MakerDAO fears for its DAI stablecoin

In the wake of sanctions on the crypto mixer Tornado Cash, the founder of the lending giant MakerDAO now sees his own project, the DAI stablecoin, in danger.

In the wake of sanctions on the crypto mixer Tornado Cash, the founder of the lending giant MakerDAO now sees his own project, the DAI stablecoin, at risk.

Rune Christensen, founder of the popular DeFi protocol MakerDAO, is worried about how vulnerable the sector, and his own company, could be to regulators' actions. During a DAO meeting on Discord, Christensen even considered disconnecting MakerDAO’s DAI from its dollar peg.

After the full ban on the Tornado Cash mixer, funds and wallets related to the site were frozen. Circle Pay, the issuer of the second-largest stablecoin, USDC, was among them. Circle was able to freeze funds on suspicious wallets thanks to the centralized control of USDC.

This creates big problems for MakerDAO. This is because more than 30 percent (about $3.6 billion) of its DAI stablecoin reserves are USDC. And they are thus vulnerable to censorship by authorities. Such a move would have wide-reaching consequences for the entire DeFi sector.

MakerDAO: USDC Vulnerability

Users deposit their cryptocurrencies into the Maker protocol to receive DAI in return. DAI is tied 1:1 to the value of the U.S. dollar. The process is largely decentralized, but DAI is partly backed by USDC, a centrally controlled cryptocurrency.

If Circle were to freeze this as well, a large portion of the reserves would be sidelined. The result would be a total collapse of the protocol. Users would no longer be able to redeem DAI fully for their original cryptocurrency. Maker, the largest DeFi project with roughly $9 billion in total value locked, would be in serious danger.

MakerDAO is now grappling with how to avoid this danger. With some bold maneuvers, which are also being considered by Maker’s founder, Christensen suggested in a Discord community call that DAI’s peg to the U.S. dollar could be intentionally decommissioned. The more than $3.5 billion in USDC reserves could be used to buy Ethereum as new collateral for the DAI stablecoin.

MakerDAO: Ethereum as a New Reserve?

Such a move echoes recent official actions by Terra Luna founder Do Kwon, who bought a large amount of bitcoin as collateral for his stablecoin UST earlier this year. What followed is likely to be remembered by everyone in crypto. In theory, a stablecoin could be backed only by volatile crypto assets. But what happens if this huge value loses ground in a sharp price drop? The structure starts to crumble.

In the long term, MakerDAO must seek a censorship-resistant alternative to USDC. Only then can it remain a truly decentralized protocol.