Dai — Why?

Thoughts on risk, dependencies and trust—does ‘decentralization’ add any value for stablecoins?

Dai is now king on the land of Ethereum. It is a stablecoin pegged to the US Dollar that is minted through ETH collateralized debt positions and governed by the MKR holder community. Some have called it ‘the mainstream usecase for crypto and blockchains’ or ‘the holy grail of cryptocurrencies’. Most applications being built today integrate it at its core.

This post will ask questions that I find unanswered as to why Dai really matters. In essence, in the midst of some community initiatives shedding light on how to improve the least decentralized aspects of Dai, taking the opposite view I explore whether an improved centralized alternative can work better for providing the value Dai claims to provide to stablecoin holders today.

I expect these questions to face some rejection in the MKR holder community, Ethereum/DeFi supporters and overall Dai fans. Counter intuitively, while we’ll be asking if a centralized alternative could work better, I don’t expect these questions to face such reaction from people who value decentralization as the means to censorship resistance, lower systemic risk and absence of third party trust.

I might be wrong!

Context

To give context to the post, here are some different opinions I hold on crypto:

The most relevant property of any cryptocurrency is censorship resistance, and it’s most important use is as a form of money that is not controlled by any single party.

Ethereum should not have forked because of The DAO hack.

A stablecoin can be a great way to onboard more people into dapps with less friction from asset volatility.

Most ‘DeFi’ applications are centralized, thus harming their long term value proposition.

I’m building Guesser.

Issue #1: Third Party Trust

Centralized stablecoins (like USDC), despite being ERC20 compatible today, might give the issuer (Coinbase, Circle) the ability to blacklist addresses from receiving or sending money— they can ‘freeze’ funds.

Dai is governed by MakerDAO, a set of smart contracts themselves governed by the MKR token. As recently discussed in the Ethereum community, MakerDAO currently has at least four custodians. Each of them can steal all the ETH deposited as collateral in the system, print as much DAI as they wish, and drain the ETH/DAI pair liquidity on pretty much any smart contract based exchange or protocol… all in one transaction.

If censorship resistance is not fully enforced in a protocol, it’s not existent at all. Choosing a stablecoin that fits one’s needs then comes down to evaluate whether one’s activities are prone to being flagged or targeted or if you consider that risk lower than MakerDAO’s trust model’s risk.

Question #1: Is censorship resistance a real property of any stablecoin live today or a mere aspiration of the crypto community? Question #2: Is Dai’s inherent third party trust a better model than a centralized stablecoin if the issuer were to reside in a more permissive jurisdiction than the United States?

Issue #2: Systemic Risk

Economic dependencies

Dai recently ‘upgraded‘ to Multi-Collateral DAI (MCD) abandoning ETH as the only form of collateral and planning to introduce off-chain assets into the collateral mix, along with the counter-party risks that poses. Single collateral Dai proved it could at times be not as resilient as desirable to quick/big ETH price moves, having even traded at values under $0.9 at its historical minimum in its ~two years of existence.

Centralized stablecoins like USDC keep a 1 US dollar reserve for every 1 ethereum dollar they issue. The issuer is to be trusted to redeem the digital dollars for paper when asked to do so, and matters like company bankruptcy might affect the asset’s market survival.

Software dependencies

MKR’s price feed ‘oracle’ is currently governed by less than 15 addresses.

USDC’s blacklisting system can be hacked.

Question #3: Operating on a blockchain, can a decentralized margin system ever be as efficient as a centralized fund keeper in maintaining a peg without losing a full degree of decentralization? Question #4: Can any single app’s oracle system ever be more resistant to bribing or malfunctioning than a centralized server can be to hacking?

Issue #3: The USD Peg

I have always found the ‘mission’ of US dollar pegged stablecoins to not be really optimized for the (longer) long term. If we need a form of money outside the reach of any government or ruling party control (and therefore we need to use a slow, inefficient but trust-minimized blockchain) then why build a system pegged to the value of that government’s currency?

But this isn’t the point of this issue #3. We must point out that to cash out any of the two stablecoin types to any fiat currency we’ll be forced to go through more or less the same intermediary exchanges. Given they are currencies built to be pegged to fiat currencies and don’t represent a high return investment opportunity, this action (apart from savings) could be expected to be somewhat common — we all need to buy groceries. These venues will ban stablecoin pairs or cashouts as soon as they’re asked to do so by local governments, regardless of how decentralized the underlying currency is.