TL;DR:
Now with some clarifications to reduce misinformation potential
- Financial regulation trends towards a post-9/11 paradigm of “either you’re with us or you’re against us” with eventual zero tolerance for anything that doesn’t give full control and surveillance powers to the state
- The window of opportunity for DeFi to prove that it is worthy of a new middle ground of being considered a public, neutral financial utility rather than regulated as banks has now closed because DeFi failed to deliver anything of real value, and the massive crashes of Terra, Celsius etc ruined its mainstream image
- Physical crackdown against crypto can occur with no advance notice, and with no possibility of recovery even for legitimate, innocent users. This violates two core assumption that we used to understand RWA risk, making the authoritarian threat a lot more serious.
- Dai cannot become blacklistable, so Maker does not have the option of becoming compliant
- The only choice is then to be prepared to limit attack surface through RWA exposure reduction, by having the option of enforcing a maximum relative exposure to RWA - triggering this would likely cause Dai to free float away from USD, at stable, predictable rate that feels like negative interest rates
- The Endgame Plan offers two effective tools to deal with this: MetaDAOs and Protocol Owned Vault
- MetaDAO token farming with Dai provides justification for why a free floating currency should exist and why users should accept something that falls in value vs USD
- MetaDAO tokens can also incentivize more supply of Dai generated from decentralized collateral, allowing the system to scale better while remaining decentralized
- Protocol Owned Vault (Maker accumulating a large amount of leveraged staked ETH) is another important tool as it allows Maker to earn income from negative Target Rate of Dai, and put a lower limit to how negative the Target Rate can go.
What’s the timeline for this:
Long form
This post is to outline the argument of why limited RWA exposure and free floating Dai is necessary, and the tools we can use to turn it from a risk into an opportunity.
Much of the information and opinion I’ m sharing here comes from conversations I’ve had with various well connected insiders following the TC sanctions, as well as knowledge that is publicly available and in some cases has been shared more privately over the past years.
The post 9/11 paradigm of financial regulation
First lets briefly discuss what I’ve heard many people refer to as the “post-9/11 paradigm”. Basically this is a financial regulatory trend that, when taken to its extreme, divides all financial activity into two boxes: Either you’re fully compliant, regulated bank, or you’re a terrorist.
Important to note that it’s a trend, not a black and white reality, meaning obviously there’s plenty of financial activity that isn’t fully regulated as a bank with total government control - but over time the trend is one way and financial freedom will get eroded, never increased as long as this trend remains.
Of course government control of finance is a historic trend that dates back literally the very first invention of paper currency in China (and how it eventually got controlled and hyperinflated), but 9/11 can be seen as the event that really created the modern momentum for this trend to reach a point where it is slowly but surely going to choke out all forms of financial freedom that it possibly can.
The fact that the mainstream views finance as an extremely shady industry run by evil and greedy wall street bros of course helps, because from that (pretty much true) perspective its easy to see why it makes sense to maximally regulate them into the ground.
The window of opportunity
The window of opportunity is an idea that me and many others held: The possibility that the immense potential benefits of blockchain technology and DeFi, when applied to the financial system through RWA integrations, could become the catalyst that finally changed the paradigm of financial regulation away from the post-9/11 paradigm and into a new post-blockchain paradigm. It’s easy to see how the advantages of transparency, credible neutrality, efficiency, inclusion etc. helps solve the problems that makes finance and wall street bros seem so bad in the first place.
Ideas like Clean Money and Financial Inclusion stemmed from this perspective, that if we played our cards right and used the last big crypto bull run to show real tangible benefits beyond what people would be expecting that truly showcase the massive positive potential of blockchain to the mainstream, such as mass financing of large scale renewable energy infrastructure that effectively did the governments job for it, or large scale access to cheap and efficient financial services for developing countries, etc.
At a certain point, if enough of things are done, and are combined with an aligned and effective media and PR campaign and united vision from our industry, the thinking is that it could be enough to finally show that there is a limit to when it makes sense to keep cracking down, increasing control and increasing bureaucy for financial activity because the upside in terms of public goods from permissionless financial innovation is impossible to ignore, and can overpower the politics of the old paradigm and introduce a new, third category that sits between fully regulated and fully decentralized: A Financial Public Good - blockchain enabled, neutral financial infrastructure that isn’t treated like a bank, but is treated like roads or Linux. Even if North Korea uses roads or Linux, we’re obviously not going to ban that because of the significant value it provides to all of society.
