Peg Stability Module (PSM)

What does the PSM actually do, and how is it different from ordinary “Arbitrage that holds the peg”?

Ordinary peg-holding arbitrage relies on enough buyers, sellers, and market depth, with arbitrageurs moving price back by trading across venues. But that depends on depth; when depth is thin, the peg goes soft. The PSM is different — it's an official fixed-rate swap window provided by the protocol, guaranteeing in plain terms that you can swap $1 of USDC for exactly one DAI, with zero slippage, no borrowing, and no debt created. That gives arbitrageurs a permanent, official 1:1 channel. The result is that DAI's deviation from $1 is squeezed to near nothing, because any deviation beyond the fee gets erased instantly by arbitrage. In short, ordinary arbitrage leans on the market; the PSM is the protocol itself stepping in to provide a hard, near-perfect 1:1 channel, turning the peg from “roughly stable” into “almost nailed down.”

Why is the PSM often criticized for “making DAI less decentralized”?

The issue is that USDC swapped in through the PSM doesn't disappear — it stays in the protocol's reserves as backing for DAI. When lots of arbitrageurs swap USDC for DAI through the PSM, DAI's reserves accumulate a large pile of USDC — at one point, more than half of DAI was actually backed by USDC. That's awkward: DAI claims to be a “decentralized, not reliant on any single institution” Stablecoin, but if a big chunk of its collateral is USDC, its fate is indirectly tied to Circle. When USDC briefly depegged to $0.88 during the March 2023 Silicon Valley Bank event, DAI was dragged down with it — the cost of the PSM playing out live. The critics' core point: you think you're holding a decentralized asset, but you're actually bearing USDC's centralization risk.

Is the PSM swap really zero-cost — are there fees or caps?

Not entirely zero, but close. The PSM usually carries tiny in/out fees (called tin and tout in Maker's design) — say 0% in, 0.1% out — set by governance vote, and most of the time very low or even zero, so to arbitrageurs they're nearly negligible. Beyond fees, the PSM has one key limit: each PSM has a “debt ceiling” — a cap on how much USDC that swap window can absorb. The point of the cap is exactly to control the USDC-dependency risk from the previous question — to stop DAI's reserves from being flooded without limit by one centralized Stablecoin. So in practice the PSM is a very-low-fee swap channel with a quota ceiling; when the quota is full, the hard Arbitrage channel temporarily stops working, and the peg leans a bit more on market depth again.

Advanced: how did Sky later reduce the USDC dependency the PSM creates?

Sky (formerly MakerDAO) knows the PSM is double-edged: it stabilizes the peg but stuffs the protocol with USDC. The fix wasn't to scrap the PSM but to “put the incoming USDC to work.” Concretely, through the protocol's allocator units, the USDC collected by the PSM is largely deployed into real-world assets (RWAs) — mainly short-term US Treasuries — plus some on-chain strategies. This achieves two things: first, it lowers the single exposure to “USDC sitting idle in reserves,” diversifying the collateral across Treasuries, crypto vaults, RWA loans, and more; second, those Treasuries generate real interest, which becomes exactly the yield source the Sky Savings Rate (SSR) pays to sUSDS holders. In other words, Sky upgraded the PSM from a “pure USDC reservoir” into a funding hub that takes capital in and routes it out to earn — a key step in USDS evolving from DAI into a yield-bearing stablecoin.