A few folks have asked, “Why hasn’t someone forked Maker’s CDP system without the MKR token?”

You can – but you’ll end up with a system that looks somewhat like Basis.

Here’s how:

Assume Alice owns the only CDP in the Maker system (“CDP A”), from which she created 100 DAI. She created this CDP and its 100 DAI exactly 1 year ago, and no one else in the past year has created any additional CDPs or DAI.

If the Stability Fee is +10%:

  • When Alice is ready to close out her CDP, she will have to deposit 110 DAI to her CDP to close it out, but there are only 100 DAI in the system.
  • Even if Alice went out and bought back all 100 DAI, Alice’s only option is to convince someone else (say, Bob) to create a CDP, issue 10 DAI, and sell those 10 DAI to Alice.
  • Alice can do this by paying Bob >$1/DAI, either in USD or another stablecoin or BTC…but this would break the peg with DAI trading >$1.
    • Instead, Alice can “borrow” the DAI and promise Bob that she will pay him back 10 DAI (plus some interest ε) sometime in the future.
    • Alice can sell Bob an IOU: a promise that Alice will give Bob 10+ε DAI in the future, in exchange for his locking up ETH in a CDP to create DAI today.

If the Stability Fee is -10%:

  • Alice only needs to deposit 90 DAI to her CDP to close it out. Let’s say she already owns 90, and the remaining 10 are owned by Bob.
  • Bob sees that once Alice redeems her 90 DAI to CDP A to close it out, Bob’s 10 DAI will be worthless. Bob then hurries to offload his 10 DAI for anything > $0, even if it’s < $1. DAI begins trading like a hot potato, with its price dropping the more people believe that Alice is going to close out CDP A. This would break the peg, with DAI trading <$1.
  • To prevent this, Alice can buy back Bob’s 10 DAI with a note that promises that in the future, his note can be redeemed for 10 DAI (plus some interest ε).
    • Alice can sell Bob an IOU for DAI: a promise that Alice will give Bob 10+ε DAI in the future, in exchange for his 10 DAI today.

In both cases, the temporal mismatch between the demand for DAI (based on the Stability Fee) and supply of DAI (based on the size of Alice’s CDP), means that Alice needs to convince Bob to sell or loan DAI to her in order to keep the peg at DAI = $1.

How is this like Basis?

These “IOUs” that Alice gives to Bob are what the Basis project called “Bonds”. These standardized IOUs help parties like Alice and Bob coordinate, rather than Alice needing to broker her own OTC transaction with each “Bob” in the system in USD or some other currency.

In December 2018, the Basis project shut down because their lawyers determined that the “Bonds” would have been characterized as unregistered securities. It’s unclear whether the above Maker/Basis system would have the same characterization. Here are a few differentiating features:

  1. Alice’s IOUs can be seen as unsecured loans with very short maturities. (Bob can demand, for example, that Alice pay back the loan within 24 hours.)
    • This could affect how Alice and Bob can transfer their risk to other parties, since there are transfer restrictions on unregistered securities.
  2. Alice and Bob are entering a bilateral agreement, rather than a unilateral agreement between a centralized (albeit algorithmic) “central bank” and “Bobs”.
  3. Alice and Bob could find each other through peer-to-peer discovery, rather than through a centralized bond auction on an exchange.

Open questions

There are a few open questions that this post can’t cover, but which there hopefully will be more discussion of on other parts of the internet or at hackathons!

  1. In the first case, when the Stability Fee is positive, Bob should only accept Alice’s IOU if ε ≥ Stability Fee, so that his own Stability Fee is covered. Does this suggest that as the Stability Fee increases, ε increases, and so on? (Is there a mechanism that will normalize the Stability Fee back to 0?)
    • Notably, Basis didn’t have to answer this question, since they could “print” extra Basis on their own, without needing ecosystem participants to create the stablecoin on their own.
  2. In the second case, what mechanism should be used to find the market clearing price of ε? Whose tokens should be bought back, and at what price? Basis’s bond auction mechanism (including maturities) sought to answer these questions.