Maker is a name that beginner cryptocurrency and blockchain enthusiasts will see mentioned frequently on message boards and trader communities. However, reading about Maker and its stablecoin DAI out of context is difficult, as the technology itself is many layers deep and undeniably complex. At present Maker is one of the best financial applications of the decentralized blockchain on the market, so it’s vital to gain a better understanding, regardless of your role in the crypto market.
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What is Maker?
Maker is the name of a single blockchain project that has multiple facets, including two cryptocurrencies, a smart contract, and an ecosystem tied to the Ethereum blockchain. The first and most crucial thing to understand about Maker is that it’s financial in nature, and the entire carefully balanced stack of functionality on which it is designed has one purpose: to transplant the idea of leverage from centralized to decentralized markets.
The first component of Maker is its stablecoin DAI. DAI is a blockchain cryptocurrency like Ethereum or Bitcoin, but it has no volatility relative to the dollar. Much like Tether, TrueUSD, USDC, or any of the other dollar-pegged stablecoins, the value of 1 DAI always equals $1. However, it’s not because each DAI is backed by a physical dollar in some faraway bank account—as a decentralized idea, DAI’s value is backed by ETH and managed by a very smart contract called a CDP.
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CDP: This is Maker’s second module and stands for Collateralized Debt Position. The CDP is a smart contract that stores ETH and issues DAI stablecoins on the blockchain, with the ETH used as collateral. It’s like a loan from a bank using material assets as collateral.
The final component is the cryptocurrency Makercoin (MKR). MKR token holders are responsible for maintaining the integrity of the network, managing CDP collateral, and ensuring consistent governance. This position of responsibility means that MKR holders are rewarded with fees, but they’re also the last line of defense should a black swan event occur that upsets Maker’s delicate balance.
How Does Maker Work?
The goal of Maker is to allow cryptocurrency holders to leverage their assets and gain increased exposure to the market if they like. One can easily deposit their ETH to a CDP and use the DAI issued to them to buy more ETH, for example. Even so, there are questions about DAI’s stability without the physical dollar backing, how the currency would react to abnormal movements in crypto trends, and the Makercoin’s greater role in the system.
Even without physical backing, DAI isn’t “free money”. When someone sends their ETH to a CDP, it’s locked and no longer theirs until they deposit the same amount of DAI that it originally issued. The amount of DAI that you can create with ETH is always changing, which combats volatility in ETH itself. For instance, one day you could deposit 1ETH and receive 66 DAI, while the same amount of ETH might create 75 DAI a day later. You’ll only get this ETH back if you deposit 66 or 75 DAI to the CDP, respectively. This is called the collateralization ratio, and it’s one of the lynchpins of the CDP smart contract. It’s also voted on periodically by MKR holders, which is a big part of their job.
|Read Also: What are StableCoins? A Complete Guide|
Moreover, isn’t always $1.00 exactly. On some days it’s as low as $0.98 and others as high as $1.02. It might not seem like a wide range, but even a few pips off the dollar’s value can create chaos. To deal with the inevitable reality of DAI being worth more than $1, Maker has an algorithm that adjusts fees and the collateralization ratio (independent of MKR holders) that make it more lucrative to create DAI with ETH. However, rising ETH prices merely further collateralize DAI and don’t lead to real problems other than needing to adjust the collateralization ratio.
If It All Falls Down
If DAI is worth less than $1, it’s a bit more troublesome. This could happen if ETH falls in price rapidly, thus pulling the price of DAI down as well. If such an event were to persist without being addressed, the system would collapse. In the case of falling ETH and DAI prices, the Maker system automatically liquidates CDPs before the amount of ETH inside them falls below the value of the DAI they created. This is the risk of leverage. Maker’s site even has a handy panel listing all active CDPs and their individual ID and value, and when the market crashes (as it has been prone to do lately) it’s a crucial source of knowledge.
Even though these keep DAI collateralized, cryptocurrency markets look much differently in bear markets than they do during black swan events (which one should not discount). This is where MKR holders come in. They’re incentivized by fees, but the final “emergency” function of Maker is that if the entire system goes belly-up, Makercoins are liquidated along with the ETH in every CDP. This is why the value of MKR is so high (nearing $400 per coin at the time of writing). It’s a lucrative opportunity to control a revolutionary decentralized financial idea, but also involves individual financial risk.
Why Do We Need Maker?
Maker’s version of completely decentralized stablecoins is crucial for the next generation of transactional ideas built on blockchain. Lending platforms, betting websites, and even remittance applications cannot abide by any volatility, or else significant risk is introduced. Imagine sending money to a friend abroad and seeing the value fluctuate by 20% before it arrives.
Decentralized value transfer projects should also be able to give their customers the utmost safety, and without a bank or other authority to guarantee the return of their funds, a new solution is needed. Relying on the legal system to ensure that token holders are repaid in the event of fraud is unsustainable, as stablecoins backed by dollars are essentially a certificate that shows you’re owed $1, but only through the traditional legal system can you get reimbursed. With Maker this idea is revolutionized and devoid of middlemen, even those that are only necessary to use in catastrophic events.
For all the new functionality it brings to the young cryptocurrency market, Maker can be forgiven its somewhat complicated design. Cryptocurrency traders of all experience levels need to familiarize themselves with Maker as soon as possible, to prepare themselves for the highly impressive and independent crypto finance sector that Maker has already ushered in.