MakerDAO considers dropping DAI’s dollar peg

On Thursday, MakerDAO’s co-founder Rune Christensen suggested on Discord that the protocol should rethink its exposure to Circle’s USDC after Tornado Cash crackdown.

Following the U.S. Treasury decision to sanction crypto mixer Tornado Cash over alleged money laundering, Christensen proposed to depeg the protocol’s decentralized algorithmic stablecoin DAI from USDC, a fully backed dollar-pegged stablecoin issued by Circle. Currently, about 32% of DAI is collateralized by USDC.

“I have been doing more research into the consequences of the TC sanction and unfortunately it is a lot more serious than I first thought. I think we should seriously consider preparing to depeg from USD,” he wrote on MakerDAO’s official Discord channel. “It is almost inevitable it will happen and it is only realistic to do with huge amounts of preparation.”

To uproot USDC from the protocol’s $10.9 billion treasury, Christensen suggested the “yolo USDC into ETH approach.” Obviously, converting so much collateral into another cryptocurrency can result in DAI depeg, but the “risks are acceptable, because USDC is no longer the no-brainer it used to be,” Christensen wrote.

However, not everyone in the community believes the risky idea is worth it. Ethereum co-founder Vitalik Buterin was among those who voiced concern about the potential implications of such a move.

“Errr this seems like a risky and terrible idea. If ETH drops a lot, value of collateral would go way down but CDPs would not get liquidated, so the whole system would risk becoming a fractional reserve,” he tweeted in a reply to a Yearn Finance contributor Banteg (@bantg).

CDP, a short for a collateralized debt position, is a type of loan that serves as a backbone of MakerDAO’s stablecoin system, allowing to mint new DAI against escrowed collateral until the borrowed funds are returned. Anyone who wishes to take a loan may lock their ETH in a smart contract and generate stablecoins against the deposit. The users can freely withdraw or deposit surplus collateral as long as the minimum collateralization ratio is maintained.

CDPs are required to be overcollateralized, which means that you should deposit more cryptocurrency than you receive as a loan. As of August 2022, the minimum collateralization ratio for ETH stands at 170%, meaning that you should lock $170 worth of Ether to get $100 DAI.

Unlike centralized stablecoins, like Tether’s USDT and Circle’s USDC, DAI is governed by a decentralized autonomous organization, MakerDAO. In March 2022, DAO members voted to back the stablecoin with USDC to avoid being wiped out by the pandemic crypto crash. Thanks to it, DAI held well through the 2022 crypto winter and managed to avoid the fate of Terra’s UST, another algorithmic stablecoin that lost its peg in May with disastrous consequences for the entire crypto market.

But now the situation has changed, and USDC collateral cannot be viewed as a safe option anymore. On August 10, Circle froze $75,000 in USDC belonging to users of a blacklisted Tornado Cash, signaling it would comply with all OFAC regulations. And being dependent on a centralized institution that prioritizes adherence to the US law over the principles of privacy and deregulation is never a good thing for any crypto platform.

Circle attempted to defend its move in a blog post, explaining that the company is bound to comply with the US sanctions.

“We know that complying with the law and helping to stop money laundering is both right and our obligation as a regulated financial institution,” Circle founder Jeremy Allaire wrote. “We also know that doing what is right compromised our belief in the value of open software on the Internet and our belief that the presumption and preservation of privacy should be enshrined as a design principle in the issuance and circulation of dollar digital currencies.”