MakerDAO – A Critical Component of Open Finance

The cryptocurrency market has been suffering some setbacks since the second half of 2017, with some countries announcing restrictions and others outright banning them. The primary objective of this move was to prevent the overwhelming volume of fiat currencies entering the cryptocurrency markets at that time. In countries like South Korea, China, and even in the United States, there have been several regulations and limitations on the usage of cryptocurrencies in their respective markets.

As a remedy for the situation, a new class of cryptocurrencies called stablecoins emerged, which are pegged to a fiat currency, such as the United States Dollar or the Great Britain Pound. These stablecoins allow for more practical usages of cryptocurrencies, as they have a relatively stable and less volatile value. Thus, they act less like a stock and more like a piece of currency.

Among the several stable coin projects in existence at the moment, MakerDAO’s DAI stable coin is one of the most popularly used.

What Is The DAI Token?

As mentioned before, DAI is Maker Dao’s stablecoin which is pegged to the United States Dollar. The stability of the token relies on the market, where users are offered incentives for holding for borrowing DAI coins. These rules are regularly changed in order to maintain the stability of the coin. Since the DAI is supposed to be pegged with the Unite States Dollar, the cost of borrowing increased when the value falls below $1 and decreases when it is above $1.  At the time of writing, (9/23/2019), the DAI token is valued at $1.01, with a marketcap of $87139780 USD. The token is currently trading on 103 active markets, spread across exchanges such as Radar Relay, HitBTC, Yobit, DDEx, Bittrex, FatBTC and  BitInka, to name a few.

How Does It Work?

A low threshold of volatility has to be viable in case of any monetary transaction such as long-term betting, gambling and purchases with payments done in advance. They cannot be denominated by cryptocurrencies which have fluctuating values and volatility. Such transactions also face limitations when it comes to being bound by differing regulations in different nations.

DAI tokens can be acquired directly from exchanges or can be created by locking up some of the user’s Ether in Maker Dao’s Collateralised Debt Position (CDP). The Collateralised Debt Position concept has been introduced by MAkerDAO in early 2015, which acts as a measure of maintaining volatility for the stablecoin.

To ensure that DAI’s value stays relative to the US Dollar, certain mechanisms are in place. This can be explained through the following steps:

  • DAI is backed and stabilized by a smart contract platform on the Ethereum blockchain, by using a series of dynamic feedback systems known as CDPs.
  • CDPs help facilitate an efficient decentralised margin trading platform, allowing a user to deposit an asset to a smart contract as collateral for a loan.
  • After receiving the asset, the CDP allows the user to generate the equivalent amount in DAI
  • The DAI tokens can then be used for payments, for a personal savings account, and act similarly to any existing cryptocurrency.

How Is It Different From Other Stablecoins: Comparisons

When it comes to the comparisons between DAI and other stablecoins such as USDC, GUSD and USDT, DAI has some fundamental differences.

  • Unlike the majority of its stablecoin peers which are backed by fiat reserves held in a bank, DAI uses a different methodology.
  • The transparency of DAI’s token can be seen on chain at all times, as opposed to other stablecoins.
  • DAI maintains stability by using the Collateralised Debt Position Concept.

What Is It Collateralized By?

Among the two major types of stablecoins available, they are collateralised by cryptocurrencies which make them decentralised, or by fiat currencies. In this case, DAI falls into the former category,

Because it is crypto-collateralised, DAI  can be used as debt collateral, which in turn stabilizes the system and rules out volatility. DAI’s on-chain issuance provides greater transparency and audit-ability. In this case, collateral is held in a smart contract and can only be accessible when the stablecoin debt is cleared. Similarly, the smart contract can be closed and the collateral can be sold if there is excess collateral.

In addition to this, MAKERDAO uses a governance token called MKR, which governs the system and fills any shortfalls in collateral. This makes DAI, fully decentralised as well as being backed by an asset. Its solvency is hence not determined by any single entity or locality. The autonomous system of smart contracts which it uses, helps it  to respond instantly to varying market dynamics, keeping the price, stable.

Why Is It Important To Have a Permission-Less & Decentralized Stable Coin?

There are several reasons why people prefer Stablecoins – mainly due to its permission less and decentralised nature. Much of this has to be the prevention of extreme price volatility that is prevalent in most cryptocurrencies. Some of the reasons why a permission-less stablecoin is required, are mentioned in brief below.

  1. Widespread Adoption: Even though cryptocurrencies have been in the news for quite some time, it still has not experienced widespread adoption. Some businesses such as Overstock and shopify accept cryptocurrencies as payments. By using Stablecoins, the various impediments towards widespread adoption can largely be removed. By leveraging the various advantages of cryptocurrencies such as low fees, fast transactions, digital wallets, security and immutability, while maintaining a stable value that is not affected significantly by volatility.
  2. Unbanked Communities: For many unbanked individuals around the world, the need to make international payments quickly and securely is the main priority. Cryptocurrencies which are sometimes used are subject to massive fluctuations, which make them unsuitable for acting as a medium of exchange. Stable coins on the other hand, are not speculative in nature, and can be efficiently used for cross border remittances. For individuals living in nations with economic uncertainties, stable coins can be used to transfer the value without being subject to any localised laws and conditions.
  3. Safe Haven: Stablecoins can act as a safe haven for crypto holders in the event of a market crash.  By moving their funds from cryptocurrencies into stable coins, the risks associated with incurring losses due to volatility are significantly reduced.

Final Thoughts

The DAI stable coin is expected to be a game-changing project, due to its promise of providing a safe and secure way for transferring US dollars globally. With other stablecoins also rising in popularity, the success of DAI would present the opportunity to create a total blockchain based commerce, removing the impediments which non-blockchain finances and commerce present.

Leave a Reply