The USD-pegged stable coin DAI

Recent distrust about stable currencies like Tether / USDT (owing to the Bitfinex affairs of missing $850 M funds) has brought focus to other stable coins like DAI.

DAI is the decentralized stable coin from Maker DAO. Maker DAO is the decentralized autonomous organization on the Ethereum blockchain that strives to maintain balance by curbing volatility by offering collateralized crypto loans through its stable coin DAI and its native currency MKR.

Despite the bear market, MKR remains the top 20 largest cryptocurrency according to the CoinMarketCap data, garnering about $525 million of market cap. Maker DAO is also ranked among the top 5 Dapps on State of the Dapps across all platforms.

Unlike other stable currencies, DAI is a decentralized stable coin that maintains a 1:1 peg with USD through an automatic mechanism called TRFM (Target Rate Feedback Mechanism). The Target price is provided by an updatable price feed. The Target Rate determines the needed change of price of DAI over time in order to reach the Target Price during a market swing. In future target rate can be automatically adjusted in response to emerging market conditions.

Maker DAO

These days, several crypto based financial organizations are trying to gain the market share for providing loans against the mortgage of various crypto assets. But unlike centralized offerings by Nexo, Celsius or Salt, Maker DAO is trying to do this through a decentralized autonomous governance model. This will probably bring in more transparency and fair interest rates in the crypto market and we need not remain slave to centralized consumer-dominating models.

Since Maker DAO is Ethereum based, it presently offers loans against Ethereum assets only. ETH holders can deposit theri ETH to receive their share of interest from the borrowers. All ETH is deposited in the form of WETH (Wrapped ETH) and corresponding PETH (Pooled ETH) is issued to the depositor that represent her share of total pool of ETH deposited in the system. DAI is issued to borrowers against the debt of PETH. Thus making it easy to calculate the individual share of earnings and borrowings.

Then what is MKR for?

Unlike DAI, MKR is not stable but a volatile currency. When a borrower deposit back the borrowed principal (called **Collateralized Debt Position or CDP^^) in form of DAI, interest (or Stability Fee) is charged in form of MKR coin. MKR is a utility token in Maker DAo and can be used for voting in the DAO governance system. MKR holders also vote for deciding the rate of interest known as Stability Fee in this system.

CDP - Collateralized Debt Positions

As is quite clear with its name, CDPs are collateralized ETH assets for debt. A maximum of two-third of DAI can be generated against your CDP. You can deposit your ETH as your CDP and generate up to 2/3^rd of DAI tokens against it. 1/3^rd margin position is held as reserve to allow for the market price fluctuations. Effectively, this means that you can take upto 66.67% of loan against the value of your pledged ETH.

This means if you want a loan of $1000, you need to generate 1000 DAI tokens and for this you need to deposit at least $1500 worth of your ETH. For depositing your ETH and generating DAI, there is a self service CDP portal. You can easily manage your account, do top ups (in case the prices of ETH drops and you want to avoid liquidation of your pledged assets). In case of prices of ETH falling below the minimum mortgage requirement, either you need to top up more ETH or repay some DAI, otherwise your assets will get liquidated. An additional charge of 13% is applied for liquidation.

The generation and burning of DAI is managed by CDP smart contract to always back it with at least 150% worth of ETH.

MKR collected as stability fee are also burned. Stability fee is calculated on the continuous compounding basis to track even the small accruals. Currently Stability Fee is quite high but it keeps changing according to the votes from MKR holders. In past quarter, Stability Fee has increased about 40x. From 0.5% APR levels it has been recently voted up to 19.5%.

Global Settlement

The provision of Global Settlement in the governance model by an operation known as cage is an insurance and motivation for the DAI to remain around its Target Price. When it's not the case, it will shut down the Maker platform and ensure all CDP users and DAI holders get the correct amount of assets at the cage price. This threat of global settlement keeps the markets to tend towards the target price of DAI and thus ensuring its price stability.

My views on DAI and Maker DAO

In my humble opinion, this decentralized governance model for a price stable currency has an upper hand than centralized asset backed models. The system is very transparent and anyone can verify the total CDP and DAI issued at any given point. Further global settlement clause gives more price guarantee for DAI. Stability of DAi allows users to take full advantage of their crypto assets and provides a safety net from high market volatility.

The whole design is well thought after and everything is laid down in its White Paper. I don't think there could be any better strategies to achieve a price stability for a currency. The only volatility is limited to that of USD. But I hope, MKR community can decide to change the pegged asset if need arises e.g. when USD attain a hyper inflation stage, there won't be any point in pegging DAI to USD any more. So I really hope there is a provision to change the pegged asset.

Frequent hike in Stability Fee is a point of concern too. A 19.5% fee seems highly unreasonable to me and puts me off as a borrower from this model. But it will always reach a point what market can bear and would give the best returns to its depositors.

Apart from that I'd like the CDP system to accept many more cryptocurrencies to facilitate more users and gain a bigger market share.

My Rating for this Dapp

Overall, though the system is slightly complex to understand for me, I'd like to appreciate the amount of thought applied to put it in practice and is working very successfully. I'd like to give this Dapp 4.5 stars out of 5.