What is MakerDAO?

MakerDAO is an Ethereum-based smart-contract platform that allows the issuance of DAI Stablecoin against crypto-assets. Who created it and how does it work? Let`s find out!

The mission of the DAI-linked project is “to create stability in the world of decentralized things.” This stability is realized through DAI, a vital element of the ecosystem and the first decentralized stablecoin on the Ethereum blockchain. The ERC-20 standard token is used in popular Ethereum wallets and is listed on major exchanges.

Who created MakerDAO?

The creator of the MakerDAO platform is Rune Christensen, a Dane. He studied biochemistry and international trading, after which he co-founded Try China, an international recruiting company.

In 2014, Christensen founded and led the Maker Foundation, headquartered in Santa Cruz, California.

In March 2015, Christensen, former Amazon software engineer Andy Milenius and several other developers began work on creating a decentralized platform that allowed users to borrow cryptocurrency-backed Stablecoins.

On March 26, 2015, Christensen published an article in which he introduced the concept of eDollar, a stablecoin on the Ethereum blockchain. The motivation for the creation of the stablecoin was in part due to BitUSD’s inability to attract market makers, which led to a lack of liquidity.

Christensen proposed motivating market makers, later called Keepers, by rewarding them with utilitarian Maker tokens (MKR) for providing liquidity.

How did the MakerDAO platform evolve?

In the first iteration of the platform, the central element was Single Collateral Dai (SCD, “monolateral Dai”), launched in December 2017. The only asset used as collateral for loans was Ethereum.

Shortly after SCD’s launch, the volume of Stablecoins generated reached $100 million. The value of collateral decreased by 94% over time, but the system remained healthy, and the DAI token maintained a 1-to-1 peg to the U.S. dollar.

While the SCD platform proved viable, the creators decided to move to a Multi Collateral DAI (MCD) concept with a multi-collateral DAI token and the ability to implement other key changes.

In October 2018, American venture capital firm Andreessen Horowitz (a16z) invested $15 million in MakerDAO.

In late 2018, the Maker Ecosystem Growth Foundation (MEGF) was created to oversee Maker’s $200 million development fund, led by nine executives appointed by Christensen.

According to the testimony of Andy Milenius, the project’s CTO at the time, there was disagreement among the MEGF board members over the distribution of funds because Rune Christensen wanted full control of the development fund, which had previously been overseen by several parties.

The MEGF CEO offered a choice:

“The Red Pill” to those who were willing to accept its guidance and focus on such aspects as regulatory compliance and integration into the existing financial system.

“Blue pill” to those who did not want to stay within the formal organizational structure and were willing to lose funding over time, but to continue working on the MCD voluntarily.

However, a third faction emerged that sought an alternative to these proposals and called itself the “Purple Pill.” According to Christensen’s opponents, he tried to usurp power and impose his vision for further development of the project at the expense of decentralization.

Christensen accused the group of conspiracy and fired the five MEGF board members of the Purple Pill. They challenged that decision in court. Maker Foundation left Director of Business Development Ashley Sharp and CTO Andy Milenius.

On November 18, 2019, Maker introduced a multi-collateralized version of the Dai Stablecoin (MCD). The old version of the coin was renamed Sai.

Platform members voted for the Basic Attention Token (BAT) as the first additional collateral option. Along with the new options to collateralize the generated Dai Stablecoins, the Dai Savings Rate system was launched, allowing you to earn interest on the deposited Stablecoins.

There was also the release of the Oasis DeFi-Hub, designed to give users access to MCDs. The Oasis Borrow interface allows you to store collateral in special vaults (Vaults), while Oasis Save allows you to freeze DAI on a smart contract at a certain interest rate.

In December 2019, MakerDAO developers patched a critical vulnerability that could have resulted in the loss of more than 10% of DAI token holders’ aggregate collateral.

On December 31, 2019, the Maker Foundation registered the Dai Foundation in Denmark to protect the trademarks and intellectual property of the Maker community.

At the end of December 2019, the process of transferring the management of the project into the hands of the community began, ending in March 2020. As a result, the Maker Foundation organization transferred all MKR control tokens to users. Holders of the asset were given full control over a special smart contract that gives the governing community the ability to vote on the issuance and destruction of tokens, as well as future changes to the rights set of that contract.

