Thread by @Rewkang

0) To understand MKR value accrual, you need to understand its economic underpinnings.

I just published Maker (MKR) Valuation Fundamentals - The case for Trillion Dollar Maker

I will summarize in this thread 👇

medium.com/@Rewkang/maker…

1) An undoubtedly top project in the space. Maker has achieved actual product market fit in a sea of userless projects. Yet we still seem to lack an understanding of how value accrual actually works in the MakerDAO system - and what MKR stands to be worth in the long run.

2) As humans, we tend to find analogs when trying to understand new concepts. While equities/stocks are a commonly referenced analog, MKR best fits the characteristics of a commodity - it is used as a resource - both to pay fees and to recapitalize CDP liquidations

3) The value of equities derive from the underlying business's ability to generate profits. The value of commodities is derived from the market's supply & demand economics. Thus, we must understand supply & demand curves.

4) Accounted for in MKR units, the supply of MKR is elastic. At a certain point in time, there will be more people willing to sell their MKR At a price of $10,000/MKR than at $10/MKR.

5) The utility functions of MKR in the MakerDAO system cause there to be an inherent & deterministic demand for MKR. The MKR that is demanded for stability fees & liquidations is consumed permanently (referred to as a burn) in the same manner as conventional consumer commodities.

6) Given the following annual average variables, a certain annual MKR demand denominated in Dai can be calculated:

- Total Dai Supply
- MKR Stability Fee
- Dai Savings Rate (DSR)
- Liquidation Penalties

These factors contribute to what we call the “Dai burn ratio”

7) The dai burn ratio is the percentage of Dai’s total network value that is “paid” to the MakerDAO system through MKR burning on an annual basis. Applying the Dai burn ratio to the total DAI supply yields the total MKR demanded/burned in a given year:

8) The MKR/DAI exchange rate can be applied to determine the amount of native MKR demanded by the market. The interesting phenomenon is that that the higher the MKR price, the less MKR is demanded & vice versa. The Maker demand curve follows a power law distribution.

9) Let's pick two data points as an example. Consider a scenario of the MakerDAO system demanding of 1M Dai (in MKR) for fees, At a price of 500 Dai/MKR, this would require 2,000 MKR. At 100,000 Dai/MKR, this would require 10 MKR.

10) Let's flip the script. If MKR demand is actually calculated for in Dai terms, we can look at the supply and demand curves from this perspective as well.

The transformed demand curve is inelastic - the MKR equiv. demanded is constant for a given stability fee & Dai supply.

11) The supply curve follows a root function: Each increase in MKR price results in a subsequently larger amount of MKR (denominated in Dai) available to the market supply.

12) So how do we derive a valuation for MKR given this economic foundation? We can start by understanding that the amount of value burned is economically equivalent to the amount of value distributed to non-burned tokens.

13) Think about it this way - If MKR supply is perpetually burned, but demand is consistent or growing, then MKR's supply must continuously expand to counteract this burning. MKR tokens aren't freely minted, so the mechanism through which supply expands is through price increases

14) The percentage of MKR supply that is burned on an annual basis is referred to as the MKR Burn Rate, and can otherwise be thought of as a rate of return.

15) Given cost of capital principles, we know that this rate of return will equilibrate to a level that investors are willing to accept given their expectations of risk & future growth for a MKR investment

16) This is traditionally how investors think about investments —higher risk investments (i.e. stocks) necessitate a higher return, while lower risk investments (i.e. US Treasuries) will be bid down to lower yields by the market

17) In the case of MKR, the higher the MKR market cap, the lower the burn rate/rate of return, and vice versa. With this perspective, we can model out potential MKR market caps that correspond to various rate of returns in different scenarios.

18) Using this framework, we can come up with up a (rough) estimate of a valuation that MKR may potentially achieve. To arrive at this estimate, there are three variables that are important to focus on:

- Dai Supply
- Dai Burn Ratio
- Expected Annual Return

19) The total Dai supply is a function of both the collateralization ratio and the assets collateralized.

The average collateralization ratio currently hovers between 250–300%. In the long run, I believe this will drop to 150% due to lower volatility of collateralized assets.

20) We can bucket the potential assets to be collateralized into 3 main categories:

- Permissionless Cryptoassets ($50–100T)
- Tokenized Fiat ($40–100T)
- (Semi)Fungible Non-Bearer Assets (e.g. stocks, treasuries, corporate bonds, commodities) ($100T+)

21) The average collateralization rate among these assets could fall within the range of 0.5% - 5%. For context, in just over a year of launching, MakerDAO has already locked >2% of total ETH supply.

22) The Dai Burn Ratio is primarily driven by the stability fee & DSR. For SF, the interest rates of secured loans work as a proxy, as they are similarly backed by assets. Looking specifically at the 30-year Fixed Rate Mortage, we find that the average rate floats between 4-7%.

23) The DSR will play a large role in managing the Dai peg. My estimated range for DSR is 2–5%.

Taking this all together, we can approximate a 2–4% Dai Burn Ratio. Here are a few scenarios modeled out:

24) The last step is determining the rate of return investors are willing to accept.

Based on risk & growth factors, it is likely that the rate of return ranges between 3–6% in the long run after Maker is a proven system & model .

25) Taking all of these factors together, It is clear that there are many potential scenarios which lead to a Trillion Dollar + valuation. I've open sourced the model for anyone to plug and play with various assumptions themselves.

docs.google.com/spreadsheets/d…

26) The point of this analysis was to paint a picture of what MKR could be worth if the first step of the vision of the MakerDAO was accomplished - becoming a global permissionless credit facility.

27) Of course, as with any fledgling project, there are many risks and uncertainties. These include trust assumptions dealing with non-bearer assets, code risk, and competition with decentralized/centralized alternatives.

Thanks to Nik Kunkel, @_alekslarsen, @mrjasonchoi, and many others for long discussions around everything MakerDAO that have shaped my thoughts on this.

cc: @RuneKek @cburniske, @alexhevans, @KyleSamani, @ricburton, @cyounessi1, @cdixon, @marcandu