A breakdown of MakerDAO and Dai (Stablecoin)
MakerDAO, and its stablecoin DAI, has risen as the most successful decentralized stablecoin protocol to date, growing its total supply by 46x in the last twelve months and generating over $63M in net earnings since the start of 2021.
It’s not something that the crypto community should sleep on.
MakerDAO: History
Founded in 2015, MakerDAO is an overcollateralized stablecoin project running on Ethereum blockchain. MakerDAO was born out of the recognition that early cryptocurrencies were highly volatile and thus not very useful as a medium of exchange. The development of the project was originally led by the Maker Foundation but is now controlled by a DAO.
The protocol was officially launched in 2017 as the Single-Collateral DAI system (also known as SAI) which allowed users to mint DAI using ETH as collateral. In the same year, Maker raised $12 million through a sale of MKR tokens to Andreessen Horowitz, Polychain Capital and other crypto-focussed venture capital firms.
Following the successful launch of Single Collateral DAI, Maker launched the Multi-Collateral DAI (MCD) system in 2019, accepting an increased variety of collateral types beyond ETH.
The total supply of DAI reached $100 million in May 2020, 7 months after the launch of MCD. A little over a year later, in June 2021, the total supply of DAI has now surpassed $5 billion
More on Maker Protocol
The Maker Protocol allows users to issue DAI, a stablecoin pegged to the value of the US dollar, by locking collateral assets of a greater value in the system’s vaults. Maker currently supports a variety of collateral types including volatile cryptoassets, stablecoins, liquidity tokens and Real World Assets (RWA).
DAI combines the advantages of a low volatility currency with the key attributes of cryptocurrencies (permissionless, borderless, transparent, peer-to-peer, etc.). DAI is generated, backed, and kept stable through collateral assets that are deposited into Maker Vaults on the Maker Protocol (e.g. $1,000 worth of ETH is deposited into a vault as collateral to issue 500 DAI). This, paired with the adjustability of interest rates, ensures that DAI’s value is always equivalent to one US dollar.
When DAI is issued, the Vault owner takes a loan against their deposited asset, similar to any other form of collateralized lending. If the collateral value of the vault decreases below a specific threshold, the position could be liquidated by the Maker protocol to repay the outstanding DAI debt. The user will be charged a penalty for being liquidated. Under normal circumstances, a vault owner repays their original DAI loan back with interest to regain control of their collateral.
The protocol’s revenues are derived from three main sources:
Interest revenues from overcollateralized loans
Liquidation revenues from fees charged on liquidated vaults
Stablecoin trading fees from the Price Stability Module (PSM)
Its primary purpose is to aid with keeping DAI’s peg to the dollar. Moreover, it allows Maker to adjust its collateral structure depending on the market’s appetite for lending services.
Governance
MKR is the governance token of the Maker protocol. It allows those who hold it to vote on protocol changes such as collateral onboarding, governance parameter changes, budget approvals, etc.
The income generated by the Maker protocol indirectly accrues to tokenholders. Currently, cash flows are used for three main purposes being:
Covering the protocol’s development and operational costs
Building a safety buffer to cover potential liquidation losses (surplus buffer)
Buying and burning MKR tokens out of circulation
Conceptually owning MKR could therefore be compared to owning equity of a bank that is performing continuous stock buybacks.
Out of the initial supply of 1,000,000 MKR tokens, around 907,000 are still in circulation. The difference is accounted for by the ~9,000 MKR tokens bought back and burned by the protocol and the 84,000 tokens that have been given over to the DAO by the Maker Foundation in May 2021 as part of of its process.
Traction and Growth
Over the last twelve months, the overall stablecoin market has grown from $11 billion to now over $100 billion.
This 10x YoY surge in total supply was driven by sustained capital inflows into the crypto economy as well as growing volumes in DeFi. The popularity of stablecoins can also be attributed to their inherent qualities – offering investors a low volatility safe haven while retaining all the key attributes of cryptocurrencies.
Maker has been able to capitalize on this surge, increasing its outstanding DAI supply from $127 million to over $5 billion in the last twelve months. DAI currently has an 8.2% share of the stablecoin market on Ethereum and about 5% overall. It is the fourth largest stablecoin by market cap.
The demand for lending and DAI has pushed Maker’s monthly net income soaring, with the first six months of 2021 resulting in over $63 million in profits. When compared to the last six months of 2020, this represents more than a 7x increase.
Lending revenues, derived from interest earned on loans, averaged approximately $7.7 million monthly during the first half of 2021, up 13x from the second half of 2020. This growth is directly attributable to the uptake in loan volume as well as higher interest rates, which have risen progressively from 2% in late 2020 to 5% in April / May 2021 and now sit at 2% (for the ETH-A vault) due to decreased market demand for leverage. Lending revenues represent Maker’s most recurrent and stable source of income.
Liquidation revenues, derived from penalties charged on liquidated vaults (13%), also contributed considerably to Maker’s strong performance. Benefiting from significant market volatility, monthly liquidation revenues spiked to $9.4 million in May 2021.
Although more irregular in nature, MKR tokens benefit from decreases in collateral values through the collection of liquidation fees (assuming orderly liquidations). Over time, this means that MKR tokens could have a lower downside correlation with the overall market.
