How to use Ether as Collateral for Crypto Leverage with MakerDAO

TL:DR; A smart contract-based, algorithm driven way to use crypto assets as collateral while protecting overall system integrity offers a glimpse of a possible future where “too big to fail” no longer applies.

As I shared the other day, I have been spending a fair amount of time recently playing around with the earliest versions of the 1st generation crypto products out there.

One of them is the MakerDAO stablecoin system and its currency, DAI.

Now, I have written about stablecoins a lot (here, for example) and I have long admired what the MakerDAO team was doing. They had a project well before ICO mania came along and I know that some people in the industry whom I really respect, like Nick Tomaino, are big fans.

I am still not totally sold on the concept, but that doesn’t mean I can’t play around with it, does it? 😉

Back in the very early days of my fascination with crypto, I remember one skeptic saying to me, “well, how does credit work with Bitcoin?”

I didn’t have an answer then.

He challenged me and said, “without credit, the current capitalist economy would not exist.”

I was stumped.

Well, the Collateralized Debt Position that MakerDAO offers is basically an answer to that.

Simply put, you lend Ether to a smart contract as collateral and, in return for securing it there, you get DAI, the stablecoin that is algorithmically generated and maintained at a rate of 1 Dai = 1 USD.

It gets a bit complicated as that ratio depends on the Ether price and I’m not sure I can totally explain it just yet, but what’s important is that you now have an asset (DAI) which is pegged at $1 USD.

You can use that to buy other crypto assets and it’s a loan secured by your collateralized Ether.

But it’s not a 1 to 1 ratio, you actually are getting crypto-leverage.

What’s cool about this, however, is that unlike in a “too big to fail” scenario, if the price of Ether falls below a certain point, you either have to pony up more to keep your position open or it is automatically liquidated, keeping the system in balance.

Or “stable” I guess is a better term 😉

I have to admit that using this system (and I think their UX is great and they have a great explanatory video which I highly recommend, but it may take a few watches) has moved me more in the direction of believer.

Over a year ago, I read their whitepaper 6-8 times and I just walked away feeling confused.

Now, I see the potential. I’ve actually created some crypto leverage which I can go out and use to invest or do whatever I want.

The system is protected. It’s all automated. No shady bankers hiding anything off the books.