But unfortunately, as you can probably imagine, this window of opportunity has now closed for good. First of all, the blockchain industry completely and utterly failed to produce anything of value during the bull run. Basically nothing was achieved and no new products, services or anything with tangible benefit derived from blockchain technology has entered the mainstream consciousness at any level. Maker is a good example where we had a lot of initial support for Clean Money and a theoretical agreement with the concept - our intentions were in the right place. But nobody cares about intentions, and we were incapable of actually acting on that desire and turning words into action because, as it turns out, operating DAOs and doing useful working in decentralized paradigms is extremely hard.
Secondly and much worse than just the fact that crypto has still failed to show any kind of value to society are the human tragedies that the failures of the last crypto cycle produced that have now become synonymous with blockchain and crypto in the public consciousness. Essentially the moment Terra collapsed is really the moment we should have realized that there is simply no possibility that we will be able to persuade the public that crypto should be treated differently from other financial services. So not only has crypto produced nothing useful, but the mainstream awareness of crypto centers around disasters like Terra, Celsius and other crypto scams that have destroyed the savings of innocent, regular people that were lied to and in some cases even committed suicide as result. We unfortunately managed to create the mainstream image of the crypto bro as the one type of person that’s even worse than the wall street banker bro.
In hindsight, it is maybe also have been slightly naive to believe in the window of opportunity when you deconstruct it to what it really is: Thinking that we would stand a chance of re-engineering a meta as strong as 9/11… But no matter what, whether or not it was ever even possible, it is now over for good and we need to readjust our world views to get in line with reality.
The two core assumptions of RWA risk
The TC sanctions should not be seen as a direct consequence of any of these factors - rather it is most likely a random even that doesn’t really have anything to do with crypto directly, but rather was simply a quick and short term oriented attempt to produce a political win through some announcements and press releases. But it is a wakeup call to the consequences of not picking one of the two paths. Do you want to be treated as a bank, or do you want to be treated as something else than a bank and do you understand the full risk and consequences of that?
The risk of RWA was always considered justifiable, despite the fact that DAOs have no real legal presence or entity or ability to enforce legal rights (even if governments erroneously think so), because of two important factors.
The first factor was that any attempt to seize RWA or crack down on crypto’s weak points, such as blacklists or collateral freezes, would be telegraphed in advance in order to allow innocent and legitimate users time to respond. The thinking was that governments wouldn’t just nuke Maker and cause widespread harm to innocent people, they would simply ban Maker from relying on their legal systems if we don’t follow their regulatory regimes. That turned out to be wrong as in the TC sanctions case, it was kept secret right up until the trap was sprung, and innocent users (luckily a small amount) had their USDC frozen in the tornado cash smart contracts.
The second factor was the thinking that even if a freeze or seizure of RWA collateral happened, innocent users would have some path to recover their money, such as in the case of the e-gold Value Access Plan (VAP) e-gold - Wikipedia .
Unfortunately, that turns out not to be a given as seen with the TC sanctions, where right now it looks those affected by USDC blacklist may have effectively lost their money, and the ETH designated as risky may not have an easy path to legalize their assets, even if they are completely innocent and used TC for financial privacy completely legitimately.
This means the consequences of not being compliant and not becoming a bank are extremely severe. They’re not something you can just gamble with, especially not when it pertains to peoples savings.
Why Dai has no choice but to prepare to free float
So that leaves us with the two fundamental options: The path of compliance and eventually, on a long enough timeline, turning Maker into some kind of next-gen fintech product/neobank. Or the path of decentralization which means strictly limiting the degree to which regulatory crackdowns can damage the protocol.
But, there’s one important caveat: The path of compliance isn’t even available to us. Why? Dai was engineered that way, as the developers who created it had the foresight to build it in such a way that it could never possibly become a tool of financial surveillance and control, by completely locking out the possibility that a blacklist can be added or that it can be upgraded. Despite all our governance bureaucracy and troubles, Dai is actually a truly decentralized stablecoin in this sense.
There exists certain publicly discoverable facts, that when combined together with the fact that Dai cannot ever be blacklistable no matter how much Maker Governance would want to, makes it clear that there is a ticking clock counting down above our heads, and at some point in the future there is a high probability that Maker will be hit by a severe attack by global authorities targeting any attack surface they can find, through a process similar to what led to the TC sanctions.
