As a leader in the DeFi (decentralized finance) world, MakerDAO has always been obsessed with U.S. Treasury bonds. Since MakerDAO officially incorporated RWA (real-world assets) into its strategic development direction in 2020, MakerDAO has bought nearly 1.2 billion U.S. Treasury bonds. Why does the decentralized world's DeFi protocol introduce real-world assets? What is the intention behind this? Is the creation of DAI (the token launched by MakerDAO) after the introduction of U.S. Treasury bonds the same as the Federal Reserve creating money?
To respond to these questions, we need to start with the nature of money.
This article will start from the perspective of currency, from the nature of currency to the binary structure of central bank-commercial bank to the balance sheet structure of MakerDAO, and lead everyone to explore and understand the significance behind MakerDAO's introduction of U.S. Treasury assets.
Author: DrSamo (Twitter: @BirkSamo), Spinach Spinach! (Twitter: @wzxznl)
Table of contents
What is money? What is the nature of money?
An abstract unit of value supported by national law
A bookkeeping system used by members of a society to track and record credit or debt balances when they transact with one another
A standardized representation (Token) that creditors use to transfer a specific bond relationship to a third party
How is money created?
Types of currency - high-energy currency and credit currency
The dual structure of central bank and commercial bank
The process of money creation
Does Makerdao have the ability to create currency?
About MakerDAO
Is MakerDAO creating money?
What does MakerDAO’s purchase of US debt mean?
Summarize
What is money? What is the nature of money?
There is a widely circulated saying that "the essence of money is credit", but many people may know it but not why. Regarding the question of what money is, I would like to quote Professor Zhai Dongsheng's book "Money, Power and People": "Money is a social cooperation system and public product composed of three basic elements."
An abstract unit of value supported by national law:
As an abstract unit of value, the value of money does not come from itself (for example, the production cost of a piece of paper money is much lower than the value it represents), but from the trust people place in it. This trust is largely given and guaranteed by national laws.
First, national laws clearly define the legal status of currency. In most countries, the law stipulates that the national currency is the only legal means of payment. This means that if you take a national legal tender note to buy goods or services, the seller must accept this payment method.
Secondly, national laws protect the credit of the currency. The central bank or similar institutions in most countries are responsible for maintaining the stability of the national currency, including controlling inflation and preventing serious economic crises. These efforts help protect the credit of the currency and make people believe that holding the currency is safe.
Finally, national laws give money a special status. Only state institutions have the right to issue money, and any unauthorized creation or reproduction of money is considered illegal.
So when we say that money is an abstract unit of value backed by state law, we are actually emphasizing the legal status of money and how this status helps maintain the value and credit of money.
A system of accounting used by members of a society to track and record credit or debt balances when they transact with one another:
In the ancient trading system, how did people trade without currency? They might trade through barter, like, I give you a chicken, you give me a bag of rice.
However, there are some obvious problems with this type of trading. First, we need to find trading partners with mutual needs, also known as the "coincidence of wants", which is very difficult in many cases. Second, we need to determine the exchange rate, that is, how many bags of rice is a chicken worth? This is also a very complicated problem.
To solve these problems, people invented money. Money can be thought of as a bookkeeping system that helps us track and record credit or debt balances. For example, if you provide me with a service, you may not immediately ask me to provide you with an equivalent service. Instead, I may give you a proof of debt, which is money, indicating that I owe you a service. At some point in the future, you can use this proof of debt to get me or someone else who accepts this proof (money) to provide you with an equivalent service.
In general, money is a bookkeeping system that tracks and records credit or debt balances when members of a society transact with each other. It makes transactions simpler and more efficient, and it also makes it easier to measure and transfer value.
A standardized representation (Token) by which a creditor transfers a specific bond relationship to a third party:
To understand that money is a standardized representation (Token) of a creditor transferring a specific bond relationship to a third party, we can use a simple analogy.