Ending support for Sai had been planned since the launch of the multi-token system. On March 30, 2020, the Maker Foundation launched a vote to discontinue Sai. After the motion was approved, the community set a transition period from April 24 to May 12, during which time users could convert their debt positions to the multilateral system. Sai holders had the option to convert tokens on third-party platforms like Uniswap.

On March 12, 2020, amid the collapse of Ethereum quotes, attackers withdrew over $8 million from the MakerDAO system. One of the main reasons for the incident was the imperfection of the Auction Keeper system. The incident prompted the community to accelerate a full transition to MCD.

In April 2020, investors filed a $28 million class action lawsuit against the Maker Foundation and several affiliates. They were accused of intentionally misrepresenting the risks associated with collateralized debt positions (CDPs). Maker Foundation later announced changes made to the MakerDAO system to prevent similar crises in the future.

On May 3, 2020, MKR holders approved the use of tokenized Wrapped Bitcoin (WBTC) and tBTC as collateral.

On May 11, 2020, the MakerDAO community stopped the Single-Collateral SAI (Single-Collateral DAI). The service completed the transition to Multi-Collateral Dai (Multi-Collateral Dai, MCD or DAI) Stablecoin. The remaining tokens of the old type were automatically converted to Ethereum.

The transition from SAI to DAI made it possible to issue stablecoin not only against Ethereum, but also ERC20 tokens WBTC, tBTC, Basic Attention Token (BAT), and USD Coin (USDC).

How does MakerDAO work?

MakerDAO is an ecosystem of two tokens:

– the stablecoin DAI

– the utility token Maker (MKR)

DAI

The DAI token is pegged to the U.S. dollar at a 1:1 ratio and is backed by various digital assets. The issuance scheme of this stackable token can be compared to the issuance of gold-backed money. The difference is that cryptocurrencies are used instead of precious metal: the user sends a certain amount of ETH or other tokens to a smart contract, which issues the token. The system is called Vaults.

Liquidation is the process of selling collateral to cover the funds in DAI that users generate from their Vaults.

The liquidation price is the price at which the Vault is liquidated. Users can lower the liquidation price by posting additional collateral or by returning DAI to the Vault.

The viability of the system is maintained through Vault liquidations when the collateral value of the debt positions falls below the Liquidation Ratio.

The Liquidation Ratio is the minimum level of collateral for each type of Vault. If it is not reached, the Vault is considered unsecured and has to be liquidated.

Oracle Maker Protocol provides a system with price data used to track the non-compliance of Vaults with the Liquidation Ratio. The latter is set based on the risk profile of the Vault and the Stability Fee. There may be different types of Vaults for each collateral, with different liquidation ratios and Stability Fees.

Liquidation Factor = (collateral size x collateral value ) ÷ generated DAI × 100

For example, a Vault with a liquidation ratio of 150% would require at least $1.50 of collateral value for every $1 of generated DAI.

If the collateral value falls to ≤ \$1.49, it is liquidated to cover the generated DAI. In addition, a so-called liquidation penalty is imposed.

DAI tokens represent a collateralized debt to MakerDAO. At the same time, the collateral always exceeds the value of the loan.

If the value of the collateral falls below a certain value of the loan, an auction is initiated in which network members, referred to as liquidators, buy back the collateral for DAI. The system then burns the resulting stablecoins, reducing the issuance. This mechanism is designed to ensure a peg to the dollar.

DAI Savings Factor

The DAI Savings Rate/DSR is a variable accrual rate from DAI tokens locked into the DSR smart contract.

Vaults users receive accruals automatically while retaining control over the tokens. The DSR smart contract has no withdrawal or deposit limit and no liquidity restrictions. The rate is set and adjusted by the holders of the MKR tokens via an on-chain management system.

DSR is a global parameter that can go down or up, affecting the demand for DAI. An increase in DSR motivates users to hold more DAI, a decrease leads to a drop in demand for tokens.

These changes are reflected in the market price of DAI. If a Stablecoin trades below the dollar exchange rate, the DSR can be raised to increase the demand for DAI, and therefore its price. If the DAI trades above the dollar, the DSR can be lowered to reduce the demand for a stablecoin and lower its price.

