What is MakerDAO and stablecoin DAI
The MakerDao project went live in December 2017, with DAI as the USD stablecoin and MKR functioning as the governance token. It is one of the most popular decentralised finance applications running on Ethereum with steadily increasing traction since its launch. MakerDAO reached its all-time high market cap of $97M on 9 July 2019–1.5 years into production — and currently has a market cap of $78M.
Ethereum’s native ETH token is used as collateral backing for DAI. And while ETH has fluctuated more than 94% since MakerDAO’s launch, the DAI stablecoin has kept its USD peg relatively steady. The DAI did have a dip towards $0.92 but has since recovered to $1.03. That has everything to do with how the DAI token is created and collaterised.
How to make a DAI
To get DAI, you need to deposit Ether to the smart contract of Maker, which creates a Collaterised Debt Position (CDP). At a minimum, the collaterisation rate of ETH backing DAI is 150%. That ratio includes a built-in margin to absorb ETH price fluctuations — ETH needs to be able to cover the value of DAI associated with it, despite price drops in the ETH markets.
If, however, the price of Ether falls too far so that the collateral can no longer cover the DAI that’s been issued, the smart contract will automatically dismantle the CDP.
This is a very similar to how BitShares uses BTS to create market pegged assets, which is how Bitspark was able to create the Philippine peso stablecoin stable.PHP with BitUSD as the collateral backing.
Running the MakerDAO system
MakerDAO is run as a Decentralised Autonomous Organisation. This means that the ecosystem is governed by the people that hold the MKR token. With that token, people can influence certain things regarding the protocol such as:
- Deciding on the ratio for the collateral backing each CDP;
- Setting the rate for annual borrowing, also called the stability fee;
- Putting a halt to the protocol in case of emergency.
The role of annual borrowing rates (stability fees)
For the longest time, the annual borrowing rate for DAI was at 0.5%, making it a far cheaper borrowing mechanism than any other traditional USD borrowing service. However, in May 2019 the stability fees reached 19.5%. Why did the community vote for continuous rate hikes?
They raised the stability fee in order to maintain the DAI’s peg to USD. The DAI was trailing in the lower $0.90 — $0.95 band, and in order to prevent it from falling any further, MKR token holders kept voting to increase the borrowing rates (stability fees).
How does this work?
If the borrowing rate is low, then people are encouraged to lock up more ETH and borrow more DAI. If the borrowing rate is high, the cost of making DAI is high making it less attractive.
In other words
- Low stability fees means more CDPs are opened which means more DAI is sold on the markets
- High stability fees means more CDPs are closed which means less DAI on the markets.
This way, the MKR community can influence market behaviour which in turn puts buy and sell pressures on the DAI token. In doing so, the MKR community can manage the price of DAI and keep its peg to the USD stable and intact.
MakerDAO today
Since then, people have started voting for lowering the rate, and plans are in the works to improve the stability fee by making people vote on a pre-set range. There are even plans to remove the need for a stability rate altogether using Multi-Collateral DAI which allows people to use any ERC20 token as collateral backing for DAI.
Either way, as a credit facility that issues loans with borrowing rates, MakerDAO is still one of the most popular decentralised finance applications available on the market to date.
Originally published at https://www.bitspark.io.