Suppose you are on an island where everyone can grow crops, fish, or do other productive activities. If you help me grow crops today, I may owe you a debt, such as a promise to help you fish someday in the future. However, this debt relationship can be difficult to manage because we need to remember who owes whom what and when the debt can be repaid.
To solve this problem, we can introduce a standardized representation or token to represent this debt relationship, which is currency. For example, I can give you a shell, which represents the debt I owe you. You can use this shell to ask me for the fishing service I owe you at any time, or you can give this shell to other people on the island and let them ask me for the service. In this way, the shell becomes a standardized representation of the creditor transferring a specific debt relationship to a third party.
In modern society, the same principle applies to the money we use. When you hold a $100 bill, you actually have a claim (cash is a debt to the central bank that issued it) that allows you to demand a certain value of goods or services from society. You can also give this bill to someone else and transfer this claim to them.
In general, money is a standardized representation of debt that allows us to manage and transfer debt relationships more effectively, so when we understand that the essence of money is credit, we can think of the essence of money as a transferable debt or transferable credit. Because of this, the value of modern money does not come from its material, but from social consensus and trust in the currency issuing institution (such as the central bank). After further understanding the process of money creation, you will have a deeper understanding of the essence of money is credit.
How is money created?
Types of currency - high-energy currency and credit currency
Money is usually divided into two categories: Base money and Credit money:
Base money, also known as base money or central bank money, is a currency directly issued by the central bank with final payment capabilities. This includes coins and banknotes used in our daily lives, as well as commercial bank reserves stored in central bank accounts. The value of high-powered money mainly comes from the support of national laws and the trust of society. Because of its finality of payment capabilities, it is often regarded as the basis of money supply. Although high-powered money is the basis of money supply, in modern society, most of the money supply is actually made up of credit money.
Credit Money, this form of money is mainly created by commercial banks through lending and deposit activities. When a bank lends money to a customer, it is actually creating new money.
In the modern monetary system, the vast majority of money is credit money. In other words, the vast majority of money in the real world is created by commercial banks rather than the central bank. This is a process accomplished through the "money multiplier effect", in which commercial banks use deposits to make loans, thereby creating new money.
For example, when a person deposits $1,000 into a commercial bank, assuming the reserve requirement ratio is 10%, the bank needs to deposit 10% of it into the central bank as a reserve, and then lend out the remaining $900. When the $900 is eventually deposited into another commercial bank, the bank can again reserve $90 and lend out $810 at a 10% reserve requirement ratio. This process can be repeated, creating new money in each round.
In this model, although each bank creates new money in lending, their total amount is limited because the amount of each round of lending will gradually decrease. This also means that although commercial banks can create money, their ability to create money is not unlimited, but is affected and constrained by multiple factors such as the central bank's monetary policy and the Basel Accord.
The dual structure of central bank and commercial bank
In the modern monetary system, central banks and commercial banks together form a dual structure that aims to balance the issuance and circulation of currency.
Central banks play a critical role in the monetary system. They are responsible for formulating and implementing monetary policy, controlling the supply of base money, regulating interest rates in the economy, and maintaining financial market stability. Central banks influence the money supply through open market operations, such as buying or selling government bonds.
When the central bank buys government bonds, it injects base money into the market and increases the money supply; conversely, when the central bank sells government bonds, it absorbs base money from the market and reduces the money supply. In addition, the central bank also sets the deposit reserve ratio, which is the proportion of deposits that commercial banks must keep in the central bank or itself, to influence the commercial banks' ability to create money.
Commercial banks are the main source of money creation. Commercial banks conduct their business by accepting deposits and making loans. When a commercial bank makes a loan, it actually creates new money because the loan amount is added to the borrower's bank account, thereby increasing the money supply in the economy. However, this money creation ability of commercial banks is limited, both by the monetary policy constraints of the central bank and by the international financial regulatory framework such as the Basel Accord.
