The DeFi blue chip is the latest protocol to be struck by shock waves from the U.S. Treasury Department’s decision Monday to sanction Tornado Cash, a so-called “mixer” that lets crypto users anonymize their transactions.
Maker is making contingency plans to execute an emergency shutdown should core contracts underpinning DAI, its stablecoin, be sanctioned by Washington, according to posts from MakerDAO founder, Rune Christensen, in the project’s Discord channels. “If we get nuked by the U.S. government, we simply die,” Christensen warned.
The move to blacklist Tornado Cash, which the Feds say laundered $7B worth of virtual currency, has already rocked USDC, the No. 2 stablecoin in terms of market value.
On Tuesday, Centre, the consortium behind USDC, blacklisted 38 wallet addresses and froze the USDC tokens they held. Centre, which was set up by Circle and Coinbase, has now banned 81 wallet addresses in total since USDC was launched in September 2018.
The blacklisting of Tornado wallets has called the decentralization of MakerDAO’s DAI stablecoin into question because the token is heavily backed by USDC. So there’s a contagion effect going on.
According to Daistats, USDC is currently the single-largest source of collateral backing DAI, with $3.56B USDC currently locked in the protocol. The dominance of USDC among DAI’s collateral assets has many in the crypto community urging Maker to reduce its reliance on the centralized stablecoin.
Critics have even described DAI as “wrapped USDC” in reference to its sizable USDC backing. Nadia Alvarez from MakerGrowth’ the DAO’s core growth unit, told The Defiant that DAI is backed by a diverse portfolio of cryptocurrencies and a number of real world assets, which limits exposure to any one asset. She said DAI is collateralized by 33.9% USDC, 23.2% ETH, and 7.6% WBTC, among other assets.
“MakerDAO is always working to diversify its exposure even further, adding new stablecoins and other wide ranging assets to its collateral,” Alvarez said.
DAI is an overcollateralized stablecoin that can be minted against assets deposited into the MakerDAO protocol. With a third of the collateral backing Maker’s DAI stablecoin comprising USDC, Maker is now scrambling to work out how to minimize its exposure to the centralized stable token and alleviate concerns that DAI may not be so decentralized after all.
That’s important because maintaining censorship resistance is a hallmark of decentralization.
MakerDAO is the largest DeFi protocol by total value locked, representing 13% of the sector’s combined capital with $8.7B, according to DeFi Llama. While its MKR token has a modest market cap of $965M, MakerDAO has long been respected as one of the most prestigious and influential DeFi organizations in the space.
It isn’t just Maker’s DAI that is facing pressure — Ameen Soleimani, a contributor to the algorithmic stabletoken protocol, RAI, told The Defiant that “every DeFi protocol is thinking about reducing their USDC exposure” in response to Centre blacklisting the wallets associated with Tornado Cash.
MakerDAO went live in December 2017, allowing users to mint its DAI stablecoin against overcollateralized ETH deposits. It has steadily expanded the list of assets that users could provide as collateral to mint DAI against.
USDC became the third collateral asset supported by the protocol in March 2020, garnering criticism that DAI’s decentralized structure was at risk of being compromised by the centralized assets increasingly backing its supply.
On Aug. 8, Erik Voorhees, the founder of crypto exchange ShapeShift, tweeted an open letter to the Maker community imploring it to start unwinding its USDC backing and “converting it into stables that are more censorship-resistant.”
“You have some time to do it, but you need to get started,” he added.
The question of how to manage DAI’s sizable USDC reserves amid the OFAC sanctions is dominating discussions on MakerDAO’s social channels. DAI’s peg to the dollar is maintained by Maker’s Peg Stability Module (PSM), which allows users to swap stablecoins such as USDC at a one-to-one basis in exchange for DAI.
Maker’s USDC PSM contract is the single largest wallet by USDC holdings. It contains 3.56B USDC — double the stash held by USDC’s second largest hodler, Binance, which possesses 1.78B USDC. Polygon’s PoS bridge is the third-largest USDC wallet with 1.61B tokens, followed by Aribtrum’s bridge with 828M USDC.
