Résumé
MakerDAO is a decentralized finance (DeFi) project with a cryptocurrency-collateralized stablecoin, DAI, whose price follows that of the US dollar. Its community manages the currency through a decentralized autonomous organization (DAO). Users generate DAI by locking cryptocurrencies in a Maker Vault at a certain liquidation ratio. For example, a liquidation ratio of 125% requires $1.25 of crypto collateral value for every $1 of DAI.
The stablecoin is over-collateralized to account for volatile crypto prices, and stability fees are also charged. Your cryptocurrency is liquidated and used to recover any losses if your collateral falls below the liquidation ratio.
The DAI remains stable because its DAO controls the stability fee and the DAI savings rate. Stability fees affect the supply of DAI by changing the cost of issuing DAI. The DAI savings rate affects the demand for the currency, which changes the returns of investors who stake DAI. When the DAI moves away from its target price, the DAO uses these two mechanisms to bring it back there.
DAI has similar advantages to other stablecoins and cryptocurrencies. It can be easily transferred around the world, used to make payments or lock in profits and losses. You can also use DAI as leverage and place it in the DAI Savings Rate contract to earn interest.
To participate in governance votes and executive votes, users purchase MKR tokens which grant them voting power. These are used to make decisions related to the Stability Fee, DAI Savings Fee, Team, smart contracts and other topics.
Introduction
Stablecoins are extremely popular cryptocurrencies that provide a middle ground between traditional finance and digital assets. While they mimic fiat currency while operating like cryptocurrencies, these blockchain-based tokens are attractive for “locking in” profits or losses.
To date, the largest cap stablecoins are backed by fiat. They operate by maintaining a reserve that supports the stablecoin. However, stablecoins backed by cryptocurrencies are also popular. In this article, we will look at one of the most famous examples, MakerDAO, and see exactly how it maintains a $1 price with a volatile guarantee.
What is MakerDAO?
MakerDAO is an Ethereum (ETH) project launched in December 2017 by Rune Christensen. It is focused on creating DAI, a crypto-collateralized stablecoin whose price tracks that of the US dollar. Rather than being managed by a group of developers or a single entity, the MakerDAO ecosystem uses the MKR governance token for project proposals and decisions. This governance model is called DAO (decentralized autonomous organization).
Users access MakerDAO through the Oasis DApp. There they can create secured loans, participate in governance and manage their existing Maker Vaults. In this decentralized ecosystem, smart contracts and game theory allow DAI to maintain a relatively stable value. DAI can be used in the same way as fiat-backed stablecoin and offers the same benefits.
What is DAI?
DAI is MakerDAO's stablecoin pegged to the US dollar and one of the largest stablecoins and largest cryptocurrencies by capitalization. The ERC-20 token has an unlimited supply as long as users continue to post collateral to issue more DAI.
MakerDAO uses crypto-collateralization to maintain its value rather than a vault of fiat reserves. It can be a bit complicated to understand how crypto, known for its volatility, can provide support for a stablecoin. In short, the cryptocurrency a user deposits to issue DAI has a much higher value than the stablecoin they receive. This leaves additional room for downward price movements of collateral.
Just like any other stablecoin, DAI has several advantages when used:
1. It is best suited for expenses requiring stability. Merchants and individuals do not always accept payments in cryptocurrencies which can change in value overnight.
2. DAI benefits from all the benefits of blockchain. Stablecoins can be transferred worldwide without a bank account. They are also incredibly safe if stored correctly.
3. You can use it to secure profits or losses and hedge against certain risks. DAI will offset some of the overall risk in your portfolio and is a useful way to enter or exit positions without going off-chain.
How does crypto collateral work?
Collateral is a common concept in traditional finance that you are probably already familiar with. When you take out a loan, you must provide something of value as collateral. It is used to guarantee the loan if you cannot repay it.
Physical and fiat guarantee
A pawn shop is a good example. You can hand over jewelry (collateral) in exchange for a cash loan. You can then repay the loan plus a fee to get your collateral back or allow the pawnbroker to keep the collateral to repay their loss. Collateral serves as a safety net, and the same concept applies to mortgages and car financing. In these cases, the goods (property or car) serve as collateral.
Fiat-backed stablecoins like BUSD are collateralized with fiat currency. A user deposits their money (the collateral) and receives tokens in return. He can return these tokens to the issuer if he wants, but the issuer still has the money if he doesn't. This mechanism allows arbitrages to be carried out which make it possible to maintain the parity of the stablecoin. To learn more about this, see our article What is a stablecoin?.
Guaranteed crypto
Crypto-collateralized stablecoins like DAI accept cryptocurrencies as collateral rather than fiat currencies. A smart contract with rules manages these funds: issue X stablecoin tokens for Y ETH deposited. Return amount Z of ETH when amount X of stablecoin is returned. The exact amount of collateral needed depends on the project issuing the token. This ratio will mainly depend on the volatility and risk of the asset used as collateral.
What is DAI over-collateralization?
