Maker protocol was one of the first DeFi apps to acquire widespread acceptance, and it is now one of Ethereum's most popular DApps. It's one of the most common names I've came across since discovering DeFi. But what is Maker DAO, exactly?
MakerDAO is a decentralised governance community that uses an inbuilt governance mechanism in the Maker protocol to facilitate the generation of Dai, the world's largest decentralised stablecoin. The Maker protocol is a series of smart contracts that enable the creation of Dai. Maker started with three tokens:
- Sai and Dai (both tied to $1) stablecoins
- Single Collateral Dai, or Sai (SAI). As collateral, it is exclusively backed by Ether.
- Multi Collateral Dai (DAI) or Dai (DAI). It accepts a variety of cryptocurrencies as collateral, including ETH, BAT, USDC, wBTC, COMP, and others.
- Maker token for governance (MKR). MKR holders are the only ones with the power to vote for system changes.
Maker had intially started out on December 19, 2017, with the Single Collateral Dai. It could only be minted with Ether (ETH) as collateral. Maker then unveiled the new multi-collateral Dai on the 18th of December 2019, which could be minted with either ETH or BAT as collateral, with plans to add other cryptocurrencies in the future.
SAI has been phased out, and Maker no longer supports it. Maker maintains Dai as the de-facto stablecoin.
What is Dai
Legacy cryptocurrencies are extremely volatile, with large intra-day price swings. In order to function, a decentralised economy needs stable money. Stablecoins, which are pegged to other stable assets (such as the US dollar), were created to address this issue. Stablecoins are divided into two categories:
- **Centralized stablecoins **One of the first coins of this type was Tether (USDT). Every USDT is said to be backed by a dollar held in the issuer's regular bank account. Users must assume that the USD reserves are fully collateralized and exist, which is a serious issue. We must also trust the custodians not to inflate the currency artificially.
- **Decentralized stablecoins **They are created using surplus collateral in a completely decentralised manner, run entirely on distributed ledgers, are administered by DAOs, and their reserves can be audited by anybody.
Decentralized stablecoins possess higher risk than centralized stablecoins.
Dai is the largest decentralised stablecoin in the world. It enabled a slew of new DeFi activities and apps that weren't previously possible. Every Dai in circulation is backed by excess collateral, which means that the collateral is worth more than the Dai loan. Dai can be used in the same way as any other cryptocurrency: you can send it to people, use it to pay for things, or hold it as savings.
Why Dai
Why would you lock up a higher-value asset like ETH only to issue a lower-value Dai? Instead, you could have sold your assets in USD. There are three scenarios that might arise:
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You require immediate cash and believe that the asset you possess will increase in value in the future.
In this situation, we can keep our item in the Maker vault and issue Dai to obtain the money right away.
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You need money right away but don't want to pay taxes when you sell your asset. You can take out a loan by issuing Dai instead.
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You’ll be able to conduct investment leverage on your assets if you feel the value of your assets will increase.
How to get some DAI
There are two ways to get Dai:
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**Minting Dai **This is similar to putting a valuable in a pawnshop as collateral in exchange for cash. Here,
- valuable (collateral) —> cryptocurrency (collateral)
- cash —> Dai
- pawnshop —> Maker
- legal contract —> vault smart contract
- interest —> stability fees
There can be multiple vaults for the same collateral. For instance, there are three Ethereum vaults on https://oasis.app/borrow . These have different collateral ratios and annual fees, to suit different needs.
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**Trading Dai **Dai can be sent anywhere once it has been generated. Without having to mint DAI, it may be acquired on cryptocurrency exchanges.
This method of purchasing Dai is more convenient because you don't have to put up any collateral and don't have to worry about things like collateral ratio and stability fee.
Dai Savings Rate (DSR)
Dai holders can earn savings while keeping control of their Dai. The Dai Savings Rate is a variable accrual rate received by locking Dai in the DSR smart contract, which has no withdrawal, deposit, or liquidity restrictions. MKR token holders actively set the rate:
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When the price of Dai rises above 1 USD, MKR holders can choose to gradually lower the DSR, reducing demand and bringing the market price of Dai closer to the 1 USD target.
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When the price of Dai falls below 1 USD, MKR holders can choose to gradually raise the DSR, creating demand and driving the market price of Dai up to the target price of 1 USD.
Vaults
A vault is a tool that allows us to deposit collateral and mint Dai. The total supply of Dai changes as a result of the collective vault usage. You generate Dai by depositing excess collateral, and you destroy Dai by returning the Dai balance you generated. Anyone can look up the amount of circulating Dai and the amount backing it because the process of Dai generation takes place totally on-chain. Vaults come in a variety of types, depending on the type of collateral that was used to generate Dai.
Vaults are over collateralized and have a liquidation ratio that vault owners need to uphold to prevent the liquidation of their vaults. A 13 percent liquidation penalty is applied when a vault is liquidated, and the collateral is auctioned to cover the loan. On top of that, there's a debt ceiling.
Why open a vault
Vaults allow users to gain access to the underlying value of their assets without selling them. Here are a few examples of how vaults are used:
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Make use of leverage
By investing the created Dai from their vault, you can 'leverage' collateral in a decentralised method to increase exposure to a specific asset. Users wanting leverage should exercise caution because it increases both the danger of loss and the opportunity for profit.
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Utilize Assets for Liquidity
Users in need of liquidity should resort to vault, as Dai can be used for any purpose.
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Repayment Schedule That Is Adjustable
Vaults offer terms that are flexible. There are no deadlines for repayment, no minimum payments, and no credit score criteria. As long as their vault is correctly collateralized, users can pay back the loan at their own leisure.
Liquidation
The process of selling a user's collateral to cover the amount of Dai generated from their vault is known as liquidation. By closing vaults that do not reach the minimum collaterization ratio for their collateral type, it helps to ensure that Dai is always backed by a sufficient amount of collateral.
Only the quantity of collateral necessary to pay off the outstanding debt and liquidation penalty is sold during the liquidation procedure. Withdrawal of the remaining collateral is possible.
The minimum level of collateralization for each vault type before it is considered under-collateralized and liquidated is known as the liquidation ratio.
*Liquidation Ratio = (Collateral Amount * Collateral Price) / Generated Dai * 100 *
The price at which a vault becomes vulnerable to liquidation is known as the liquidation price. It can be reduced by adding more collateral or by returning Dai to the vault.
Liquidation Price = (Generated Dai * Liquidation Ratio) / Amount of collateral
The fees paid by vault owners when the value of their collateral reaches liquidation price are known as liquidation penalty. It aids in the prevention of Auction Grinding Attacks.
Stability Fees (SF)
Vaults aren’t free to use, and they come with risks. Minting Dai requires the payment of Stability Fees. The SF is a variable rate determined by MKR holders through a voting process. If a user wants to retrieve their collateral, they must pay back the Dai they created as well as the SF accumulated.
The system will automatically send Dai to a 'Surplus Auction' once the maximum level of surplus has been reached. Keepers bid in MKR for DAI during this auction. The successful bidder receives DAI, and the MKR paid by the winner is burnt.
Emergency Shutdown
Emergency shutdown is triggered in the black swan event of a large drop in the price of a collateral. This is used as a final resort to settle the Maker platform by shutting down the system. It assures that Dai holders and Vault users obtain the full value of their assets.
Why Maker
Why use Dai when there are so many other stablecoins available? The core distinctions of these coins lie in their protocol. Unlike most stablecoin platforms, Maker is entirely based on a distributed ledger, which means it has all of the properties of a blockchain right out of the box. It is safe, immutable, and transparent.
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