Stability Fee

A Stability Fee is an additional fee that is continually assessed to DAI holders who use Vaults.

A portion of the Stability Fee is used to keep the Maker Protocol running, including covering the costs of operating DSRs, Risk Teams, and other mechanisms.

The stabilization fee on Vaults of all types is modified by votes of the MKR holders who manage the protocol. The decisions they make are based on recommendations by Risk Teams assessing the risk of the collateral used in the system.

Risk Teams may update their proposed Stability Fees when the underlying asset or the entire system changes fundamentally.

Stability Fees accumulate on the Maker Protocol’s internal balance sheet. As soon as the maximum liquidation balance is reached, the system automatically transfers the DAI to the Surplus Auction. During the auction, Keepers bid the higher price in MKR for the DAI. The winner of the auction receives the stablecoins, and the MKRs it pays are burned.

According to the project’s white paper, the target value of DAI on the Maker platform has two main functions:

• Calculating the Vault’s collateral-to-debt ratio;
• Determining the value of collateral assets in a global settlement situation.

In the event of severe market volatility, future versions of the platform may incorporate a Target Rate Feedback Mechanism (TRFM). It does not involve a fixed peg of DAI to the dollar, but changes the target rate, motivating market participants to maintain the DAI rate at the target value.

When the TRFM mechanism is activated, the target parameters change dynamically, balancing supply and demand for DAI. The feedback mechanism moves the market price of Stablecoin in the direction of the changing target price.

With TRFM, the target rate rises if the market price of DAI falls below a certain point. As the price rises, it becomes more expensive to generate stablecoin with collateralized debt obligations. This also increases the attractiveness of holding DAI, contributing to the demand for the coin. The combination of reduced supply and increased demand causes the market price of Stablecoin to rise, approaching the target.

Conversely, if the market price of DAI exceeds the target price, the target rate decreases, leading to an increase in generation appeal and a decrease in demand to hold the stablecoin. As a result, the market price of DAI decreases, approaching the target price.

DAI Application Options

Maker representatives provide an example of four areas that could benefit from the use of DAI stablecoin:

Gambling markets. Long-term betting doesn’t make sense with volatility-prone cryptocurrencies. Not only does this carry the risk of a decrease in the size of the bet, but also a decrease in the prices of the underlying assets. Using an asset that is stable in price allows you to limit your risk to the usual probability of losing.

Financial markets. Stable in-price collateral is well suited for derivatives based on smart contracts.

International Trading. The cost of cross-border payments can be quite high. By eliminating intermediaries, DAI reduces costs to an adequate level.

Transparent accounting systems. With verifiable transactions, DAI enables organizations to improve efficiency and reduce the likelihood of abuse.

Maker (MKR)

In addition to the DAI Stablecoin, the platform uses Maker (MKR), a native Maker Protocol token.

Maker Protocol is a set of smart contracts with which DAIs are issued.

It is one of the first decentralized finance applications to become widespread. The platform remains one of the largest in the Ethereum segment.

In 2017, the Maker Foundation issued 1,000,000,000 MKR tokens. They were distributed to the first users and sold out in three rounds of private sales (for a total of $64.5 million).

Similar to gas in Ethereum, MKR acts as “fuel” to pay commissions for using the system’s smart contracts. Once commissions are paid, MKR tokens are burned.

MKRs are destroyed when the liquidation balance of the Maker Protocol system exceeds the minimum threshold. The excess DAI is auctioned off for MKR tokens, which are then burned. Conversely, when the Maker Protocol has a deficit and the system’s debt exceeds the maximum threshold, MKR tokens are created and auctioned off to recapitalize the system.

The primary responsibility of MKR holders is to ensure the stability of DAI and the health of the system as a whole.

MKR also serves a governance function — the token is used to vote on the risk management mechanisms and business logic of the platform. Every MKR holder has the right to vote and create a new proposal. The proposal with the highest number of votes automatically receives the status of “important”, thus influencing the further development of the entire project.