One thing to clarify is that this is still very likely many years out - or at least we have to assume that’s the case because we simply do not have any realistic short term options that would enable to us to survive it. I’m also not claiming it is guaranteed, nothing ever is. No one can possibly predict something as complicated as this but if I had to I would “only” give it a 50/50 chance to happen at some point over the next decade. But if you know that there’s a 50% chance an airplane is going to crash, you are not going to board that airplane.
I’m obviously not going to spell out the facts I’m referring to above, but it’s fairly simple to put two and two together in light of recent events. I would encourage others to also not discuss it in public, there’s no reason to create that kind of unwanted and dangerous attention early on, even if its not yet likely to be a big risk.
As a result, we must choose the path of decentralization, as was always the intent and the purpose of Dai. And just like this was the original design of Dai, choosing the path of decentralization means preparing for the likely possibility that Dai will have to become free floating. The reason for this is simple: the path of decentralization means limiting our attack surface to physical threats, and specifically our RWA collateral as a percentage of the total portfolio. In the Endgame Plan I put this limit at 25% (before insurance and defensive measures are applied) during Eagle Stance, which is the strategy the protocol would employ while it is still not clear if there will actually be a crackdown or not.
The only way to guarantee a hard limit on RWA exposure is to allow Dai to free float, as excess demand for Dai may not be able to be met with additional supply backed by fully decentralized assets such as ETH. The only way to then deal with this imbalance and prevent the peg from breaking - which can break the entire system if the faith is lost that Maker Governance will take action to protect the peg - is to introduce a negative Target Rate, that would cause the price of Dai to free float away from 1 USD to a lower exchange rate, driving away Dai demand and increasing Dai supply as it becomes cheaper to generate with decentralized vaults such as ETH.
This can be a very hard reality to accept, but there is unfortunately no way around it. Dunning-Kruger attempts to guarantee a peg to 1 USD without having access to USD linked RWA collateral only ends in even worse misery and disaster, such as the Terra collapse. So our only choice is to prepare and do everything we possibly can to make it a transition that Maker can survive, and if we really play our cards right, it may end up becoming the opportunity Maker was waiting for all along.
2 powerful tools that can make free floating Dai a success
The main challenge with decentralization and free floating Dai is that nobody cares about it until its too late. And I mean LITERALLY nobody, even the people LARPing and running their mouth about decentralization aren’t using Rai. So the downside of decentralization, which is that it can lose value relative to the dollar, is extremely obvious and in your face, and most of the upside is completely hidden and cannot be understood by the human brain because of our inability to perceive long term and tail risk.
The Endgame Plan provides two very strong tools that can overcome this challenge and turn the free floating of Dai into something that Maker can survive, and even thrive with. The Endgame Plan was already designed around the idea of physical resilience and decentralized from the beginning, it was just treated as a more theoretical and abstract threat, so all that was really needed to change was to prioritize and accelerate the implementations of these measures.
MetaDAOs and MetaDAO tokens
The most important tool available are MetaDAOs. What’s the only way to get someone to accept a free floating price and decreasing rate that makes them lose value in dollar terms over time? You have to give them something else in return.
As it turns out, while decentralization has almost only downsides, there is one tangible upside that people actually care about. And it is not just any upside, it is the single most powerful thing that brought most people into the crypto space in the first place: The ability to create tokens. As also described in the Endgame Plan post, the creation of blockchain tokens is by far the most powerful form of meta engineering, and it is in fact so powerful that even governments recognize this power and try very hard to shut it down and control it.
With a decentralized currency, the creation of a decentralized economy run by decentralized businesses governed by tokens becomes possible, and it cannot be shut down or controlled by authorities regardless of how much they’d like to - as long as you have a real, actually decentralized currency underpinning it.
And you can provide this benefit to Dai holders right “in their face” by yield farming them MetaDAO tokens of projects that have real, profitable, sustainable and fully decentralized business models - but again that’s only possible because of the existence of a fully decentralized currency, which closes the loop and justifies the fact that Dai is free floating.
Beyond justifying the existence of Dai even if it is free floating, MetaDAO token yield farming can also be used to incentivize generation of decentralized Dai from fully decentralized collateral such as Staked ETH (Or, for maximum value preservation, EtherDai), which helps grow the supply of Dai and reduce the negative rates Dai holders have to accept.
