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Decrypting DeFi is Decrypt's DeFi email newsletter. (art: Grant Kempster)

For longtime readers of this letter, you’re surely aware of the two leading decentralized stablecoin providers: MakerDAO and Terra.

Both Tether (USDT) and USD Coin (USDC) are much larger than both of these projects, but they fail the decentralized test.

MakerDAO is behind the stablecoin DAI, and Terra is behind the fast-growing UST stablecoin. And though Terra has made a late entrance into this scene (Maker debuted in 2014 and DAI arrived in 2017), UST recently took the crown as the largest decentralized stablecoin by market cap.


For reference, USDT has a market cap of $80.8 billion, USDC has $52.4 billion, Terra has $15.8 billion, and DAI has $9.3 billion.

Market capitalization of UST (purple) and DAI (orange) over the past year. Source: CoinGecko

As you can see, UST took the lead in December. At that time, some folks may have thought it was just a fluke akin to various other flash-in-the-pan stablecoin attempts from the past.

Since then, however, UST has continued to surge.

And just as the stablecoin has surged in size, so too has Terra’s governance token LUNA, now a top 10 cryptocurrency by market cap—ahead of Cardano, Solana, and Avalanche. Since UST overtook DAI on December 20, the price of LUNA has risen from roughly $78 to today’s price of $93.5—a 19% hike.

The parallel rise of these two assets is no surprise either. That’s because each time more UST is minted, LUNA is destroyed.


And insofar as the Terra-based DeFi ecosystem has expanded and increased demand for a native stablecoin, there’s been tons of LUNA destroyed (meaning less available on the market).

For more on how Terra works, check out our Learn article on the subject.

The rise of Defi activity on Terra since November 2020. Source: DeFi Llama

Terra’s growth has shocked many, but perhaps none more so than MakerDAO. And now the project is finally acting.

MakerDAO has either implemented or is currently mulling over new updates to help improve the adoption of its stablecoin and also rethink the tokenomics of its native MKR token.

The very likely pretext for this wave of changes is to bring DeFi’s original central bank back to the top.

One proposal under discussion is that of turning MKR into a sort of vote-locking token akin to Curve and Yearn’s “ve-” models. This means that to participate in various governance proposals, you would need to stake your MKR token. In exchange, you would receive “stkMKR” and voting rights.

More importantly, though, those who stake MKR tokens also would be rewarded with additional MKR (similar to staking or yield farming rewards).

These rewards would be generated through a surplus auction, a Maker event that is triggered whenever there is a surplus of DAI. The excess DAI is sold for MKR and a percentage of this auction would, according to this proposal, be diverted to stkMKR holders.

Diagram of current surplus auction mechanism and the proposed mechanism. Source: MakerDAO

The idea behind this redesign is to entice users to 1) buy MKR so they can stake and participate in MakerDAO governance, 2) stake MKR tokens, thus moving them off of the market and creating a band of never-sellers, and 3) create juicy incentives such as an APR for staking.

Another update was that of adding stETH-ETH liquidity provision (LP) tokens as collateral to MakerDAO.

Quickly, in case you forgot how Maker works: Maker mints DAI with overcollateralized collateral.

You want DAI? Then you’ll need to deposit more than 100% of any number of other cryptocurrencies, ranging from Ethereum, Wrapped Bitcoin, Uniswap, and on and on.

With the addition of stETH-ETH LP tokens, that list of eligible collateral gets a little longer.

It’s a particularly interesting inclusion because it also shows how a traditionally conservative (at least for DeFi) project is onboarding a bit more risk than in the past.

The reason this particular asset is riskier than your run-of-the-mill cryptocurrency is that it relies on two other cryptocurrency projects. Here’s how it works.

You’ll first need to stake your Ethereum on Lido Finance and get stETH in return. Then you’ll deposit that stETH into Curve Finance’s stETH pool to get the stETH-ETH LP token. Finally, you can now deposit that LP token on MakerDAO and mint DAI stablecoins.

stETH-ETH LP pool on Maker.Source: Oasis (DAI minting tool for Maker)

You can then take those stablecoins and buy more cryptocurrencies, keep those stablecoins in another lending protocol earning interest, or simply rinse and repeat the stETH to DAI circuit until you’re max leveraged.

The last suggestion is, of course, a massive risk. If ETH tumbles, dragging down the value of that LP token below the 155% collateral ratio set by Maker, you’ll be liquidated.

The final proposal, and perhaps most controversial, has been that of onboarding more real-world assets (RWAs) as collateral to the Maker protocol.

“It’s time for the Maker protocol to take bold action and seed the next phase of DeFi,” tweeted hexonaut, a protocol engineer at Maker who contributed to the proposal. “The bull market has been kind to us all, but that time is passing. We need to take the next step and begin integrating with the real world at scale.”

So, like the stETH-ETH LP token mentioned above, hexonaut (and two others) proposed to open the collateral pool to assets like real estate loans or debt financing. This means you could mint DAI using non-crypto things.

And there are already protocols built to bridge these two worlds too, including Centrifuge (which has already minted more than $78 million in DAI using these kinds of assets).

And in order to make this less risky for Maker, hexonaut also proposed another change to Maker: Increase its surplus by removing the current burn mechanism.

“We propose this first step to stop the burn and focus on building a massive system surplus,” they write. “By refocusing all profits into the surplus buffer this will allow us to risk-on for the protocol without causing existential threats like flop auctions.”


The surplus burn, which was also briefly mentioned above, uses surplus DAI in the market to buy MKR tokens and then burn (crypto speak for destroy) those tokens. The latest proposal wants to eliminate this mechanism and let the surplus run so that the protocol will be liquid enough to onboard more risk.

With more funds sloshing around, black swan events akin to what happened in March 2020 (when DAI briefly lost its dollar peg) could be better cushioned.

Well, that’s the idea, at least. And, of course, overtaking Terra.

Decrypting DeFi is our DeFi newsletter, led by this essay. Subscribers to our emails get to read the essay first, before it goes on the site. Subscribe hereand read last week's essay: How The Juno Network DAO Voted to Revoke a Whale's Tokens.

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