MakerDAO: a different type of stablecoin

crypto.inferno (67)in #blockchain • 6 years ago

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Here at Inferno we’ve always taken an interest in so-called stablecoins, whether they’re the shady, centralised and opaque variety like Tether or the more decentralised and transparent type like TrustUSD. However, these can both be considered backed coins, tokenised fiat. There’s another approach, and it lives entirely on the blockchain.

If you want to create a stable (low price volatility) crypto token, there is more than one way to go about it. Most initiatives so far have gone down the backed token route, that is, holding USD in a bank account and issuing tokens for each dollar held.

There’s another approach, though, which is to peg the value of the token to its USD value using various blockchain– and smart contract-based measures. This idea is nothing new; initiatives like Nubits and BitUSD tried this years ago – neither with a great deal of success, it has to be said. Nubits is currently trading at around $0.10, instead of the $1 it’s supposed to be. BitUSD has fared a little better but hasn’t exactly displayed the stability that would be expected of a ‘stablecoin’.

But a new breed of stablecoins has launched. Powered by smart contracts and Oracles, they have a plan to do the job better than any other coin has managed – providing, for the first time, stable, decentralised crypto tokens that run on maths, not trust in a third party. But how does this magic work? Here, we give a brief overview of MakerDAO’s Dai coins, each of which is algorithmically pegged to $1 USD.

Essentially, Dai are collateralised with crypto, rather than fiat (like Tether, TrustUSD, GeminiUSD etc). Every Dai, nominally worth $1, must be backed by sufficient ETH to ensure they genuinely have that value. Price feeds tell the smart contract how much ETH is worth at any given time. If the price of ETH goes up, no problem: each Dai is more than covered. But if it goes down, there’s a problem. You never want to get to a point where each Dai is backed by less than $1 of ETH.

That’s dealt with in at least two ways. Firstly, there’s a collateralisation ratio. Basically, this means that if I want to issue $100 in Dai, then I’ll need $150 in ETH to start with. That gives some wiggle room for day-to-day volatility.

Then there’s a second mechanism that comes into play if the price of ETH falls too far. If that occurs, the ETH you’ve locked in the smart contract to create Dai is liquidated to cover the dollars represented.

Simple in theory, though the reality encompasses more complex scenarios such as a ‘Black Swan’ event in which ETH crashes hard and fast. It’s an impressive idea on the page, and a significant improvement on previous versions of the idea. But we’ll have to wait and see whether it stands the tests of the real world, in a way that Nubits and BitUSD couldn’t.

You can find a more detailed rundown of the MakerDAO system here.

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