Decentralized Ethereum Stablecoin DAI under enormous pressure! The end of DeFi?

The monster crash on Thursday in the crypto world is historically unparalleled. Bitcoin has lost almost 50% of its price at the top. The altcoins were no better. The loss of value was particularly dramatic for Ethereum. The MakerDAO, which issues a decentralized stablecoin on the US dollar with DAI, is based on the platform.

Crypto tokens blocked in smart contracts ensure the stability of the DAI. By far the most used is the native currency ether to cover stablecoin. The value of the covering cryptocurrency must be at least half more than the value of the issued DAI. 

If the price of the blocked crypto tokens falls near the generated DAI, the system opens the position for liquidators. These numbers return the stablecoins to the smart contract. The smart contract destroys the DAI and releases the ether. The liquidators receive a part as a reward, what is left goes back to the creator of the position. For a more detailed description of how MakerDAO works, read this article.

On Thursday, the ether price plunged by almost 50% in less than a day. Many positions had to be liquidated. Liquidators are usually in competition with each other. This should lead to the release of positions released for sale at the profitability limit.

Due to the Ethereum network and the transaction backlog, a situation occurred in which a liquidator had no competition and could open positions for 0 DAI for a few hours. A forum by Maker speaks of damage incurred equivalent to $4 million. One even discusses an emergency shutdown, it says there.

The system provides that this damage will be paid for by selling maker tokens. The ethers purchased with the maker tokens are intended to cover the circulating stable coins again. The makers are created out of nowhere for the action, inflation so to speak, which goes on the cap of the maker holder.

The current state

The price of the DAI is around 10% higher. This is because positions are just being lucratively liquidated or for the emergency auctions which are being accumulated. Nevertheless, a lot of uncovered DAI tokens are currently in circulation. So DAI should be worth less than a dollar.

The current crisis threatens the DAI in the same way as the already Stablecoins Nubits or BitUSD of Bitshares. Both are among the first crypto-covered stablecoins. Their dollar coverage is broken in the long run because of similar price crashes that overwhelmed their buffer systems. The maker has learned from these mistakes and introduced additional buffers. Now the system has also reached its limits.

The causes and consequences

The extreme volatility of cryptocurrencies, which was displayed again on Thursday, makes it difficult to control crypto-covered stablecoins. Although the mechanisms are mature, the entire functional chain is too slow. An Ethereum transaction takes 15 seconds. The Maker Oracle only updates prices every hour. The system is responding too slowly. A centralized exchange reacts in the nanosecond range and accordingly creates prices quickly.

0/ We need to accept the reality that yesterday, *the crypto markets broke*

DeFi broke in obvious ways

CeFi broke because CeFi relies on DeFi to arb venues

Again, this situation shows that blockchain’s main problem is still scalability. A stablecoin is based solely on trust. Many users have lost confidence in the MakerDAO. A few days ago, it was the most promising stablecoin project, but it looks different after the crash on Thursday.

The DeFi protocols that are based on DAI as stablecoin naturally also suffer from the incident. Even though centrally controlled, physically covered stablecoins like Tether are widely criticized, they appear to be safer in disasters. The fluctuations in the USDT were minimal in contrast to DAI.

It was a black day for the still young DeFi scene, but you will learn from the incident and make the systems more secure. One possibility would be to set the deposit much higher so that you have more space. Ethereum is working on scaling solutions, there are also protocols that are much faster, such as EOS. There are already 2 decentralized stablecoin projects with a similar concept to MakerDAO: Vigor and Equilibrium . 

Even if the MakeDAO falls to its knees, the potential and possibilities of DeFi are too great. The next few years are likely to remain exciting in this regard.

This article was originally written in German by Lukas Mantinger