Moving Forward: Lessons from MakerDAO and Liquity

Hubble Protocol is hosting its monthly Community Forum this Thursday, March 10th, at 6 PM UTC. This article will provide some important information for a constructive discussion,

Hubble Protocol is hosting its monthly Community Forum this Thursday, March 10th, at 1800 UTC. On Monday, we published an article (Hubble Community Forum Topics) outlining some major changes we want to discuss with everyone during the call.

This article will provide some important information for a constructive discussion, and you can find even more reading material at the bottom of this article if you’d like to take a deeper dive. So make sure you join us on Discord this Thursday and have your voice heard!

As Hubble transitions towards DAO governance, the involvement of the Hubble community becomes ever more important. We’re hoping to see many of you at the Community Forum.

Our Priority is Making USDH an Essential Build Block for DeFi

The DeFi community needs a decentralized and censorship-resistant stablecoin that can meet the demands of a growing market. Accordingly, Hubble designed USDH to meet these demands.

Decentral Park Capital pointed out in its investment thesis, “Hubble is building a primary stablecoin for the Solana ecosystem. We believe USDH can also form the build block for other DeFi protocols that encompass stable assets at the core of their design.”

This assessment puts us in league with MakerDAO and its stablecoin offering, DAI, with around $9.4 billion in circulation. DAI has become the decentralized stablecoin of choice for DeFi on Ethereum and other EVM compatible chains, and Hubble is on track to provide an even more censorship-resistant stablecoin with USDH on Solana.

How Research Focuses Hubble’s USDH Strategy

Keeping the success of DAI in mind, Hubble commissioned a study, the History of DAI Demand, that follows DAI from its launch to the present day.

According to the report's findings, the widespread use of DAI in DeFi can be attributed to its price stability. As a result, the demand for DAI steadily began rising at the end of 2020 when MakerDAO solved the problem of how to stabilize DAI’s peg.

A chart demonstrating the consistent rise in demand for DAI after the token gained price stability.

This pattern highlights the need to ensure USDH’s price remains tightly pegged 1:1 with USD. The graph illustrates rising demand for a more decentralized stablecoin like DAI, and USDH can fill that demand by being an even more censorship-resistant token.

A chart demonstrating the price stability of several decentralized stablecoins.

As you can see from this graph taken from the report, DAI is the “most stable decentralized stablecoin between all the available options.” Our goal is to pursue this kind of stability for USDH and increase its adoption across DeFi.

We need to make USDH the most decentralized AND most stable stablecoin.

What Hubble Can Learn from MakerDAO

We can learn a lot from the steps MakerDAO took to stabilize DAI’s peg. MakerDAO spent years figuring out how to peg DAI closely to $1.00, and we should benefit from that knowledge to speed up the process for USDH.

MakerDAO describes DAI’s journey to price stability in The History of DAI at Par Value. There are also hundreds of posts discussing this topic on MakerDAO’s forum, and we’ll outline the gist of a few discussions here.

Stability Fee and Savings Rate

DAI’s peg first relied heavily on a Stability Fee (SF) and a DAI Savings Rate (DSR). In theory, the SF controls supply (raise the SF to encourage repayments), and the DSR controls demand (lower the DSR to encourage selling DAI).

These adjustable rates are traditional policies for controlling supply and demand, but they weren’t strong enough to keep DAI well pegged.

It should also be noted that the DSR could be attributed to early demand for DAI. Still, it was an ineffective pegging mechanism, since its leverage bottoms out when the rate can’t be lowered further than 0%.

The Peg Stability Module

A stronger stability mechanism for DAI arrived, however, when MakerDAO introduced a Peg Stability Module (PSM). After this, the PSM seems to have become the most significant source of price stability once the PSM fees were reduced to zero.

The PSM is a smart contract that lets users easily arbitrage USDC (Circle), USDP (Paxos), and GUSD (Gemini) for DAI and vice versa. Swaps made through the PSM are always 1:1, i.e., 1 DAI always equals 1 USDC.  

If DAI falls below $1.00, the PSM gives users a risk-free opportunity to profit by burning cheap DAI for USDC. When DAI rises above $1.00, users can swap USDC for expensive DAI through the PSM and swap it back to USDC through another exchange for profit.

