How Maker enables a crypto-backed stablecoin
The stablecoin with the biggest market cap remains USDT with currently over 44 bn. It was the first stablecoin to be issued, initially based on Omni (Bitcoin). It has since expanded to exist on most of the major blockchain protocols. Tether keeps the USDT stable by ensuring that for each USDT in circulation, one US-Dollar is held in their treasury. However, due to that setup and a lack of transparency, concerns frequently arise around the centralization. Just recently, the company behind Tether, Bitfinex, settled a fine with the SEC, which in their words was “not an admission of guilt”.
Pegging the value of a stablecoin to a value existing in the real world is easy. What’s harder is creating a stable cryptocurrency that doesn’t rely on a real-world asset backing it. MakerDAO is aiming to provide a decentralized stable currency with DAI. MAkerDAO was founded in 2014 by Rune Christensen. Together with his core management team and core developers, they worked on the platform for 4 years before releasing it officially in 2018.
Maker — formerly Maker DAO
Maker is a pioneer in the crypto-industry as they were the first to launch a stablecoin based on other cryptocurrencies. What it comes down to is that Maker connects borrowers with lenders. To borrow DAI (the stablecoin mirroring the value of the USD), borrowers will have to deposit ETH in the Maker smart contract. This process is also referred to as opening a “collateral debt position” — as the borrower essentially takes out a loan. Similarly to taking out loans in the traditional financial systems, borrowers will have to put up collateral. Due to the volatile nature of cryptocurrencies, borrowers have to over-collateralize their loans. Let’s say you wanted to take out $100 DAI at a collateralization ratio of 1,5. You have to deposit $150 worth of ETH to take out $100 in DAI.
The question is, why would you do that? Loans are used by most ordinary people when they can’t finance a purchase out of pocket or don’t want to do so. Putting up more than the loan in collateral seems slightly useless.
Yet, it isn’t for trading purposes. It allows ETH holders to leverage their ETH to increase the return they make on their trades without having to sell ETH. This makes sense only if you’re bullish on ETH. You could deposit 1 ETH and take out a CDP for 1000 DAI. You then sell the DAI for more ETH — 0.8 ETH for our example’s sake. When ETH goes up, you can sell the 0.8 ETH for $1200. You use $1000 of your return to close your collateral debt position and keep the $200. Now you’ve leveraged your 1 ETH allowing you to earn more than by just holding.
Benefits of a CDP include that it doesn’t have any time limits, minimum repayment schedules, no counterparty risk, nor does it require any credit history by the borrower. The only payment required will be the final settlement plus a 0.5% fee to be paid in MKR.
Obviously, ETH isn’t always moving upwards. When the price of ETH falls and collateralization decreases, liquidations will automatically be triggered by Maker. During liquidation, the ETH held as collateral will be sold on the market to cover the debt positions and to ensure the value of DAI.
Liquidations and over-collateralization of debt positions are two mechanisms used to stabilize DAI. A third important component in the Maker ecosystem is the MKR token. It introduces another tool that can counterweigh price fluctuations. If the ETH price drops too quickly for liquidations to cover the debt positions, MKR will be created and sold on the market to raise additional collateral. It’s also used to pay for fees when repaying a loan.
The Maker Token is also crucial for governance. As the name of Maker implies (formerly MakerDAO), it’s a decentralized autonomous organization. Decisions are voted upon by tokenholders. Participants are incentivized to vote favourably for the platform by receiving fees as rewards. If they made poor governance decisions, the value of the fees they received would ultimately decrease. Decisions that holders can vote on include collateralization ratio and the annual borrowing fee. The fee has been raised several times to help stabilize DAI, but advocates are understandably looking for a more long-term solution.
The chart is visualizing quite nicely the soft-peg of Dai. As it’s not hard-pegged against the dollar like other stablecoins, the value is fluctuating. Historically, DAI has often been trading below the dollar while it’s seen towards the end of 2020 increases well above that value. Nevertheless, it seems as if recently volatility has decreased on Dai, and Maker remains one of the strongest DeFi players. According to DeFi Pulse, more than 8 billion USD worth of tokens is currently locked in the Maker protocol.
With Maker, users can easily take out a loan or earn interest on DAI in makers own CDP portal, which can be accessed with different popular wallets such as Meta Mask, parity or Ledger Nano. The team has partnerships with various companies and crypto projects, including OmiseGo, Tradeshift, Kyber Network and many more and continues growing the ecosystem. Maker will certainly benefit from the increasing interest in DeFi.
To learn more about Maker or maybe even open a debt position, head to their website.
MKR is now trading on Bitcoin.com Exchange with USDT, BTC and ETH pairs.