DeFi: Decentralized Finance Lending Protocol MakerDAO Might Add Stablecoin USDC as Collateral to Address Dai Liquidity Problem

The MakerDAO community is reportedly considering the possibility of adding the USDC stablecoin as an additional type of collateral in order to provide more Dai (another major stablecoin) liquidity into the decentralized finance (DeFi) platform.

MakerDAO (where DAO stands for distributed autonomous organization) is an attempt to create a Ethereum (ETH)-powered decentralized lending protocol.

Following last week’s major Ether price crash, the MakerDAO lending system suffered from  a (approximately) $4.5 million Dai deficit, as certain liquidators (called “Keepers”) managed to win collateral liquidation auctions with 0 Dai.

As reported by The Block, this means that the auction winners did not have to reimburse the MakerDAO lending system with any Dai, in order to cover their outstanding debt obligations. Because of this issue, the MakerDAO system will be auctioning newly minted Maker (MKR) governance tokens on March 18, 2020 (in an attempt to cover losses).

MakerDAO’s community is now considering a proposal to add USDC as a third collateral type  (ETH and BAT tokens are already being used) to help create Dai liquidity and drive the Dai peg back towards the desired $1 mark.

A community thread noted:

“Given the ongoing liquidity risk of Dai in an uncertain market, both the community and members of the Maker Foundation have been making noise in the official chat about onboarding USDC as collateral as an emergency measure to help mitigate this liquidity risk.”

Maker token holders will get a chance to cast their vote on this proposal today (March 17) at 23:15 UTC. Meanwhile, the MakerDAO Foundation, a non-profit entity that supports the leading MakerDAO DeFi protocol, is working on the technical aspects of making it possible to implement the proposal.

Before potentially adding support for USDC, the MakerDAO community will have to work figure out how much the Stability Fee should be, and also determine the Debt Ceiling for USDC-backed Dai loans.

A Stability Fee is the yearly interest that borrowers pay, and is determined and added on top of the current debt and paid by the vault owners of the MakerDAO ecosystem. The lending protocol’s community members have recommended setting a relatively high stability fee for USDC, in order to prevent or discourage non-Keepers from mining USDC-backed Dai, however, this may change in the future.

Keepers may benefit from the higher liquidity contributed by USDC-collateralized Dai and use the newly created stablecoin tokens for the liquidation auction.

Data shared by Vishesh Choudhy shows that around $52 million in Ether collateral could get liquidated if the price of the crypto asset drops lower than $56.

Maker token holders will have decide on where to set USDC’s debt ceiling, which is the maximum debt that can be issued against any type of collateral.

If the Stability Fee is relatively high, then the ceiling may also be higher, so that the system can offer adequate liquidity. But MakerDAO community members need to be careful by not setting it so high that it could create additional risk.

The community might also decide to hard-code or fix the USDC price at $1, instead of relying on a price oracle and then trying to figure out an appropriate liquidation ratio that would incentivize users to create USDC-collateralized Dai.

Kevin Yedid-Botton, principal at Parafi Capital (a company whose funds are used for market making on several DeFi protocols), argued:

“Adding USDC as collateral to Maker is valuable, as it provides an auxiliary source of credit backed by stable collateral in order to inject and provide DAI liquidity in moments of market dislocation as witnessed over the past week.”

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