MKR holders vote on four key Vault risk parameters to ensure the stability of the Maker system:

• Debt Ceiling — the maximum amount of debt that can be created by one type of Vault;
• Liquidation Ratio — The ratio of collateral to debt at which a Vault becomes vulnerable to liquidation;
• Stability Fee — an additional fee calculated as an annual interest rate on top of the Vault’s principal debt;
• Penalty Fee — a measure of the maximum amount of DAI that can be charged if the debt is liquidated.

Thus, MKR holders are the ultimate authority in MakerDAO. They manage the system and participate in the distribution of profits, but have to bear losses if the decisions made are unsuccessful.

What are the risks associated with MakerDAO?

The creators of MakerDAO describe the platform’s biggest risk factors and offer a list of actions to mitigate them.

• Malicious hacking. If there is any vulnerability in smart contracts, an attacker could try to steal collateral from the Maker platform.
• Competition. Stablecoin’s decentralized DAI system is quite complex, so users may prefer simpler centralized stablecoin systems.
• Irrational markets. Prolonged periods of irrational markets can cause users to lose confidence in the stability and liquidity of the system. A large pool of capital needs to be raised to address this problem. This will improve the rationality and efficiency of markets.
• Regulatory Risks. According to the U.S. Securities and Exchange Commission (SEC), some Stablecoins may be subject to securities laws. According to the SEC’s classification, one stablecoin may be tied to real assets like gold or real estate, another may be tied to fiat currency, and a third may use various “financial mechanisms that maintain price stability.” A third category, which includes DAI, could be the subject of intense regulatory scrutiny.

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How is MakerDAO evolving?

In August 2020, MakerDAO joined the Global DeFi Alliance, an international consortium of centralized and decentralized financial service providers and platforms. The consortium aims to promote decentralized finance projects and develop the ecosystem, including by connecting the “disparate DeFi communities in the Asia-Pacific and Western regions.” The organization was led by Huobi DeFi Labs.

In June 2020, MakerDAO members voted to add tokenized trading invoices, royalties for streaming music, and ZRX, MANA, tBTC, and Uniswap Dai Liquidity Token as collateral for loans to DAI.

In September 2020, Maker token holders (MKR) refused to compensate collateral holders in MakerDAO, liquidated during the March market crash. From Sept. 8 to Sept. 22, 38 voters holding 87,899 MKRs participated in a survey on the compensation plan. The anti-reimbursement option received 65% of the vote (over 57,000 MKR).

At the end of August 2020, the MakerDAO community voted to add LINK, LRC, and COMP tokens as new options to secure the issuance of the DAI Stablecoin.

As of July 2021, the list of pledged tokens includes Ether, USD Coin, Wrapped Bitcoin, Paxos Standard, Chainlink, Trust token, UNIV2DAIETH, Yearn, UNIV2DAIUSDC, UNIV2WBTCETH, UNIV2UNIETH, UNIV2USDCETH, Uniswap, renBTC, Basic Attention Token, Decentraland, 0x, Aave, Loopring, Gemini dollar, UNIV2WBTCDAI, Balancer, Compound, UNIV2LINKETH, Kyber Network, UNIV2ETHUSDT, Tether, USD Coin, UNIV2AAVEETH, UNIV2DAIUS

In April 2021, New Silver, a real estate rehabilitation investment company, partnered with Centrifuge to use MakerDAO as a financing vehicle and opened a $5 million line of credit to issue a DAI.

The diversification of the collateral portfolio is expected to make the DAI more secure. The Maker team emphasizes that in the long run, with the approval of MKR holders, almost any tokenized asset with acceptable risk parameters can be added to the DAI pledge portfolio.

In 2020, DAI’s capitalization grew more than 20 times due to the hype surrounding DeFi. MakerDAO became the first DeFi protocol with a total locked-in value (TVL) of $1 billion.

In early 2021, the total value of blocked funds (TVL) on DeFi project MakerDAO’s smart contracts reached $3.15 billion amid Ethereum’s rapid growth. In May, the figure approached $9 billion.

The state of the MakerDAO system can be monitored using daistats.com.

On July 20, 2021, MakerDAO creator Rune Christensen announced that the DeFi-platform “has gone through a full development cycle” and is now fully decentralized. The Maker Foundation has fulfilled its commitment to the development of the project and has handed over all strategic and operational decisions to the DeF. The Maker Foundation will be discontinued in a few months.