MakerDao's Wrapped Tokens: High Stakes, High Risks
Yesterday I was discussing with some Italian Twitter users about the risks of MakerDao. So here are a few reflections.
First of all, an interesting thread directly from MakerDao.
Now let's get straight to the point: How has MakerDao been functioning in the last year? After enabling ETH withdrawals, especially through LIDO, there has been a stake boom. In practice, users stake ETH and receive stETH (that wrapped stuff of dubious validity). This way, they can receive about a 4% yield, always in stETH.
Note: Based on the news I have up to today, redeeming requires 2 weeks to get back your ETH. Remember that.
But why settle for so little when you can do the trick? Lido allows you to wrap your fake ETH stETH again. And there it becomes wstETH. This "token" can only be used in one place: the MakerDao protocol. Why not stETH? Because it's staked and changes in quantity over time due to APY, while wstETH is fixed. Now you send this doubly wrapped token to the Maker protocol (vault) and receive a fresh and ready-to-use StableCoin, DAI, for your collateral (of dubious origin at this point).
And what do you do with DAI? Coincidentally, MakerDao allows you to stake it with a respectable 8% APY!!
Let's take a look at Maker's collateral situation... and we find that 46% of the collateral is wstETH 2.77bln$ ,with $1.23 billion DAI staked.
All very nice, because both Lido and MakerDao are raking in fees as if there's no tomorrow. However, there's something that doesn't add up. Doesn't it seem like a distributed Ponzi scheme? A little here, a little there... someone has to lose out eventually. However, the main purpose is always to prevent tokens from entering circulation. So you make ETH "rare" by locking it on Lido and make DAI "rare" by locking it on MakerDao. ETH maintains its price stability, and DAI maintains its price stability.
So my stake of a stake on wrapped tokens for another stake with collateral of collateral is ultimately "stabilized" and sufficiently secure.
At least until something "serious" happens. What could be the inherent risks? First of all, a drop in the price of Ethereum will certainly trigger a chain of liquidations on the protocols. Collateral is lost, especially for MakerDao, which will immediately sell the locked ETH until the "value" of the borrowed DAI is recovered (out of thin air...). What remains, the user can withdraw... oh, but wait... they are wstETH. So they will have to take the wstETH and return them to LIDO to get stETH back, then close the position and get their ETH back... after 2 weeks (as far as I know now).
This will unleash absolute madness, but above all, a ton of fees for Lido and Maker, who will see the protocol shake but at the same time generate profits at the speed of light. If we also add that there's no real Proof of Reserve for Lido, we could introduce the risk that the ETH has already been sold at much higher prices than buying back low to return them to users.
Whatever happens... the current volume on MakerDao and Lido is showing very similar facets to past drops.
Is it time to fasten our seatbelts?
First of all, an interesting thread directly from MakerDao.
Now let's get straight to the point: How has MakerDao been functioning in the last year? After enabling ETH withdrawals, especially through LIDO, there has been a stake boom. In practice, users stake ETH and receive stETH (that wrapped stuff of dubious validity). This way, they can receive about a 4% yield, always in stETH.
Note: Based on the news I have up to today, redeeming requires 2 weeks to get back your ETH. Remember that.
But why settle for so little when you can do the trick? Lido allows you to wrap your fake ETH stETH again. And there it becomes wstETH. This "token" can only be used in one place: the MakerDao protocol. Why not stETH? Because it's staked and changes in quantity over time due to APY, while wstETH is fixed. Now you send this doubly wrapped token to the Maker protocol (vault) and receive a fresh and ready-to-use StableCoin, DAI, for your collateral (of dubious origin at this point).
And what do you do with DAI? Coincidentally, MakerDao allows you to stake it with a respectable 8% APY!!
Let's take a look at Maker's collateral situation... and we find that 46% of the collateral is wstETH 2.77bln$ ,with $1.23 billion DAI staked.
All very nice, because both Lido and MakerDao are raking in fees as if there's no tomorrow. However, there's something that doesn't add up. Doesn't it seem like a distributed Ponzi scheme? A little here, a little there... someone has to lose out eventually. However, the main purpose is always to prevent tokens from entering circulation. So you make ETH "rare" by locking it on Lido and make DAI "rare" by locking it on MakerDao. ETH maintains its price stability, and DAI maintains its price stability.
So my stake of a stake on wrapped tokens for another stake with collateral of collateral is ultimately "stabilized" and sufficiently secure.
At least until something "serious" happens. What could be the inherent risks? First of all, a drop in the price of Ethereum will certainly trigger a chain of liquidations on the protocols. Collateral is lost, especially for MakerDao, which will immediately sell the locked ETH until the "value" of the borrowed DAI is recovered (out of thin air...). What remains, the user can withdraw... oh, but wait... they are wstETH. So they will have to take the wstETH and return them to LIDO to get stETH back, then close the position and get their ETH back... after 2 weeks (as far as I know now).
This will unleash absolute madness, but above all, a ton of fees for Lido and Maker, who will see the protocol shake but at the same time generate profits at the speed of light. If we also add that there's no real Proof of Reserve for Lido, we could introduce the risk that the ETH has already been sold at much higher prices than buying back low to return them to users.
Whatever happens... the current volume on MakerDao and Lido is showing very similar facets to past drops.
Is it time to fasten our seatbelts?