Crypto Governance Research excerpts
The main goal of the MakerDAO is keeping the value of DAI, a collateral-backed cryptocurrency, stable relative to the US Dollar (i.e. a “soft peg” stablecoin). DAI is issued and managed through a system of smart contracts running on the Ethereum blockchain. MakerDAO governance is primarily concerned with determining the risk parameters that are used to manage the portfolio of assets backing DAI (at time of writing just ETH, but soon others with the introduction of multi-collateral DAI).2
MKR is Maker’s “governance” token. MKR holders vote on proposed changes to the system via “voting contracts” (smart contracts running on the Ethereum blockchain). 1 MKR = 1 vote, and there are two types of votes: “executive votes” and “governance votes”.
Governance votes can be used to vote on one or multiple issues at once. They do not automatically trigger updates to the Maker system; these must be implemented via executive votes. Nor are they binding resolutions. Rather, they are used to poll community sentiment towards larger, more substantial changes to the system. This can include making changes to the structure or governance processes of the Maker Foundation, including adding new Oracles, adding a new risk team (people that create and apply risk models), or adopting a new voting process. Votes can be time-limited. If the vote is time-limited, votes are tallied at the end of the voting period and a simple majority (<50%) determines the outcome.
Executive votes are a more common occurrence, and are used to change the state, or “governance variables” of the smart contracts constituting the Maker infrastructure. Typically this means modifying the existing “risk parameters” of smart contracts that manage Collateral Debt Positions (CDPs), the debt instruments used to issue DAI and manage its supply. For example, an executive vote could be held to decide whether or not to raise the “stability fee” (i.e. “interest” paid to MKR holders on loans of DAI). Executive votes can also introduce new parameters or smart contracts. For example adding a new collateral type once multi-collateral DAI is launched.
Executive votes are binding. If passed, they are automatically implemented on the blockchain after a 24 hr delay (a measure to protect against hacks or governance attacks). Any Ethereum address can make a proposal and trigger a vote. However, in practice, since the MKR supply is currently centralized into the hands of a few key players such as the Maker Foundation and large investors, only executive votes created by the “core team” currently have a reasonable chance of passing.
For now, proposals for executive votes are created in a more traditional, centralized process within the Maker Foundation, utilizing the “Risk Governance Framework” detailed below, a formal process that attempts to emulate the scientific process. Feedback from MKR holders and the general “governance community” is taken into account at various stages. Maker’s goal is to perform a “gradual decentralization” of this process over time as the system matures.
Maker has created an internal process that utilizes an objective “risk governance framework”. In this process, “risk teams” (professionals employed by the Maker Foundation) utilize a formal, rigorous framework for continually evaluating the qualitative and quantitative risks associated with various collateral types. For instance the volatility risk, liquidity risk, and stability of the asset fundamentals. The outputs of this framework are then input into well-understood risk models borrowed from traditional finance to determine optimal “risk parameters” such as the debt ceiling, liquidation ratio, stability fee, and other parameters. The core team then presents their new models, data and suggested parameters to MKR holders and the community at large. Feedback from the community is incorporated and then put into a proposal for an executive vote. The executive vote itself can be used to gather further feedback from MKR holders, which can be incorporated back into the proposal. Eventually, MakerDAO intends to further decentralize this process, creating multiple risk teams elected by MKR holders that compete with each other using the risk governance framework, creating a “decentralized, open scientific risk management community”.
In practice, this process seems to follow a fairly regular weekly cadence. Risk team members answer questions about potential changes to risk parameters on a regular basis on Maker’s chat and subreddit. Major decisions are typically debated and made during weekly MakerDAO Governance and Risk meetings, which are livestreamed and open to community participation via chat, then made available on YouTube and Soundcloud. Meetings and transcripts are made available on github. Typically, decisions made in Governance and Risk meetings are put to the community in Governance votes to poll sentiment, then put into Executive votes shortly thereafter unless governance votes reflect strong dissent.
Executive voting is not time-limited, but instead employs continuous approval voting. Whichever proposal currently has the most votes represents the current state of the system. There is no quorum, incentivizing MKR holders’ continuous participation. At any time, a new proposal can be submitted to MKR holders (e.g. a proposal to lower the debt ceiling to decrease exposure to ETH). If it gains a majority of votes, it will be automatically implemented. The proposal contract is granted administrative access, and after implementing changes to the system, wipes its logic and cannot be reused. New proposals are not immediately implemented however. There is a 24 hr delay period, in which “Emergency Oracles” can trigger an emergency shutdown in the event of “long-term market irrationality”, hacking, or security breaches.
Changes to existing risk parameters (variables in existing smart contracts) can be implemented automatically. Major upgrades involving changes to smart contract logic must be performed through the emergency shutdown process (i.e. rebooting the entire system).
The MKR token was launched on Dec 27, 2017. 1,000,000 MKR were premined. Maker did not ICO. In the early days, tokens were sold strategically by the Maker Foundation to members of the community, with preference given to early contributors to the project. Sales were largely negotiated on an individual basis in Maker’s chat.
In 2017, the Maker foundation made its first institutional sale to Polychain Capital, a deal which was publicly negotiated with community input on the MakerDAO subreddit. Subsequent sales to other institutional investors such as Andreesen Horowitz, Placeholder VC, and others, were modelled on this deal, according to founder Rune Christensen in a podcast, where Maker distribution is discussed generally.