This dual structure of central banks and commercial banks enables the monetary system to maintain flexibility and stability. By adjusting monetary policy, the central bank can control the supply of base money, thereby affecting the overall interest rate level of the economy and helping the economy cope with risks such as inflation or deflation;
Commercial banks can adjust the supply of credit money through lending activities to meet the capital demand in economic activities. At the same time, since the money creation capacity of commercial banks is constrained, this also avoids the risk of excessive expansion of money supply, leading to inflation or financial bubbles.
The process of money creation
In order to more intuitively reflect the process of money creation, using the balance sheet is a very good tool. Observing the changes in the balance sheet provides us with a magnifying glass for deep insight into financial behavior (for ease of understanding, the following charts are simplified models).
The central bank creates money: Taking the Federal Reserve as an example, the Federal Reserve usually creates US dollars through open market operations. Open market operations can be understood as the Federal Reserve purchasing assets (such as Treasury bonds, etc.) from market counterparties, and then the US dollars are created "out of thin air". The "massive money printing" of the Federal Reserve that we experienced during the epidemic is actually the Federal Reserve frantically purchasing various assets in the market and then spreading US dollars into the market.
Assuming that the Federal Reserve purchases $5,000 of Treasury bonds from commercial banks, the changes in the balance sheet are:
When the Federal Reserve purchases $5,000 worth of Treasury bonds, there is an additional $5,000 in bonds on the asset side of the Federal Reserve's balance sheet, and an additional $5,000 in high-energy currency on the liability side. At this time, high-energy currency is created "out of thin air", and there is an additional $5,000 in liquidity in the market.
We can see the process of dollar creation from the Fed's balance sheet, and this process has expanded the Fed's balance sheet and increased the dollar liquidity in the market, which is called "balance sheet expansion". I believe that everyone has often heard the term "balance sheet reduction". The table in the so-called "balance sheet reduction" and "balance sheet expansion" refers to the balance sheet. Recently, the interest rate hike and balance sheet reduction that everyone often hears about is actually the Fed's withdrawal of dollar liquidity in the market. Since the Fed can create dollars by purchasing assets, then conversely, the Fed can "destroy" dollars by selling assets, which will lead to a reduction in the balance sheet and achieve the effect of reducing the supply of dollars.
Commercial banks create money: For commercial banks, money creation is achieved through the loan process. Suppose a depositor deposits $5,000 in a commercial bank. At this time, the $5,000 deposit is an asset for the depositor, but a liability for the commercial bank because it needs to continue to pay interest to the depositor.
Of course, commercial banks will not just take depositors' deposits. In order to make a profit, they will lend at an interest rate higher than the deposit interest rate, and obtain the deposit-loan interest rate spread as profit. Assuming that the bank is ready to issue a deposit of $5,000, you will find that there is no cash transfer in this process as imagined. The commercial bank just adds a loan and deposit out of thin air on the balance sheet, and the new currency is born (of course, it also needs to deposit a deposit reserve with the central bank). In fact, most bank deposits are created by the banks themselves, and these created currencies are called credit currencies. Most of the currencies we use in our lives are this kind of credit currencies.
Commercial banks can repeat this process, creating new money in each round. Therefore, although the initial high-energy currency is only $5,000, the total money supply often far exceeds this amount through the deposit and loan activities of commercial banks. This is the so-called money multiplier effect. Assuming the deposit reserve ratio is 10%, when the $5,000 high-energy currency returns to the commercial bank's reserve account at the central bank, the corresponding deposit becomes $5,000 ÷ 10% = $50,000, which is a 10-fold expansion.
But the process of commercial banks creating money is not unlimited. The ability of commercial banks to create money is constrained by the central bank's deposit reserve ratio and financial supervision. If large-scale withdrawals occur (bank runs), or loans cannot be repaid, commercial banks may face liquidity problems or even bankruptcy. Therefore, although commercial banks have the ability to create money, this ability is not unlimited and not risk-free.
