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MakerDAO Contemplates ‘Emergency Shutdown’ If Sanctions Hit DAI

tl;dr Summary:  Big daddy of DeFi, MakerDAO, announced its willingness to perform an “Emergency Shutdown” as a last resort if regulatory authorities sanction it. Meanwhile, the committee is abuzz with what it can take to reduce dependency on USDC.

The recent Tornado Cash episode has sent ripples throughout the blockchain universe, forcing many to rethink their strategy to avoid being victims of state-sponsored sanctions.

One such project is MakerDAO, which is currently the biggest DeFi project and has received much attention. 

Source: https://defillama.com/

In some ways, other DeFi projects are waiting to see what Maker does and the impact of its steps on the market before making their own changes.

According to statements from MakerDAO creator Rune Christensen in the project’s Discord channels, Maker is planning an emergency shutdown if the core contracts underpinning DAI, its stablecoin, are sanctioned by Washington. “If the US government nukes us, we simply die,” Christensen warned.

MakerDAO is an Ethereum-based decentralized organization that allows cryptocurrency lending and borrowing without an intermediary. 

Using crypto to borrow crypto is quite tricky. Most crypto assets move so dramatically that the amount borrowed in crypto and the amount owed could be significantly different in a short time.

That is where MakerDAO comes in. MakerDAO enables anyone to borrow money and forecasts how much they will have to pay back by combining loans with its stable currency DAI.

It has developed a protocol that allows anyone with ETH and a MetaMask wallet to lend money in the form of DAI. Users can create DAI by locking up some ETH in MakerDAO’s smart contracts—the more ETH is locked up, the more DAI can be made. When users are ready to release their ETH, which served as collateral for their DAI loan, they repay the loan plus any fees.

For more information on MakerDAO, you can refer to their documentation here.

Like any stablecoin, DAI is backed by collateral, which is higher in value than all the DAI debt and pegged to the US dollar, meaning the value of one DAI hovers around one USD.

Source: https://coinmarketcap.com/currencies/multi-collateral-dai/

Unlike other stablecoins like USDC or USDT backed by the US dollar, DAI is backed by a collection of crypto collateral assets like ETH, BAT, and MANA, including USDC and USDT. 

In reality, out of the $10.46B locked in the protocol, USDC is presently the single largest source of collateral backing DAI, according to Daistats.

Source: https://daistats.com/#/overview

An over-dependence on USDC means it is susceptible to being frozen by Circle(the group behind USDC stablecoin), just as we witnessed in the case of Tornado Cash and its wallets.

Critics have, in the past, referred to DAI as “wrapped USDC” because of its substantial USDC backing. 

An emergency shutdown could be the last resort for MakerDAO, but there are also talks within the community to try and find ways to reduce its dependence on USDC as collateral. 

Erik Voorhees, the founder of crypto exchange ShapeShift, posted an open letter to the Maker community on August 8, suggesting it begin unwinding its USDC backing and “converting it into stables that are more censorship-resistant.” 

“You have some time to do it, but you need to get started,” he emphasized.

Managing DAI’s substantial USDC reserves in the face of the US Treasury penalties is the top conversation on MakerDAO’s social channels, with Rune suggesting replacing USDC with ETH. It would lead to DAI losing its peg and potentially lead to a Terra LUNA-type contagion situation but worse given the size and scale of MakerDAO. 

But Rune feels that the market might accept the decision this time, given the circumstances, unlike Vitalik, who feels that this is a “risky and terrible idea.” 

Interestingly, Vitalik prefers Reflexer, another crypto collateralized but non-pegged stablecoin. 

The Tornado Cash story appears to have kicked a hornet’s nest of activity within the blockchain community, and for good reason. If decentralization needs to be preserved, protocols and projects must consider the consequences of the actions taken by governments—not just in the US but worldwide—on themselves and factor in the appropriate changes. 

The entire ecosystem is going through a phase of introspection, and only time will tell how this will impact the future of this industry.

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