I’ve looked into MakerDAO off and on for a while now. If you don’t know, MakerDAO is a collateralization DeFi service that is built on the Ethereum Blockchain.
It allows anyone with an Ethereum wallet and some ETH, BAT or (recently added) USDC to create a collateralization smart contract and receive and instantaneous loan in the form of DAI — a soft-pegged stable-coin.
The amount that you can take as a loan varies based on the collateral that you put up.
For example, if you use 10 ETH as collateral (currently worth ~$1,360 USD), then you can take a loan for an amount ranging from $20 USD to $891 USD.
It seems too good to be true.. right?
There are some key characteristics of these loans that you need to understand before diving in:
- Liquidation Price
- Liquidation Penalty
- Collateralization Ratio
- Minimum Ratio
- Stability Fee
The Liquidation Price is where your risk lies: if the price of your collateral — ETH, BAT or USDC — reaches this liquidation price, your position can be liquidated and you will suffer a 13% liquidation penalty.
The Liquidation Penalty is 13% which means that if your position gets liquidated, you’ll receive your original collateral back less the 13% fee and the amount of DAI that has been loaned to you.
Your Collateralization Ratio is simply the ratio between the value of your collateral and the value of your outstanding loan. If you took a $500 loan on $1000 worth of collateral, then your current collateralization ratio = 200%. If the value of that collateral drops 10% to $900, then your collateralization ratio becomes 180%.
Your collateralization ratio needs to be above 150% at all times — this is what is referred to as the “minimum ratio". If it drops to 150%, it means that you’ve reached the liquidation price and thus are at risk to be liquidated and pay a hefty penalty.
The Stability Fee is the current interest rate that is accrued throughout the lifetime of the loan. The longer you have the loan, the more interest you will owe. At the time of this writing, the stability fee is 7.5% which means that if you hold a loan for 12 months, then you'll owe 7.5% in interest + the original loan amount.
This stability fee is a variable amount that is set by the MKR governance model (MKR holders have voting rights), so it is subject to change over time. The stability fee is paid in MKR tokens and is subsequently burned. You can view the current and historical stability fee here: https://mkr.tools/governance/stabilityfee.
Example — My First CDP:
Let’s use my first CDP vault as an example use case of MakerDAO:
I put up 19 ETH ($2,584) as collateral and received a 1000 DAI loan (~$1,000 USD).
- Liquidation Price — if ETH drops to $78 USD, then I am at risk of being liquidated
- Liquidation Penalty — if the above happens, then I’ll get my collateral back less the DAI loan amount and a 13% penalty
- Collateralization Ratio — current ratio when opening the loan is 256.748% which is a pretty modest ratio. It gives me a lot of wiggle room to the downside
- Minimum Ratio — if the Collateralization Ratio drops to the minimum ratio (150%), then I am at risk of being liquidated
- Stability Fee — current stability fee is 7.5%/year. If I hold this loan for 12 months, I’ll owe 7.5% of the loan amount ($75 USD) in MKR tokens when I pay back the loaned DAI.
Again, this is my first loan. It's an experiment with the MakerDAO ecosystem and I’m curious to see how this progresses. I’ve kept my eye on this platform for a while now and I’m excited to see how it continues to mature.
There was a recent mass liquidation that caused a lot of issues on the MakerDAO system. I was watching to see how those events unfolded, how users were impacted and how solutions were installed.
None of what I’ve said in this post is financial advice. I’m a brand new user of MakerDAO. DYOR and proceed with caution. To me, the MakerDAO system carries a great deal of risk and I am remaining extremely cautious with this process.
Do You Have Experience With MakerDAO?
I’d love to hear from some more people who have experience in using MakerDAO. Up until this point, I have been a passive bystander. Watching the ecosystem evolve and seeing how the potential pitfalls play out (like the scenario that I mentioned above).
If you’ve used MakerDAO, I encourage you to share your experiences in the comments below. Have you ever been liquidated? Have you ever done the liquidating? Have you used DAI loans successfully?