There are many reasons why someone may want to borrow against their UMA tokens, including asset diversification, tax minimization, acquiring leverage for yield farming, taking a levered long position on UMA, and so on.
However, there are security risks to making UMA tokens available to borrow on protocols like Aave. An unlikely scenario is that enough tokens could become available to borrow that someone could acquire > 50% of the voting tokens and corrupt the DVM. This is something we could see coming from a mile away and figure out how to address, so let’s ignore that possibility for now, though acknowledging that it meaningfully decreases the Cost of Corruption.
A more realistic risk is someone borrowing tokens to boost their voting rewards so much that it would be to their advantage to raise spurious disputes to the DVM, since their voting rewards would be greater than the final fee, and as a borrower of UMA token holders, they have no long-term skin in the game. They could raise disputes, borrow tokens before the snapshot, sell their rewards, and pay back their loan for a profit.
UMA as Collateral on Maker and UMA
An alternative to making UMA available to borrow on lending protocols is making it a collateral type on Maker, covering the common use case where you want to lock up collateral to borrow Dai. Intuitively, I think this would increase the Cost of Corruption, since it removes UMA from circulation, and in the event of an UMA price dip, borrowers would need to buy UMA tokens to lock up as additional collateral or pay down their debt to avoid getting liquidated. This would add an additional layer of price defense before we get to the buy-and-burn outlined in our documentation.
Another alternative along the same lines is making UMA available as a collateral type within the UMA protocol itself. This is more useful, since you can mint pretty much any kind of synthetic, instead of only being able to mint Dai. It has a similar security benefit, removing UMA from circulation and requiring borrowers to buy up UMA in the event of a price dip to shore up their collateral or pay down their debt. Fees would be paid in UMA tokens, which would go into the store.
These UMA tokens in the store would be useless for a buy-and-burn, for obvious reasons, but would be removed from circulation. I guess you could burn them in the event of a price drop, but I’m not sure the burn would serve any real purpose.
At first glance, I can’t see any risks to the DVM of having UMA as a collateral type, only benefits. I think that having UMA as a collateral type would provide an additional layer of price defense before we would have to resort to a buy-and-burn from the store.
We would get similar benefits by having UMA as a collateral type for MakerDAO.
We would decrease the Cost of Corruption by making UMA available to borrow on protocols like Aave, though the risk may be manageable, and a number of governance tokens are on Aave already. I think the risk of a borrower raising spurious disputes to the DVM to cash in on voting rewards is a realistic attack, though.
If we wanted the ability for people to borrow UMA-like tokens on Aave, and UMA was a collateral type within the UMA protocol, we could set up a uUMA synthetic that tracks the price of UMA but conveys no voting rights. The collateralization ratio could probably be close to 1:1, or maybe exactly 1:1, since the synthetic price literally tracks the price of the collateral. Need to think about that a bit more.
This uUMA could then be made available on lending platforms like Aave without increasing the risk to the DVM. In fact, there may be a continuous increase in demand for UMA to lock up as collateral to mint uUMA that can be loaned to people who want short-term price exposure to UMA and aren’t concerned about not being able to vote. So, like locking up UMA to mint other synthetics, this probably increases the security of the protocol by removing actual voting UMA from circulation.
UMA Short Positions
One thing to think about is that allowing UMA to be used as collateral within the UMA protocol also allows people to short UMA. I don’t know if this creates a risk to the DVM. At first glance, I think it’s actually a security benefit, since UMA locked up as collateral is not available to purchase for corrupting the DVM when the price drops, and someone looking to close out their short will need to buy UMA tokens to pay back their debt, further reducing the tokens available to an attacker.