So in the end you will find that commercial banks can create "money" out of thin air, but the money that people can withdraw (high-energy money) is far less than the money that has been created (credit money). This is a bit like playing the "ten bottles and nine caps" game, which is why any honest bank cannot withstand a bank run.
Before the modern credit currency system matured, any country could abuse currency at will. The current legal tender issuance system ties the issuance of new currency to the debt of sovereign states. Each high-energy currency is backed by an equivalent amount of national debt, which requires interest payments. This makes the issuance of additional currency a costly thing, which can theoretically limit the government's impulse to abuse currency.
But when it comes to the Federal Reserve creating money by purchasing Treasury bonds, you will find that if the U.S. Treasury keeps issuing new Treasury bonds to repay old ones, and the Federal Reserve keeps purchasing fresh dollars and then paying interest, doesn't this mean that the U.S. government can still print as much money as it wants?
The modern credit currency system actually implements a mechanism of checks and balances. The U.S. Treasury does not have the right to print money, but it has the right to issue treasury bonds; the Federal Reserve can print money indefinitely, but it does not have the right to spend the money at will. The Treasury still needs to borrow funds at market interest rates, and the excessive issuance of treasury bonds will lead to higher borrowing costs. At the same time, the U.S. Treasury has a legal debt ceiling for issuing treasury bonds.
The debt ceiling is set by the U.S. Congress and limits the total amount of money the government can borrow. When this ceiling is reached, the Treasury will be unable to issue new bonds, forcing the government to balance its budget by reducing spending and increasing taxes. Failure to resolve the debt ceiling issue could lead to a technical default on U.S. Treasury bonds, which would have serious implications for the global economy.
By understanding the process of money creation by the central bank and commercial banks, we will find that the modern monetary system has made certain institutional designs to prevent sovereign governments from abusing money. However, in practice, there are still loopholes in "constantly borrowing new to repay old" to circumvent the cost of issuing bonds. In the history of the United States, when the debt ceiling was reached many times, the debt ceiling was always raised at the last minute.
The entire modern monetary system is essentially still a game of passing the parcel. National debts need to be repaid with interest. What if you can’t pay them back? What if you still need to spend money? Keep printing money to pay the interest and keep spending. Of course, if you are a small country like Venezuela, this behavior of borrowing new money to repay old debts can only lead to the depreciation of the local currency, and cannot solve foreign currency debts.
But if your currency is the strongest hard currency in the world, and there is no greater power that will make you pay any extra price for borrowing new money to repay old debts, then you will feel good about borrowing money, and you will feel good about borrowing money all the time. Seeing this, you will find that the anchor behind modern currency is actually debt, and debt can be understood as a kind of credit. Seeing this, you will have a deeper understanding of the saying "the essence of currency is credit".
Does Makerdao have the ability to create currency?
About MakerDAO
MakerDAO is a project that runs on the Ethereum blockchain and integrates over-collateralized stablecoins, lending, storage, user co-governance and development. The core of MakerDAO is the Maker Protocol, also known as the Multi-Collateral DAI system, which allows users to use assets approved by the protocol as collateral to generate decentralized stablecoin DAI, such as pledging $10,000 of ETH to generate $6,500 of DAI.
In 2022, MakerDAO passed a proposal to use funds in the Pegged Stability Module (PSM) to purchase U.S. Treasury bonds[1]. This proposal is of great significance to MakerDAO.
First, let me introduce PSM (Peg Stability Module), which is an important part of the MakerDAO project. The main function of PSM is to help DAI maintain a 1:1 peg with the US dollar. When the market price of Dai deviates from $1, PSM will help adjust the supply of DAI in the market to return its price to $1.
