Make Money Selling Dai
Presently, you can earn a return of around 1% by selling an asset known as Dai. That is because people are willing to pay a 1% premium to acquire Dai on exchanges like Coinbase.
Dai is a cryptocurrency. There are only two ways to acquire Dai. You can buy Dai from someone, or make it yourself.
You can make a profit selling Dai you make yourself. There is an interest cost associated with earning that profit. However, it is negligible over short periods. Here is how trading Dai can make money out of thin air.
The cryptocurrency world loves decentralization. Even organizations aspire to be decentralized. One type of cryptocurrency-inspired organization is called a decentralized autonomous organization (or DAO). Some of these organizations encourage arbitrage.
Maker is one such DAO. Thanks to Maker, you can take out a collateralized debt position (or CDP). A CDP is a fancy word for a loan. The loan is not free. It must be repaid with interest.
There is another catch to this loan. The CDP that Maker allows us to take out must be collateralized. Presently, the collateral required for a Maker loan is Ether (or ETH).
Collateral
Not only do you have to use ETH as a guarantee, but the amount of ETH that you need to supply as collateral is also more than the value of the loan itself. Presently, the minimum collateral you need to put up for 100 ETH worth of Dai (or DAI) is 150 ETH.
What sense does this make? The loan Maker offers us doesn’t make much sense to a consumer. It is actually irrational. It makes little sense to use 150 ETH to take out a loan to buy 100 ETH worth of chocolate.
Not only am I paying more for 100 ETH worth of chocolate, but also am I paying interest until I retire my debt to Maker. An overcollateralized loan is totally nonsensical in this regard. Clearly, Maker isn’t trying to make it easier to acquire real goods like chocolate.
Why, then, does Maker exist? Why have people committed half a billion dollars to Maker’s financial contraption?
Leverage
The reason is simple. The assets locked into Maker CDPs were not committed out of a desire to consume real goods and services. The assets were committed because of a desire to make more on an existing financial investment.
In some ways, the total value locked (TVL) in CDPs an indication of a bullish sentiment around Ether. CDP holders are most likely bullish on ETH in the long term. If they weren’t bullish, they’d invest their idle capital directly into some other enterprise with a cost of capital under 14% (i.e. the present interest rate on a Maker CDP).
However, they’d never do that because they expect the value of ETH to appreciate more than 14% over the year and they don’t want to miss out on that increase in the value of their investment in Ether.
Given Ether’s history of appreciation, it is not unreasonable to expect ETH to appreciate more than 14% over the year. Therefore, as long as you can repay that 100 ETH loan (plus interest) in a profitable scheme, a CDP is totally rational.
For example, if my buddy says to me that he can guarantee me a 15% return in some endeavor, I’d be a fool to not hang on to my ETH if I expect ETH to appreciate 17% or more within a year. ETH would provide a better return. Simultaneously, I’d be a fool not to take out a Maker CDP and invest that additional capital into my friend’s venture. His venture returns more than the cost of the Maker loan I’d use to finance his venture.
Maker gives us financial leverage. The acquisition of leverage is the only valid reason to take out a CDP. The awesome thing about the leverage Maker affords us is that it is totally decentralized and impossible to censor.
Volatility
There is an issue with the CDP. It is collateralized with a volatile asset (i.e. ETH). Volatile assets have prices that are constantly and frequently changing. It would not be wise to finance your chocolate consumption with volatile collateral.
Maker provides financial leverage in the form of Dai. Dai does not fluctuate as much as ETH. It is redeemable for one dollar. The US dollar has a stable value. The US Federal Reserve works hard to make it that way. Similarly, Maker will do just about anything to make Dai stable in value with respect to the US dollar.
Mild price fluctuations are not bad for CDP holders when the price of Ether generally appreciates with respect to US dollars. However, volatility is not good when Ether declines in value with respect to the dollar. Declines in the value of ETH can offset the gains from selling DAI (or make you regret consuming that chocolate even more).
Serious fluctuations in price are worrisome. If the price of Ether declines past a certain threshold, Maker forces us to pay our debt. This scary phenomenon is known as liquidating a CDP. The liquidation fee is presently 13%.[1]
Hedging
To make money risk free trading DAI, we need to limit our exposure to a decline in the price of Ether with respect to the dollar. Hedging allows us to make DAI to sell profitably at 1% while the value of Ether fluctuates.
A hedge on ETH is a financial contract that expires at some time in the future. At expiration of the contract, a quantity of ETH that you agreed to is delivered to you.
One way of hedging against an undesirable fluctuation is to take the 150 ETH that you want to commit to a CDP and divide it in half. Put only one half in the CDP. Then short the remainder.
Shorting the remainder means selling (the 75) ETH so that you can later purchase it at a lower price. This provides insurance for the other 75 ETH that must serve as collateral for the Maker CDP. Any profit from the short offsets any loss in value in ETH locked in the CDP.
Settlement
The hedge is settled when you take delivery of the ETH you agreed to purchase on expiration. When the contract expires you physically receive the quantity of ETH that you specified in the short. The price at settlement is the amount you contractually owe. It is the price you must pay acquire the ability to sell ETH when you opened the short position.
