Snappy guide to MakerDAO and DAI tokens

shaun
shaun
Dec 22, 2017 · 5 min read

This is meant to be a quick and dirty introduction with sufficiently alluring/confusing details that it will pique your interest to google it further. Please comment with corrections/suggestions — but be gentle :)

disclaimer: I am not associated with the project, it does irritate me that they like haskell and cute 3 letter variable names, I do currently hold a small number of MKR, I may not know what I’m talking about.

Let’s address the elephant in the room; There are a lot of hodlers with significant crypto gains that either want to avoid paying taxes altogether or to defer for as long as possible. If they want to ‘take profits off the table’ in fiat without using a reputable exchange that requires their verified identity, there aren’t a lot of secure options.

Tether (USDT) is a viable solution, and with $1,219,734,258 issued (as of this writing) there appears to be plenty of interest in the token. However even if you can ignore the FUD surrounding their liquidity and governance, it seems like Tether (the company keeping the funds in reserve) could be exposed to significant risk in the event of a regulatory crackdown.

The DAI token became active Dec 18 (ish) and offers an alternative. Like USDT it tracks the dollar but does so using smart contracts on the ethereum blockchain. Using the dashboard they provide, anyone can mint new DAI through the creation of a collateralized debt position (CDP), whereby a user locks up their ethereum (ETH) as collateral. An amount of DAI tokens less then or equal to the collateralization ratio can then be drawn from the CDP by the owner.

There is only one CDP type at the current time, and the current governance rules have configured it to require at least a 166% collateralization ratio, meaning if you locked up $166 USD worth of ETH, you would be able to draw a maximum of 100 DAI (worth $100 USD). This isn’t to say you always have to operate your CDP at the limit — in fact as of this writing most of the currently open CDPs are more conservatively leveraged — albeit this will probably change as the herd rolls in.

What you do with the DAI at this point is up to you. If you wish to speculate that ethereum is going up you might buy $100 more ETH with that DAI, essentially investing on margin, leveraging the original $166 investment into 266$ worth of ETH.

If ETH doubled in value the collateralization ratio for your CDP would go up to 332%, meaning you could actually draw an additional 100 DAI which would reduce the ratio again to its minimum of 166% . Another option would be to take the gains from having purchased surplus ETH and buy back 100 DAI at the lower price and use it to close the CDP and release your original ETH investment.

If the value of ethereum dropped, then your CDP would be at risk of automatic liquidation, whereby the smart-contracts administering the system would shutdown the CDP on your behalf and return your original ETH collateral minus the amount of ETH required to acquire the 100 DAI needed to close it down (at a price much higher than what you sold it at, thus incurring a net loss on your part). Before the liquidation event occurs you have the option of reducing the collateralization ratio by returning some of the DAI.

And then on the other side of the trade are DAI buyers. Investors who wish to lock in profits they’ve made in the volatile token markets, speculators who want to sleep at night, or just ordinary users that need a stable cryptocurrency that is worth today what it was worth yesterday for transactions.

Finally there’s one last important piece to this puzzle. In addition to DAI the system has a second token MKR. These tokens carry a responsibility for voting on governance issues, among them the kind of CDP types available and their configurations. The MKR owners are rewarded with a 1% governance fee charged on all open CDPs (the fee is actually burned reducing MKR supply). MKR owners are incentivized to set wise system limits under the threat of dilution if CDPs go ‘under-water’. This happens if a CDP liquidation is triggered and there is insufficient collateral to cover the cost of the DAI required to close the CDP (i.e. the value of ETH that was locked up in the CDP dropped so quickly that it is worse less then the DAI drawn from the contract). To cover the difference new MKR are issued and sold on the open market to raise the necessary ETH.

Other then USDT, the only other ‘up-and-coming’ stablecoin I know of is Basecoin which appears to still be in early stages and lacking in substance. Given that MakerDao has been in development for several years and had a precursor test market up and running for months (?) with real ETH at stake, I can’t help but think they will have have a strong first-mover advantage. If they can build confidence in their platform it seems inevitable that they steal a healthy marketshare, possibly even triggering a run on Tether — wouldn’t that be fun!

links:

edit: the minimum collateralization ratio is 150% not 166%, MKR governance fee is currently 0.5% (jan 2018)

Coinmonks

Coinmonks is a non-profit Crypto educational publication. Follow us on Twitter @coinmonks Our other project — https://coincodecap.com

shaun

Written by

shaun

Coinmonks

Coinmonks

Coinmonks is a non-profit Crypto educational publication. Follow us on Twitter @coinmonks Our other project — https://coincodecap.com

Welcome to a place where words matter. On Medium, smart voices and original ideas take center stage - with no ads in sight. Watch
Follow all the topics you care about, and we’ll deliver the best stories for you to your homepage and inbox. Explore
Get unlimited access to the best stories on Medium — and support writers while you’re at it. Just $5/month. Upgrade