MakerDAO is a complex system, but this complexity is born from its grand vision. It doesn't just develop and provide the largest decentralized stablecoin, Dai; it is also conducting an unprecedented experiment: a decentralized "central bank" on the blockchain.
Dai: The Mechanism of Generation
Maker is a smart contract system on Ethereum that provides the first decentralized stablecoin, Dai ( which can be simply understood as the U.S. dollar on Ethereum), and a derivative financial ecosystem. Dai is issued through over-collateralization by digital assets, with 1 Dai = 1 U.S. dollar. Since its launch in 2017, Dai has maintained its peg to the dollar.
For everyday users who simply want to use Dai as a stable currency, understanding the underlying mechanism isn’t necessary. You can exchange for Dai on supported platforms and use it like dollars (Dai is an ERC-20 token).
For advanced users or those looking to generate (borrow) Dai, the process involves interacting with smart contracts:
Suppose you hold cryptocurrency, like Ethereum. You don’t want to sell your ETH but need liquidity for spending or further investment.
- You lock $1,500 worth of ETH into a smart contract called a Collateralized Debt Position (CDP) as collateral.
- Based on the risk parameters of that collateral (a discount rate, often around 2/3), you can generate 1,000 Dai, equivalent to $1,000.
- You convert this Dai into dollars or use it to invest in other assets.
- When you want to reclaim your collateral (ETH), you repay the 1,000 Dai plus a small stability fee (paid in MKR, currently around 0.5% annualized), retrieve your ETH, and keep any profits (from ETH's price appreciation or investments made with the Dai).
👉 Explore advanced borrowing strategies
Dai: How Is Stability Maintained?
A natural question arises: what keeps Dai's price stable, especially if the price of the collateral asset, like Ethereum, falls?
Dai is always over-collateralized, meaning it is always backed by more than enough assets.
If the collateral asset's price rises, the backing for Dai becomes even stronger. If the asset's value falls to a certain threshold (and the CDP owner hasn't added more collateral or repaid Dai), the contract automatically triggers a liquidation. Any user can liquidate under-collateralized assets and earn a 3% risk-free profit. This incentivizes market participants to act as "Keepers" within the Maker system. They not only profit from the system but also protect Dai's solvency.
The system also includes a "lender of last resort" mechanism and a global settlement process (where Dai holders can redeem their Dai for a dollar's worth of underlying assets) to further protect Dai's stability. Market downturns in 2018 and beyond have not impacted Dai's peg. Furthermore, the upcoming Multi-Collateral Dai (MCD) upgrade, which will include assets like tokenized gold, will significantly diversify the portfolio of assets backing Dai, fundamentally spreading its risk.
Dai: Real-World Applications
A common question is: How does Dai differ from USDT?
Dai can do everything USDT can, and many things USDT cannot. Unlike USDT, Dai is publicly auditable, fully transparent, and decentralized, offering new value to users and institutions.
Beyond serving as a base currency and safe-haven asset on exchanges, Dai can be used for collateralized loans. There are documented cases of individuals using Dai-based loans to buy cars and open coffee shops.
Dai's blockchain-native properties give it advantages for low-cost margin trading.
Within the decentralized ecosystem, Dai is more than just a trading pair; it's the default stable medium of exchange for dApps. For instance, the prediction market Augur uses Dai for betting to avoid the volatility of native tokens. This use case applies to nearly all decentralized commercial scenarios.
Cross-border transfers and supply chain finance represent significant real-world applications for Dai. International supply chain company Tradeshift has integrated Dai as a payment method and is exploring tokenizing invoices for Dai-based financing. Partnerships with digital asset transfer firms like Wyre create bridges between crypto and fiat. International transfers previously done with Bitcoin or Ethereum can now use volatility-free Dai, enabling instant conversion into currencies like USD, EUR, GBP, AUD, HKD, and CNY.
Maker: The Decentralized Central Bank
So, what is Maker?
Maker is the entire system and decentralized autonomous organization (DAO) behind Dai. If you understand Dai's role as a base money, you realize Maker is effectively implementing a decentralized "central bank."
From the early gold standard to the modern banking system, money creation has evolved from being constrained by gold and reserve deposits to being based on credit creation. This better suits the liquidity demands of a capitalist economy but creates a constant trade-off between liquidity and transparency. Low transparency pushes systemic risk to the extreme.
