Maker x Aave: Addressing variable interest rates in DeFi

MakerDAO recently announced a collaboration with Aave to implement the DAI Direct Deposit Module (D3M) to minimize the uncertainty of borrowing DAI through Aave. Due to the different interest rates prevailing in DeFi, DAI users are reluctant to borrow; Aave users who want to use DAI no longer need to worry, thanks to D3M, which solves this problem by enforcing the highest lending rate. The highest borrowing interest rate refers to the highest interest rate at which the loan issued will generate interest over time, which can only be repaid by the borrower.

Furthermore, Maker is expected to earn interest because the borrowing of DAI in the Aave agreement drives a surge in demand. In the words of Haseeb Qureshi, managing partner of Dragonfly Capital, the D3M module “makes Aave like a commercial bank on top of the MakerDAO central bank.” The token liquidity provided by Aave on L2 will enable Maker to consolidate its position as the main provider of stablecoins on L2, while its users can enjoy the security provided by the collateral stored in L1.

How market makers operate in DeFi

The market maker in DeFi provides a token pool, which is usually stored in a smart contract, and users can use the contract to store and borrow constituent tokens. Depositors contribute funds to the fund pool in exchange for special tokens, such as Aave’s interest-bearing tokens or Aave’s a tokens, which represent their contributions and the resulting interest. After providing a certain amount of tokens, the amount of these special tokens received by the depositor depends on the exchange rate. As the exchange rate and time increase, if the depositor wishes to cash out from the pool, then he will be entitled to more contribution tokens.

The interest received by the depositor is represented by the supplier’s annual rate of return (APY). Similarly, the borrower may wish to issue a loan from the pool and do so through the process of over-collateralization: deposit assets whose value exceeds the value of the loan. Loans are issued at a certain interest rate, described by the borrower’s interest rate, and this interest rate is higher than the supplier’s APY.

Why over-collateralize your assets? Why not sell collateral directly in the first place? You may not want to sell these tokens—even though you used them as collateral—in exchange for fiat currency; in fact, use them as The collateral proves how precious they are to you. This over-collateralization ensures that if the smart contract suspects that the borrower is in arrears, the assets will be paid off safely and there will be enough assets to repay the depositor.

If it shows that the value of the borrowed amount exceeds the value of the collateral multiplied by its collateral coefficient, the smart contract will perform collateral liquidation: a measure of the quality of the collateral provided by the borrower.

For an off-chain example, imagine an entrepreneur wants to borrow $5 million. He promised to repay after a period of time, but the bank wants to ensure that if he cannot repay, they have enough assets to repay investors. Therefore, the bank requires collateral—say, a farm worth 10 million U.S. dollars. The US$5 million loan he received has interest. If he cannot repay the principal, the loan will be liquidated and auctioned. Then, the generated funds will be used to compensate the bank’s investors. The farm is mortgaged because the market continues to fluctuate: the assets used as collateral may depreciate. Therefore, assets (farms) whose value exceeds the loan are accepted as collateral.

Maker’s story

Affectionately known as Ethernet Square Maker “central bank”, there are two operators tokens: MKR and DAI. MKR is the governance token used in MakerDAO, while DAI is a stable currency: its value is still pegged to 1 U.S. dollar. Both MKR and DAI can be purchased on exchanges, and their value will increase by stimulating their scarcity.

DAI is created when Maker users lock a certain amount of ETH or other Ethereum-based assets (such as USDC) in Maker vault (a smart contract based on the Maker protocol) as collateral. When users deposit Ethereum-based assets into vault as collateral, they will receive DAI as a kind of loan, which maintains a soft peg to the U.S. dollar. However, because the prices of these assets are always fluctuating, Maker requires users to over-collateralize; the deposited assets exceed the DAI they get. As mentioned earlier, this is the standard practice for the entire DeFi. DAI loans generate interest over time; for borrowers, this interest rate is called a stability fee. An inherent problem with DeFi volatility is that a large amount of stability fees may be incurred over time, which adds disturbing uncertainty to borrowers. If the market’s DAI exceeds its current demand, DAI faces the risk of oversupply; this is equivalent to the value of DAI depreciating over time and its price falling. MakerDAO responded to this situation by increasing the stability fee to incentivize borrowers to repay the loan in part or in full. Incentive repayment reduces the existence of substitute loans in the market.

Maker x Aave: Addressing variable interest rates in DeFi

How does lending work in DeFi.

The loan principal and stability fee must be repaid in the form of a loan-backed loan (DAI). Destroy the deposited DAI to shrink the supply of tokens and push the price back up. DAI is essentially backed by debt. Since the loan has been partially or fully repaid, the corresponding amount of DAI is destroyed.


Aave is also a market maker in the peer-2-contract model, allowing users to exchange assets with smart contracts without having to find peers who are willing to participate in the transaction.

The way Aave works is to use smart contracts to facilitate loans (deposits) and borrowing. Under the incentive of the provider APY, the depositor contributed some assets to the smart contract, and the borrower promised to return the asset (the interest is determined by the borrower APY) after using its assets (such as ETH) as collateral. Its extraction. Just like Maker, Aave ensures that the model is over-collateralized; users end up depositing more collateral than they end up as loan assets.