Specifically, the working principle of PSM is as follows: when the market price of DAI is higher than $1, arbitrageurs can use PSM to exchange stablecoins (determined by MKR token holders, currently only USDC is supported) for DAI at a 1:1 ratio, which is equivalent to exchanging DAI at a discount price, and then selling it on the market at a price higher than $1 to make a profit. Conversely, when the market price of DAI is lower than $1, users can use PSM to exchange DAI for US dollar stablecoins at a 1:1 exchange rate, and the circulation of DAI will decrease, so the exchange rate will rise back to $1. Such a mechanism automatically adjusts the supply of DAI through market forces to keep its price stable.
If we observe MakerDAO's balance sheet in 2022, we can find that PSM's assets account for more than half of MakerDAO's assets, and PSM almost all contains the centralized stablecoin USDC, which also means that DAI is actually a shell of USDC to some extent.
But when MakerDAO started buying U.S. Treasury bonds, we found an interesting phenomenon: the asset and liability sides of MakerDAO’s balance sheet are almost consistent with the Federal Reserve’s balance sheet (U.S. Treasury bonds: U.S. dollar high-energy currency vs. U.S. Treasury bonds: DAI stablecoin):
So the question is: Does this mean that MakerDAO is sharing the right to create money based on U.S. Treasury bonds, which was previously monopolized by the Federal Reserve? What does it mean for MakerDAO to buy U.S. Treasury bonds?
Is MakerDAO creating money?
Let’s first give the answer. MakerDAO did not create currency, so what went wrong?
To understand the problem, we need to put three concepts in front of us:
Central Bank: The central bank represented by the Federal Reserve has the strongest ability to create money, and the additional money will be high-energy money. In the simplest model, the Federal Reserve can create money out of thin air, but in practice it is not possible, and the US dollars it prints cannot flow directly into the market. The US Treasury has the power to issue US debt but not the power to print money, and the Federal Reserve has the power to print money but not the power to spend it at will. This decentralization achieves the purpose of issuing fiat currency anchored by the debt of sovereign countries, and curbs the impulse of sovereign governments to issue currency indiscriminately.
Commercial banks: have the ability to create money through credit expansion, and all they create are credit money. As mentioned above, after a loan is approved, there is actually no "transfer of funds" as we understand it, but the bank simply records an additional asset and a liability in its balance sheet. Banks only need to maintain their "core capital adequacy ratio" at a safe level, which is generally required to be 8%.
Stablecoin issuers: They have the simplest business, collecting USD from customers, issuing stablecoins at a 1:1 ratio and being responsible for acceptance. Similar to Circle issuing USDC and Tether issuing USDT, they theoretically do not have the ability to expand credit, but only keep USD for customers and then issue corresponding USD stablecoins. MakerDAO's issuance of DAI is also very similar to them, especially the 1:1 exchange service between DAI and USDC provided by its PSM module. If USDC is considered a "USD voucher", then DAI in the PSM module can also be considered a "USDC voucher".
The PSM module is very confusing when liquidity is good. It continuously provides stable liquidity between DAI and USDC. But in essence, it is a "reserve treasury". When everyone wants to exchange their DAI for USDC 1:1 through the PSM module, it is obvious that this treasury will be exhausted.
The USDC in this reserve vault belongs to MakerDAO, but MakerDAO does not have a loan agreement and the ability to expand credit. It cannot and should not re-lend this USDC. It should lock up these USDC and only use them when providing a 1:1 exchange between DAI and USDC, just as Circle cannot easily use customers’ dollars.
So where does MakerDAO get the money to buy US Treasury bonds?
If you use DAI to buy US Treasury bonds directly, they will not recognize it. MakerDAO exchanged USDC in the DAO treasury for US dollars and then purchased US Treasury bonds.
Understanding the modern credit currency system based on "central bank-commercial bank", we can see that the process of issuing currency by the third role, the stablecoin issuer, is very different. Compared with the central bank's ability to create high-energy currency out of thin air and the expansion ability of commercial banks' 8% core capital adequacy ratio, the ability of stablecoin issuers to create currency can be said to be minimal. It is like Nongfu Spring - we do not produce currency, we are just the porters of currency.
