A Simple Guide to MakerDAO and the Different Types of DAI Stablecoins
MakerDAO has become a foundational part of the development of decentralized finance as an area of application for distributed ledger technologies like blockchain. The company has developed a stablecoin called DAI that’s pegged to the U.S. dollar and created through a collateralized lending protocol instead of being issued as debt to a bank.
Anyone can create DAI by depositing Ether as collateral. The Ether stored in a debt position can be recovered by paying back the minted DAI plus a stability fee set by holders of the MakerDAO token. To prevent unpaid loans from wrecking the system, MakerDAO requires loans to be overcollateralized and the system will automatically liquidate a user’s position in the event that the value of the collateral drops below an acceptable threshold.
The system has become popular enough that a project called DeFiSaver has been started to help users avoid liquidation. At the time of writing, DefiSaver recently failed to save a number of collateralized debt positions (CDPs) from being liquidated due to delays to the transactions responsible for closing the positions but to their credit, the company alerted customers to the mistake, explained what they can do to fix the problem, and offered to compensate the owners of the liquidated CDPs for their inconvenience.
Different Types of Dai
Being able to mint and use a digital asset that’s pegged to the U.S. dollar without a fiat on/off ramp provides an important piece of infrastructure in the development of Web3 — a decentralized Internet. While cryptocurrency users still need fiat on/off ramps to acquire the cryptocurrency needed to mint DAI, developers can now create applications that leverage DAI while avoiding certain risks associated with regulatory uncertainty and oversight.
As a convention, new forms of DAI use lowercase letters before DAI to refer to the different applications. Here are some of the ways people are currently leveraging DAI:
What’s better than a stack of money? A stack of money that’s gaining interest! cDAI lends DAI using Compound’s automated money market protocol to provide holders with an asset that automatically gains interest. Lending protocols have received a lot of attention in DeFi for providing impressive interest rates of +10%. The system works by providing liquidity to hedge funds and margin trading pools. High demand for liquidity and a low supply of assets like DAI, in addition to the high risk associated with emerging technology, contribute to the high interest provided by lending protocols like Compound.
lsDAI creates futures contracts on cDAI that enable users to hedge their loans of DAI by taking a short position on the DAI lending rate. In simple terms, lsDAI is a derivative that can be used to reduce the risk associated with lending DAI. The makers of lsDAI also plan to enable users to take a leveraged position on the future DAI lending rate and create a money market where participants can earn interest by supplying liquidity to the market. Derivatives like lsDAI may be interesting but are generally not for investors without a strong grasp of the fundamentals of finance.
Launched by @boredGenius, poolDAI is a “no-loss donation protocol.” That means that poolDAI allows users to pool their DAI together, generate interest using the Compound lending protocol, and then donate the interest to a third party. Those funding the pool can withdraw their funds at any time. Instead of simply donating money to a worthy cause, individuals can lend their funds out to others, donate the interest, and take their initial deposit out whenever they feel like it. The only thing the person donating gives up is the time preference on their money rather than the money itself.
Similar to poolDAI, rDAI enables holders to generate interest on DAI and then donate it to a third party. poolDAI enables users to pool their funds and donate the interest but rDAI lets users do the same thing without pooling their funds first. Both protocols could be used to accomplish the same goal but by encouraging users to pool their funds, poolDAI incorporates a more social aspect to the donation process.
Developed by user onboarding aficionado Austin Griffith, xDAI makes it fast and cheap to use DAI by leveraging the xDai sidechain from POA Network. xDAI was developed alongside the Burner Wallet to enable users to send and receive DAI without worrying about transaction fees or following the steps necessary to create a secure wallet. The ease of use has made xDAI and the Burner Wallet fantastic educational tools. Event organizers can quickly create and fund wallets they can then distribute using pieces of paper with QR codes printed on them. Attendees can scan the QR codes to pull up the wallet and use their funds to purchase things like food and drinks.
MakerDAO is in the middle of transitioning from a single-collateral system to a multi-collateral system. Rather than simply allowing users to deposit Ether and mint DAI, the platform will enable users to deposit a variety of cryptocurrencies as collateral. In addition to adding support for new forms of collateral, the update will include the Dai Savings Rate, a feature that will allow DAI holders to automatically gain interest on their DAI using a decentralized lending protocol.
As a decentralized approach to the creation and use of U.S. dollars, the importance of DAI is difficult to understate. From new forms of DAI to entirely new DeFi products, we will surely continue to see interesting new applications from the Ethereum and DeFi ecosystems. Combining the new, decentralized infrastructure coming out of the world of distributed ledger technologies with financial products and theories that have stood the test of time will continue to produce fascinating innovations in DeFi products and services.
Interested in shaping the UX/UI of decentralized lending? Sign up for Early Access to beta test Helis Network’s simple Lend & Earn solution and let us know what YOU want to see in a decentralized lending product. 😀