Dharma, one of the leading Decentralized Finance platform has proposed new upgrades to its cDai interest rate model under its Compound improvement model for better user experience.
In a blog post published on 27th April, Dharma claimed that the new changes would ease the burden on capital suppliers without impacting the interest of borrowers.
— Dharma (@Dharma_HQ) April 27, 2020
In its blog post, Dharma claimed that its existing Dai interest model at the time of development did not take into consideration several factors like the Stability Fee (SF) and Dai Savings Rate (DSR) in the existing MakerDAO's Multi-Collateral Dai (MCD) system for a prolonged period of time.
Thus, the current zero interest rate model is causing a lot of issues and does not offer a good user experience for the capital suppliers when SF and DSR are kept at zero.
As a result, capital suppliers make zero profits until capital utilization is above 90%. Even when capital utilization is above 90% these rates fluctuate widely.
How Does The Decentralized Collateral Model Works?
Decentralized Finances work on top of the Ethereum blockchain, where DAI (non-asset backed stablecoin) is the primary fuel. A user can put their ETH in a smart contract as collateral and draw an equivalent amount in Dai.
Now the user can utilize Dai as per their wish and whenever they want to withdraw their collateralized ETH, all they need to do is pay back the loaned Dai along with the interest rate.
This mechanism also helps in keeping the value of Dai at $1 despite not backed by the actual US Dollar itself. This is done through the dynamic interest rate system created by MakerDao called Target Rate Feedback Mechanism (TRFM) where, if the inflation leads to an increase in the value of Dai above $1, the interest rate is lowered and vice versa. This system aims to keep the value of Dai stable at all the times and equivalent to $1 USD.
How Do These Proposed Changes Benefit Capital Supplier
The proposed changes to the cDai interest system offer a modest interest rate to capital suppliers when the interest rates are below 90%, and as the interest rates are greater than 90%, the interest volatility slightly decreases.
When the Dai saving rates were set to zero, the plotted graph looked like the following chart:
While the proposed changes to the rates would make the graph look something like the following chart:
Decentralized Finance has been seen as a revolutionary use case for decentralized cryptocurrency financial system and also achieved the milestone of $1 billion locked in collectivized assets.
However, 2020 turned out to be a nightmare not just for the mainstream crypto space, but even for the Defi ecosystem which suffered from numerous hacks in recent times, the most recent being DForce.
DForce, in particular saw the loss of $25 million locked in collateralized assets. However, it later turned out that the hacker was trolling the network as they returned all of $25 million stolen assets the very next day.
Similarly, the black Thursday crypto market crash also exposed several flaws of the De-Fi ecosystem when the price of major crypto assets fell by 50%, which led to several thousand Colleralized debt Position (CDP) being partially or fully liquidated.
This caused investors to lose millions and they were miffed since MakerDao has advertised that if the value of the collateral fall by 13%, the collateralized asset would be returned to the investor with a max 13% penalty cut.