The borrower’s interest rate is higher than APY. As each transaction on the blockchain occurs, these interest rates will change from time to time, which highlights the availability of tokens in the agreement, which leads to changes in interest rates.

The difference with Aave is that borrowers can choose to issue loans at a stable or fixed interest rate. Stable interest rates can only be maintained for a short period of time-until the agreement urgently needs liquidity or the liquidity provider is not satisfied with the APY they receive-and can be rebalanced. Under certain market conditions, variable interest rates are still a profitable option, so users can choose to switch between the two models for any asset they pledge.

Aave’s liquidity provider receives a token, whose value is still linked to the sum of the value of the underlying token (such as DAI) and the accumulated token interest according to APY. These a-tokens are ERC-20 tokens and can be transferred; the owner will be entitled to the original capital contribution and the resulting interest. In the case of Aave, the amount of a tokens received by the depositor for providing liquidity is fixed in a 1:1 manner; as blockchain transactions continue to accumulate, the corresponding increase in the number of a tokens owned by the supplier indicates Increased the exchange rate.

Constantly changing problems, stable solutions!

Maker is one of the largest Ethereum applications that provides lending services to its users. Fluctuations in loan interest rates are an obstacle to many users who want to borrow DAI on Aave. MakerDAO raised these interest rates to maintain the token’s soft peg to the U.S. dollar and provide stability. These interest rates will remain high until the token price stabilizes. For more than a year, stablecoins have been restricted in supply issues, making DAI lending rates in secondary markets such as Aave unattractive.

On the other hand, Aave has always relied on individuals to provide stablecoins in the past. This approach is no longer in line with the increasing speed that the agreement has experienced recently; it needs an efficient, sustainable and reliable stablecoin export that can provide stablecoins on L2 and consolidate its position.

Where did D3M come from

D3M brings an innovative strategy of creating DAI on the Aave protocol, which can be best explained through the Twitter of MakerDAO’s smart contract protocol engineer Sam MacPherson.

Maker x Aave: Addressing variable interest rates in DeFi

Basically, the MakerDAO community can modify the target borrowing rate of DAI on Aave to ensure the token’s maximum competitiveness in the agreement. D3M functionally allows Aave users to borrow DAI at a fixed maximum interest rate (currently 4%) because the collateral stored on Aave is used to offset the additional interest.

The requirement for D3M is due to fluctuations in stability fees caused by market operations. D3M casts DAI according to the Aave protocol; on the other hand, the corresponding amount of aDAI is stored in its Maker vault. The automatically generated token aDAI is Aave’s native token and is provided to any user who deposits DAI into the pool. aDAI tokens, including tokens stored in Maker vault, like other liquidity pools on Aave, will accumulate APY over time and bring profits to suppliers. Just like other liquidity pools running on Aave. Maker holds aDAI as collateral when minting DAI; in turn, aDAI is backed by the borrower’s collateral stored on the Aave protocol.

D3M Vault will adjust different interest rates by changing the amount of DAI on Aave. When interest rates fall below the expected level, D3M will reduce a certain amount of liquidity to stabilize interest rates. If the interest rate is higher than expected, D3M will cast more DAI into Aave’s loan pool.


Maker benefits from the increased liquidity of its stablecoins, as Aave users will now be encouraged to borrow after the extreme fluctuations in stability fees eased. Due to the existence of D3M, Maker’s dependence on USDC in expanding the supply of DAI has also decreased. The aDAI interest generated by depositing DAI in the Aave agreement will be used as an external source of income for Maker. In addition, since Aave has launched a liquidity mining plan, MakerDAO can also influence Aave’s governance by collecting Aave’s assets.

Maker x Aave: Addressing variable interest rates in DeFi

Aave is currently branching its liquidity pool across L2 and may become a potential gateway for DAI to spread across L2. In the past, the company has relied on individuals to issue stablecoins as loans, but these loans are not robust enough to achieve the path that Aave envisioned. Now, Aave users can get them directly from Maker. Users of the agreement are guaranteed by a double-digit interest rate, which prevents people from taking out loans and avoids the risk of losing collateral in the event of sudden market fluctuations.

The basic goal of MakerDAO is to expand its stablecoin on DeFi and ensure its market position in the rise of new stablecoins.  ~Anthony Beatty Maxbit

In general, this cooperation has opened up exciting new avenues between DeFi, such as the ability to deploy stablecoins through other secondary lenders of L2. The basic idea of ​​D3M—holding the collateral of another protocol in exchange for lower interest rates—can be extended to Web3 applications and the crypto world. A partnership based on agreement and trust is beneficial to users of both parties and encourages competition to re-evaluate the market in order to maintain their competitive advantage. Although D3M is one of the main obstacles to the DeFi industry-a powerful experiment with extreme volatility in interest rates-its basic ideas can be used by other types of DAOs.

This module manages to eliminate high interest rate restrictions on borrowers and adds features that encourage exclusive cross-DAO collaboration. For example, a social DAO can create media markets and exclusive content for its partners. Similarly, DAOs that focus on creators can work with partners to create exclusive spaces for young talents to showcase their skills and gain recognition faster in overpopulated areas. There are two main ways to develop an industry: eliminate restrictions or increase functions. Makerx Aave D3M successfully achieved these two points.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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