Key Takeaways:
- MakerDAO is a decentralised autonomous organisation (DAO) that allows users to lend and borrow cryptocurrencies without the need for intermediaries.
- MakerDAO issues DAI, a stablecoin on the Ethereum blockchain, and Maker, its governance token.
- DAI is a stablecoin designed for various decentralised finance (DeFi) applications, including lending, borrowing, trading, yield farming, and remittances.
- Anyone can acquire DAI on the open market; MakerDAO membership is not required.
What Is MakerDAO?
MakerDAO is a decentralised autonomous organisation (DAO) that focuses on developing technology for decentralised borrowing and saving. It enables users to lend and borrow cryptocurrencies without relying on any intermediaries. MakerDAO issues two cryptocurrencies: DAI, a stablecoin created on the Ethereum blockchain; and its governance token, Maker (MKR).
DAI is a stablecoin that aims to maintain a value of one US dollar. The MKR token supports the stability of DAI and enables governance for the system. The development of the MakerDAO system is governed through direct voting by participants in the ecosystem in efforts to make it transparent.
What Are the Key Features of MakerDAO?
MakerDAO and DAI have gained popularity in the decentralised finance (DeFi) ecosystem and are used for a wide range of applications, including lending, borrowing, trading, and as a stable store of value in the volatile world of cryptocurrencies. Below are some of the key features that MakerDAO members and holders of DAI and MKR value:
The DAI Stablecoin: DAI is a cryptocurrency stablecoin that aims to maintain a 1-to-1 peg with the US dollar. Unlike other stablecoins that are typically backed by traditional fiat currency in a centralised bank, DAI is collateralised by cryptocurrencies like Ethereum (ETH) and other Ethereum-based assets approved by MKR holders. Users can generate DAI by locking up their collateral assets in a smart contract on the MakerDAO platform in order to obtain the decentralised and collateralised stablecoin.
Learn more about stablecoins and the different forms of backing.
Collateralised Debt Positions (CDPs): To generate DAI via the MakerDAO platform, users need to create Collateralised Debt Positions (CDPs), which is a smart contract on the MakerDAO platform where users lock up their ETH as collateral and generate DAI based on the value of that collateral. Users are required to maintain a certain collateralisation ratio to ensure the stability of the system. If the value of the locked ETH falls below a certain threshold, the CDP may be liquidated and the collateral auctioned to cover the debt.
The MKR Token: In addition to DAI, MakerDAO has its own governance token, called MKR, whose holders play a crucial role in governing the MakerDAO system. They are responsible for making decisions about parameters, risk management, and the overall governance of the platform. In addition, MKR tokens are used to pay fees and penalties within the system. If a CDP is liquidated, a portion of the collateral is used to buy and burn MKR tokens, reducing the total supply, which can push up the value of MKR tokens.
Learn more about how DAOs work.
Governance and Voting: MKR holders participate in the governance of MakerDAO by voting on proposals and changes to the platform’s parameters. This decentralised governance model allows the community to collectively decide on issues like stability fees (interest rates on generated DAI), collateral types, and other system parameters.
Decentralisation and Stability: MakerDAO aims to provide stability in the cryptocurrency market by creating a stablecoin (DAI) that is not reliant on a centralised authority or traditional financial (TradFi) institutions. The system’s decentralisation and transparency are intended to reduce the risk of manipulation and maintain the stability of the DAI stablecoin.
Transparency: The MakerDAO system operates on the Ethereum blockchain, providing transparency and auditability of its operations. Users can track the issuance and circulation of Dai on the blockchain.
What Is the DAI Token?
DAI is a stablecoin designed to maintain a stable value, soft pegged to the US dollar. Its stability makes it useful for a wide range of use cases within the DeFi ecosystem and beyond.
Stable Means to Store Value: DAI is often used as a stable means to store value within the volatile world of cryptocurrencies. Users can hold DAI without worrying about the price fluctuations in the way that is commonly associated with other cryptocurrencies like Bitcoin or Ethereum.
Decentralised Trading: Traders in the DeFi space frequently use DAI as a stable trading pair. It provides a stable unit of account for trading against other cryptocurrencies, allowing traders to potentially hedge against market volatility.
Lending and Borrowing: DAI plays a central role in DeFi lending platforms, where users can borrow DAI by collateralising their assets, and lenders can earn interest by providing DAI to borrowers. The stability of DAI ensures that borrowers can repay their loans without facing constant substantial price volatility.
Yield Farming and Liquidity Provision: DeFi users often participate in yield farming and liquidity provision by providing liquidity to decentralised exchanges (DEXs) and liquidity pools. DAI is a commonly used asset for these purposes, as it allows users to earn fees and rewards while maintaining a stable value.
Remittances: DAI can be used for cross-border remittances and international payments. Its stability and low transaction fees make it an attractive option for transferring value across borders.
Hedging: Businesses and individuals use DAI to hedge against the price volatility of other digital assets. For example, a business receiving payments in cryptocurrency may convert those funds into DAI to reduce the risk of value fluctuations.
