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Is MakerDAO Giving Out Unlicensed High-Risk Loans, And Do We Care?




MakerDAO’s stablecoin, Dai, seems to be doing well despite Ether's price fluctuations. But MakerDAO is more than just a stablecoin; it appears to be a lending service, albeit lending virtual currency that can be exchanged for fiat. It's not clear that it's licensed as such.

Many have argued that stablecoins are the key to cryptocurrency's mass adoption.

The reasoning is that the price volatility of most digital currencies, such as Ether and bitcoin, presents too much of a risk for payment processers, banks, businesses, and lenders. It's also fair to say that most consumers would prefer to know how much their money is worth so that they can be reasonably confident their rent will cost the same this month as it did last.

How MakerDAO Works

MakerDAO is the creator of Dai, a decentralized stablecoin pegged to the US dollar and used for Ether-backed loans. There are a lot of stablecoins out there, but what makes Dai different is that rather than being "backed" by USD in a third-party bank account somewhere, it's backed by Ether held in a "collateralized debt position" (CDP), a MakerDAO-created an EDCC (or smart contract).

This is how Dai works at its most basic: You put a certain amount of Ether into the CDP. For the sake of simplicity, let's say it's 1 ETH. Let's say, again for simplicity's sake, that at this time, 1 ETH is worth $500 (optimism, folks). The CDP then holds your ETH as collateral and issues you a loan/line of credit in Dai.

You would not get the full $500 worth of Dai, though, because something needs to be held as collateral against the loan/line of credit, and the price of ETH fluctuates. Because of this fluctuation, your collateral must always be at least 150 percent of your loan. So maybe you get $300 worth of Dai. You can then convert that Dai to USD and purchase whatever you'd like.

Your ETH then stays locked in that contract until you pay back the Dai, or until the value of ETH drops below 150 percent of the value of your debt. If and when the value of your ETH drops below that amount, the CDP is liquidated and sold to the highest bidder in order to pay the CDP holder's debt (plus a 13% liquidation fee).

If you pay your debt (with stability and governance fees), then you can have the contract release your ETH, which in turn burns the deposited Dai. Or, you can use your CDP as a kind of credit card, continually borrowing and paying it back indefinitely (barring the liquidation of your ETH due to a drop in the market value).

How Dai maintains a relatively stable value is a bit more complicated, but (for now) suffice it to say that since its launch at the end of December 2017, Dai has held pretty close to $1. (There was a bit of volatility in the first couple months, though: On February 28, one Dai was worth only 88 cents, and on January 27 it reached $1.07.) 

Even with the drastic market volatility of Ether recently, the value of Dai has not moved more than a few cents above or below the dollar. 


The Legal Part

Gregory DiPrisco, head of business development at MakerDAO, once described Dai as "a stablecoin that lives completely on the blockchain chain with its stability unmediated by the legal system or trusted counterparties."

Note, he only said that the coin's stability is "unmediated by the legal system," but that is misleading: The coin's stability is maintained in part through interest, and interest is most definitely regulated. You'll remember that when a person repays their Dai debt, they pay governance and stability fees. Without getting into the nitty gritty, it's through governance and these stability fees that the coin's value is regulated. Though MakerDAO generally avoids calling these fees "interest," the organization does (repeatedly) refer to them as such on its FAQ page: "When you pay down your debt by returning Dai to your CDP. You will be charged outstanding interest proportional to the amount of Dai being returned."

It goes on to directly refer to the governance fee and stability debt as interest:

"The total interest accrued in the CDP can be calculated like this:
(((Total Stability Debt in DAI * (1 + Current Governance Fee in decimal format)) ^ (Age of Stability Debt in days/365)) - Total Stability Debt in DAI ) = Total Governance Debt owed in DAI"

All of this is to say that MakerDAO offers a virtual currency lending service using the Ethereum blockchain. This puts MakerDAO in somewhat of a gray area legally.

Whether MakerDAO's governance and stability fees are considered interest matters, because interest is a highly regulated feature of loans. For example, in New York state, lenders may offer credit to borrowers without a license if interest rates fall below 16 percent and if the loan is under $250,000. As it stands, MakerDAO's fees are well below New York's 16 percent maximum for unregulated lenders. However, I was unable to find any documentation suggesting a limit to the amount an individual can borrow, so long as they have enough collateral. And in any case, even if there was a limit, an individual could hypothetically take out another loan using a different CDP with a different address.

However, the particular kind of loan MakerDAO CDPs issue come with some unique risks. The type of traditional lending most similar to Dai loans are probably asset-based lending, or more specifically, an asset-based revolving line of credit. Namely, the risk borrowers of this credit type face is the possibility that the collateralized asset decreases in value – something particularly risky when cryptocurrency is the collateral.

Of course, how MakerDAO deals with this (as explained above) is through liquidizing the CDP and charging the borrower a fee.

ETHNews reached out to the New York State Department of Financial Services to inquire about consumer protection laws specific to unlicensed lenders and asset-based lending but did not receive a response.

Somewhat regardless of what MakerDAO's legal status is in New York, lending licensure laws vary state by state, and lenders must comply with lending laws in every state they operate in. ETHNews could find no evidence that MakerDAO has sought such licensing. ETHNews reached out to MakerDAO for a comment, but did not receive answers to our questions.

It is notable though that the organization recently teamed up with Wyre, a regulated KYC/AML compliant blockchain money transfer company. With Wyre's help, Dai can now be exchanged for 30 or more major fiat currencies worldwide. This development adds some credibility to MakerDAO, though it does nothing to address the concerns over lending licensure.


A Similar Company Doing Things Differently

Another company offering cryptocurrency-backed loans is SALT. Where MakerDAO operates in a legal gray area, SALT has made clear efforts to comply with federal and state law. In doing so, it operates a bit differently. Instead of issuing loans in a stablecoin, it lends in dollars by pairing cryptocurrency holders with accredited investors. Investors must be accredited because SALT acknowledges that this is an investment opportunity, and thus must comply with SEC regulations. Entities offering investment opportunities must register with the SEC under the Securities Act of 1933 and the Securities Exchange Act of 1934, unless the securities offering falls under an exemption from registration. One such exemption is if investors are qualified as "accredited investors" and the proper SEC filings are made. This is the method SALT utilizes to achieve regulatory compliance. 

The downsides to this model are that, first, borrowers and lenders must jump through bureaucratic hoops and, second, they are accountable to an investor to pay on schedule. MakerDAO offers more independence and flexibility.

I bring up SALT to illustrate one way for a cryptocurrency-backed lending platform to possibly operate legally, not to recommend that MakerDAO do the same. (I am not a legal expert and do not claim to offer legal advice.) Further, MakerDAO is an on-chain, decentralized autonomous organization and application that offers virtual currency loans through code contracts. Code contract-issued stablecoins are integral to the platform and reflect a particular ethos of decentralization, trustlessness, and self-sufficiency.

It's debatable whether MakerDAO offers securities. But it is definitely offering loans. Whereas SALT has gone out of its way to at least appear above board, MakerDAO may be testing its luck.

Alison Berreman

Alison has a master’s in English from the University of Wyoming. She lives with her pooch in Reno. Her favorite things to do include binge listening to podcasts, getting her chuckles via dog memes, and spending as much time outside as possible.

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