Trading revenues refer to fees collected from Maker’s Price Stability Module (PSM). This module saw a significant uptick in May and June 2021 as demand for DAI rose while crypto collateralized loans decreased. As a result, the protocol has now converted more than $3 billion of USDC to satisfy the demand for DAI.
Dai is therefore a dynamic system that adjusts its collateral backing accordingly to market conditions and needs. As the crypto market expanded during the first half of 2021, the system capitalized on the need for leverage and backed its reserves primarily on ETH loans.
Potential cases for DAI
The growth of the total DAI supply has a significant impact on the valuation since it directly drives the total interest revenues (>80% of projected income) and indirectly affects liquidation revenues. Note that in the last twelve months, DAI supply has grown by over 4,500%. All scenarios assume a 4 billion 2021 average DAI supply.
Bear case: Supply grows at an annual rate declining from 50% to 5% to reach $42 billion at the end of 2031. This would represent assets on the scale of a small-sized U.S. bank. This scenario portrays a notable slowdown in the growth of the crypto ecosystem and/or Maker loses market share versus its competitors.
Base case: Supply grows at an annual rate declining from 125% to 10%. This would result in a total supply of DAI of $183 billion by 2031, similar to the assets of a mid-sized U.S. Bank. This scenario implies a continuing growth of DeFi along with Maker continuing to gain market share over its rivals.
Bull case: Supply grows by an annual rate declining from 175% to 10%, putting the total 2031 DAI supply at $359 billion. This would represent assets on the scale of a large-sized U.S. bank. For this scenario to be achievable, Maker would need to capitalize on a significant expansion of the crypto economy as well as on the onboarding of large real world asset pools and/or central bank digital currencies.
Liquidation Revenues
In terms of liquidations, we have assumed that a percentage of the average total DAI supply will be liquidated and thus subject to the 13% penalty fee. This percentage is set at 4% and projected to decrease linearly to 2% over the forecasted period.
Trading Revenues
The base for 2021 is 3.3 billion in volume. The fees earned are set at 0.1% of forecasted volume. This assumption results in this revenue stream representing 5% of lending revenues. Historically, this number has been around 7%.
Expenses
We have assumed that liquidation expenses will represent 7.5% of liquidation revenues.
For workforce expenses, we have assumed that they will account for 20% of revenues in 2021 and decrease linearly to 15% in 2031 as the protocol scales and matures.
Roadmap
The following are some of the key upcoming initiatives and updates to be implemented to the protocol:
Flash Mint Module Implementation: Following a vote passed on July 1st 2021, the Maker Protocol has activated the Flash Mint Module. This module will allow users to mint up to 500 million DAI with the only condition being that the loan is repaid back in the same transaction with a fee (currently 0.05%). This will allow anyone to exploit arbitrage opportunities in the DeFi space without having to commit upfront capital and constitutes a new revenue stream for the protocol.
Multichain Strategy: The community is working on developing Maker’s multichain strategy in an effort to ensure that the protocol remains relevant across multiple chains. Moreover, developers are working on an Optimism DAI bridge that will allow for fast withdrawals from Optimism L2 rollup. This is expected to be fully deployed by Q3/Q4 2021.
Aave D3M: Maker is introducing the Maker Direct Deposit Dai Module (D3M) in cooperation with the Aave team. This module will allow DAI to be minted on Aave to enforce a maximum borrow rate for DAI on that lending platform. Ultimately, this will help MakerDAO gain capital efficiency, grow its supply and make DAI the primary choice for stablecoin borrowers on Aave.
Competition
Maker competes in both the stablecoin and collateralized lending markets.
As highlighted previously, DAI has been able to make considerable gains in terms of market share over the last twelve months on its centralized rivals. We believe that this trend will continue in the future. DAI possesses a strong competitive moat due to its decentralized nature, transparent reserves and increasing prominence in the DeFi ecosystem. Regulatory and transparency risks of fiat backed stablecoins and the low reliability of algorithmic stablecoins could further DAI’s competitive hedge over time.
DAI also has the ability to create a low volatility currency backed by real assets (crypto-assets, RWA etc.) Over the long term, DAI could unpeg from the USD and be pegged against a specific basket of goods.
In terms of borrowing, Maker enables more certainty in the charged interest rate than variable rates competitors like Aave or Compound. Furthermore, Maker benefits from variable rate lending protocols as long as their variable rates are higher than Maker’s stability fee. Market participants can borrow from Maker and lend at a higher interest rate with the ability to close out their loan at any time if their collateral value decreases.
Conclusion
Maker has set itself as a top contender in both the stablecoin and lending markets, two fundamental segments of the buoyant DeFi ecosystem. This has enabled Maker to scale and generate over $72 million in net income for tokenholders over the past twelve months. Backed by a strong development team, community and a growing user base, we see Maker as poised to continue its growth over the coming years. Achieving the proposed valuation will nonetheless require overcoming challenges such as bridging the gap between demands for DAI and lending through innovative solutions such as RWA. We look forward to seeing DAI’s market supply continue to grow and MKR tokens being burned.
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