Today, an Executive Proposal was placed into the Maker Voting Portal recommending the integration of ETH and WBTC collateral types into Liquidations 2.0, the most recent upgrade to the Maker Protocol’s Liquidations system. The far-reaching overhaul of the system, approved by Maker governance last month after a great deal of community discussion and support, should enable the Protocol to scale more effectively and position MakerDAO for its next phase.
Importantly, the upgrade also marks the last major bootstrapping effort by the Maker Foundation in conjunction with the MakerDAO community, and will drive the DAO on its path toward further decentralization. The upgrade to the Liquidations System coupled with governance approval of the Core Unit Framework—the structure for managing the work and budgets necessary to operate the DAO—set the stage not only for more rapid decentralization, but also for the long-planned dissolution of the Foundation.
With a goal of reaching complete dissolution by December 31, 2021, the Foundation will increase its focus on winding down. In the days ahead, updates will be published in this blog to keep the community informed.
Collateral Integration with Liquidations is Intended to Further Safeguard Maker Vaults
The proposed integration of ETH and WBTC—the two most popular collateral types accepted by the Maker Protocol— follows the approved integration earlier this month of LINK and YFI. Should voters approve ETH and WBTC, around 70% of all Dai, including the vast majority of Dai generated against non-stablecoin collateral assets, would then be covered by the updated Liquidations system.
In the coming weeks, two additional proposals are expected to be placed into the Maker Voting Portal—one asking governance to consider the integration of the remaining standard collateral types, and another proposing integrating all of the LP tokens accepted as collateral in the Protocol.
Full integration of all Maker Vaults with Liquidations 2.0 is intended to reduce the risk of the Protocol becoming under-collateralized and increase user confidence in system efficiency.
The Importance of the Liquidations System, and How It Works
The Liquidations System is a critical element of the Maker Protocol, as it enables the community, through auctions, to help maintain the necessary level of collateralization for all Dai generated by users in Maker Vaults. In short, the system helps Dai maintain its soft peg to the US Dollar by ensuring that the Maker Protocol remains over-collateralized at all times.
Liquidations 2.0 is designed to be simple to use, more efficient and secure than version 1.2, and should create more opportunities for Keepers and others to participate in auctions.
All Dai in existence is backed by any one of several digital assets accepted as collateral in the Maker Protocol and locked in Maker Vaults. Each collateral asset is assigned a Liquidation Ratio (LR) that ensures the Dai generated against it is over-collateralized. For example, the LR for ETH-A* is 150%, meaning every 100 Dai generated from an ETH-A Vault must be collateralized by at least $150 worth of ETH.
As long as a Vault owner maintains the LR of the collateral asset, they can continue to generate Dai against it; however, if the LR drops below the required threshold, an auction can be triggered and the contents of the Vault sold for Dai.
Auction proceeds are used to cover Dai issued by the Vault, satisfy incurred stability fees, and pay a Liquidation Penalty set by Maker governance (currently 13%). Any Dai remaining from the sale are returned to the Vault holder.
The Path to Liquidations 2.0
The road to the new Liquidations system began a little over a year ago through a process of developer research, design considerations, and community engagement aimed at exploring options to improve the reliability and efficiency of collateral auctions. The system redesign “Pre-MIP” discussion, which was open to all on the Maker Forum, culminated in a clear, actionable way forward: A stopgap update (the release of Liquidations 1.2 in September 2020) followed by a complete overhaul of the system, Liquidations 2.0.
What the Upgrade Offers
Operationally, the new Liquidations System, which has been audited by Quantstamp, Trail of Bits, and ChainSecurity, seeks to offer more security and predictability, and promote decentralization by making it easier for a larger number of users in the Maker community and the DeFi sector as a whole to participate. The final audit reports are available for download here. Additionally, Gauntlet performed economic simulations of Liquidations 2.0 and 1.2 for purposes of comparison. That report is here.
Technologically, Liquidations 2.0 provides a series of qualitative changes to the system, aimed at making the liquidations process faster and more efficient, robust, and reliable. Key changes include:
- Dutch Auctions. In this model, the initial reserve price is set slightly above the market price and then reduced over time, rather than starting low and increasing, as was the case with the English auction model. In a Dutch auction, the first bid received wins the auction. This improves on speed and efficiency, as the system offers no opportunity to underbid the asking price. Anyone who sends Dai to an active auction will receive an equivalent amount of collateral based on the current price. Additionally, capital is not tied up while bidders wait for the auction to end, and, because Vaults are more likely to be liquidated at close-to-market price, users might benefit further.
- Decentralized Exchange (DEX) Integration. Previously, only Auction Keepers with dedicated software and well-maintained servers typically participated in auctions, though some individual users have participated in the past. While Keepers are still a feature of Liquidations 2.0, DEX integration means that anyone who uses a DEX or aggregator that’s supported by the upgrade can now participate via that DEX. The collateral is sold at the current market price to whoever wants to buy it at the time, much like a regular DEX trade.
- Support for partial bids. Partial-bid support means there is no longer a minimum capital requirement (previously 50,000 Dai). This enables broader participation from across the DeFi community.
- Support for flash loans. Because auctions now end with the first bid, a participant can make use of single-block composability to purchase liquidated collateral without any capital at all (beyond the ETH required for gas) by taking out a flash loan. Once purchased, the user can sell the collateral on a DEX and then repay the loan—all in the same block. This feature also promotes decentralization by reducing the up-front capital required of a user to liquidate an under-collateralized Vault.
Serving the Growing DeFi Sector
The redesign of the Liquidations system not only broadens collateral auction participation, but also reduces the amount of time from auction kick to auction completion and the possibility of auctions closing with a very low bid. The result should increase decentralized auction participation, reliability, and efficiency of the Liquidations system, enabling the Maker Protocol to scale effectively and support the rapid expansion of the DeFi space.
Check out MIP45, which details the redesign of Maker’s Liquidations System.
*Some collateral assets accepted in the Protocol have two or three variations designated by the letters A, B, or C. Each variation represents a different set of risk parameters for a specific asset. For example, ETH-A, ETH-B, and ETH-C allow users to generate Dai from ETH at different Liquidation Ratios and Stability Fees.