Does Stablecoin DAI Need Negative Interest Rates?

Editor's Note: This article comes fromFirst class warehouse blockchain research institute (ID: first_vip1), reprinted by Odaily with authorization.

Editor's Note: This article comes from

First class warehouse blockchain research institute (ID: first_vip1)

First class warehouse blockchain research institute (ID: first_vip1)

, reprinted by Odaily with authorization.

On March 12, the coronavirus hit the markets. U.S. stocks plunged 10%, the biggest drop since the 1987 stock market crash. The prices of bitcoin and ethereum plummeted nearly 50%.

DAI has since fallen back to the $1.01-$1.03 range. However, DAI has been above $1 for a month without any signs of returning.

The Corner Bank

Dai’s underlying smart contract, the Maker protocol, has a number of tools that can help push the price of dai back to its $1 target price. Negative interest rates are a contentious topic, both in the world of cryptocurrencies, as well as in the realm of regular fiat currencies. But it is possible that negative interest rates will succeed in lowering the price of dai.

Is DeFi ready?

Before discussing negative interest rates, a quick recap of dai 101.

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Just imagine how a bank works? Let's say you want to borrow $10,000 to invest in a small business. Your First Corner Bank needs you to mortgage some assets before lending you money. You put up your $100,000 house as collateral. It lends you $10,000 in new money that you can use to buy everyday items.

Dai also works on the same principle. If you want a DAI loan, you need to submit collateral to the DAI system, such as $100,000 worth of ether. The DAI protocol lends you a sum of money, say $10,000 worth of DAI. Now these new DAIs can be invested in the crypto economy.

“No one wants to suddenly have to pay interest after years of earning interest. But a stablecoin is not free, it has to be made.”

If you're behind bars, there's a good chance your $10,000 loan won't be repaid. This created problems for both companies. Some of First Corner's deposits (or dai's stablecoin) no longer have a corresponding repo party.

But First Corner and DAI have protections. They can seize your house or your ether and sell it to fill the $10k hole.

So both kinds of dollars are safe and stable. But that stability is valuable. People like to use dollars as a safe way to save, or for everyday use, as a guarantee of future purchasing power. Non-stable assets cannot provide such services.

Why did dai rise to $1.50?

Let’s first take a look at what happened to the price of dai after March 12. As the pandemic spreads, there is an increasing urgency to acquire the most liquid and safest asset — the U.S. dollar. That means dumping stocks, Ethereum, Bitcoin, everything.

One source of funds is the Ethereum collateral locked up by debtors to obtain loans. In order to keep Ethereum, the debtor has to buy back DAI to repay the debt. They desperately bought back the stablecoins of Dai, and as a result, the price of the stablecoins rose to $1.50.

After 30 days, DAI continued to trade at over $1, seemingly implying insufficient balances in the dai system. The desire to liquidate DAI debtors is high, driving the price of DAI up. But not enough people are willing to take on new debt to the system, which would create new DAI stablecoins and drive down prices.

What tools does Maker have?

Maker already has some tools in place to help with this imbalance.

One is to allow more types of collateral to be mortgaged in the dai system, increasing the number of potential debtors. As a result, more DAI is created, driving the price of DAI down.

Another tool is lower interest rates. The stability fee is the interest rate that debtors pay to the dai system. If the stability fee is lowered, it reduces the burden on debtors. Existing debtors will be less eager to liquidate. Bold new players may come forward and take on loans. New dai is created, bringing the price down to $1.

The price of dai (USD) in early March, source: dai.descipher.io

Reduce the savings rate for DAI. Owning DAI and locking DAI can earn interest. Reduce deposit interest, encourage dai holders to stop depositing coins, these people sell dai, thereby reducing the price.

Maker has used all of these tools in the past 30 days. The stability fee quickly dropped from 8% to 4%, then 0.5%. The DAI savings rate drops to 0%. Maker also added USD Coin, another popular stablecoin that accepts USD Coin as collateral.

But the above approach is not enough to restore the $1 anchor.

What about negative interest rates?

In theory, the next step would be to drop deposit rates into negative territory.

We are all used to debtors having to pay interest. The opposite is true for negative interest rates. Being a debtor earns interest. A negative stability fee will encourage more people to take debt on the DAI system. This will increase the supply of dai, thereby reducing the upward pressure on the dollar peg.

DAI has a negative savings rate, which means that anyone depositing money into DAI’s stablecoin will receive no interest. They have to pay a certain fee. As a result, the supply of DAI increases.

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There are two obstacles to implementing negative interest rates:

The first is technology. Maker's code does not support stability fees or dai savings rates dropping to negative values. A similar issue arose with fiat currencies in 2015, when banks discovered that their software did not allow bonds to trade at negative interest rates. They quickly modified the code and the problem was solved.

Maker has an indirect way of imposing negative rates: the target rate feedback mechanism. For example, lowering the target price of dai to 99 or 98 cents simulates negative interest rates. But this mysterious mechanism is now dormant (it was crossed out from the Maker white paper). The target rate feedback mechanism is complex and annoying: 1 token = $1 complicates things compared to setting the stability fee to a negative rate.

The second hurdle to negative interest rates is instinctive. Many people who hold stablecoins see interest as a legitimate return on savings. For them, negative interest rates are tantamount to forfeiting their returns. Only evil central banks can impose this anomaly on the world.