Cryptocurrencies and crypto assets, in general, are known for their massive price fluctuations. For this reason, using such assets to borrow has always presented a problem because the amount a borrower has to pay back could be very different from what they borrowed.
DAI is soft pegged with the US dollar and built on ERC-20 to facilitate collateral lending and borrowing. By coupling loans with stable tokens, DAI allows users to borrow money and easily predict the repayable amount.
Anyone with Ether cryptocurrency and a MetaMask wallet can lend themselves funds in the form of Dai. All a user has to do is lock up some Ether in MakerDAO smart contracts and mint the Dai stablecoin. The more ETH they lock, the more they can borrow. To unlock their ETH, a user simply pays off the loan.
This guide will go deeper into DAI and the MakerDAO history and whether or not it’s worth an investment. Let’s jump in.
What Are MakerDAO & Dai?
MakerDAO is a peer-to-peer organization created on the Ethereum network to allow people to lend and borrow using cryptocurrencies. The p2p organization is also known as Decentralized Autonomous Organization (As an open sourced blockchain ledger, Decentralized Autonomous Organization (DAO) is determined by a clear set of rules ...). The process of lending and borrowing is controlled by smart contracts.
Because cryptocurrencies are highly volatile, MakerDAO uses a stablecoin known as Dai to determine lending rates and repayable amounts.
Simply speaking, MakerDAO is a crypto lending credit facility that gives loans at predetermined interest rates. If a MakerDAO user wants to borrow, they would first deposit the Ethereum into a Maker smart contract. The smart contract creates a Collateralized Debt Position (CDP).
Assuming asset A trading at $100. If the user deposits asset A at a collateralized rate of 150%, they would receive 40 Dai tokens.
However, if asset A depreciates and its price falls below $100, the borrower is automatically closed out of their position. For them to get back their initial deposits from the MakerDAO ecosystem, they would have to pay back the amount they received, plus a fee.
On the contrary, if the asset A value appreciates, the user can draw Dai tokens from their CDP, using the newly created Dai to buy more of token A and adding more assets to their CDP to protect against a drop in the value.
MakerDAO Use Cases
The Maker Protocol — aka the Multi-Collateral Dai system, or MCD — was created to unlock the possibilities of Decentralized Finance (DeFi) takes the decentralized concept of blockchain and applies it to the world of finance. Build... and to provide its users and developers with innovative financial tools. Therefore, the Maker Protocol, together with its Dai stablecoin, forms a vital base layer infrastructure for numerous other protocols in decentralized finance.
For example, Dai is used and accepted by numerous community-developed applications in the DeFi space. A good example is the Heritage platform from Airbus A^3. It is a blockchain-based donation and fundraising platform that allows charities to use smart contracts and cryptocurrencies to open up fundraising opportunities to a new class of potential donors.
UNICEF also uses Dai Stablecoin to enable donors to fund blockchain-based open-source explorations for social projects. Any Dai donations made to UNICEF go toward research funds and bounties for different tech projects aimed at helping vulnerable populations.
Other DeFi applications operating in the Maker ecosystem and using Dai include Outlet and Uniswap. The outlet is a high-yield alternative to a savings account, while Uniswap is a protocol designed to enable fast, efficient cryptocurrency trades of Ethereum.
Beyond applications in commercial finance, MakerDAO hopes to have an impact on regions currently suffering from hyperinflation by offering a stable alternative to volatile fiat currencies.
In the gaming industry, Dai is used for games such as Battle Racers, Axie Infinity and SkyWeaver to allow users to create tokenized in-game assets and earn rewards for the tokens on the blockchain. MakerDAO has even launched the Dai Gaming Initiative to encourage the creation of gaming apps that integrate Dai rewards.
MakerDAO is also looking to integrate Dai into the art world with the goal of incentivizing artists to trade their artworks, digitize their work as unique non-fungible tokens (NFT), and prove ownership.
History of MakerDAO
Rune Christensen founded MakerDAO in 2015. Its headquarters are located in Santa Cruz, California.
