MakerDAO Proposal Seeks to Boost DeFi Fixed-Rate Loans

Fixed rate lending has been slow to take off in DeFi. That’s what one of the latest MakerDAO proposals is seeking to change. 

Maker Improvement Proposal 43 would enable MakerDAO to buy fixed-rate loans. The goal is that having DeFi’s largest protocol buying tokenized loans issued by other protocols, at more favorable terms, will boost that market.

“The TLM will permit Maker governance to encourage liquidity/target lower rates for fixed-term Dai loans by providing a standing offer to buy loans at a target interest rate,” the proposal says. TLM refers to Term Lending Module.

Yield Protocol

The fixed-rate loans, already developed and issued by Yield Protocol, use MakerDAO’s vaults to mint the Dai borrowed by users when those users deposit Ethereum. The loans manifest as “fixed yield tokens” or fyTokens, which function analogous to zero-coupon bonds, and provide a fixed payout at a set maturity date.  

Enabling the TLM would give MakerDAO a new tool to increase the supply of Dai. The proposal would enable a special vault which would purchase fyDai with newly minted Dai. 

If, for example, fyDai was trading at above the rate which MakerDAO sets for loan purchases, fyDai holders would be incentivized to sell the loan to MakerDAO. This is similar to the Federal Reserve performing an open market operation: when floating interest rates are near zero in the MakerDAO system, but the protocol needs to inject Dai into the system in order to maintain the peg, it can do so by purchasing fyDai at below the going market price.

The protocol already adopted a monetary policy tool in the Peg Stability Module last year, when MakerDAO’s stability fees, effectively the protocol’s interest rate, hit zero. Because the Peg Stability Modules exposes MakerDAO to USDC, a fiat-backed stablecoin, MIP43 may allow the protocol to maintain Dai’s peg more independently.

Dai Peg

“The great thing about this MIP43 is how it may be able to help Maker satisfy several important goals: increasing Dai adoption, increasing protocol revenue, and improving the Dai peg,” Allan Niemerg, one the proposal’s co-authors, told The Defiant.

“MKR (Maker) hasn’t really benefited  from the yield farming craze because, even though users are earning high yields on their Dai, Maker is limited in how high it can raise stability fees without impacting the peg,” Niemerg expanded. 

MakerDAO’s MKR hasn’t benefited from yield farming as much as other tokens, but as Dai is used extensively in the process, the protocol has certainly contributed to the trend: Dai consists of 59% of all outstanding loans in crypto, worth ~$2.7B. 

Further the total value locked (TVL) in MakerDAO multiplied by a factor of 12 during 2020, demonstrating the protcol’s extensive use during DeFi’s breakout year during which demand for Dai threatened to break the stablecoin’s peg.

The ability to buy fixed-rate loans will give the protocol another tool with which to maintain the one dollar mark.

Non-Partisan Proposal

MIP43 wouldn’t limit MakerDAO to only being able to buy Yield Protocol loans. Niemerg expanded, saying “while this was built with Yield in mind, we tried to make it as non-partisan as possible, so it could be used to buy other loans as the market grows.”

While the proposal is currently in the “request for comment” stage in MakerDAO’s governance process, the potential for the leading DeFi protocol in terms of total value locked (TVL) to adopt fixed-rate, fixed terms loans already bodes well for the financial primitive’s adoption.