Protocol Owned Vault
The other major tool is the Protocol Owned Vault - the strategy of having Maker itself accumulate large amounts of leveraged, Staked ETH and that way become a net issuer of fully decentralized, overcollateralized Dai. This has two big advantages: First of all it allows Maker to take advantage of the negative rates created from natural Dai demand, that will actually get exacerbated by the existence of MetaDAO yield farming (which nevertheless has to exist because it provides the fundamental core justification for why Dai even makes any sense at all if it’s not pegged to the dollar).
It should be easy to see how it can be very lucrative to both have a significant leveraged exposure to an asset that earns a yield of 5+% per year, and then on top of that have large amounts of debt that itself could yield e.g. 5% per year due the negative rates making it automatically go down over time in dollar terms.
Secondly and much more importantly, having a protocol owned vault allows Maker to more directly control and impact how negative the rates are allowed to get, helping stabilize the free floating Dai and protect users against the uncertainty of randomly getting hit by extremely negative rate because of some demand or supply shock. Basically, if the rates get low enough Maker can step and in allow the Protocol Owned Vault to take on very high leverage in order to first of all stabilize the rates so they don’t go any lower, but then also just harvest the massive potential for yield that debt with very negative rates have.
Cypherpunk meta
A last major benefit of decentralized and free floating Dai is that it allows Maker to finally return to its true roots. Not just the roots of Maker and Dai, but of crypto itself, which ultimately comes from the Cypherpunk movement all the way back from the early 90’s when governments first tried to ban encryption and enforce a hellish dystopian future where the concept of any kind of personal privacy itself becomes illegal (much like financial privacy has already become).
It’s hard to overstate how many of Maker’s cultural, community and governance problems ultimately stems from the perceived deviation of this original ethos, and the contradiction that many of the necessary actions taken over time, such as the regulatory strategy of the Maker Foundation (which required very tight information control), or the introduction of unlimited USDC in order to enforce the USD peg at all costs. In the end I don’t believe those choices were wrong at the time, as it allowed us to get to where we are today and have real network effects, momentum and success. But we should not underestimate the cost it had on the community and the soul of the project - and now we have the chance to get all of that back again.
I think this is actually the factor that may end up being the biggest wildcard of all. If we can recapture that original spirit and once again prove to be the vanguard of the entire crypto spirit as we once where when we pioneered actually functional on-chain stablecoins and created DeFi, it will create a completely new level of attention and positive meta around the Maker ecosystem as a whole, which will result in an influx of users, community members, contributors - but also increase spark in Maker Governance, reducing bureaucracy, stalling and extractive intentions.
Maker will not just become exciting once again, it will be the single most exciting and important place to be in all of crypto - and we have the perfect tool that allow us to capture that meta and hook people into our ecosystem: MetaDAO yield farming.
Collapse meta
Another last point that is important to discuss is how this all fits into the broader, global meta caused by the state of irreversible, accelerating decline that exists in modern globalized society. There are multiple factors, including overshoot, overpopulation, climate change, peak oil, peak farmland, peak fertilizer, post-truth social media etc. It is likely that modern global capitalism cannot overcome these problems of its making, and the most immediate consequence is that politics will become increasingly polarized and unhinged. The world is going to enter a new, much more chaotic and unpredictable equilibrium dominated by anarchy, ecofascism, deglobalization and large scale human suffering.
This matters for Maker and Dai for two reasons.
The first reason is that broken states and limping zombie economies, or states obsessed with capital controls and general authoritarianism, tend to be more likely to crack down on crypto. It’s easy to see the trend if you look at the list of countries that have already banned crypto: Bitcoin ban: These are the countries where crypto is restricted or illegal | Euronews
This means that as the global economy and socioeconomic stability increasingly falls apart across most places in the world, the likelihood of a physical attack by state actors against Maker goes up. As this trend is accelerating and irreversible, this by itself adds another strong argument on the pile of why Maker has to prepare to go fully decentralized and expect the worst against it’s RWA collateral, requiring it to become free floating.
The second reason is that such a chaotic and dystopian future is exactly the reason why Dai and crypto as a whole exists. People will need tools to navigate the future when government and the elite can no longer be trusted to even keep themselves from collapsing, let alone keep the best interests of the people in mind. The most important and powerful tool in such a situation is going to be collapse-resilient, decentralized money.
As all other currencies pour fuel on the fire of the global financial ponzi scheme that is already deeply in overshoot, we can prepare for the worst and focus on accumulating resilient collateral such as ETH, or even eventually physically resilient RWA (as described in the Endgame Plan post) and build something that could end up meaning the difference life and death for millions.
. Long time since we chatted over beers in my buddy’s Davos brewery)