Bounty: How is DAI stable?

in dai •  4 months ago

I am looking for a good description of how Maker keeps the DAI coin stable, specifically how the incentive structure prevent DAI from fluctuation.

I would like to have a simple explanation that I can share with "normal " people without them needing to read a big scientific paper.

I would also like to understand the business model of MKR from an investors perspective, again in simple words so it can be shared.

Links are just as valuable as your own words if they answer these questions.

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Ill try my best:

The Dai is a decentralised protocol the uses Ether as a collateral to secure a stable coin, much like BitUSD based on bitshares. One party deposits ether into a smart contract and that ether is used to create dai coins that keep a fixed value in dollar as long as ether does not fluctuate too wildly. If ether goes up, the issuer of Dai coins wins because less ether is needed to represent a fixed $ value, if ether goes down the issuer looses their ether to secure a fixed value of the dai.

Should the dai be below a dollar in value, then people may buy dai and convert it back into ether using the collateral, getting a better price than directly buying eth on the market. If the price of a dai is larger than 1$, everyone can use ether to issue new dai coins and sell them back to buy ether. This creates a downwards pressure, but is not completely risk free.

The MKR coin is used for a "stability" fee and to set risk parameters, etc..
It is strictly speaking not necessary if one would accept a simple non-evolving smart contract. Because it is not essential in the process it is very hard to make a business case for it. Should the MKR holders be able to make MKR a widely used collateral for the dai coins, then the price could rise a lot. Currently this is not possible and only ether is accepted as collateral. Otherwise they slowly gain value from the "stability" fee but I am not sure why an investor would want voting rights for the smart contract.

As an investor I would rather conclude that if dai replaces thether, it is beneficial to ether and they way to benefit from dai is buying ether; or going the extra step and personally issue dai coins (very risky).

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Great explanation. Can you explain how the buying of cheap dai works?

I have created dai myself and am aware how this works from a user perspective

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This is Example 4 of the whitepaper. You buy some dai of the market at a price below 1$. Then, if the there are collaterals below the liquidation ratio, you can bid on them in a debt auction using these dai to obtain the ether.

You now bought ether at a discount corresponding to the undervaluation of dai.

If this does not work for some reason, there is also the global settlement that has to be initiated by the holders of the MKR tokens. In that case you will directly get collaterals in ether corresponding to 1$ per dai. But this is nothing you can activate personally.

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Yes i think I understand now.

The liquidated cdps get auctioned off, which will allow people to buy eth cheaper with dad, which will create demand for dai. At the same time the liquidation fee will prevent people from letting their positions be undercollateralized, also making them buy dai from the market.

Let me add a little rant on MKR.

The idea of having a stablecoin on ether is fantastic. BitUSD are great, but they run on bitshares and ether is simply in a much stronger position. But when you simply translate the recepie for BitUSD to the ethereum blockchain you realise that you will not make money from that contract.

So what to do? Simply invent an extra MKR token, that is not needed at all and let people pay an extra "stability" fee to MKR holders. But why? In bitshares you only pay fees for the bare transactions.

Now they were a little smarter and say MKR is not only used to pay some extra fees, it is also the governance token. But we do not need governance. There can be different risk versions of dai and people can simply choose what they want. Quite quickly few parameters supported by the community would turn out to be solid standard values and these can even evolve dynamically by free market actions without any need for anyone to decide what these should be. We need freedom and multiple choices and not one single "correct" choice decided by MKR holders.

In the end I think the whole MKR business is the developers trying to make money of a purely p2p smart contract. This is also why I think that there is no long term future for dai. At some point the same functionality will be available without having to pay fees to some random MKR holders. Anyone wanting to spend that work can publish such a smart contract. Then its only a matter of time until dai will not be used anymore because nobody likes to pay extra fees. And because collateral are in hard eth, this will be just as secure. The question is how long will this take? And the answer considering that the number one of stablecoins is still thether could be quite a long time :(

Here is a blog post explaining MakerDAO: https://www.tokendaily.co/blog/a-deep-dive-into-makerdao

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I dont understand how the target rate keeps the price stable.

This is a very good article, for me it goes in great detail about many aspects of the system that are easy to understand but thw most important aspect, which is how the peg is maintained under normal circumstances needs to be covered in more detail. Or in other words I dont understand this yet fully.

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The whole idea of the target rate feedback mechanism (TRFM) does seem somewhat speculative if it will really work. The good news is that it is not really needed.

The idea is that if a dai is trading at 0.95$ or so, then the system will just say it will be "officially" traded at 1.1$ in a week from now. This has psychological consequences that people maybe now think that buying at 0.95$ is a good idea. It also has hard consequences in that all the debt ratios will be computed using that 1.1$ value.

The reason why I am not convinced in this mechanism is that once you have a 0.95$ value the peg is already broken and then just saying it is actually 1.1$ does not fix that. It seems like fighting a symptom and not the cause.

What we need are hard promises like the global settlement. That is what counts in the end. That option exists but is hard to trigger.

We have seen BitUSD on bitshares work for a long time through all the crashes and booms, and it does not have any fancy TRFM. It simply delivers one hard promise and that is that you will at any point you want be able to cash out in bitshares.