Interest rates have spiked for deposits of dai, the U.S. dollar-linked stablecoin, on the decentralized finance (DeFi) platform Compound, another ripple effect from the worldwide coronavirus-related market meltdown.
The annual percentage rate a user would earn by lending dai on the platform rose above 14 percent as of 19:00 UTC Monday – the highest level since March 16, according to Codefi Data, a unit of Ethereum startup ConsenSys. Earlier in the day, the rate was in the mid-single digits; for most of April, it had been below 1 percent.
Dai, a stablecoin issued by the MakerDAO protocol, is designed to maintain 1:1 parity with the dollar. Its value is backed by ether and other cryptocurrencies that are locked up in a smart contract, the Maker collateral vault. However, dai has been trading above $1 for nearly two months.
“Over the past few days, many Compound users have begun withdrawing dai, and in some cases selling it above $1 in anticipation of dai returning to its peg,” said Compound CEO Robert Leshner.
The rate hike is the result of those withdrawals and the resulting shortage of funds to lend.
Data from Ethereum blockchain explorer Etherescan shows a total of 6.9 million dai were withdrawn from the Compound protocol on Saturday and Sunday.
“The substantial outflows pushed gross borrowing above gross deposits on dai’s lending pool for a moment over the weekend,” DeFi Rate told CoinDesk.
At press time, the utilization ratio, or gross borrowing to gross deposits, was at 94 percent, according to Compound data.
Out of whack
“Dai markets have been under considerable stress the past few weeks, with the price of dai consistently being above $1,” Leshner told CoinDesk. As noted, it is a stablecoin and is supposed to trade around $1.
Dai began trading above $1 at the end of February and rose as high as $1.25 on Bitfinex on March 12.
The unprecedented rise was caused by the global dash for cash, mainly U.S. dollars, triggered by the relentless coronavirus-led sell-off in the traditional markets.
"One source of funds was the ethereum collateral that debtors had locked up to get loans. To get at this ethereum, debtors had to repurchase dai in order to pay back their obligations. Their desperation to repurchase dai stablecoins was such that the price spiked to $1.50, " noted CoinDesk’s columnist J.P. Koning.
Bitcoin fell by nearly 40 percent on March 12 and hit a low of $3,867 on the following day, according to CoinDesk’s Bitcoin Price Index. Bitcoin and stocks have recovered significantly over the past couple of weeks. However, dai is still trading above $1.00 - a sign the desire to liquidate dai is still strong.
Observers, however, are worried about the lack of exchange rate stability. "It is an existential threat to MakerDAO’s long-term success. An emergency action is required," ParaFi Capital said in a post on MakerDAO forum.
The alternative investment firm focused on blockchain and decentralized finance markets has recommended the addition of link, the token of the Chainlink network, as new collateral in
MakerDAO. “Given its market cap, liquidity profile and appetite for speculation, we see value in onboarding LINK into MCD,” noted ParaFi Capital.
“Meanwhile, MakerDAO is responding with proposals to increase the number of assets that back dai, which will allow more dai to be minted, lowering its price,” said Compound’s Leshner.
As a result, some investors may be withdrawing dai to sell the stablecoin while it is above $1.
The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups. As part of their compensation, certain CoinDesk employees, including editorial employees, may receive exposure to DCG equity in the form of stock appreciation rights, which vest over a multi-year period. CoinDesk journalists are not allowed to purchase stock outright in DCG.
Learn more about Consensus 2023, CoinDesk’s longest-running and most influential event that brings together all sides of crypto, blockchain and Web3. Head to consensus.coindesk.com to register and buy your pass now.