Stablecoin Primer — Maker DAI shallow dive

Osman Sarman
Published in
9 min readApr 7, 2022


This article is part of the Stablecoin Primer article series Section 4. If you are interested in reading the other articles, check out this post.

Shallow dive format is as follows: Protocol -> Token(s) -> Design Principles -> Key Metrics -> Why use or mint DAI?


DAI stablecoin is created and managed by the Maker Protocol, which is governed by MakerDAO. Think of Maker Protocol as a financial institution focused on lending that operates globally on blockchain (i.e., Ethereum). A widely used analogy for Maker Protocol is a pawn shop.

MakerDAO is the organization composed of a decentralized group of contributors (i.e., MKR token holders) that govern important aspects of the Maker Protocol. Maker Protocol’s main source of income is the interest fees on loans it issues and its main expense is the interest paid to depositors (there are more sources of income and expenses though). Some of the key aspects that sets Maker Protocol apart is that it is global and it does not require KYC to issue loans. Also, Maker Protocol does not act as a centralized custodian of the customers’ collateralized assets.


As we briefly discussed in Section 3, tokens allow things to operate flawlessly on blockchains. For the Maker Protocol, two tokens lie at the heart of things: DAI and MKR.

  • DAI is the end product of the Maker Protocol. It is a stablecoin soft-pegged to $1 and backed by excess collateral. For example, $100 worth of DAI is at least backed by $170 worth of Ether. Maker Protocol has multiple mechanisms in place to coordinate the supply of and demand to DAI in the open market, ensuring its price remains stable (more below in the stability section). For now, think of DAI as the end product of a Maker Protocol, like the Twitter App of Twitter Inc.
  • MKR token functions like a badge showing that its holder works at Maker DAO, kind of like an employment badge. Holders of the MKR token participate in the decision-making and contribute to key activities like software development to improve the Maker Protocol and its end product, the DAI stablecoin. MKR token is more advanced than just an employment badge, in that anyone can own it and its value can appreciate as more people use the Maker Protocol. Specifically, MKR token holders vote on important decisions like interest rate (i.e., stability fee), types of assets (e.g., bitcoin, ether, real world assets) accepted as collateral, collateral ratios, and more.


Maker Protocol has various interconnected mechanisms in place to influence demand and supply of the DAI stablecoin with the ultimate goal of keeping its value pegged at $1. Let’s discuss these key mechanisms:

  • Stability fee: MakerDAO ensures how much DAI is in supply by adjusting its stability fee. Users mint new DAI by depositing collateral crypto-assets to Maker Vaults, which are smart contracts that function as escrow. When users want to redeem their collateral assets, they pay a stability fee, which is essentially an interest fee. Simply, when DAI > $1, stability fee is lowered so more users mint DAI, and the opposite applies when DAI < $1. Keep in mind that here we are talking about generating net new DAI, which increases the total supply of DAI. Stability fee is not relevant when purchasing DAI from secondary markets.
  • Minimum collateral ratio: Every DAI in circulation is backed by excess collateral. Excess collateral is defined by minimum collateral ratio which is always > 100%. For example, to generate 100 DAI using ether when the minimum collateral ratio is 170%, a user needs to deposit a minimum of $170 worth of ether. In this scenario, if the collateralized ether’s value drops below $170, Maker Protocol fines the user and uses this fee to keep the system overcollateralized (that’s why the Protocol recommends users to deposit more collateral than the minimum collateral ratio.) At the protocol level, this ensures that Maker is sufficiently backed. Each type of collateral has a different minimum collateral ratio agreed by the Maker Governance Risk Protocol. Most recent collateral ratios for each type of collateral can be found here.
  • Debt ceiling: There is a protocol-wide maximum amount of debt that can be issued for each collateral type. For example, only a total of ~$20 billion of debt can be issued using ether. This ensures that collateral (and its associated risk) backing the Protocol is sufficiently diversified.
  • DAI Savings Rate (DSR): A global parameter used to incentivize demand to DAI, DSR is essentially the savings rate users get when they lock their DAI in a DSR smart contract. When DAI is > $1, DSR is lowered by MKR token holders so that demand for DAI is reduced, pushing its price back down to $1.
  • Emergency Shutdown: To further protect DAI’s stability and make the protocol crash resistant, Maker Protocol has an Emergency Shutdown module. This is a last-resort mechanism governed by Maker Governance and ensures that the system allows users to withdraw the net value of assets to which they are entitled to. Even in the worst-case scenario of a bank-run — if all users want to redeem their collateral by turning in their DAI at once — users will be able to redeem an amount of collateral that’s at least equal to the amount of DAI they bring in. This builds trust.

I have largely reworded these from the Maker Protocol Whitepaper and have only included the most important stability mechanisms here. If interested, highly suggest reading through their whitepaper.


While reviewing Maker Protocol’s decentralization, we want to understand if there is a single point of failure within the system and how transparent its monetary policy is to the users.

