MakerDAO: Farewell SAI, Long-Live DAI

Collateralized Debt Position (CDP) owners involved in the MakerDAO ecosystem are forced to swap their single-collateral SAI tokens for multi-collateral DAI, also known as MCD effective since May 12th.

The MakerDAO project is shutting down the SAI system which is backed only by Ether (ETH, Ξ), urging users to trade their SAI for DAI, an analogous Ethereum-based stablecoin backed by ETH, and WETH among other ERC-20 tokens, as part of the platform’s latest upgrade.  

DAI is currently backed by ETH, BAT, USDC, and wrapped Bitcoin (WBTC) – essentially an ERC-20 token pegged to Bitcoin’s price and it inherits all the characteristics of SAI, plus a few new perks including new collateral options, advanced lending, as well as a new DAI savings interest rate model. 

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While the MakerDAO ecosystem was expecting the termination of the SAI system, it wasn’t an urgency for the DeFi giant, who re-considered the subject after March’s exploit that allowed some users to capitalize on a technical detail causing some $8mn worth of ETH locked in CDPs given away basically for free.

In a nutshell, anyone in the Ethereum DeFi ecosystem can stake his ETH, to generate DAI. This DAI generated is usually worth 1/3 of the initial installment, and it can be used by the user as seen fit. Unlocking the ETH would require to pay the amount of DAI borrowed, as well as a fee determined by the MKR community. 

This is a great lending model and it works fine as long as the price of ETH is stable or rising, but it can cause extreme confusion when the price of ETH drops near or below the value of DAI generated by the CDP. 

In that case, MakerDAO makes sure the ETH is automatically unlocked and returned to their respective owners as long as a fee is paid to the MKR platforms, or…there is an ongoing auction that would unlock the ETH to the highest bidder, making sure that arbitrary opportunities and malicious actors would not be eligible to tamper with the system. 

Nevertheless, that was exactly the case this March, when ETH saw a drop of nearly 30% in less than 24h. As a result, many academic investors panicked and sold their positions at a low price in the fear of holding assets that worth even lower in the future, and by domino effect, this triggered vast liquidations of CDPs.

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The problem was that nobody, literally, was aware of the auction and its details except a guy who bid $0 to unlock CDPs paying the ‘fat’ fee associated with each locked position.

Let’s say we have ~$100 worth of ETH and we lock it to generate ~$30 worth of DAI or simply 30 DAI. In order to get our ETH back, we would have to pay the 30 DAI, plus a fee that can range anywhere between 5% and 20% depending on MKR stakes holders.

What happens when ETH reaches a point below $30 apiece? Well, bidders can buy the ETH off CDPs as long as they pay the pre-fixed fee associated with each position. In this case, if the fee was 10$, one could pay $3 in gas + the highest bidding price <$30 to grab an ETH worth $30.  

“The purpose of these auctions is to raise enough DAI to pay back the CDP debt. However, because gas prices on Ethereum on 12 March were so high and the queue was so long, bids that offered “regular” gas prices weren’t being processed fast enough” – ClassNode Insights describes in a relevant publication. 

A user, most likely a bot, was able to win all of these auctions with bids of exactly 0 DAI, allowing it to purchase bundles of dozens of ETH virtually for free or at a 10% rate, considering that only the gas fee would have to be covered, even if expensive at that time.   

The strange auctions were noticed quickly by several Redditors, and while some tried to make sense of the MakerDAO system, others attempted to expose the vulnerability or even copy the strategy for the sake of profit. 

When addressed the matter, MakerDAO said the exploit is not considered a flaw in the system, but attributed the problem to lack of well-crafted documentation and lack of communication, suggesting that if we had more bidders, obviously the single bidder would not be able to pull this off. 

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The transition from SAI to DAI is expected to harden the security of respective scenarios as CDP would distribute its weight to multiple different virtual currencies and not just one single digital asset.  

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