Even if we look at currency issuance from a longer-term perspective, the way stablecoin issuers supply currency is completely different. During the Bretton Woods system, the U.S. dollar, which was issued by the U.S. with its gold reserves, gradually became a game of ten bottles and nine caps. As the U.S. dollar was issued and gold reserves were lost, the number of caps became fewer and fewer. [2]
Of course, if we only focus on voucher stablecoins, the issuers will starve to death, so we also accept Circle to replace part of its customers' US dollar deposits with short-term US Treasury bonds. This is essentially replacing more liquid US dollar demand deposits with less liquid but higher-yielding US Treasury bonds, so that the income can be used to pay the company's business operating costs. MakerDAO does something similar, which is to replace the interest-free USDC reserves with interest-bearing US Treasury bonds to generate income and support the protocol.
This behavior will cause USDC to be unable to cope with a 100% run now (which was theoretically possible when it only enjoyed the interest on current deposits), and will also weaken DAI's anchoring to USDC. In essence, it is an act of exchanging liquidity for profits, but compared to ten bottles with nine caps, this is more like 100 bottles with 99 caps.
From the balance sheet
In addition, from the perspective of the balance sheet, DAI is a liability for MakerDAO, while USDC in the PSM module is an asset of MakerDAO. This behavior is essentially that MakerDAO replaces part of the USDC assets in the balance sheet with another asset, U.S. Treasury bonds. This is a very normal asset replacement process for any company or DAO. In this process, no new DAI is created out of thin air, nor is DAI used as a high-energy currency for credit expansion to amplify the money multiplier.
In summary, MakerDAO does not share the Fed's ability to create money. In particular, it is very difficult to create a strong currency with a value scale function, such as the US dollar stablecoin. This is also the original ideal of BTC, to make decentralized currency an anchor for all economies and to save people from being exploited by sovereign governments' excessive issuance of currency. Even BTC still has a long way to go in its journey to replace legal tender, and DAI also has a long way to go in its journey to replace legal tender (or centralized stablecoins).
What does MakerDAO’s purchase of US debt mean?
The problem we pointed out is that while MakerDAO increased U.S. debt on the asset side, it did not increase the corresponding DAI on the liability side; it was merely an asset replacement.
But thinking from another perspective, can we also assume that part of DAI’s endorsement was previously the reserved USDC, and after the replacement, part of DAI’s endorsement became U.S. Treasury bonds issued by the U.S. Treasury, thereby enjoying the credit endorsement of the United States, a sovereign country?
This switching of endorsements is valid, and similar things have happened many times in the real world.
Other currencies backed by the US dollar
Historically, it is not uncommon for countries with smaller economies to use the US dollar as an anchor to increase the credit of their own currencies.
European countries after World War II
After World War II, all European countries were devastated. There was not enough gold in the treasury, and the government did not have enough credit to issue bonds. This made it very difficult to stabilize the national currency. If you were not careful, it would easily lead to a multi-lose situation of competitive devaluation. At that time, the US dollar stood up and served as a bridge of stability for the world economy. The United States reserved gold, and other countries reserved US dollars. In fact, each country borrowed the endorsement of the US dollar to increase the credit of its weak legal currency.
The United States certainly took advantage of this process. After the Marshall Plan funded Europe to restore its productivity, Europeans worked hard to produce things to earn American green paper, and they also had to pay interest on the US dollar, which was considered to be full seigniorage. But the United States also undeniably provided a stable environment for the recovery of the world economy, and the US dollar has gradually consolidated its position as the world's core currency.
This story is Web3-ized. The United States reserves gold, which means MakerDAO over-collateralizes ETH and other core assets to mint DAI; various countries reserve dollars, which means DAI reserves USDC.