  • Decentralized governance: As we already established, Maker Protocol and its DAI stablecoin are governed by MakerDAO (DAO = decentralized autonomous organization). MakerDAO participants vote on important protocol related decisions and the income earned by Maker Protocol is completely visible to all tokenholders. Maker Protocol can only be shut down collectively by MKR token holders. However, MKR token holders are disincentivized to shut down the protocol without valid reason because this would directly have a negative impact on MKR’s value.
  • Transparent monetary policy: Parameters we discussed in the Stability section above pretty much make Maker Protocol’s monetary policy, which is completely transparent to the MKR and DAI holders. While this is crucial in building trust in the Maker Protocol, users are urged to educate themselves on Maker’s monetary policy.
  • Collateral type: DAI is a crypto-backed stablecoin. If the crypto used to back DAI is decentralized, it is safe to assume that DAI is permissionless enough. For example, ether-backed DAI can safely be considered permissionless, or decentralized. However, if a fiat-backed stablecoin is used as collateral, DAI’s permissionless nature becomes questionable.


For the Maker Protocol, the key question that defines capital efficiency is, “how much DAI can a user get in return for the collateral they deposit in a Maker Vault smart contract?” If you can’t already tell, this is defined by the minimum collateral ratio, which is calculated by dividing the $ worth of collateral deposited by the amount of DAI minted. If a collateral is deemed to be risky, the collateral ratio tends to be higher making DAI more capital inefficient. Especially in bear markets, when non-stablecoin cryptocurrencies are deemed more risky, the Maker Protocol becomes increasingly capital inefficient. This leads to more DAI being collateralized by fiat-backed stablecoins as safety measure. The cool thing, however, is because the Maker Protocol is based on code, minimum collateral ratios required can be adjusted instantly based on the market demand.


Maker Protocol has a great website called MakerBurn that has dashboards and lots of graphs on KPIs regarding the Maker Protocol and DAI tokens. Here, I’ve handpicked the metrics/graphs that are the most aligned with our discussion:

  • DAI Supply: $9.4 billion
  • DAI Peg Variance:
Source: Coinmarketcap
  • Stablecoin collateral ratio: This ratio shows how much of DAI is created from stablecoins vs. non-stablecoins. Currently at 63%, stablecoin ratio suggest that majority of DAI is created from centralized stablecoins. Critics of DAI argue that overreliance on fiat-backed stablecoins effect DAI’s decentralization. Supporters suggest that since DAIs collateral typs and ratios is determined and adjusted by its users, stablecoin collateral is what the market wants at the moment.


With all this convincing that the Maker Protocol is really awesome behind us, you may still be asking why you would want to hold a complex decentralized stablecoin like DAI instead of a centralized and more established stablecoin like Tether’s USDT. Or better yet, you may be asking why lock in excess collateral to mint DAI. You may be asking what’s in it for me? The following is not meant to be financial advice but I’ll propose a few reasons for you you may want to hold and / or mint DAI.

Use (more applicable to Consumers)

You (as a consumer) want to keep your hard earned fiat money in a US dollar pegged stablecoin and you fear that long term stability of centralized stablecoins (e.g., USDC) is in peril due to imminent regulation. If that’s the case, you want to look for a stablecoin that is permissionless (i.e., no KYC required, no censorship) and DAI is great option. You can proceed to a fiat-to-crypto exchange to buy DAI.

Mint (more applicable to DeFi Participants)

As discussed in the stability fee section, here we are referring to generating (minting) new DAI. Generating new DAI is analogous to creating a collateralized debt position in that you deposit some collateral to create a DAI position, which is essentially like a loan that you need to pay back. As such, minting DAI is a more complicated process that requires the minter (i.e., DeFi Participant) to have a certain level of financial understanding as well as a valid rationale for minting DAI. With that said, below are a few reasons why one may want to mint DAI:

  • Easier to mint than buying from the secondary market — If you want to buy millions of DAI to put it in a liquidity pool and you already hold lots of long term crypto investments, it may be easier to mint new DAI via the than buying it on exchanges.
  • Decentralized Leverage — If you believe that your collateral asset (e.g., ether) will appreciate in value, you can use it to mint DAI, then use that DAI to buy more of the same collateral. For example, instead of $200 of ether sitting in your wallet, you can lock it in a Maker Vault to mint 100 DAI, and buy $100 more of ether. This way, you have invested $300 in ether instead of $200. This is basically margin trading.
  • Loan against crypto asset (pawn shop) — How about if you legitimately want to take a dollar denominated loan against your crypto assets? For instance if you want to purchase real estate but still want exposure to the crypto market and don’t want to pay capital gains on the crypto you would otherwise need to sell. Needles to mention that these loans are real-time and don’t require KYC.
  • Arbitrage — If the DAI price is above $1, you can mint DAI to sell it on exchanges for a profit.

STABLECOIN PRIMER article series

Stablecoin Primer — Intro: Rower and slow cooker

Stablecoin Primer — Section 1: Path to stablecoins

Stablecoin Primer — Section 2: Stablecoin landscape

Stablecoin Primer — Section 3: Stablecoin types

Stablecoin Primer — Section 4: Stablecoin shallow dives— USDT, DAI (you are here), UST, and more

Stablecoin Primer — Section 5: Stablecoins’ future

Stablecoin Primer — Bonus section: Anything missed

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Special thanks to NEAR Team Grants for making this research possible.

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Osman Sarman

Engineer and ex-consultant exploring stablecoins, twitter: @_namsso_