Granted, MakerDAO has sacrificed some decentralization by making fiat-backed centralized stablecoins a significant feature of their peg stability mechanism, and this has been referred to as “an existential threat” to DAI with over $5 billion worth of USDC in the PSM reserves.

If Hubble wants USDH to remain censorship-resistant, we’ll have to find an alternative approach to implementing MakerDAO’s Price Stability Module. Collateralizing USDH with a centrally issued stablecoin that can block users and freeze tokens is the last thing we want to do.

Choosing What Works for Hubble and What Doesn’t

Since our earliest days, Hubble has been integrating great ideas from other protocols. One standout feature, the Stability Pool, was an idea borrowed from an Ethereum stablecoin project called Liquity.

Our litepaper included plans to incorporate many features from Liquity’s elegant design, but Hubble is planning a wider scope of developments that will set it further apart from Liquity.  

Consequently, we plan to eliminate some Liquity-inspired features, including the redemption mechanism and Recovery Mode. We’re moving away from these features to improve user experience and create a more user-friendly system overall.

Why Hubble is Nixing the Redemption Mechanism

The redemption mechanism was meant to help lift USDH’s price when it falls below $1.00. In theory, users could redeem cheap USDH from the market for $1.00 of crypto from Hubble, reducing the amount of USDH on the market and lifting USDH’s price.

This feature made USDH attractive as a stablecoin that could be arbitraged for blue-chip cryptos for a small fee, but there’s a major problem with redemptions. The blue-chip cryptos for USDH redemptions would be taken from users’ deposits.

In the end, we aren’t comfortable with using the community’s collateral to help raise USDH’s peg, especially if there are other options available. It doesn’t seem fair.

Looking at data from one year since launch, Liquity’s users experienced more than twice as many redemptions (1,266) as liquidations (532), and redemptions were much less easy for users to prevent.

Looking closer at the data, around 17% of redemptions were taken from troves (accounts) holding a collateral ratio above 150% (below 66.6% LTV). For example, one trove had a collateral ratio of 189% when it forfeited 130 ETH on May 20th, 2021.

A table demonstrating redemptions on Liquity:

Even though redemptions are a net-zero loss, since a user’s debt is also wiped clean when redeemed against, who knows if that user would rather have held onto their ETH? Holding ETH for just a few more months into November would have meant exposure to the token’s all-time high.

Why We Want to Phase Out Recovery Mode

Recovery Mode is another sticky situation we want to move away from, because it’s another mechanism that increases users’ uncertainty about their deposits.

In theory, Recovery Mode creates a buffer between total system collateral and total system lend, so crypto deposits will always overcollateralize USDH. If Hubble’s System LTV rises above 66.6%, then Recovery Mode is triggered, and accounts with an LTV below 66.6% can be liquidated to preserve system stability.

In practice, Recovery Mode shouldn’t affect users as surprisingly as redemptions, but it has a pronounced chilling effect on deposits and borrowing. Additionally, other users’ borrowing habits can lower Hubble’s System LTV, which also doesn’t seem fair.

Looking again at data from Liquity, the vast majority of liquidations were triggered, as intended, below a collateral ratio of 110% (above 90.9% LTV). During Liquity’s brief time in Recovery Mode, the highest collateral ratio liquidated was 122%, so most users who borrowed at safer collateral ratios were not affected.

A table demonstrating liquidations on Liquity:

That being said, Recovery Mode is a mechanism Hubble doesn’t want its users to worry about. There are ways to make sure an individual user’s account won’t be affected by the unhealthy borrowing habits of others, and we intend to implement those options.

Join Us Thursday at 6 PM UTC on Discord

We’re inviting you to join us and discuss all of these changes during a Community Forum held on Discord this March 10th at 6 PM UTC.

You can register here:

If we work together, we can make USDH a very important piece of the DeFi puzzle being pieced together on Solana today.

Please, come and share your opinions with Marius, our project lead, and let’s discuss how we can elevate Hubble to the highest tier of DeFi protocols as a community.

Read More

Here are additional resources related to the topics mentioned in this article:

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