Mike McDonald, the creator of MKR.tools, took to Twitter to point out to the fact that nearly 1% of the total circulating supply of Ether (ETH) is now locked up in MakerDAO smart contracts.
Since the circulating supply of ETH is currently 103,219,284 ETH, we come to a stunning number of a million Ether being tied up with Maker in their “pooled Ether” (PETH) smart contract.
Ether as a backing for stablecoin
Maker is a project which leans on the Ethereum network, whose main product is a stablecoin Dai.
Dai is the first such cryptocurrency which isn’t pegged to the actual fiat currency in some bank account in order to be exchangeable with the dollar in 1:1 ratio. Instead, it utilizes its users’ Ether locked in smart contracts to ensure the stability of the cryptocurrency through a series of seemingly complicated but logical mechanisms.
Simply put, users lock away their ETH through collateralized debt position (CDP) smart contract in order to be able to produce Dai stablecoins. By doing so, they lose control over their Ether as it is then being used by MakerDAO for the stability of the system. That Ether is frequently referred to as wrapped Ether or WETH.
Since the price of Ether is volatile like any other cryptocurrency’s, the problems for the Dai network would begin if the value of locked Ether drops below the value of Dai created by users.
Maker devised a strategy to ensure that such an event doesn’t ever happen.
If the value of Ether slides down to a certain threshold, which Maker considers dangerous, they would terminate CDPs, and sell ETH from PETH to the highest bidder for Dai until there is enough stablecoin to pay for what was created through CDPs.
The danger for ETH
All that locked Ether may be a good thing for the Maker ecosystem but may present a possible problem for Ether.
1% may not seem like much, but it is surely enough to bring down the price of ETH further down if its value declines enough for Maker to start auctioning it for Dai.
However, Dai’s stability isn’t only ensured by the PETH smart contract.
Since the cryptocurrency market is known for its tendency to suddenly surge or plummet, if the latter happens, and there is no time for Maker to react in the described way, then the stability of Dai is ensured by creating more Maker’s MKR tokens and selling them on the open market.
Needless to say, that would have a huge negative effect on the price of MKR.
Not all locked ETH contributes to Dai market capitalization
The market capitalization of Dai currently stands at roughly $72.5 million, which brings us to the conclusion that not all Ether from CDPs is contributing to it.
All dangers described above may seem a bit lighter when we know that Dai is still a fairly rarely used stablecoin, as its daily trading volume is just below $12 million, which is far away from Tether’s recent $5 billion in daily volume.
On the other hand, MakerDAO’s other cryptocurrency, MKR, is one of the rare coins whose price recorded a positive movement across the last two months, currently valued at $546 per token.
This is not investment advice. Cryptocurrencies are highly volatile assets and are very risky investments. Do your own research and/or consult an investment professional before investing. Never invest more than you can afford to lose. Never borrow money to invest in cryptocurrencies.