MakerDAO and Aave’s DeFi Conflict Reopens Over DAI’s Perceived Risk Growth

The one-time symbiotic relationship between decentralized stablecoin issuer MakerDAO and lending protocol Aave is falling apart.

As new innovations are being tested in the decentralized finance (DeFi) sector, tensions are starting to build. The threat of these innovations puts the two major protocols at a crossroads.

At the center of the controversy is a controversial stablecoin that reflects the “basic trade” and maker direct deposit die module (D3M), known as Ethena USDA.

MakerDAO launched its Dai (DAI) token in 2017 as a decentralized stablecoin backed by Ether (ETH). Users had to spend tokens on the MakerDAO platform by locking in ETH.

In the year In November 2019, Maker launched Multi-Pledge DAI, which allows DAI to be backed by multiple cryptocurrencies, including centralized stablecoins such as USD Coin (USDC).

Ave (formerly known as ETHLend) launched at the same time as a peer-to-peer cryptocurrency lending platform, and DAI was integrated into the platform as collateral from the very beginning.

Both platforms have partnered during the 2021 DeFi boom. D3M's launch in partnership with Aave enabled it to connect directly with the secondary market by actively executing the highest variable loan rates.

During the bear market of 2022, things changed with the collapse of major DeFi protocols and major cryptocurrency lenders, as well as the banking crisis that led to the collapse of Credit Suisse, putting unprecedented pressure on these protocols.

Alarm bells call as stable coin depeg

The 2022 bear market has seen a series of losses and highs since Terra Ecosystem in May. The Terra Algorithm stable coin crashed after losing its peg.

The collapse of Terra (LUNA), previously a top 10 cryptocurrency with a market capitalization of more than $40 billion, has become worthless within days as it entered a “death spiral” that led to the creation of trillions of tokens.

The collapse of the Terra ecosystem had devastating consequences, eventually leading to the collapse of lending platforms Celsius and Blockchain, among others. As a result, MakerDAO voted to temporarily suspend Aave's D3M to protect itself.

The bear market later saw the centralized stablecoin USDC briefly lose its peg as the now-defunct Silicon Valley bank's $3.3 billion stash of storacoin fell. The stakes were restored to ensure that deposits were fully made after the controllers entered.

That DEPEG rang alarm bells for MakerDAO, which soon asked for “urgent executive proposals to address concerns about the protocol.” At the time, Meeker moved to divest his exposure to Aave, saying “the overall risk-reward of investing in D3M is not favorable under current circumstances.”

Speaking to Cointelegraph, Becky Sarwate, head of communications at cryptocurrency exchange Cex.io, said the next step for a decentralized autonomous organization (DAO) was to buy real-world assets in the form of US Treasuries “to strengthen market confidence in DAI. Bringing the network's value mix to greater consensus.”

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In fact, real-world assets, including US Treasuries and short-term loans, currently represent the largest DAI support, accounting for 20% of the settlement fees generated in March.

According to Sarwate, the protocol has moved to restore the credit to the stable coin. The decision has some market participants concerned, particularly because of the new exposure that some see as riskier stockey funds mirroring hedge fund trading.

There is tension between MakerDAO and Aave

MakerDAO and Aave became more direct competitors over time. In the year In early 2023, MakerDAO introduced the Spark Protocol, a version 3 fork of Aave that allows users to borrow, lend, and share DAI. This fork is connected to Maker's D3M, effectively giving DAI users an Aave competitor.

Later that year, Aave introduced GHO, an algorithmically stable coin pegged to the US dollar. A “decentralized, hyper-linked” asset backed by multiple digital assets – including Ether – makes GHO as effective as DAI.

According to market data, neither platform was successful in scaring away the competitor. The Spark protocol is currently locked in at $2.4 billion in total value, down from more than $4 billion, while Ave has more than $10.6 billion locked up in its smart contracts across 12 chains.

On the other hand, DAI's circulation is more than $5 billion, making GHO nearly $50 million.

The tension between these two protocols peaked in early April 2024 when AaveDAO limited the amount of MakerDAO DAI stablecoin allowed on the lending platform and may remove it entirely.

When the issue eventually fell by 12 percent loan-to-value, Mark Zeller, founder of the Aave Chain initiative, proposed removing DAI as collateral on Aave. Value is locked.

The smaller-than-expected reduction came after a detailed analysis from Chaos Labs called for a more conservative approach. Cex.io's Sarwate says:

“On the one hand, MakerDAO has expanded the DAI credit line from 100 million to 1 billion tokens for a short-term ceiling, putting Ave in a difficult position.

She said the company's decision to put some of its newly minted DIA into USDe, the artificial dollar, added to this concern. This algorithm has raised doubts in the market that it plans to replicate the strategy of stable coin mutual hedge funds.

Cooking point

MakerDAO's indirect exposure to USde coupled with an extended credit line appears to be a boiling point for the Aave community, a stablecoin that is particularly controversial.