China after Reform and Opening Up
The roles of money in a planned economy and a market economy are very different. During the economic transition period, China also experienced chaos in currency issuance. The authorities, realizing the serious consequences of inflation, quickly withdrew the over-issued currency. However, economic development requires capital, and capital in China was so scarce at the time. How to solve the problem of what anchor the newly issued RMB should be?
In the same way, the reserve of US dollars is used to enhance the credit of the RMB. China began to promote the introduction of foreign capital, but foreign capital (mainly US dollars) cannot be circulated directly after entering China. The actual process is that the State Administration of Foreign Exchange receives US dollars, and then issues additional RMB according to the exchange rate to foreign investors, who then invest in China with RMB. After China joined the WTO, this trend has grown rapidly, making a large part of the newly issued RMB endorsed by US dollars. Of course, the State Administration of Foreign Exchange cannot sit and wait for the depreciation of US dollars. While buying a large number of US bonds to earn interest, it also indirectly introduces the credit of the US government to endorse the RMB through US dollars and US bonds.
This story is Web3-ized. Can't the RMB issued through private placement be understood as a kind of Wrapped USD? These RMB issued through the reserve of USD borrow the credit of USD.
Countries and regions that implement the linked exchange rate system
The most typical example is Hong Kong. The linked exchange rate system has been implemented in Hong Kong since October 17, 1983. Through a rigorous, robust and transparent currency issuance system, with 100% foreign exchange reserve guarantee, the Hong Kong dollar exchange rate has remained stable in the range of 7.75 to 7.85 Hong Kong dollars to 1 US dollar. The Hong Kong dollar has turned itself into a voucher for the US dollar, but it is not 1:1.
Under normal circumstances, the Hong Kong Monetary Authority will not intervene in exchange rate fluctuations. The three note-issuing banks (Bank of China (Hong Kong), The Hong Kong and Shanghai Banking Corporation Limited, and Standard Chartered Bank) conduct arbitrage activities to stabilize the exchange rate. When the Hong Kong dollar is about to exceed the narrow range of 7.75 to 7.85, the Hong Kong Monetary Authority will use its US dollar reserves to buy Hong Kong dollars or sell Hong Kong dollars in exchange for US dollars, using two-way means to forcibly lock the exchange rate between the two currencies. [3]
This story is Web3-ized. The existing Hong Kong dollars before 1983 were backed by the gold standard, just like the DAI issued with over-collateralization before that. The arbitrage behavior of the three note-issuing banks is the on-chain arbitrage robots trying to level the price difference between DAI and other stablecoins. The role of the Hong Kong Monetary Authority is equivalent to the PSM module of MakerDAO.
Two forms of currency endorsement
From the above examples, we can abstract two sources of endorsement:
The part backed by hard currency (mainly the US dollar today) or precious metals (mainly gold) is called “hard backing”.
The part of the small country's endorsement with its own credit is relatively weak and can be called "soft endorsement".
Almost all small countries' legal currencies use the "hard" part of their reserves to improve the "quality" of their own currencies, and then quietly add the "softer" domestic credit to dilute it and collect "seigniorage."
If a country is irresponsible, such as Venezuela, it also has a certain amount of hard currency reserves, but after adding several zeros to the currency face value, that little bit of hard currency is meaningless. Such hyperinflation cannot solve the problem of foreign currency debt, but can only reap the people of the country.
If a country is more responsible, it can fully enjoy the benefits of the "hard backing" of its currency, slowly add its own "soft" elements while maintaining a relatively stable currency value, and gradually expand its own credit. Just like Rome in the era of precious metal standard, it continued to add water to reduce the quality of gold and silver coins at the end of the empire, and continued to collect coinage taxes for more than a hundred years.
Comparing DAI to a small country’s fiat currency
So for DAI, if USDC and US debt are considered as external hard endorsements, what is its "soft endorsement"? Obviously, it is the part generated by over-collateralization, which is not "soft" and is the only issuance method in decentralized stablecoins that can withstand long-term testing. This is more like a "hard-hard" behavior, replacing the "soft" part of small countries' continuous issuance of currency with watered-down, over-collateralized, fully-reserved, open and transparent issuance rules.
