Maker’s DAI Asset Rating Downgraded by Exponential Following Collateral Strategy Review

Exponential has recently downgraded the rating of the Maker DAI pool from Low risk to Average risk, based on a careful reassessment of the risks tied to Maker’s collateralization strategy for DAI.

MakerDAO operates as a lending platform that underpins a decentralized stablecoin known as DAI, which is designed to maintain a stable value pegged to the U.S. dollar, thereby facilitating exchanges with more volatile cryptocurrencies.

The protocol enables individuals to secure loans in DAI by using various cryptocurrencies as collateral. However, these loans are overcollateralized, requiring borrowers to deposit more assets than they wish to borrow.

While the lender-borrower framework appears beneficial for MakerDAO, analysts from Exponential have concluded that a detailed evaluation of its evolving collateral strategy warrants the change in risk rating to Average.

Initially, DAI was entirely supported by on-chain assets, including ETH and a few centralized stablecoins, fostering a straightforward and overcollateralized model for DAI holders.

Exponential co-founder Mehdi Lebbar noted that Maker’s recent shift towards integrating real-world assets (RWAs) into its collateral structure marks a significant departure from the original single-asset model. While this diversification may be beneficial in a high-interest rate environment, it introduces new layers of risk that need careful management.

Lebbar highlighted the recent defaults in smaller RWA vaults as a cautionary example of the potential risks of merging traditional financial instruments with decentralized systems. He stressed the importance of the DeFi community understanding how these assets generate yield and the possible consequences should key RWA-backed vaults underperform or default.

In terms of potential future upgrades, he mentioned that improvements could occur if Maker were to replace lower-quality collateral and enhance governance mechanisms surrounding decision-making within the protocol. He also expressed concerns regarding the risks of further diversifying into lower-quality collateral without adequate risk controls, emphasizing that ensuring the financial health and governance practices of the protocol must align with the interests of DAI holders remains paramount.

Over time, MakerDAO has increasingly focused on RWAs, which now represent nearly 30% of DAI’s total backing. This strategic pivot has introduced additional complexities, prompting Exponential to reevaluate the situation.

The reliance on RWAs has enabled MakerDAO to elevate the DAI Savings Rate (DSR) yield to 8%, taking advantage of the prevailing high-interest rates. Although this creates favorable revenue conditions for MKR holders, it simultaneously elevates counterparty risks for DAI holders linked to legal frameworks and transparency.

Concerns arise regarding how each RWA generates yield, the involved counterparties, and whether MakerDAO would bear responsibility for ensuring compliance in real-world defaults.

Though they are minor in relation to DAI’s broader backing, there have already been four defaults on smaller RWA vaults. If larger RWA vaults experience similar issues, it could trigger a bank run, endangering DAI’s 1:1 USD peg, according to the report.

Exponential analysts assert that the addition of lower-quality collateral strays from DAI’s initial decentralized model, amplifying risks to the stability of DAI as a USD stablecoin.

Enhancements in collateral quality could mitigate protocol risk. Moreover, effective governance mechanisms that can adequately manage risks linked to new types of collateral could potentially lead to an upgrade of the risk rating.

However, Exponential has cautioned that any further move toward accepting lower-quality collateral without strong risk controls could result in another downgrade.