The on-chain, over-collateralized creation of Dai provides liquidity that adjusts to demand while eliminating the risk of money being "printed out of thin air." Every unit of Dai is backed by sufficient assets. Furthermore, Maker has no counterparty risk and isn't subject to the monetary policy of a single sovereign state. Dai generation occurs via on-chain contracts, eliminating centralized custody risk—even the Maker development team cannot tamper with or seize user assets.
This robust system requires sound governance.
MKR: Governance and Utility in MakerDAO
MKR is the utility and governance token of the MakerDAO. MKR holders participate in the governance of the system and benefit from its success.
As a utility token, MKR is used to pay stability fees. When users repay their Dai loans, a portion of the interest is paid in MKR, which is subsequently burned. This means MKR holders effectively earn continuous interest income through a buyback-and-burn mechanism.
Concurrently, MKR is a governance token. Holders vote on key risk parameters within the system, such as:
- Types of acceptable collateral assets
- Liquidation ratios
- Stability fee rates
The value of MKR is intrinsically linked to the health of the Maker system. Sound governance leads to healthy system expansion and increased cash flow (more fees burned). Poor governance could potentially lead to the dilution of MKR value or the minting of new MKR to cover bad debt. This incentivizes MKR holders to manage the system prudently.
👉 Learn more about decentralized governance models
Concluding Thoughts
Bitcoin aimed to create a peer-to-peer electronic cash system, but it's undeniable that, for now, this attempt has failed in that purpose. Bitcoin's extreme price volatility prevents it from performing money's most basic function—a unit of account. This stems from a critical flaw in its design: mimicking gold's fixed supply, which made it a target for speculators. Bitcoin's deflationary nature punishes lenders (imagine a loan denominated in Bitcoin from years ago). A fixed supply design ignores the fact that money is essentially a transferable debt, and its supply should adapt to the demand for credit.
This is also the origin of Dai's name— derived from the Chinese word for "loan" (贷, Dài). Dai is a transferable loan issued against fully-backed assets, its value derived from its collateral. Dai is pegged to the U.S. dollar because the dollar is the current global settlement currency and the most widespread numeraire on crypto exchanges. In the future, Dai could have derivatives pegged to the Euro, Yen, or other currencies.
Stablecoins are a hot topic. The key issue for a stablecoin isn't the control of its money supply or the "advanced" nature of its algorithm. It lies in the governance of its backing assets, the ecosystem it依托于 (relies upon), and the trust people place in it.
Maker's mechanism is not a fanciful idea detached from reality. Our vision is ambitious, but we know it must align with economic principles and be grounded in practical, real-world application. We aim to reshape the monetary system to help communities and individuals who lack access to traditional banking services.
The ‘nature’ of money cannot be found in any of its external forms, such as a commodity or note, but in its stable ability to transfer the debt that underpins economic transactions.
Joseph Schumpeter, The Theory of Money
Frequently Asked Questions
What is the primary difference between Dai and USDT?
Dai is a decentralized, transparent, and auditable stablecoin backed by over-collateralized crypto assets on the Ethereum blockchain. USDT (Tether) is a centralized stablecoin backed by reserves held by a company, with less frequent and transparent audits.
How is the value of Dai kept stable at $1?
Dai's stability is maintained through a system of over-collateralization, autonomous liquidation processes for under-collateralized loans, incentivized Keepers, and emergency mechanisms like global settlement, ensuring its peg to the U.S. dollar.
What is a Collateralized Debt Position (CDP)?
A CDP is a smart contract that locks up cryptocurrency as collateral to generate Dai. It defines the terms of the loan, including the collateralization ratio and the stability fee required to reclaim the locked assets.
What role does the MKR token play?
The MKR token serves two primary functions: governance (MKR holders vote on system parameters) and utility (it is used to pay stability fees on Dai loans, which are then burned, creating value for holders).
Can I lose money using a CDP to generate Dai?
Yes, if the value of your collateral falls significantly and you are liquidated, you will lose a portion of your collateral. It's crucial to monitor your collateralization ratio and manage risk carefully.
What is Multi-Collateral Dai (MCD)?
MCD is an upgrade to the Maker protocol that allows multiple types of digital assets (beyond just ETH) to be used as collateral to generate Dai, diversifying the risk and expanding the use cases of the system.