The problem with over-collateralizing stablecoins is that when the underlying asset price fluctuates rapidly, large-scale liquidation activities may cause fluctuations in the exchange rate and issuance of DAI, and the growth rate of money supply is relatively slow. For DAI, the significance of this "hard-to-hard" approach is more to take advantage of the massive influx of US dollars into the decentralized world, rapidly increase the issuance of DAI (through 100% reserve issuance of the PSM module), and increase the stability of the exchange rate of DAI.
The significance of relying on external credit to achieve rapid growth in issuance is very significant. One of the reasons why gold gradually withdrew from the international trade settlement currency is that after the industrial revolution, the productivity of modern society has exploded. Compared with the rapid increase in goods and services, the supply of gold as a currency has not kept up, resulting in a deflationary trend. Deflation, like hyperinflation, is a very bad thing for the economy. In addition to maintaining the stability of its own anchor, DAI is also very important to increase its issuance to match demand when the entire cryptocurrency market grows in size.
The significance of reserve diversity
After understanding the above examples, we find that the process of MakerDAO seemingly creating currency is actually the process of MakerDAO replacing the reserve components in its own balance sheet.
Increase USDC reserves: As real-world dollars continue to flow into the crypto world through stablecoins, DAI also gains the ability to quickly increase its supply. It is no longer limited by the previous dilemma of slow supply expansion when using mainstream cryptocurrencies such as ETH as over-collateralization.
Increase U.S. Treasury reserves: Skip the intermediary of Circle and directly enjoy the endorsement of U.S. Treasury bonds issued by the U.S. Treasury. If more U.S. Treasury bonds were replaced to endorse DAI, then in the last USDC run crisis, the impact on DAI would be smaller. This is the positive role that reserve diversity plays in exchange rate stability.
Among MakerDAO’s asset types, we can also clearly see that the proportion of real-world assets RWA (such as U.S. Treasury bonds and other assets) is increasing, and the reliance on stablecoin assets is decreasing.
Summarize
After analyzing the question "Does MakerDAO share the Fed's ability to create money?" from two perspectives, we can find that the answer is no longer important. MakerDAO's purchase of U.S. debt is a replacement of the assets allocated on the asset side of its balance sheet as the "central bank" of DAI, and this replacement ability is the key.
In fact, central banks in the real world also have the ability to choose the assets they allocate. For example, in 2008, in order to save the subprime mortgage crisis, the Federal Reserve began to accept mortgage-backed securities (MBS) into its asset side; the Bank of Japan magically held a large number of Japanese company stocks as assets through trust funds, so that the Bank of Japan became the largest single shareholder of many large companies.
So in summary, the significance of MakerDAO purchasing US Treasury bonds is that DAI can use the power of external credit to diversify the assets behind it, and the long-term additional income brought by US Treasury bonds can help DAI stabilize its own exchange rate and increase the flexibility of issuance. In addition, incorporating US Treasury bonds into the balance sheet can reduce DAI's dependence on USDC and reduce single-point risks. All in all, it is beneficial to its development. We look forward to it making greater achievements in the development of decentralized stablecoins.
Reference：
[1]https://cn.tokeninsight.com/zh/research/analysts-pick/understanding-dai-let-it-not-be-wrapped-usdc-anymore
[2]https://mirror.xyz/bocaibocai.eth/_66d8wRKfs7ZYBfqgMOHH4Lm3GWrRfWg-7fkzU-hMPQ
[3]https://zh.wikipedia.org/zh-hans/Hong Kong Linked Exchange Rate System
[4] https://myantokengeek.medium.com/Popular Science-Web3-Balance Sheet-fc41440b3e1c
[5]https://forum.makerdao.com/t/makerdao-2022-financial-results-and-retrospective/19636
[6]https://dune.com/SebVentures/maker---accounting_1