MakerDAO has gained popularity as a lending protocol based on Ethereum. It offers the ability to borrow cryptocurrencies through a secured stablecoin DAI. In today’s lesson, we will explain what Maker DAO and DAI stablecoin are.
What is MakerDAO?
MakerDAO is a decentralized lending platform built on the blockchain Ethereum. The protocol uses intelligent Ethereum contracts to automate as well as lend its stablecoin DAI. Smart contracts also provide other functionalities of the protocol, like its management. The protocol is often referred to as decentralized banking based on blockchain. The MakerDAO protocol issues its stablecoin – DAI.
What is stablecoin DAI?
As we mentioned in the paragraph above, DAI is a stablecoin security in the DAO lending protocol. The Marker Foundation was founded in 2014 by Rune Christensen and launched the open – source MakerDAO in the same year. Like most DeFi lending platforms, Maker DAO is based on Ethereum smart contracts.
However, once launched, the MakerDAO protocol was missing a very key element – money. To be more precise – digital money, but not as variable in value as altcoins. And that’s where stablecoins came in.
Stablecoin DAI was launched on the platform in 2017. Its goal was simple – it was to become an unassailable collateral for loans on the platform. By 2022, stablecoin DAI had become the fourth largest stablecoin in terms of market capitalization. It is also the most popular option if we talk about dApps. DAI supports 400 dApps and a similar number of cryptocurrency wallets.
At this point, the question probably occurred to you – why is stablecoin DAI so unique? Because it is backed by many stablecoins and cryptocurrencies. The bulk of DAI’s backing is centralized coins, including stablecoin USD Coin (USDC) and Pax Dollar (USDP). This is followed by Ethereum, Wrapped Bitcoin and dozens of other equally popular cryptocurrencies.
To sum up the dissertation on this interesting stablecoin, we can say that it is an algorithmic stablecoin, centralized and flexible enough to be fully decentralized at the same time.
DAI token – how does it work?
DAI is an ERC-20 token, and can be purchased on major exchanges, i.e. Binance or Coinbase, but also on Uniswap.
Moreover, given that MakerDAO is an open-source protocol on blockchain Ethereum, anyone can issue stablecoins DAI. How. To generate new DAI, users need to borrow them from the MakerDAO vault. This option is available to system users through the Oasis dApp. It is one of hundreds of dApps available on the MakerDAO ecosystem.
Using Oasis, we borrow stablecoin DAI, depositing ETH-based collateral. A intelligent contract (vault) is then created, where DAI is stored as actual escrow. After repaying the loan so taken out, the stablecoin DAI is transferred to the user’s wallet.
Simply put – DAI is created by borrowing assets (minting), and in the portfolio by repaying the loan, i.e. burning.
Interestingly, the platform’s native token MakerDAO, or MKR, is also a stability regulator. All you need to do as an MKR token holder is to use it to establish a DSR – DAI Savings Rate. As a reward for this, MKR holders get interest.
MakerDAO and its functionality
The protocol is interested in that it offers users the option to deposit ETH in intelligent Maker contracts, in exchange for earning in the form of minted DAI tokens.
Next – MakerDAO allows depositors to earn interest on DAI they hold in a DAO “bank.” DAI tokens are locked into a DAI Savings Rate (DSR) contract.
DAI stablecoins are accumulated based on the DSR interest rate.
By blocking ETH, WBTC, Link, MATIC or MANA as collateral, one will receive a higher interest rate loan in DAI tokens.
Token MKR
MKR is also a token of ERC-20. At the same time, it is a function of the native token of the MakerDAO protocol. MKR is also a recapitalization source for the MakerDAO protocol. To encourage users to have this native token, MKR users have the privilege of taking part in the management aspects of the protocol.
What can such users do? Add new types of collateral, regulate intelligent contracts or adjust risk according to protocol (including talk of debt ceilings, liquidation ratios or stability and savings rates).
Decommissioning process in the MakerDAO protocol
The managers in the protocol are users who hold a sufficient number of MKR tokens. The holders of MKR have developed an interesting strategy for overseeing the liquidation risk that arises from the volatility of collateral. If the collateral deposited by users, cannot cover the debt, they are liquidated automatically, thanks to arbitrageurs. The funds raised through the liquidation process are used to pay off the debt and the penalty that comes with such liquidation.
If such a process does not generate enough DAI and is unable to cover the debt, it is then transferred to the Maker Buffer. This is the pool that contains the fees generated for the withdrawal of collateral in addition to the liquidation proceeds. Interestingly, if the amount of DAI in the Maker Buffer is not sufficient, then a debt auction will be initiated, and the protocol itself will mint MKR tokens. It will then sell them to the referents to obtain DAI and recapitalize the system.
MakerDAO and the risks
The main threat to the protocol is the risk posed to it by the semi-decentralized security types accepted within its vaults. When MakerDAO debuted in 2017, it allowed only ETH to be used as a backup asset for DAI.
At this point, we are seeing considerable changes. More than half of DAI is backed by centralized stablecoins. As a result, DAI dependent on centralized stablecoins exposes the protocol to regulatory risk.
Another risk for MakerDAO are the oracles on which it depends. MakerDAO uses them to provide up-to-date asset prices for its intelligent contracts. Oracles, however, are susceptible to price deviations. Consequently, unreliable oracle services can have disastrous consequences for loan holders in MakerDAO. Because of inaccurate price information, they can be held up.
Summary
The MakerDAO protocol and stablecoin DAI are fascinating topics. The MakerDAO protocol would not exist without the security of stablecoin DAI. However, as is sometimes the case with decentralized lending applications – everything is ahead of them. MakerDAO is a relatively young protocol that is sure to surprise us with its development in the coming years.
