MakerDAO is a Decentralized Finance (DeFi) project with a crypto-collateralized, stablecoin DAI pegged to the US dollar. Its community manages the coin via a Decentralized Autonomous Organization (DAO). Users generate DAI by locking cryptocurrency in a Maker Vault at a certain Liquidation Ratio. For example, a 125% Liquidation Ratio requires $1.25 of crypto collateral value for each $1 of DAI.
Precisely speaking, stablecoins are hugely popular cryptocurrencies that offer a middle ground between traditional finance and digital assets. As they mimic fiat currency while operating like cryptocurrencies, these blockchain-based tokens are attractive for "locking in" profits or losses.In this article, we'll explain what does makerdao mean and what is makerdao used for.
What is MakerDAO?
MakerDAO is an Ethereum (ETH) project launched in December 2017 by Rune Christensen. It focuses on creating DAI, a crypto-collateralized stablecoin pegged to the US dollar. Rather than be run by a group of developers or a single entity, the MakerDAO ecosystem uses the governance token MKR for project proposals and decisions. This governance model is known as a DAO (decentralized autonomous organization).
What is DAI?
DAI is MakerDAO's stablecoin tied to the US dollar and is among the largest stablecoins and cryptocurrencies by market capitalization. The ERC-20token has an unlimited supply so long as users keep supplying collateral to generate more DAI.
MakerDAO uses crypto-collateralization to maintain its peg rather than a vault of fiat reserves. It might be a bit puzzling how crypto, known for its volatility, can provide the backing for a stablecoin. Simply put, the crypto a user deposits to create DAI has a much higher value than the stablecoin they receive. This allows extra room for downwards price movements in the crypto collateral.
How does crypto collateral work?
Collateralis a common concept in traditional finance you'll likely have come across before. When taking out a loan, you'll need to provide something of value as collateral. This is used to cover the loan if you cannot repay it.
What is DAI overcollateralization?
Stable and relatively low-risk assets like fiat, precious metals, and property are the usual favorites for collateral. As we mentioned, using crypto as collateral is riskier for lenders as its price can change wildly. Imagine a project that asks for $400 of ETH in collateral for 400 tokens pegged to USD.
If the price of ETH drops suddenly, the lender's collateral won't cover the loan they've given out. The answer here is to overcollateralize: the lender instead asks for $600 of ETH when loaning out 400 tokens of their USD stablecoin.
What are collateralized debt positions (CDP)?
MakerDAO has used overcollateralization to maintain a reasonably reliable peg for years. As smart contracts control the DAI generation process, it works efficiently and without human interference. When you want to borrow DAI stablecoin, you lock up crypto in a CDP smart contract. This CDP will set a Liquidation Ratio, for example, 1.5x, meaning you'd need to provide $150 of ETH for $100 of DAI. A user can add more if they want and reduce their risk. If the collateral amount falls below 150% (1.5x), they'll incur a penalty fee. Eventually, the user risks liquidationif they fail to repay their DAI with the added interest rate (the Stability Fee).
What are Maker Vaults?
Maker Vaults are where users put up their collateral and generate DAI. These allow you to use multiple, different cryptocurrencies as collateral simultaneously. The Maker Vault also burnsDAI once a user returns it. The process is as follows:
1. You deposit supported cryptocurrencies to the Maker Protocol.
2. The deposit opens a Maker Vault position.
3. You can withdraw Dai determined by your collateral amount. You will also need to pay the Stability Fee.
4. To get your crypto collateral back, repay the withdrawn DAI.
You're free to generate or return Dai and add or withdraw your collateral at any time. You must, however, maintain the Liquidation Ratio shown in the Vault. If you drop below this ratio, the Vault will liquidate your collateral.
How does the DAI's value remain stable?
Apart from reducing the risk for MakerDAO as lenders, the CDP mechanism helps peg DAI to USD. MakerDAO can also vote to alter the Stability Fee and DAI Savings Rate (interest paid to stakers in the DAI Savings Rate smart contract) to manipulate supply and demand for DAI. These three tools work together to maintain DAI's $1 peg. Let's see exactly how it happens:
1. When DAI dips below the peg, the system makes it attractive for users to repay their debts, retrieve their collateral, and burn their DAI. This can be achieved by raising the Stability Fee, which makes borrowing more expensive. The DAO could also increase the DAI Savings Rate, increasing demand for investment in the token.
2. When DAI is above its peg, the opposite occurs. The DAO creates incentives to generate DAI if the Stability Fee is lowered. This creates new DAI and increases the total supply, lowering the price. MakerDAO could also decrease DAI's demand by reducing the DAI Savings Rate, meaning investors look elsewhere to earn interest.
Where can I buy DAI?
DAI is available to purchase on large cryptocurrency exchanges, including Binance. After creating an account and completing any KYC checks, you can purchase DAI directly with a credit or debit card.
Choose the fiat currency you want to pay in the top field and select DAI at the bottom. You’ll then see clear instructions on adding your card to your account. If you wish, you can also use the exchange viewto swap DAI for another cryptocurrency.
How do I participate in MakerDAO's governance system?
To have a say and vote in MakerDAO, you'll need to hold the project's governance token MKR. The token has a maximum supply of 1,005,577 MKR, and roughly 40% was distributed to the team and early investors at deployment. The DAO held the rest for future sales.
MKR holders can vote to change the platform's Stability Fee, DAI Savings Rate, Liquidation Ratio, and other aspects. Their vote is proportional to the amount of MKR they hold.
Closing thoughts
As the dominant crypto-collateralized stablecoin, DAI has been a proven success. The system mitigates the volatility of crypto all without fiat collateralization, which is quite a feat. Do not forget its significance in the history of DAOs. It's one of the longest-running and largest DAOs that paved the way for many others.
