[ARFC] Chaos Labs - Migrating MKR to SKY on Aave V3 Ethereum Main Market - 10/20/24

[ChaosLabs]

Summary

In light of the recent rebranding of MakerDAO’s MKR token to SKY, Chaos Labs recommends initiating a migration from MKR to SKY for the Aave V3 Ethereum Main market. This report evaluates the current status of the MKR market and proposes new parameters for the SKY listing. The migration aims to address potential liquidity and liquidation risks while ensuring the safety of the protocol and its users.

Motivation

The primary motivation for migrating from MKR to SKY stems from the liquidity shift from MKR to SKY on DEXs. Although MKR and SKY are convertible 1:24,000 and the conversion process is atomic, the migration also involved moving the primary liquidity pool from MKR/DAI to SKY/USDS. This liquidity migration poses a risk during liquidation events, as liquidators may struggle to find efficient SKY routing. Not all DEX aggregators include the migration contract, and those that do may not automatically route through the SKY/USDS pool. This could lead to delayed liquidations, increasing the risk for the protocol. The chart below shows that MKR-USDC liquidity has declined quickly since the launch of SKY at the end of September.

It is worth noting that additional revenue from Sky operations is directed towards SKY liquidity. This ensures that the liquidity situation will improve over time.

Usage

Currently, the largest user in the MKR market represents a significant portion of the market’s usage. The user’s position represents 77% of the supply deposited and 77% of the debt ceiling. The user is also borrowing against their MKR on other lending markets, which further compounds the risk; on-chain liquidity may not be sufficient to cover potential liquidations if they were to occur simultaneously across markets. However, we note that the user’s positions carry differing health scores, reducing the likelihood that all positions would be liquidated in parallel.

While the MakerDAO rebrand opened a conversion of MKR to SKY on a 1:24000 basis, and the conversion is reversible, the largest user’s extensive borrowing across multiple markets and the limited routing to the available SKY liquidity highlight the need for migration.

Migration Plan

The proposed migration plan involves several timed steps to ensure a smooth transition while minimizing risk:

1. Reduce LTV: The first step is to set LTV to 0%, ensuring that no additional value can be borrowed against MKR collateral. This change will further incentivize current and future MKR suppliers to move their positions to SKY.
2. Gradual Debt Ceiling Adjustments: As part of the migration, we will gradually reduce the MKR debt ceiling whenever part of it becomes unused; e.g., currently, the debt ceiling is $12M, but only $7.1M is utilized. We will increase the SKY debt ceiling by the same amount for each reduction in MKR’s debt ceiling. This gradual approach ensures a controlled transition from MKR to SKY without allowing further leverage in the market.
3. List SKY with MKR Parameters: SKY will be listed on Aave with the same parameters as MKR, with the exception of the debt ceiling, supply cap, and borrow cap. The suggested supply and borrow caps are derived by multiplying the caps of MKR at the time of listing by 24,000, as the conversion ratio suggests. The debt ceiling will start from the size of the reduction of the MKR debt ceiling and gradually increase over time.
4. Monitor and Adjust: Throughout the migration process, Chaos Labs will monitor the market for liquidity stress and provide recommendations to ensure stability and gradually migrate the debt ceiling. The goal is to prevent a single user from over-leveraging the protocol while ensuring a smooth shift to SKY as the primary asset.
   In addition, we will also provide recommendations to reduce the LT of MKR to ensure that more positions slowly migrate to the SKY asset. The LT reductions will be correlated to the open positions in order to minimize forced liquidations.

Recommendation

As the first three points of the Migration Plan can be effectively conducted at the same time, we provide the changes we recommend to initiate the migration.

MKR changes

As discussed above, we recommend reducing the LTV to 0% to encourage the use of the new SKY market for new stablecoin borrow positions. We also recommend keeping the LT and the Liquidation Bonus unchanged to allow the existing positions to continue being managed and avoid liquidations.

Additionally, given the recent drop in debt ceiling utilization as it currently stands at 59%, we recommend reducing the debt ceiling from 12,000,000$ to 8,000,000$ to then use as the initial debt ceiling for SKY.

SKY Listing

Since MKR is being migrated to SKY at a rate of 1:24000, the migration contract is instant and atomic, and the SKY asset has a significant amount of DEX liquidity, the asset inherits all the properties of MKR with a significantly larger liquidity routed through aggregators.

For this reason, we recommend aligning the initial parameters with MKR, except for the supply and borrow caps, which are adjusted for the migration rate and the debt ceiling starting from $4M. The new debt ceiling value is derived from the amount by which the MKR debt ceiling was reduced in the recommendation above.

