(4/100) Crypto Countdown: MakerDAO

As a reminder, the Crypto Countdown series aims to outline in absolute Layman’s terms, what each of the Top 100 cryptocurrencies are aiming to achieve and how they are going about it.

The next project on the Crypto Countdown series is an endeavour called MakerDAO. I personally think that everyone should have a basic knowledge of stable coins so, out of the 3 previous posts, this is the project I would recommend looking into if you have time!

I don’t feel the need to put a disclaimer against advocating this project, if you want to invest... go crazy! However, be warned, the point of a stable coin is that it is inherently “stable”. This means, that the coin is designed in such a way that its price will not fluctuate.

Breaking it all down

Let’s first start off with a short definition, as provided by the folks at MakerDAO, and I will help you break down what it all means:

Maker is a decentralized autonomous organization on the Ethereum blockchain seeking to minimize the price volatility of its own stable token — the Dai — against the U.S. Dollar.

The who’s-who

  • Maker is the creator of the Dai stable coin
  • Dai is a cryptocurrency that is price-stabilised against the value of the U.S. Dollar

What is a decentralised autonomous organisation (DAO)?

A DAO does what it say on the tin, it is an organisation that is both decentralised and autonomous. This organisation operates without needing a centralised party to make decisions. Instead, at its inception, as series of rules are outlined that the organisation has to follow, similar to setting goals and objectives in a centralised company. However, unlike centralised companies (who can change these goals when they wish), DAOs digitally enforce the rules they are set up with. Once the DAO gets deployed, outside forces cannot interrupt it.

We are familiar with the term “decentralised”, which allow projects to spread their resources across the globe, avoiding the red tape and inefficiencies associated with running large companies and the risk of jurisdiction-specific censorship.

The Ethereum Blockchain

The Dai stable coin system is currently running on Ethereum. There are some interesting dynamics between Ethereum-based assets and the creation of Dai, but we will get to that later on.

What is the goal of Maker?

By now, anyone with any involvement in crypto will have noticed the ridiculous volatility of most cryptocurrencies. In the near-term, at least, using these cryptocurrencies for traditional payments and ongoing financial commitments would expose the user to a great deal of uncertainty. Imagine paying a subscription worth 0.0018 BTC per month… the first payment might be £10, the next £30!

With Dai, the aim is to overcome the extremely volatile prices of cryptocurrency, enabling a more sensible consumer experience. With this stability in mind, we can immediately see the value of such a stable coin over traditionally volatile cryptocurrencies. Unlike the majority of tokens and coins that we are becoming familiar with, Dai is a currency that maintains its purchasing power. As we know, cryptocurrencies are inherently global — access to crypto is not typically restricted by geography, political sentiment nor purchasing power. Thus, with Dai, anyone, anywhere has the freedom to choose a coin they can place their confidence in.

How does Dai remain stable?

The team at Maker have created a set of smart contracts (digital contracts that self-enforce), that are designed to act in a certain way depending on the market dynamics. These smart contracts are vital to ensure the stability of the currency over time — irrespective of the volatility of the rest of the market.

Each Dai coin is backed by a valuable asset (Ether). Anyone can lock up tokens as collateral and Dai can be issued against them. Thus we now have an instance of Dai being generated and lots of Ether held as collateral by a smart contract.

However, as the keen eyed amongst you will have noticed, the price of Ether fluctuates — so how do we keep the value of Dai stable if the two are so closely linked?

If the price of Ether goes up, all good — the system has more collateral and Dai is stronger.

If the price of Ether goes down, it gets a bit tricky. In theory, if the value of Ether, held as collateral, falls bellow the value of the Dai it is meant to be backing — you cannot justify the price of $1 per Dai and everything would come tumbling down.

To combat this risk, Maker liquidates some collateralised debt positions (don’t worry about this), before the value of the Ether goes below the amount of Dai. In short, auctioning off Ether for Dai until there is enough Dai to pay back what was extracted from the CDP.

Last resort token: MKR

In the event that all hell breaks loose and Ether’s price has a very fast crash (too quick for the above liquidation scheme to be effective) and the collateralisation ratio falls below one-to-one, there is a backup solution.

The Makercoin (MKR) functions as a last resort measure. If the instance above, where the collateral in the system is not sufficient to cover the total Dai, MKR is created and sold on the open market to generate extra collateral.

How will we interact with Dai in the future?

As a user, none of the stabilisation techniques should be of any concern. After all, we don’t really question why a dollar is worth a dollar, do we? Maybe we should… Ultimately, as with all stable coins, these projects have created mechanisms to allow users to benefit from programmable, yet stable, digital money.