While wider distribution of MKR is planned, MKR is fairly concentrated among a few key players. As reported in a CoinDesk article 3 on March 6, 2019, according to Etherscan, the top three MKR accounts hold a combined 55 percent of tokens. At the time of the article’s publication, the largest wallet, containing 27% of the supply, is a developer fund. This fund is controlled by a multi-signature wallet controlled by the Maker Foundation’s board. According to MakerDAO community lead David Utrobin, the Maker Foundation’s intention is to fully spend this fund “within the next few years”. On March 15th (2019) David relayed in MakerDAO’s chat that there were “around 270k MKR”. In the article, several large MKR holders were asked for information on their holdings. Polychain capital confirmed it held “a significant portion” of MKR tokens. 6 percent is owned by Andreessen Horowitz’s a16z fund. Hedge fund 1confirmation confirmed they are a “significant holder”. The Ethereum Foundation and Ethereum co-founder Joseph Lubin declined to comment regarding their holdings.
Because MKR must be used to pay stability fees, and this MKR is burned upon payment, the supply of MKR is continually decreasing as CDPs are paid off. On Jan 29th, 2019, Rune Christensen estimated on a podcast that probably “less than 0.1% of the total supply” had been burned.
The Maker DAO Commons
Rather than an initial coin offering, MKR tokens have already been minted and are being sold in an ad hoc manner by the Maker Foundation. MKR tokens are used to govern the Maker DAO, primarily to vote on setting the stability fee. Along with this rolling vote on the stability fee, MKR holders may also participate in polls. So far these are usually created by members of the Maker Foundation, which can be used to establish support for something that would be developed then put to a binding executive vote.
The Maker Foundation dominates Maker’s governance, the MKR tokens are highly concentrated and several critical functions are the exclusive domain of people who work at the Foundation. By choosing to disburse MKR tokens on an ongoing basis the Foundation opted to slowly decentralize governance of the DAI stablecoin. Writing in Aug 2019, they seem to still be near the start of that journey.
The Maker DAO is like a central bank where votes are held to set the interest rate. Over time, the aim is to decentralize more of the functioning of the DAO. For now, voting rights are highly concentrated (3 wallets control 55% of tokens). This, coupled with the dominant position of the Foundation, means that Maker DAO is not being governed in a particularly decentralized way.
Maker has however become an important entity within the Ethereum ecosystem, with use of the DAI stablecoin deeply integrated into many Decentralized Finance (DeFi) initiatives. The stakes are already quite high for Maker’s governance, and it is likely that over time the Ethereum ecosystem will push for this to be further decentralized.
In March 2020 Maker experienced its most challenging episode yet, on “Black Thursday“5 when the price of ETH crashed (along with other assets) the ETH backing many DAI positions was liquidated, and in some cases (36%) the liquidation auction malfunctioned due to on chain congestion and the ETH was given away for nothing. It was estimated that $8.3M was lost in these liquidations. Someone realized that they were one of the only people who had figured out how to get bids in by increasing the gas fee, and they bid pennies on liquidation sales, securing lots of up to 50 ETH for nothing. To its credit though the system did not collapse entirely, and the Maker team will have learned from this experience how to avoid the same thing happening in future.
Black Thursday has left a lingering hangover in the form of a class action lawsuit from investors seeking $28M 6 for losses on the basis that the Maker Foundation knowingly misrepresented the risks involved in using the platform. The MKR holders have voted no on a proposal to compensate Black Thursday victims, with 65% of tokens voting for zero compensation7. This dispute is an interesting one to watch as it sets expectations for how the MKR and DAI stakeholders will interact when the platform has a technical issue which impacts users financially.
In late October 2020 flash loans became another thing for Maker’s governors to worry about, as BProtocol flash-borrowed 13,000 MKR to vote for their own proposal.8 In this case they were already winning and just speeded the process along, so no harm done, but it still prompted a discussion of how to disincentivize MKR holders from leaving their MKR in a liquidity pool where it can be used to attack the project, until such times as this attack vector can be addressed.
- Benton, S. (2019, May 20). MakerDAO. Block Commons. https://www.blockcommons.red/crypto-governance-research/overviews/maker/ [return]
- Hoffman, D. (2018). The Role of Ether in Multi-Collateral DAI | by David Hoffman | POV Crypto | Medium. https://medium.com/pov-crypto/the-role-of-ether-in-multi-collateral-dai-cfc8b43ab50c [return]
- Cuen, L. (2019, March 5). MakerDAO Opens Token Holder Vote on Fee Hike for Ethereum Stablecoin. CoinDesk. https://www.coindesk.com/makerdao-dai-fee-hike-vote [return]
- Currency Re-imagined for the World: Multi-Collateral Dai Is Live! (2019, November 18). Maker Blog. https://blog.makerdao.com/multi-collateral-dai-is-live/ [return]
- whiterabbit. (2020, Mar 14). Black Thursday for MakerDAO: $8.32 million was liquidated for 0 DAI. Medium. https://medium.com/@whiterabbit_hq/black-thursday-for-makerdao-8-32-million-was-liquidated-for-0-dai-36b83cac56b6 [return]
- $28M MakerDAO ‘Black Thursday’ Lawsuit Moves to Arbitration. (2020, September 29). CoinDesk. https://www.coindesk.com/28m-makerdao-class-action-lawsuit-arbitration [return]
- Makerdao Vote to Not Compensate Black Thursday Victims Receives Harsh Criticism. (2020, September 24). Bitcoin News. https://news.bitcoin.com/makerdao-vote-to-not-compensate-black-thursday-victims-receives-harsh-criticism/ [return]
- ‘Flash Loans’ Now Being Used to Manipulate Protocol Votes. (2020, October 29). CoinDesk. https://www.coindesk.com/flash-loans-manipulate-defi-protocol-elections [return]