Market crash tests DeFi resilience, MakerDAO defaults, platforms undergo high-value liquidations

When a black swan event occurs, it poses a significant challenge to many decentralized finance (DeFi) projects, marking the first stress test since their inception. However, just yesterday, due to the sharp drop in Ether prices, the decentralized finance project MakerDAO's liquidation mechanism failed to function as expected. The community announced that they would begin a governance token MKR auction within two days, marking the first such event in the protocol's history.

Selling MKR to Cover Bad Debt

MKR auction, also known as debt auction. MakerDAO is essentially a decentralized lending project, where MakerDAO borrowers generate the stablecoin DAI pegged to the US dollar by depositing Ether and BAT as collateral.

In the event of a black swan, a rapid drop in the value of collateral within a short period of time would lead to the collateral value falling below the total debt value, resulting in bad debts that cannot be repaid to creditors. When the "debt with insufficient collateral value within the system" exceeds $4 million, the MKR auction is triggered.

The auction will programmatically issue and sell 50,000 DAI equivalent of MKR tokens, and liquidators can bid with DAI to acquire the collateral. The funds raised are then used to repay the outstanding bad debts. Although the purpose of this auction is to raise DAI from the market to cover outstanding debts, due to the rapid decline in Ether prices yesterday with no signs of recovery, the auction received little interest, resulting in a liquidator winning the auction worth approximately $4.5 million with a bid of 0 DAI. A member of the MakerDAO community said:

"Some of the collateral has been liquidated, and some bids in the system have only recovered 0 DAI, resulting in a net loss in the system balance. MakerDAO had a profit of $500,000 in the collateral balance before the price drop, but now needs to make up for a loss of over $4 million."

As of the deadline, MakerDAO's total loss has increased to $5 million.

Surge in GAS Fees Leads to Abnormal Bidding

Another reason for the lack of participation in the auction is the high transaction fees (Gas Fee) on the Ethereum network. Due to market volatility leading to a surge in transaction volume, the Ethereum network was congested during the sharp decline, causing panicked users to be willing to pay high amounts of Ether as miner fees to complete a transaction.

According to research analyst Matteo Leibowitz, MakerDAO liquidators' liquidation bots were not properly set up to adapt to the significant increase in Gas Fees. In simple terms, when Ethereum network fees skyrocket, the default fees set by the liquidation bots did not increase accordingly, resulting in transactions sent by these bots not being verified by miners in time, causing them to miss the auction opportunity.

MKR holders are currently discussing solutions to halt 0 DAI bidding, including raising the initial bid price of collateral auctions and extending the auction duration. As of the time of publication, it is unclear which solution MakerDAO intends to adopt.

Assisting MakerDAO Through Challenges

MakerDAO's primary challenge now is to raise $5 million in the MKR auction to fill the funding gap. In response, DeFi projects (including Paradigm and Dharma) have expressed their intention to organize stakeholders in the ecosystem to participate in the auction and assist MakerDAO through these difficulties.

Dharma similarly plans on participating in the upcoming @MakerDAO backstop auction.

We are forming a group of #DeFi ecosystem stakeholders to ensure that the total shortfall is met, one way or another. We look forward to amplifying our voices in the Maker governance process. https://t.co/oum8sviODt

— Dharma (@Dharma_HQ) March 13, 2020

Recent Developments in DeFi Projects

Amidst yesterday's intense volatility, the repayment records of various DeFi projects reached a historic high. According to data from LoanScan, the total daily repayment amount for MakerDAO, Compound, and dydx platforms yesterday amounted to $63 million, while assets worth $11.4 million were liquidated.

On the other hand, due to the sudden market downturn, investor borrowing demand decreased, leading to a significant reduction in USDC interest rates across platforms. On March 11th, the annualized lending rate remained at 2-3%, but after the sharp drop yesterday, the annualized rate dropped to around 1%.

However, due to the drop in Ether prices, MakerDAO borrowers were eager to repay DAI, leading to a surge in demand for DAI in the market. Besides a significant price premium, borrowing rates for DAI surged, with the borrowing rate for DAI on the dydx platform soaring to 47.5% at one point.

Looking at it from another perspective, although the total market value of cryptocurrencies evaporated by over $80 billion overnight, it served as a good stress test for Bitcoin and DeFi projects. These experimental DeFi projects managed to survive through yesterday's turmoil, demonstrating a certain level of resilience in their protocols during a black swan event, which will be a strong proof of concept for the feasibility of DeFi in the future.

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