Dapp Integration: Some decentralised applications (dapps) and blockchain projects integrate DAI as a stable currency within their ecosystems. This integration can enhance the usability and stability of these platforms.
Overall, DAI’s stability and versatility make it a useful asset in the world of DeFi and beyond, enabling a wide range of financial activities and providing a stable foundation for various blockchain-based applications.
Learn why liquidity matters in Liquidity in Crypto Markets: What It Is and Why It Matters.
How Does MakerDAO Work?
At its inception, MakerDAO created 1 million MKR tokens, which are used to govern the Maker protocol. MKR token holders have the power to vote on crucial decisions through a two-point process: Proposal Polling and Executive Voting. Proposal Polling, which occurs prior to the Executive Voting, allows MKR holders to gauge the community’s sentiment on a proposal before making any changes to the protocol. When an Executive Vote is passed, the Maker protocol’s code is updated to reflect the winning proposal.
Additionally, non-MKR holders can participate in voting by discussing proposals in the MakerDAO forum. Although anyone can submit proposals to MakerDAO, only MKR holders can cast official votes. The outcome of a vote is determined by the number of MKR tokens committed to a proposal, not the number of individual token holders. For instance, if 10 holders with a total of 1,000 MKR support Proposal A, but five holders with 5,000 MKR back Proposal B, Proposal B wins due to having more MKR tokens in favour.
DAI Savings Rate
MKR holders also have the authority to decide the interest rate that DAI holders earn when they save DAI on the platform. This interest rate is known as the DAI Savings Rate (DSR).
The DSR has fluctuated, reaching as high as 8.75% per annum and dropping to 0%, which happened following a market crash in early 2023, which caused DAI to trade well above $1. In response, MKR holders voted to lower the DSR to 0% to encourage the sale of DAI and bring its price closer to $1.
MKR holders typically vote to adjust the DSR based on DAI’s market price. If DAI trades above $1, they are expected to lower the savings rate to decrease demand and reduce the price. Conversely, if DAI falls below $1, they generally would raise the savings rate to increase demand and raise the price.
Can Only MakerDAO Members Acquire DAI?
MakerDAO membership is not required to acquire DAI, which can be purchased on the open market from cryptocurrency exchanges by anyone interested in acquiring it. MakerDAO membership and holding the DAI token grant users additional benefits and opportunities, such as participating in governance and earning interest on lent DAI, but they are not prerequisites for acquiring DAI.
DAI Tokenomics
The tokenomics of the DAI token, which is part of the MakerDAO ecosystem, is based on a complex system of smart contracts and mechanisms designed with the aim of maintaining DAI’s stability and value at approximately one US dollar. Below are key aspects of DAI tokenomics:
Stability and Pegging: The primary goal of DAI tokenomics is to keep the value of 1 DAI as close to US$1 as possible. To achieve this, the system employs a combination of overcollateralisation and automated mechanisms.
Collateralisation: DAI is generated by users who lock up cryptocurrency collateral in smart contracts, called Collateralised Debt Positions (CDPs), as mentioned above. The most common collateral is Ethereum (ETH); other types of assets are also accepted.
Collateralisation Ratio: Users must maintain a certain collateralisation ratio (often well above 100%) to generate DAI. This ratio ensures that the value of the collateral significantly exceeds the value of the generated DAI, reducing the risk of DAI becoming undercollateralised.
Stability Fees: Users who generate DAI by locking up collateral must pay stability fees, which are essentially interest payments, which are determined by the MakerDAO community through governance. The fees are meant to incentivise the timely repayment of DAI and to help maintain its stability.
Liquidation: If the value of the collateral in a CDP falls below a certain threshold due to price fluctuations, the CDP may be liquidated, which involves selling the collateral to cover the outstanding DAI debt and ensuring that DAI remains fully collateralised.
DAI Savings Rate (DSR): The DAI Savings Rate is a mechanism that allows DAI holders to earn interest on their holdings. Users can lock their DAI into the DSR smart contract and earn a variable interest rate determined by governance decisions.
Debt Ceiling: There is a limit, known as the debt ceiling, on the total amount of DAI that can be generated through CDPs. This ceiling is set by MKR token holders to manage the risk exposure of the system.
Burn and Auctions: When MKR tokens are used to pay fees or penalties, they are burned (destroyed), reducing the total supply of MKR. In the case of CDP liquidations, MKR tokens may be auctioned to cover outstanding debt.
Automated Market Makers: The system also relies on decentralised Automated Market Makers (AMMs) to facilitate the trading of DAI and maintain its peg to the US dollar.
How to Trade DAI
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Conclusion
Overall, the tokenomics of DAI are designed with the aim of ensuring its stability, security, and sustainability as a decentralised stablecoin. It combines collateralisation, governance, and market mechanisms to achieve its goal of maintaining a 1-to-1 soft peg to the US dollar while operating in a decentralised and transparent manner within the MakerDAO ecosystem.
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Although the term ‘stablecoin’ is commonly used, there is no guarantee that the asset will maintain a stable value in relation to the value of the reference asset when traded on secondary markets or that the reserve of assets, if there is one, will be adequate to satisfy all redemptions.
Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.
