In the past few months, decentralized finance – known as "DeFi" – has emerged as a killer use case for Ethereum.
Table of Contents
Earlier this year, the assets locked in DeFi applications were valued at over $1 billion, with smart contract activities driving the Ethereum-based financial ecosystem showing strong momentum, largely attributed to the attractive high interest rates offered by these protocols.
After injecting $2 million in liquidity into Compound and dYdX protocols, Coinbase praised DeFi as the foundation of an open financial system, highlighting its resistance to regulation, fairness, programmability, and accessibility to anyone with a smartphone to use DeFi applications.
However, the market collapse last week seemed to have shattered this narrative, as the 50% plunge in Ethereum sent the DeFi ecosystem into disarray. MakerDAO, as one of the top DeFi protocols, was undoubtedly the best example of reacting to the current situation, even discussing the possibility of emergency shutdown amidst the chaos caused by the ETH crash.
**About MakerDAO**
When talking about DeFi, it's hard not to mention MakerDAO—a DeFi protocol that allows users to obtain loans in the form of DAI through algorithmic interest rates, with DAI being a stablecoin pegged to the value of 1 USD. As collateral, borrowers need to deposit at least 150% or more of the loan value in ETH or BAT. If the collateral value of any Maker loan (also known as CDP) falls below the 150% threshold, it will be liquidated, and the collateral assets will be auctioned to maintain system stability.
The protocol's reputation led even the legendary venture capital firm Andreessen Horowitz's crypto division to invest $15 million in the protocol's governance token MKR in 2018, representing 6% of the total token supply at the time.
Despite the mandatory over-collateralization of Maker loans based on DAI by at least 150%, last week's market crisis quickly exposed some vulnerabilities in MakerDAO—some analysts suggesting that these vulnerabilities could threaten the survival of DeFi.
**What Happened to DeFi Last Week?**
After reaching $9,200 on March 7, the price of Bitcoin plummeted, dragging down the S&P 500 index, along with most other indices and assets, ultimately dropping Bitcoin to as low as $3,800 due to the impact of leveraged trading on futures exchanges.
Altcoins unsurprisingly followed Bitcoin's downward trend, and Ethereum was not spared either. ETH traded as low as $90—64% lower than its high a week earlier, according to data on TradingView.
Due to this drastic plunge—reported by CoinMetrics' Nic Carter as ETH's worst single-day drop ever—MakerDAO was also dragged into the crisis.
As shown in the chart, once ETH's price starts to exhibit extreme volatility, Maker loans are quickly triggered for liquidation. Additionally, there are hundreds of millions worth of Multi Collateral Dai (MCD) loans, the primary variant of DAI, that were also liquidated.
While loan liquidations are normal, there is an issue: the liquidated loan holders did not receive any ETH from their collateral, despite liquidation fees reportedly rising to 13%.
Continued in the next message...
