Note: The following brief is simply a thought exercise to determine ways that the Maker Foundation could have avoided (or softened) the impact of “Black Thursday.”
March 12, 2020 is a date known as “Black Thursday” within the crypto-community. On this date, during a global economic recession caused by the worsening of the COVID-19 pandemic, the Maker DAO ecosystem suffered massive CDP (Collateralized Debt Positions) contract liquidations that resulted in protocol losses of 5.67 million DAI. The historic liquidation was due to quick, and precipitous decline in Ether’s (ETH) value, the utility token of the Ethereum ecosystem. As ETH prices dropped, many token holders tried to sell their ETH at once in exchange for fiat currency and/or stablecoins, which then congested the Ethereum network and abruptly increased network transaction fees and wait times. As issued Dai became undercollateralized, many of the CDPs that issued the Dai liquidated, and there became an opportunity to win liquidation auctions with zero bids, which was 36% of all liquidations. $8.32 million was withdrawn through zero bids auctions in total.
The event, commonly referred to as a “Black Swan” event within the Maker ecosystem, is a critical attack vector that could have been avoided. The following recommendations specifically address how the Maker Foundation (and MKR token holders) could have minimized the disastrous result of a single-collateral, semi-transparent protocol environment.
Forecast, Mitigate Risk, Minimize Liability
Forecast. Oftentimes decentralized protocols understand their own, largest attack vectors, but few develop safeguards to minimize the downside of these potential exploits. In an effort to reduce the risk of a potential Black Swan event, one that Maker was well aware of before launching sDai in 2017, the Maker Foundation should have leveraged some of the MKR supply as protocol insurance partially protecting CDP owners that face immediate liquidation if a Black Swan event were to take place. Doing so could have greatly reduced CDP investor downside, and, in fact, may have served as an incentive to invest in CDPs earlier on the protocol’s lifespan. Additionally, the Maker Foundation made a decision to trade off increased liability with increased governance involvement, thus, such a protocol design could’ve served as reduced legal liability in the event of a Black Swan event.
The Maker Foundation made a decision to trade off increased liability with increased governance involvement, thus, such a protocol design could’ve served as reduced legal liability in the event of a Black Swan event.
Mitigate Risk. Next, the Maker Foundation should have not released single collateralized Dai at all. The Black Swan attack vector is too large to not be addressed, particularly in a crypto-economic system that could be rendered completely useless if a large enough Black Swan event occurs. Launching a multi-collateral Dai first, with limited capability to support proposed forms of collateral, but built-in capability to support multiple ERC20s, could have reduced the risk of crypto-economic peril even in the event of ETH’s price falling. Of course, to minimize risk even more, the ERC20’s selected would need (1) a high market capitalization (for liquidity) and (2) a negative correlation (or at the very least, a neutral correlation) to ETH’s price (and price fluctuations). By doing the latter, the Maker Foundation could have greatly limited its exposure to ETH’s volatility, even though the protocol is on the Ethereum network. ERC20s that could’ve fit these “multi-collateral Dai (v1)” requirements could have been DGX (backed by gold) and, potentially, USDT (backed by fiat currency). If this was implemented at initial release, with a more flexible version of “multi-collateral Dai (v2)” forecasted on their development roadmap, the Maker ecosystem might have seen a significantly softened effect of ‘Black Thursday’ if any at all, because a smaller portion of mDai v1 was collateralized with ETH, while the other issued mDai v1 was collateralized with DGX and USDT. Some might criticize the use of fiat collateralized stablecoins as a risk-mitigation strategy for the continuation of Dai, but, currently, USDC is an accepted form of collateral for multi-collateral Dai. Thus, one could argue that such risk mitigation is required until other digital assets become more reliable sources of collateral the Maker protocol can use.
…One could argue that using fiat-collateralized stablecoins is required in a crypto-collateralized stablecoin protocol for greater stability until other digital assets become more reliable sources of collateral the protocol can use.
Ensure Standard Communication. The Maker Foundation suffered from a $20M class-action lawsuit by over 3,000 CDP investors that were affected by Black Thursday. The group claimed that “the Maker Foundation and other third-party user interfaces informed users that, because their CDPs would be significantly over-collateralized, liquidation events would only result in a 13 [percent] liquidation penalty applied against the remaining collateral, after which the remaining collateral would be returned to the user.” Effectively, Maker did not ensure that their ecosystem products clearly educated CDP investors of the risks of CDPs by ignoring the fact that a Black Swan event, one that could completely liquidate CDPs could (and did) happen. The Foundation should have ensured that, the risk of MKR and CDP ownership was clearly communicated and re-iterated across their tools and social channels, particularly given that the organization has accepted increased liability by initially centralizing governance power.