On Discord, MakerDAO delegate Chris Blec warned that as long as Maker is involved with censorable assets as collateral, it is doomed to fail. “Good luck not getting sanctioned when DAI is already sitting in sanctioned smart contracts that can’t be paused,” Blec added.
Kyle said “why can’t this become solely a borrow and lend type of product without the need for USDC? Can’t responsible borrow and lending win?”
Some commenters suggested Maker should unload its USDC in exchange for Ether. But Christensen, MakerDAO’s founder, didn’t like the idea.
If we ape several billion USDC we will get hit by insane slippage… and then ETH will tank after once people realize what’s going on,” he said.
Other users are worried that authorities might sanction contracts that are critical to MakerDAO’s operations in the future — such as the USDC PSM — due to some DAI users moving the stablecoins through Tornado Cash.
0xbocaJ said “having the majority of DAI tied to the PSM creates a significant centralization risk; if Circle blacklists the PSM, it will have a tremendous disruptive effect on the market.” Kyle chimed in that “the PSM likely needs to be done away with.”
Christensen described Maker’s PSM appearing on a sanctions list as “the biggest risk” facing MakerDAO. However, he noted it is “unlikely to happen,” adding “there is a reason it is Tornado Cash and not Aave or Uniswap or whatever that just got sanctioned.”
In the event of the USDC PSM getting sanctioned, Christensen asserted MakerDAO would be forced to execute an emergency shutdown. Christensen said he is planning to propose a Decentralized Voter Committee dubbed Phoenix, which will be tasked with developing a plan for how the protocol could manage an emergency shutdown.
MakerDAO’s founder added that the protocol should shift stablecoins into bonds to garner cover. He said bond underwriters “can’t randomly show up on the sanctions list.” However, Christensen emphasized that OFAC sanctioning its PSM contract would have disastrous repercussions for the protocol.
“In the short run we simply do not have the ability to resist a crackdown, and we can’t pull it out of a hat,” he said. “The best option is to count on not getting sanctioned now, and then work on the fundamentals we need to have in place to be able to actually resist a real physical attack. We should just accept that if they want to shut us down, the outcome is [an] emergency shutdown.”
Speaking to The Defiant, Mark Monfort, of web3 venture studio, NotCentralised, described the blacklisting of USDC addresses as a definite threat to the stabilizing mechanism of DAI. “The fact that Maker has even considered putting in an emergency shutdown shows how significant this event is for the ecosystem,” he said.
Chris Bradbury, the CEO of Oasis.app, a DeFi project providing an independent interface for the Maker protocol, told The Defiant that Maker’s recent moves to finance legacy banking institutions demonstrates the protocol’s commitment to diversifying its collateral and reducing its reliance on USDC.
In July, Maker launched a 100M DAI vault for the 151-year-old Pennsylvanian lender, Huntingdon Valley Bank, and provided a 30M DAI loan to a subsidiary of the major French bank, Societe Generale.
Bradbury said that the centralization risks associated with USDC “is not a new challenge, and we believe the DAO continues to address it as appropriate.” He added that his team does not expect the OFAC news to impact Oasis.app significantly.
Unwind USDC Exposure
Hexonaut, a MakerDAO protocol engineer, posted on Discord that “people [are] acting as if we haven’t been attempting to unwind the USDC exposure from the beginning. Diversified RWAs have always been the goal… If you don’t like USDC then you should be voting yes to onboard RWAs.”
MakerGrowth’s Alvarez said embracing real world assets is a positive development on the part of the Maker community, and does not undermine the decentralization of the protocol or DAI.
Not everyone is convinced, however. Brian McMichael, a smart contract engineer at MakerDAO, asserted that RWAs pose the same centralization risks associated with DAI’s heavy USDC backing. “RWAs have the exact same problem. USDC is an RWA and it’s why we have the problem.”
0xbocaJ agreed, stating “I don’t think the move into RWA (which I support) really solves the underlying risk here.”