Dai at One Billion
This past weekend, the Dai stablecoin, which is created by the Maker protocol, crossed US$1 billion in circulation. This an incredible achievement in just a short period of time.
In this post we will cover:
-What is a stablecoin
-How the Dai stablecoin is unique
-What Dai means for the Maker system and the MKR token
-Why Dai at US$1 billion is such an impressive achievement
-How the MKR token fits with Ether Capital’s investment thesis
Even if you don’t follow cryptocurrency or “crypto”, you may have heard of the term stablecoin at some point recently. The profile of stablecoins have increased dramatically recently — they have exploded in popularity this year and there are now tens of billions of US dollar stablecoins on Ethereum alone. But what is a stablecoin and what is it used for?
What is a Stablecoin?
Think of a stablecoin as a US Dollar on a blockchain. Stablecoins allow you to use the flexibility and speed of a blockchain but also interact with a known, and stable, everyday unit of value.
There are two main types of stablecoins:
#1. Centralized
A centralized counterparty takes a deposit of US dollars and issues an Ethereum token that represents these dollars on the Ethereum blockchain. These tokens are redeemable by the user at any time back into the dollars deposited.
There are currently over $17 billion of centralized stablecoins on Ethereum. An example is US Dollar Coin (“USDC”), which is issued by a consortium that includes Coinbase, a well known crypto exchange based in San Francisco.
While centralized stablecoins like USDC scale well and are convenient, they do carry counterparty risk. Any USDC holder is trusting that the consortium has the full amount of the underlying dollars available and does not decline redemption or freeze funds arbitrarily. For example, a USDC holder in another part of the world may not be comfortable holding or trading in a stablecoin issued by a company in Silicon Valley.
#2. Decentralized
A decentralized stablecoin is one that is issued by a permissionless smart contract on Ethereum. In plain english, what this means is that there is no centralized counterparty — a smart contract is just software that runs on Ethereum. Maker is an example of such a program.
In Maker, the stablecoin is created by borrowers locking assets up in the smart contract (software) and borrowing against those assets as collateral. The borrowing is done in the form of a stablecoin called Dai (sidenote: Dai means credit in Chinese).
Take an example: a borrower deposits US$1,000 worth of Ether (ETH) and 500 Dai is borrowed. In this case, 500 Dai are “minted” and the borrower can do whatever he or she wants with those Dai. However, the US$1,000 of ETH can’t be accessed until that 500 Dai debt is paid back. Note that once the borrower disposes of his Dai, that Dai is “in the wild” and can be used by whoever holds it on the blockchain just like any other centralized stablecoin.
Decentralized stablecoins like Dai require overcollateralization, which presents challenges in terms of gaining scale. However, the benefits are unique. First, there is no counterparty risk. Second, there is complete transparency around the underlying funds. Anyone in the world can view the assets backing the outstanding money supply. Don’t believe us? Check out this great website that shows up-to-the-second information by scraping the blockchain. Pretty neat!
Why Stablecoins?
Now that we’ve discussed the “what” around stablecoins, it’s time for a dive into the “why”.
2020 has been a wild year in the world of crypto. Despite a prolonged bear market since early 2018, development in Ethereum has never been more robust. This year, decentralized finance (aka “DeFi”) has taken off, which has led to massive growth in stablecoins.
Source: CoinGecko
So what is DeFi? DeFi is a term that refers to on-chain exchanges as well as crypto-native lending and borrowing platforms. Let’s say I have $1,000 of Dai or USDC. I can put these assets in a lending pool on Ethereum and begin earning interest right away. How? You might have guessed it — another permissionless smart contract (software) on Ethereum!
DeFi has exploded in popularity this year. There are now over US$13 billion of assets from around the world locked in DeFi smart contracts, with much of this value in the form of stablecoins. Stablecoins are the ideal ‘quote currency’ because we all live in a world priced in dollars. US dollar denomination for on-chain applications is a natural evolution as it eliminates the volatility associated with holding positions in assets like Ether or Bitcoin.
Dai: The Gold Standard of Decentralized Stablecoins
When Ether Capital first invested in Maker last year, there were fewer than 100 million Dai outstanding. At the time, this was a credible number. But Dai did not have the depth and liquidity necessary for high volume applications. Fast forward to today, less than two years later, and the outstanding Dai amount has done more than a 10x. What accounts for the growth?
Maker created the conditions for this growth by allowing new collateral to enter the system, with an upgrade to multi-collateral Dai (aka “MCD”). Last year, you could only create Dai by bonding your Ether — this was single-collateral Dai (aka “SCD”).
Now, there are over 10 assets that qualify and there are over 40 more in the on-boarding process. As DeFi activity has exploded, Dai outstanding has kept pace and has retained its place as the largest decentralized stablecoin in the ecosystem.
Dai’s brand and liquidity has made it the most integrated and accepted stablecoin across applications on Ethereum. It has a stickiness among users and its smart contract source code has been battle tested. The team and spirit of the project mirrors that of crypto: open, transparent and with a vision for a more inclusionary financial ecosystem.
So what’s on the horizon for Maker and Dai? Having hit a billion outstanding, the next milestones will be tens of billions and then hundreds. Since Maker is a system that relies on collateral to create Dai, these milestones will require the onboarding of real world collateral onto Ethereum and into the Maker system. Stay tuned for exciting developments here!
Why the MKR Token?
Finally, let’s talk about the economic model around Maker, because this is the reason we at Ether Capital believe so fundamentally in the value proposition of this asset in our portfolio.
Maker is the smart contract (software) that allows assets to be deposited and Dai to be created. Governance of the Maker smart contract is handled by holders of the MKR token. The most important part of governance is that MKR holders are the beneficiary of fees charged by the system for Dai creation.
For example, right now creating Dai from Ether costs 2% annually. This amount, known as stability fees, is taken by the Maker system and used to buy MKR in the open market. Think of this as analogous to a company using its profits on a share buyback.
In October, Maker’s annualized stability fee surplus hit an all time high of US$27 million (see chart below). Note that this equates to a sub-20x price / earnings multiple.
Source: Messari, Dune Analytics, TokenTerminal
Currently, the annualized fee surplus is approx. US$32 million. You can see this as well as some interesting stats around protocol fees and MKR buybacks on this outstanding website.
As Dai ambitiously charts a path to many more billions outstanding, stability fees generated by the system may lead to substantial demand for MKR on the open market, putting upward pressure on the price. In this sense, MKR represents direct financial exposure to the growth of Dai.
We at Ether Capital are excited to be MKR holders and we believe in the mission and strategy of the Maker Community. Please feel free to contact us at info@ethcap.co with any comments or questions!
Ether Capital (NEO:ETHC) is an Ethereum ecosystem investor based in Toronto, Canada. Ether Capital selectively invests in projects, protocols and businesses that leverage the Ethereum ecosystem and Web 3 technologies. For more information, visit http://ethcap.co/.
