MakerDAO: Ethereum’s Decentralized Central Bank

Introduction

Blockchain technology and modern cryptography has enabled the creation of programmable money. MakerDAO and The Maker Foundation have created a platform for the generation and exchange of the stablecoin DAI, which has become a vital aspect of Ethereum’s $159 billion dollar DeFi ecosystem. 

DAI is algorithmically backed by digital assets deposited onto Maker Protocol – which is an assortment of smart contracts that operate without the need of centralized intermediaries. These assets, along with various incentive mechanisms set in place by MKR holders, keep DAI pegged to the USD. 

1 DAI = $1. 

In this article, we’ll go over some of the history, mechanics, and onboarding processes of MakerDAO to get you started on your DeFi journey. 

History

MakerDAO was founded in 2014, a year before Ethereum even launched. When single collateral DAI (SCD) was released to Ethereum’s mainnet in 2017, it helped usher in entirely new perspectives about the roles that stable reserve currencies could play in DeFi. Rather than having to rely on centralized stable coins like USDT or USDC, which present distinct third party risks, decentralized applications (dApps) could now utilize a decentralized reserve currency. This was game-changing and set the stage for multi-collateral DAI (MCD) which was released to Ethereum’s mainnet in November 2019. 

The functionality and mechanisms of the Maker protocol are governed by MKR holders. Proposals are made within MakerDAO (Maker’s Decentralized Autonomous Organization) on which Ethereum based assets are deemed acceptable as collateral and what the appropriate collateralization ratios are. 

These ratios directly affect how much DAI you can generate against deposited collateral(s). 

The Maker Protocol is a complex system involving many moving parts. Essentially, what you need to understand is the ecosystem is incentivized to keep DAI pegged to $1 by shifting the supply of DAI to equal it’s demand, and no single entity is in control of it

It’s a decentralized central bank governed by smart contracts on the Ethereum blockchain.

Onboarding

Rather than go into detail about how each aspect of the Maker protocol works, let’s focus on how someone would want to use it. 

The simplest way to utilize Maker is to lock-up (lend) your collateral in exchange for DAI (borrow). As stated, the various collateral ratios affect how much DAI you can borrow. If the current minimum collateral ratio is 145%, then you are required to deposit $145 worth of ETH for every 100 DAI you borrow. At the time of writing, the minimum amount of DAI that can be generated from opening a vault, otherwise known as the Debt Floor or Dust Limit, is 10,000 DAI.

To obtain a secured DAI loan, simply do the following. 

  1. Connect your ERC20 digital wallet (Metamask, Math, Trust) to the Oasis dApplication which hosts the Maker Protocol and sign the initial signature with your wallet.
  1. Open a Vault and choose to either Multiply or Borrow against your ETH

4. Configure your Vault settings. Don’t choose to multiply or borrow the max amounts. All you’re doing is putting yourself at a higher risk of getting liquidated if the price of your collateral drops.

5. Generate and withdraw DAI from the Maker Protocol. Do with it what you wish!

6. To unlock your collateral, simply pay back the DAI loan along with the stability fee (~2%) and your collateral will be placed back into your wallet.

You now have your ETH deposited into Maker and you have 10,000 (or more) new shiny DAI to spend or lend out. You’ll of course have to keep in mind smart contract & liquidation risks

Smart contract risk refers to the Maker Protocol being hacked. Given that this hasn’t occurred since its inception and it holds over $10 billion worth of collateral, I’d say the probability of this is unlikely – but it is not 0%. 

Liquidation risk refers to the value of your collateral dropping to a point where it needs to be sold off to maintain the aforementioned MCR. This risk can vary depending on your needs but it is under your control. 

Final Thoughts

One of DeFi’s greatest attributes is its composability

DeFi developers often refer to what they’re building as money legos. Different dApps built on the same blockchain can easily inter-operate and their digital assets can be assembled in various combinations. You can deposit ETH on Maker to generate DAI, then sell that DAI for ETH on Uniswap, and deposit your new ETH to generate more DAI, etc. 

Let your mind wander in terms of all the possibilities in this new permissionless paradigm. 

Structured DeFi products can become extremely complicated and profitable. While there are fees involved with a decentralized system like this, they are going to incentivized actors like Maker’s Keepers, rather than centralized intermediaries who can build monopolies and censor payments at their will. 

While the stablecoin wars are raging, it’s hard to say which will be around for the long haul – centralized USDT (Tether) probably won’t. MakerDAO has been a pioneer in DeFi since its inception and you can be sure that the algorithms backing DAI won’t change beyond the parameters governed by MKR holders. DAI is arguably more secure than any of the other stable coins because all the assets backing it are effectively overcollateralized. 

1 DAI=$1.

Zachary Roth

Classical musician turned crypto analyst & entrepreneur. Trying to front run web 3.0 and share what I can with the community. Technology will increasingly become blockchain based and I’ll be right there with it. 

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