Stable, relatively low-risk assets, such as fiat currencies, precious metals, and real estate, make the best collateral. As we mentioned, using cryptocurrencies as collateral is riskier for lenders because their price can change significantly. Imagine a project that asks for $400 worth of ETH as collateral for 400 tokens worth $1 each.
If the price of ETH suddenly drops, the lender's collateral will not cover the loan they have provided. The answer to this problem is to overcollateralize: the lender asks for $600 worth of ETH when it lends 400 tokens of its USD stablecoin.
What are Collateralized Debt Positions (CDPs)?
MakerDAO has used over-collateralization to maintain reliable parity for years. As smart contracts control the DAI issuance process, it works efficiently and without human interference. When you want to borrow DAI stablecoins, you lock the cryptocurrencies in a CDP smart contract. This CDP will set a liquidation ratio, for example 1.5x, meaning you will need to provide $150 worth of ETH for every $100 worth of DAI. A user can of course provide greater collateral if they wish to reduce risk. If the collateral amount falls below 150% (1.5x), it incurs a penalty fee. Ultimately, the user risks liquidation if they do not repay the DAI with interest (called stability fees).
What are Maker Vaults?
Maker Vaults are where users post their collateral and issue DAI. These allow you to use several different cryptocurrencies as collateral at the same time. The Maker Vault also destroys DAI once a user returns it. The process is as follows:
1. You deposit supported cryptocurrencies into the Maker protocol.
2. The deposit opens a Maker Vault position.
3. You can withdraw an amount of DAI determined by your collateral amount. You will also have to pay the stability fee.
4. To get your crypto back as collateral, repay the withdrawn DAI.
You are free to generate or return DAI and add or remove your collateral at any time. However, you must respect the liquidation ratio indicated in the Vault. If you fall below this ratio, the Vault will liquidate your guarantee.
How does the value of DAI remain stable?
In addition to reducing risk for MakerDAO lenders, the CDP mechanism allows the value of DAI to be pegged to USD. MakerDAO can also vote to change the stability fee and the DAI Savings Rate (interest paid to stakeholders in the smart contract DAI Savings Rate) to manipulate the supply and demand of DAI. These three tools work together to maintain the value of DAI at $1. Let's see how exactly this works:
1. When the DAI value drops below its target value, the system allows users to repay their debts, recover their collateral, and destroy their DAI. This can be done by increasing the stability tax, which makes borrowing more expensive. The DAO could also increase the DAI savings rate, which would increase demand for the token.
2. When the DAI is above its target value, the opposite happens. The DAO creates incentives to issue DAI for example with a lowered stability tax. This creates more DAI and increases the total supply. MakerDAO could also decrease demand for DAI by reducing the DAI savings rate, meaning investors would turn to other sources of income.
DAI Use Cases
As mentioned, DAI is used like any other stablecoin and shares the same advantages. You don't even need to issue it yourself and you can buy DAI on the crypto market, like on Binance. DAI also has a few unique use cases:
1. Leverage – Imagine you have $1,000 worth of ETH and you think the price will increase. However, you currently have no additional funds to purchase ETH. You can use your ETH as collateral, issue DAI, and then use it to buy more ETH. If the price of ETH rises and you want to recoup your gains, you can sell some of it to redeem the DAI tokens and get your collateral back.
2. DAI Savings Rate - You can earn interest by depositing DAI into the DAI Savings Rate smart contract. This rate varies as the DAO attempts to control the price of DAI.
Where can I buy DAI?
DAI is available for purchase on major crypto exchanges, including Binance. After creating an account and completing all KYC checks, you can purchase DAI directly with a credit or debit card.
Choose the fiat currency you want to use to pay in the top field and select DAI at the bottom. You will then see clear instructions on how to add your card to your account. If you wish, you can also use the exchange view to trade DAI against another cryptocurrency.
How do I participate in MakerDAO’s governance system?
To have a say and vote in MakerDAO, you will need to hold project governance MKR tokens. The token has a maximum supply of 1,005,577 MKR and approximately 40% was distributed to the team and early investors upon deployment. The DAO kept the rest for future sales.
MKR holders can vote to change the platform's stability fees, DAI savings rate, liquidation ratio and other aspects. Their vote is proportional to the amount of MKR they hold. You can visit the MakerDAO governance portal to view and participate in current votes.
Governance votes
A governance vote allows users to create non-technical proposals that other MKR holders can vote on. For example, it could be a change in governance, goals, team or budgets. A governance vote uses the instant runoff voting mechanism, which means you can rank your choice among multiple options.
Executive Votes
Executive votes concern technical changes to smart contracts. Proposals use a rolling approval voting system, meaning new competing proposals can always be presented. An executive vote will result in difficult changes to smart contract code, such as adjusting fees or collateral levels. Executive votes are necessary to implement some of the changes voted on in governance votes.
To conclude
As a leader among crypto-collateralized stablecoins, DAI is a success. The system mitigates the volatility of cryptocurrencies without fiat currency collateral, which is a real feat. You should also not forget its importance in the history of DAOs. It is one of the longest and largest DAOs that paved the way for many others. If you decide to experiment with DAI, remember that it poses the same risks as other stablecoins.
