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MakerDAO: When CeFi Hits DeFi

The collapse of Silicon Valley Bank (SVB) affected, among others, the USDC’s reserves and this “blue-chip” stablecoin has lost its peg to the dollar. Ironically, the only decentralized unicorn stablecoin project, MakerDAO is now in trouble due to its “reinforcing” USDC-backed component.

MakerDAO DAI depegs after USDC solvency issues

For the last year we got used to hearing about crypto project failures and DeFi project risks. Terra, FTX disasters pushed the crypto industry into “cryptowinter” and threatened the stability of the traditional financial system. Now we observe the wave of instability from the other side. Fueled by macroeconomic shifts, the traditional banking system’s instability threatens DeFi projects.

MakerDAO’s semi-decentralized stablecoin DAI has lost its peg to USD amid concerns about USDC solvency. USDC made a major part of MakerDAO’s last line of defense, the Price Stability Module (PSM) reserves. Unlike the original decentralized design of Maker’s DAO, PSM is а centralized crutch that holds up to 60% of the $5 billion stablecoin’s weight.

In response to the situation, the Risk Core Unit, a team of 11 full-time employees at Maker DAO, proposed emergency measures to stabilize the situation. They included increasing fees on USDC trades, reducing the maximum amount of DAI that can be borrowed in certain vaults - some set to zero, and reducing daily mint limits. Worth noting, the proposal has instead relaxed similar settings for Paxos positions, the reserve option that was recently set for growth.

At the time of the writing, there was no significant run on DAI’s PSM. PeckShieldAlert reported that Vitalik Buterin shorted 150K Rai Reflex Index (RAI), the stablecoin he strongly supported, to buy nearly 400 thousand of USDC and only $50 thousand of DAI. Also, Justin Sun exchanged around $130 million worth of USDC for DAI in a deal yet to be analyzed.

USDC and DAI depeg related trades of March 11, 2023
USDC and DAI depeg related trades of March 11, 2023. Source: Lookonchain

This is not the first time USDC has caused problems for MakerDAO. In August last year, Circle, the company behind USDC, complied to the sanctions imposed by U.S. Office of Foreign Assets Control (OFAC) on the largest crypto mixer Tornado Cash, announcing that its tokens processed by the mixer would not be accepted. However, MakerDAO’s PSM is operated by smartcontracts that can’t distinguish between “clean” and “stained” USDC, and moreover, possess the constant risk of blocking by Circle.

That was the first time when the community talked about the risks of merging traditional finance with decentralized one. Nevertheless, the course for centralization has never altered, and more projects like Frax are abandoning their decentralized features, concerned about the imperfections of the DeFi instruments. Will this trend reverse after CeFi failures? We will observe and report.