why we do it.'"

No one replied to them.

For Web3 projects operating on blockchain, it should leverage the efficiency brought by transparency and low trust costs, rather than erect new high walls, creating new fog, and seeking rent for itself behind the walls and in the fog.

Endgame is not the endgame that DeFi should have; it is merely the wall and fog of MakerDao.

7. References and Acknowledgments

During the writing of this article, the author discussed the topic of Maker with researcher @DigiFTTech @ryanciz233, and thanks to him for providing important information. @ryanciz233's research on Maker's RWA part will also be published soon.

MakerDAO Becoming 'a Company Run by Politics'?

Collection of Articles Related to Endgame

A16z Doesn't Support Plan to Break Up DeFi Giant MakerDAO

MakerDao collateral data: https://makerburn.com/

MakerDao expenditure statistics: https://expenses.makerdao.network/

Dai related data: https://daistats.com/#/