In 2018, Andreessen Horowitz bought 6% of the total Maker in circulation at the time, therefore providing a $15 million capital boost to the project.
MakerDao is the longest-running project on the Ethereum blockchain. The project has more than 2.3 million Ethereum in its protocol, which is approximately 2% of the total supply of Ethereum.
The MakerDAO team consists of 11 members, including:
- Steven Becker — President & COO
- Søren Peter Nielsen — Head of Product
- Andy Milenius — CTO
- Brian Avello — General Counsel
MakerDAO vs. MKR
In addition to Dai, MakerDAO has another token known as MKR. The MKR token controls the MakerDAO ecosystem. Holders of the token can control different aspects of the Maker Protocol, including the amount of collateral for CDPs, annual borrowing, and shutting down in case Ethereum crashes.
MKR holders play a vital role in the governance of the Maker ecosystem. They are responsible for regulating the platform by controlling the addition of new collateral types and their risk parameters. MKR holders are also responsible for acting as the buyers of last resort for Dai loans. This means that if the collateral ETH held in Maker Vaults is less than what is required to cover the amount of Dai in circulation, MKR is created and sold in a debt auction to raise the needed amount of collateral.
MKR’s functionality is designed to incentivize responsible behavior from MKR holders. It is also responsible for building MakerDAO into a truly decentralized system.
Whenever fees are paid in the MakerDAO system, a dollar value of MKR is bought out of the market to pay for stability fees.
Is MakerDAO a CDP?
As noted above, CDP is short for Collateralized Debt Position. In simple terms, it is when a user sets aside assets to use as collateral so that the user can then take out a loan or debt against said collateral.
On the Ethereum blockchain, CDP refers to a position or loan taken through the MakerDAO smart contract.
When you open a MakerDAO CDP, you lock in Ether as collateral. You are then able to mint up to two-thirds of the US dollar value of the Ether you’ve locked up. In other words, you must have at least 150% more collateral in your CDP than the debt you wish to take.
CDP holders must pay an annual interest rate for the opportunity to create a new Dai. This fee is known as the stability fee, and it helps deter users from overinflating the total supply of Dai. Once the loan is repaid, the stability fee owed in MKR and Dai is burned.
Is MakerDAO a Good Investment?
MakerDAO is a good investment because it is a decentralized protocol. Anyone who owns an MKR token automatically becomes part of the community and gains governance rights. This means that if you invest in MKR, you will have the autonomy to decide the future of MakerDAO.
As we have mentioned previously, MKR tokens are destroyed every time a loan is paid back. This means that the scarcity of the token increases, and the price of MKR remains high. For example, between December 2020 and January 2021, the price of MKR rose from $566 to $1,200. This rapid appreciation is practically impossible in traditional financial systems.
MKR is therefore more lucrative to borrowers as well. This is because as a user, you can lend yourself a loan by locking up your ETH as collateral and creating a Collateralized Debt Position.
That being said, holding MKR also comes with its own set of risks — although most of them are hypothetical and have not occurred. The largest risk is that the price of Ethereum can crash, rendering all the collateral in the Maker ecosystem worthless.
There is also the risk that the number of bad loans and non-repayments can increase to the point where the price of MKR tokens decreases.
In the future, the MakerDAO team hopes to overcome the extreme volatility of cryptocurrency prices. Two examples they cite in their white paper: Bitcoin’s price rose more than 300% in one month and, in another case, fell by 25% in one day.
MakerDAO hopes to achieve this stability by making use of stable digital assets, which they believe are necessary to help blockchain reach its full potential.
The team has also developed a wide array of strategies in order to help stabilize the value of the Dai stablecoin. Their white paper outlines all of these strategies, as well as steps to mitigate the risks.
The Bottom Line
MakerDAO is an up-and-coming DeFi project that is among the first-ever protocols in decentralized finance. With a strong and efficient community of developers and hundreds of partnerships, MakerDAO has become the pioneer of the decentralized finance movement. If the protocol continues on its current path, and ETH continues to be a valuable cryptocurrency, there is no doubt that MakerDAO has a bright future.