MakerDAO looks to limit volatility after USDC troubles pushed some users to DAI

MakerDAO, which manages the "decentralized" dai stablecoin, launched an emergency proposal to reduce the amount of DAI that can be minted with other centralized stablecoins after concerns over Circle's exposure to the shuttered Silicon Valley Bank pushed users away from USDC and into competing assets.

On Friday, Circle disclosed that $3.3 billion of its $40 billion in reserves remained stuck at Silicon Valley Bank, which was shut down last week by regulators. Its USDC stablecoin plunged from its intended dollar peg to $0.87, causing a massive outflow that pushed up demand for DAI.

The supply of USDC shrank by 5%, decreasing to 38.6 billion on March 13 from 41 billion on March 10 when SVB was shut. The supply of DAI shot up to 6.3 billion on March 13 from 5.1 billion over the same period, according to on-chain data aggregated by The Block.

The surge in DAI supply was largely attributed to USDC holders minting more DAI, as USDC is one of the most popular assets that MakerDAO users can lock as collateral to mint DAI in a 1:1 ratio using what is called a Peg Stability Module (PSM). In fact, USDC currently comprises more than 50% of DAI's collateral reserves, along with other crypto and real-world assets, according to data from DeFi Llama.

Lost pegs

The use of the Peg Stability Module (PSM) intensified when USDC temporarily lost its peg, prompting investors to flock to mint DAI, likely in an effort to diversify their stablecoin holdings. Analysts suggest that USDC holders would have wanted to jump ship during the market panic that ensued over the weekend, with DAI's diversified basket of assets backing its stablecoin seen as a safer alternative to USDC.

"It is likely that USDC holders wanted out of their positions given the initial lack of clarity over how much money was stuck on SVB and then the subsequent depegging," noted Rebecca Stevens, a research analyst at The Block. "Minting DAI with USDC gave users a way to convert into another stablecoin."

Despite the instability in the stablecoin market, both USDC and DAI currently trade at a dollar peg, with investor fears allayed when the U.S. government stepped in to assure all SVB depositors would be made whole.

MakerDAO's proposed solution is an emergency switch that would reduce the amount of DAI minted using Peg Stability Module (PSM) swaps and would prevent DAI from being severely impacted by USDC price fluctuations.