Athena USD takes advantage of the price differential between the spot and futures markets through a product known as a cash-and-carry trade. It works with a staked Ether (stETH) position and a short position on ETH, to hedge that exposure to the cryptocurrency.

The business is basically independent of the market and generates a product through the ETH held and the funding prices of the futures contracts are charged to the traders for the open positions. This helps to align the price of the perpetual futures contract with the price of the underlying cryptocurrency.

When there is a lot of buying demand, the funds rate is positive, and long positions pay short sellers, while the opposite is true when supply exceeds demand. Since Athena's launch, support rates have been mostly positive, allowing USDe holders to earn double-digit yields in a “delta neutral” trade.

Critics, however, have argued that the stablecoin may be under-collateralized during a cryptocurrency bear market in which the price of sustainable ETH future contracts falls below the spot price of ETH, which changes the currency rates on USDe holders.

André Cronje, founder of decentralized financial protocol Yearn.finance, noted on social media that things are going well now and funding is positive, but added, “Eventually when this turns around, funding will be negative, margin/collateralism will be cut, and you'll have an unfunded asset.”

Cronje cited other risks, including external risks related to the token used to link stETH to ETH, exchange protection risks, and proliferation risks.

Evgeny Gaevoy, CEO of cryptocurrency market creator Wintermut, mentioned on social media platform X that the key concerns are related to execution and regulation.

Sarwate said, “If USde goes into free fall, it could push DAI to the same reference point.

She added, “On the other hand, opting to avoid Aave DAI altogether could exacerbate such potential situations. If not thoughtfully presented, specifications can become violent and once free-flowing societies can crumble.

John Lo, a former key contributor at popular decentralized exchange SushiSwap and now head of digital assets at cryptocurrency fund Replenishment Capital, told Cointelegraph that while Aave's move to lower its loan-to-value ratio was smart, it could “completely eliminate DAI as collateral.” being extreme”

Lo called for more research into the scope of the D3M module and its ability to “use it as a flash lending vector – quickly raising prices on any oracle would pose a threat to all lending protocols.” Flash loans are taken out and paid off in one transaction.

Flash loans should always evaluate the risk of using oracles to issue multiple tokens, he said. The token creation – as mentioned above – was part of Terra's death knell.

The spirit of the stablecoin past

On Aave's proposal to drop loan-to-value for DAI, AveChan founder Mark Zeller cited the Aave protocol's “past experience” with somewhat “consequences of careless policies” such as Angle's agEUR, a stablecoin. It's tied with the euro in Euler, which has been hacked for a week.

Lo said Athena's USD stablecoin is “centralized, and therefore, there is little security risk in being able to withdraw more USDA at will.” This risk can be “compensated by USD reputational limits.” The most important risk is liquidity and slippage from redemptions that arise in a bank run scenario, he said.

He explained that runaway redemptions at low or negative funding rates “will force short perpetual futures positions” and “if the prices of ETH and BTC are increasing at that time,” slippage can occur.

Lo added that the slide in selling stored ETH with less liquidity should also be considered because even a 5% decline in the stablecoin's asset value is “enough to trigger a crisis of confidence”.

Cex.io's Sarwate commented to some in the cryptocurrency space that “USDe's product structure evokes the stablecoin's past” and pointed out that USDe's popularity is one in the game.

“This is leading some critics to recall the old adage about the downstream effect of double-burning if the network's delicate balance starts to falter. While higher returns may be a cause for euphoria, if conditions in the underlying asset weaken, negative effects could dominate the entire bearer chain, he said.

Lo, on the other hand, stated that he does not believe that USDe “poses specific risks to DeFi”, as “a limited token delta neutral strategy is typically implemented by funds.

According to Lo, a variety of similarly tokenized projects should begin to appear in the future, and the big question is whether the USDe itself will be able to sustain its funding rate if it falls and turns negative. .

“Many tokens and stablecoins have low liquidity on-chain, and the risk in this situation is economic exploitation, especially manipulation of the value of the word; but I do not believe that these will cause systemic risks in the way that Luna and UST operate,” he said.

However, the former SushiSwap contributor sees a silver lining in the growing conflict between both protocols and the controversy surrounding USDe, noting that the discussions and focus on these issues “governance in DAI is alive and well and, above all, widely known.”

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For him, this activity should be seen as “the number one sign of confidence in the decentralized protocol”, and reductions will eventually be implemented, he can ask how much is related to security in management and how much is to prevent competition. established existing”

What is “generally lacking in crypto” are “solid independent assessments of collateral risks and asset risk,” he said.

MakerDAO and Aave's recent spat appears to have been resolved by Chaos Labs' DAI analysis for Aave DAO, which led to a 12% loan-to-value drop. On social networks, Zeller addressed the issue with a simple “DAI stays in the Ave. We will continue. Forward.”

It is unclear whether AthenaUSD will eventually collapse, post-competition, or some other fate, but with the presence of the Spark protocol and Aves GHO, it is likely that these two protocols will eventually cross paths again.