The simplest way to short ETH is to use Opyn. The Opyn short can be offset at any time. Unfortunately, it will cost you about 0.8% in fees and other transaction costs to do so. [2]
To avoid excessive transaction fees, use dYdX or DDEX. The DDEX user interface (UI) is a little harder to navigate than Opyn’s if you are not familiar with margin trading. That said, the absence of transaction fees makes it worth your while to learn the UI.
dYdX doesn’t charge transaction fees either. dYdX uses Eth2Dai (formerly known as OasisDEX) for shorting ETH with DAI. There is more liquidity on dYdX than on DDEX these days because of this. Eth2Dai has higher transaction volumes and no transaction fees. So use dYdX.
Furthermore, DDEX charges a rental fee of 2.02% presently. However, this 2% annual rate is immaterial if you try this money making scheme over short periods (under 24 hours).
dYdX is presently paying you to short DAI. The dYdX interest rate is -13.11%. That’s fantastic. dYdX gives you a hedge that pays you back!
The chief reason to choose dYdX over DDEX is the leverage factor. dYdX allows us to short at 1X. This keeps the math simple and is also less risky than shorting at 2X.
The DDEX UI encourages you to short with leverage starting at 2X. To keep things balanced, we need to redo our math. Instead of doing a 1:1 split, we need to do a 2:1 split. That means putting 100 ETH into the CDP and only 50 ETH into the hedge.
That 50 ETH must be exchanged for Dai or Tether stablecoin (DAI or USDT) first. Totle has a simple UI for this transaction. You can get there from your Coinbase Wallet iPhone or Android app as well.
The only reason to not choose dYdX over DDEX is if you are planning to hold the short for more than 28 days. Presently, this is not possible on dYdX for regulatory purposes.
Arbitrage
Dai is made through the Maker CDP Portal. The process of making Dai is called minting Dai. When Dai is made, its value is exactly one dollar.
Thanks to market forces, the price of Dai on Coinbase is presently around one dollar and one cent. That one cent represents an opportunity to receive a return of 1% on the sale of Dai.
Consequently, the final part of this profitable enterprise is the arbitrage operation. In our case, arbitrage means minting Dai (using the Maker CDP Portal and the Coinbase Wallet), selling it for USDC on Coinbase, and later repurchasing it when the price corrects.
Convert the USDC premium to USD. Conversion costs nothing on Coinbase and the premium is money you just made money out of thin air.
You aren’t done yet though. The final steps are to close the Maker CDP and offset the DDEX hedge when the Coinbase premium disappears. Both operations require gas. Which is a nagging fee we all have to pay to engage smart contracts on the Ethereum Network. Closing the CDP also requires that you hold a dollar’s worth of Maker tokens (or MKR). Use Totle to acquire MKR from your Coinbase Wallet.
Due to gas, Coinbase/DDEX/Maker network fees, and other transaction costs, the minimum amount of Dai that you need to mint and sell to safely make a profit is presently around 600 Dai. It is hard to be precise about gas cost because they constantly vary.
Either way, exploiting arbitrage opportunities is still primarily an activity for those wealthy enough to have at least 10–20 ETH sitting idly in a hardware wallet. This may all change when Silvio Micali finishes implementing gasless smart contracts on the Algorand Network in 2020.[3]
Conclusion
Arbitrage is taking advantage of the law of one price. Ideally, we would possess an inventory (or quantity) of Dai already on Coinbase. When demand pushes the premium paid for Dai on Coinbase over 1%, we would sell our inventory. Simultaneously, we would acquire Dai somewhere else at a lower price.
In this regard, this Maker arbitrage scheme is not a real arbitrage where the profit is instant. This scheme assumes that you don’t already possess Dai. Consequently, profit depends on DAI reverting to $1 in value on Coinbase. When the value of Dai on Coinbase equals the redeemable value, the Dai made through the CDP can complete the round trip and be used to retire the loan.
Unfortunately, there is no way to determine exactly when that will occur. That said, please repeat this arbitrage as often as you can if the price of Dai is frequently fluctuating between $1.00 and $1.01 (or more). It is your duty as a capitalist. If capitalist seems a vulgar word, replace the word with: rational human being. Efficient markets depend on people doing their best to exploit arbitrage opportunities.
Many thanks to the friends that took a moment to review this article, especially Ben. Your background in market making and financial engineering is so helpful in clarifying what is theoretically transpiring place in this situation. Much respect!
As much as this article may sound like it, this is not financial advice. This is an explanation of the process of participating in the arbitrage opportunity that presently exists on Coinbase thanks to the redeemable value of Dai.
Using margin trading platforms and opening CDPs are risky activities. You should educate yourself on the risks of using smart contracts and the principles of hedging and arbitrage.
[1] It’ll cost you, but use DeFi Saver if you are concerned about liquidations.
[2] UPDATE (2019/09/18): Opyn is shutting down. Use Fulcrum instead. The UI is straigth forward and there are no fees.
[3] I am an Algorand Ambassador and the CMO of IoTrust. So I am in the habit of shamelessly plugging Algorand, DDEX, D’CENT Wallets, and other blockchain solutions that I value.
