Dai (DAI) Review – An Ether-Backed Digital Stablecoin
|White Paper URL||https://makerdao.com/whitepaper/|
Dai is the first stable peer-to-peer cryptocurrency. It is a crypto-collateral-backed stablecoin backed by Ether, with a value that is stable relative to the US dollar. Dai is leveraged with Ethereum assets through Maker, a smart contract platform. Each Dai is equivalent to one US dollar. The decentralized autonomous organization behind Dai, MakerDAO, strongly believes that blockchain-based tokens will eventually replace traditional certificates in the capital structure of organizations.
Table of Contents
The Idea Behind Dai
Traded since December 2017, Dai addresses the need for a stable cryptocurrency in the marketplace. Dai is a crypto-collateralized stablecoin, which are similar to fiat-collateralized stablecoins, but with the collateral being cryptocurrency instead of fiat. With crypto-collateralized stablecoins, however, it is necessary to have a ratio of more than 1:1 to back the stablecoin in order to absorb price fluctuations in the cryptocurrency being used as a collateral.
Here is an example of how crypto-collateralized stablecoins work: If you wanted to receive $400 in stable coins, you would need to deposit $800 in Ether. If Ether were to experience a devaluation of 50%, your stablecoin would be backed up due to the over-collateralization. But if Ether crashed completely, your stablecoin would be worthless, and the over-collateralization would make the loss even greater.
Critics of stablecoins argue that due to the over-collateralization, it is an inefficient use of capital – even more so than fiat-based stablecoins.
The company has partnered with a number of notable companies in the cryptocurrency space. In February, they announced a partnership with PayBear, a payment gateway and wallet ecosystem. Dai was the first ERC-20 token to be supported by PayBear. Kyber Network, a decentralized exchange service for crypto-assets, also announced it would list DAI on their exchange in April. Later that month it partnered with Gitcoin, a tol that allows the open source community incentivize or monetize work, offeriong $10,000 Dai on leading Web3 and OSS repositories. In May, Maker worked with Lendroid to launch, Reloanr, a secondary market for Dai loans. These are only a few of the many partnerships the company has announced since its launch.
Investment partners include Distributed Capital Partners, Scanate, FBG Capital, Wyre Capital, Walden Bridge Capital and 1confirmation. Andreessen Horowitz and Polychain Capital led the purchase of $12 million of MKR at the end of 2017.
What Makes the Dai StableCoin Unique
In most countries throughout the world, the traditional central bank is responsible for raising or lowering interest rates of the national currency. Since these central banking systems are centralized, they are able to offer different rates of loans to different individuals or businesses. In addition, the central bank of many countries covers bad debt of lenders, which over time, is covered again by higher rates of loans.
The Maker platform offers several improvements to the traditional central bank. In the Maker system, money doesn’t come out of thin air, but is instead created by borrowing against existing assets. These assets in the Maker platform, in contrast to a central bank, are a diversified pool of assets which is a better guarantee. It is the hope of Maker that Dai be pegged to the Consumer Price Index (CPI) or other metric if the Federal Reserve ever loses credibility.
In addition, in the Maker platform individuals and businesses receive loans directly from the platform, rather than a third-party that receives a cut in the traditional banking system.
MakerDAO and MKR
MakerDAO, or Maker for short, is a decentralized autonomous organization on the Ethereum blockchain. It is responsible for minimizing price volatility of the Dai against the US dollar.
The Maker token (MKR) is a token on the Ethereum blockchain. It functions as both a utility token and a governance token. As a utility token, it is used to pay fees for Collateralized Debit Positions, or CDPs, that generate Dai. When paid, the MKR is burned, decreasing the supply of MKR over time. Holders of MKR help to govern the system as well by voting for risk management and business logic of the system.
MKR also functions if the collateral portfolio of Maker becomes undercollateralized. If this happens, automatic recapitalization occurs. The Maker system creates and sells new tokens on the market to generate funds
The Maker Platform
Users can generate Dai on the Maker platform through smart contracts which lock their collateral until they repay the loan in full. These smart contracts are known as Collateralized Debt Positions (CDP); the interest rate is the Stability Fee.
Here is a step-by-step explanation of what happens when a user enters into a smart contract on the Maker platform, assuming a collateralization ratio of 150% and a 1% stability fee:
- User’s pledged collateral is accepted.
- Parameters are checked for lending against the specific collateral.
- Dai is created against the collateral.
- If the loan is paid back in full with interest, the collateral is released. Part of the interest payment is given to holders of MKR, the Maker utility token.
- If the loan goes below a specific amount, the collateral is liquidated up to the value of the loan, and the Dai is destroyed.
- If there isn’t enough collateral to cover the value of the loan in Dai, the MKR token holders will print MKR and sell it for Dai until it can offset the loan.
How Dai Maintains Price Stability
Dai is a stablecoin, meaning that it will always be equivalent to $1.00. Maker is able to create an ecosystem in which users take volatile assets and borrow stable assets by creating a diversified collateral portfolio to support each stable asset. Without the diversified portfolio, Maker would have many outstanding loans and be in serious financial trouble in the case of a black swan event.
Another function used to keep Dai stable is the Target Rate Feedback Mechanism, an autonomous mechanism which adjusts the Dai market rate to maintain it closer to the target price stable to the US dollar. It kicks in in the event of severe market instability, incentivizing users to create more Dai if it trades above one dollar. If the price of Dai falls, causing the system to be in danger of collapse, all CDPs are liquidated, with the corresponding ether being auctioned off until enough Dai is available to pay back the CDP.
How to Purchase DAI
OasisDEX is currently the main option for purchasing DAI. You can purchase DAI on OasisDEX there for ETH. It is also the exchange with the highest volume of trading at over $6 million.
DAI is also available on the following exchanges:
- HitBTC (Trade DAI with BTC on HitBTC)
- Ethfinex (Trade DAI with USD on Ethfinex)
- HitBTC (Trade DAI with ETH on HitBTC)
- RadarRelay (Trade DAI with WETH on RadarRelay)
- Kyber Network (Trade DAI with ETH on Kyber Network)
How to Store DAI
DAI can be stored in any wallet that supports ERC-20 tokens such as Coinomi, MetaMask and Myetherwallet.
For maximum security, however, you should store your DAI on hardware wallets such as Ledger Nano S and Trezor.
The Future of Dai
Dai has the potential for many different use cases across various industries, including: prediction markets or gambling applications, leveraged trading for hedging, derivatives and financial markets. In addition, governments and charities can see increased transparency through Dai’s accounting system.