It was only a matter of time until the MakerDAO lawsuit appeared. On April 14 the Maker Foundation was hit with a class action suit after the “Black Thursday” crypto crash last month exposed fundamental flaws in its decentralized lending platform.
A group of disgruntled borrowers are demanding at least $8.325 million in compensation, alongside $20 million punitive damages, and allege the Maker Foundation “misrepresented the actual risks they faced” in the event of a sudden price drop.
The court document details how clients were invited to use cryptocurrencies—notably ether—as collateral to receive loans paid out in DAI, a stablecoin created by Maker. There were told there were “certain measures in place to prevent significant investor loss,” the suit added.
It then alleges that these systems badly failed. When ether plummeted in value on March 12, “mass liquidation events” took place that should have triggered auctions for the collateral of borrowers, meaning they would have suffered “minimal, or at least mitigated, losses.” The plaintiffs claim that the Maker protocol instead sparked “pseudo auctions” where bots were allowed to buy bundles of 50 ETH with zero-dollar bids, leaving borrowers with nothing.
“Collateralized debt position holders, despite being promised that auction and over-collateralization policies in place would mitigate against dramatic drops in the value of collateral, instead lost 100% of the collateral they invested with the Maker Foundation,” the document filed in the U.S. District Court for the Northern District of California adds.
Lead plaintiff Peter Johnson says his goal is to “compensate victims of the Maker Foundation’s neglect and malfeasance that directly created the conditions leading to the $0 bid vulnerability.”
According to the court document, Johnson had 1,713.7 ETH locked up in a collateralized debt position on Black Thursday that was worth $208,000 when it was liquidated—with a single bot coming along and buying this collateral for $0. His lawyers claim that, if Maker’s systems had worked as advertised, he would have only lost $42,000, about 20% of his position.
It is alleged that “utilized oracles” used by Maker—simply described as price feeds that monitor the price of ETH and subsequently activate liquidations—“failed to maintain accurate and updated prices.” Two other factors are blamed: the crash causing “extraordinarily high traffic on the Ethereum blockchain as parties attempted to transfer or sell their digital assets,” and severe restrictions on who was able to bid on the collateral, meaning the best price was unable to prevail during the auctions.
The court document went on to claim that a scenario not unlike “Black Thursday” was envisaged in a white paper published back in December 2017, but Maker “did little or nothing to sufficiently incentivize the creation and maintenance” of a marketplace where liquidations could take place adequately. It also alleges that “highly suspicious” changes to the protocol were made during the coding process—reducing the auction window for collateral from three hours to 10 minutes, “allowing for even less fair market bidding.”
“Covering its own losses”
The April 14 court document also criticized Maker’s actions in the immediate aftermath of Black Thursday—saying the foundation “prioritized and covered its own losses” before the plaintiffs in the class action lawsuit.
It points to the MakerDAO debt auction that was held soon after the crypto crash, which was designed to cover millions of dollars in bad debt. Approximately 5.3 million DAI—with each DAI stablecoin worth about a $1—was generated by selling off newly minted MKR, a governance token. The court filing adds: “The Maker Foundation developed and maintained a system that ensured its interests were protected (and in fact enhanced) before any of its investors. While CDP Holders lost millions of dollars in investment, The Maker Foundation enhanced and lined its own pockets with liquidation penalties and collateral auctions.”
The court document also points to a risk and governance meeting held on March 24 where participants “admitted they had not messaged the risk to collateralized debt position holders that liquidation of CDPs could result in a total loss of collateral.”
According to the lead plaintiff, there could be more than 1,000 members of the proposed class action—with each member “readily ascertainable and identifiable on the blockchain itself.”
On Black Thursday itself, MakerDAO said its community “successfully navigated a brutal storm of external realities.” It has yet to publicly comment on the proposed class action lawsuit.