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MakerDAO: An Introduction and how it works

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DappRadar

MakerDAO is the protocol behind the stablecoin DAI.

The coin is designed to lessen the impact of cryptocurrency volatility on its value and stability. Running on the Ethereum blockchain, DAI and MakerDAO currently form the backbone of the growing DeFi sector. 

DeFi daily active unique wallets have significantly risen in 2020, and that success has mostly been attributed to MakerDAO. MakerDAO is a big part of the DeFi ecosystem. When the total locked value of ETH crossed the $1 billion mark, 60% of ETH was held in MakerDAO. 

Stablecoins are generally pegged to stable assets such as fiat, as is the case of Libra or Tether (USDT). They can also be backed by commodities, as is the case of Digix Gold Tokens (DGX) or cryptocurrencies. 

Collateralization systems linking crypto with fiat have long been pursued as the cornerstone of stable coin creation. Tether, for instance, was supposed to issue USDT according to the number of USD in its accounts. 

After various Tether controversies, the industry realized that a fiat-backed stable coin is grossly exposed. In a worst-case scenario leading to an exit scam of epic proportions. 

As an illustration, Tether has lately confessed that its tokens are not backed 1:1 by the USD.

How is MakerDAO different?

The MKR team designed its stablecoin to allow blockchain to reach its full potential. By backing MKR with DAI, a crypto asset they ensure that MKR is devoid of central authority. Not have to rely on the current stable coin building models. 

DAI is a digital currency with a stable price. Due to a variety of tools in play that keeps its value at the pace of the US dollar. The most significant of these tools is the smart contract platform, Maker.  

Maker ensures the stability of the DAO by utilizing Collateralized Debt Positions (CDPs). Smart contracts that hold on to the collateral deposited by users, allowing these to generate DAI, for borrowers. 

The presence of the debt locks the user’s collateral assets within the smart contract. Until a time when the user is ready to pay back the amount of DAI borrowed. When the debt is paid, the user can withdraw their collateral. 

To maintain the stability of the system, an active CDP has a higher collateral value than the debt accrued.

How the Process Works

The user will first send Maker their transaction to initiate the creation of a CDP. The user will fund the transaction, and once it is collateralized, the user can retrieve DAI from the smart contract. 

The smart contract will accrue the debt and seal off the user’s collateral until the debt is paid. There are also additional fees such as Stability Fees payable in MKR. 

The collateral is fully available for withdrawal once the debt and fees are paid. DAI initially only supported ETH as collateral, but it is moving to different CDP type crypto assets.  

This process allows MakerDAO to give its users loans without the use of trusted parties or KYC with attractive repayment terms and interest rates. The repayment terms are at the discretion of the user, and the security of the collateral and payment is guaranteed by the smart contract created. 

To keep DAI free of volatility, the collateral help by a CDP is generally worth 150% the amount borrowed.

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