Specification

MKR

Parameter	Current Value	Recommended Value
LTV	65.00%	0%
LT	70.00%	-
Liquidation Bonus	8.50%	-
Debt Ceiling	12,000,000	8,000,000

SKY

Parameter	Value
Isolation Mode	Yes
Borrowable	Yes
Collateral Enabled	Yes
Supply Cap	540,000,000
Borrow Cap	47,520,000
Debt Ceiling	4,000,000
LTV	65%
LT	70%
Liquidation Bonus	8.50%
Liquidation Protocol Fee	10.00%
Variable Base	0%
Variable Slope1	7%
Variable Slope2	300%
Uoptimal	45%
Reserve Factor	20%
Stable Borrowing	Disabled
Flashloanable	Yes
Siloed Borrowing	No
Borrowable in Isolation	No
E-Mode Category	-

Next Steps

1. Following community feedback, submit the ARFC for a snapshot vote for final approval.
2. If consensus is reached, submit an Aave Improvement Proposal (AIP) to implement the proposed updates.

Disclaimer

Chaos Labs has not been compensated by any third party for publishing this ARFC.

Copyright

Copyright and related rights waived via CC0

[LlamaRisk]

Summary

Llamarisk supports the migration proposal but recommends pausing the migration process until MakerDAO governance re-evaluates the proposed branding changes. This reassessment could lead to the reversion of the SKY token back to MKR. Currently, an active Governance Proposal is taking place, with a decision anticipated in early November.

Additionally, it has been noted that several functionalities associated with the SKY token have yet to be activated, creating uncertainty regarding the token’s full role within the Sky ecosystem due to the absence of comprehensive tokenomics documentation. Furthermore, geographical limitations affecting SKY token functionalities pose a drawback for certain users.

SKY Token Mechanisms

The SKY token can only be minted by upgrading MKR or by supplying USDS to the USDS-SKY Rewards. The SKY token rewards have a pre-determined amount of 600M tokens per year to be allocated, which counts towards the circulating supply of the token, and it becomes claimable in the UI as rewards accrue.

Users can upgrade their MKR to SKY at the rate of 1:24000. Nonetheless, the token’s use cases are still limited at the time of writing. At later stages of Sky Launch, SKY is previewed to gain additional features, including Sealed Activation and Regular Activation, which would give eligible users USDS and Token Rewards for committed participation in Sky Governance. SKY tokens can also be swapped back to MKR at the same 1:24000 ratio natively; therefore, the MKR debt can still be liquidated efficiently.

Sky Governance has yet to indicate that MKR will be completely discontinued. Accordingly, it is expected to remain unaltered for the foreseeable future unless Sky governance decides otherwise. In the meantime, users can continue to hold and use MKR tokens in the same ways as before the rebranding. Therefore, the decision to upgrade the tokens is currently optional.

However, due to the lack of tokenomics documentation, there are some parts of the SKY functioning that remain unknown, as outlined in the Sky Governance Forum post, in the original MakerDAO system, MKR tokens could be minted and sold to cover outstanding debt if the protocol’s surplus buffer was insufficient. This mechanism served as a last line of defense for the system’s solvency, but it is still being determined if SKY has retained this function.

Updated Legal Terms

Sky. money’s most recent Legal Terms, effective as of October 22, 2024, delineate geographical limitations on core platform functionalities, specifically the Sky Savings Rate mechanism, Sky Token Rewards program, and the Upgrade feature - the latter being exclusively applicable to MKR-to-SKY conversions. These restrictions are noteworthy as they affect all United States and Switzerland users.

Sky.money has implemented technical measures such as geoblocking protocols and VPN detection systems to enforce these jurisdictional constraints. The technological safeguards effectively create a barrier preventing users from restricted jurisdictions from participating in the one-directional token upgrade process from MKR to SKY.

Potential Rollback

In the face of the Maker → Sky rebranding, many users have expressed confusion over the overlapping roles of the Maker and Sky brands, especially as Sky also shares its name with the governance token. Some community members remain loyal to the Maker brand and its reputation, which requires addressing its identity and MKR tokenomics. To address these concerns, the proposal outlines options, including maintaining Sky as the core brand or re-establishing Maker as the central brand with possible updates to its identity.

Source: Sky Money Governance Forum, 25th October, 2024

Moving forward, community feedback will shape these decisions through a series of governance polls, emphasizing balancing progress with the Maker brand’s legacy. The outcome could lead to a re-establishment of MKR as the primary token or the potential coexistence of both SKY and MKR.

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk is not directly affiliated with the protocol(s) reviewed in this assessment and did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.

[ChaosLabs]

In line with LlamaRisk, Chaos Labs supports a temporary pause on the migration plan until further information is uncovered surrounding the future of the MakerDAO rebranding.

[LlamaRisk]

Happy to resume this process now that vote has concluded.