The DAO in MakerDAO is short for decentralized autonomous organization (DAO), describing a system that operates on the Ethereum blockchain. This DeFi project was created in 2015 and is now one of the most successful and influential projects in cryptocurrency.
At its core, MakerDAO allows users to collateralize Ethereum or other cryptocurrencies to generate a stablecoin called Dai. So, it has two cryptocurrencies at its core – MKR and DAI.
The MakerDAO system has two main components: the Maker smart contract and the DAI stablecoin. Dai is pegged to the US dollar, meaning its value stays stable relative to the US dollar. This is in contrast to other cryptocurrencies, which are volatile and fluctuate significantly in value.
A major benefit of Dai is that it allows users to hold and transfer value without risking the volatility of other cryptocurrencies. This makes it great for various use cases, including paying for things, sending and receiving money, and even earning interest.
Dai is completely collateral-backed, supported by real assets stored as collateral in smart contracts on the Ethereum blockchain. It is also fully decentralized and transparent, with all its activities and operations governed by a community of users through the decentralized autonomous organization (DAO).
This means no central authority controls Dai supply and makes decisions about its use and management.
Dai’s high stability and reliability are aided with a built-in mechanism called the Stability Fee, which helps to maintain its peg to the US dollar.
The stability fee is a variable interest rate charged on the collateral that backs Dai and is adjusted based on the supply and demand for the stablecoin.
So how does MakerDAO work, and how is Dai created?
First, MakerDAO is a decentralized governance finance platform. It is a DAO, which means it is owned and governed by its community of users.
Every decision about the development of the ecosystem is made through a transparent and democratic process called voting. By holding and using MakerDAO’s governance token, MKR, you can participate in the governance of the ecosystem.
You don’t need to hold MKR tokens to participate in voting. You can submit a proposal about what you believe should be incorporated into the protocol, and within 24 hours, Makers will review your ideas. If others agree, then it’ll be executed within another window period.
Voting determines everything from the project’s direction to the system’s parameters, such as the collateral requirements for generating Dai or the DSR.
One of the main benefits of a decentralized governance model is that it allows the community to contribute to the project’s direction rather than relying on a central authority to make decisions on behalf of everyone. This ensures the protocol truly aligns with the needs and interests of its users.
By collateralizing Ethereum or other cryptocurrencies to generate Dai, you take out a loan from MakerDAO. You must provide collateral worth more than the value of the Dai you want to borrow to qualify for this service.
This collateral is held in a self-executing smart contract that works according to the agreement between trading parties.
If the value of the collateral falls below a certain threshold, known as the “maintenance margin,” the smart contract automatically sells off the collateral to pay off the loan and stabilize the value of Dai. The term “liquidation” may seem more familiar when describing this process.
Dai’s value is maintained through price stability. Stability rests on a group of independent individuals called “makers” who buy and sell Dai on exchanges to keep its price pegged to the US dollar.
Makers also maintain stability through a rewards system and incentives, in which they earn a portion of the fees generated by the system.
MakerDAO offers various financial products and services. It powers the smart contract that facilitates the Multi-Collateral Dai (MCD) system, which allows users to collateralize a broader portfolio of assets, including real estate or commodities.
With MakerDAO, you’ll be rewarded for being a member of the ecosystem. The platform allows you to earn a return on collateral through participation. For instance, by depositing collateral into the system, you can mint DAI in return.
You can hold onto it or use it to borrow more money. When the collateral value appreciates, you earn your profit by repaying the loan and closing your position. This is how you earn Dai.
Muti-collateral Dai has gained the affection of the crypto community and continues to make DAI more widely used. It has stabilized the MakerDAO system and made it more resilient to external shock.
MakerDAO also offers the Dai Savings Rate or DSR, a service that allows you to earn passively just by holding Dai in a smart contract. It has been designed to maintain the stability of Dai by incentivizing users to keep their Dai instead of selling it.
How does the DSR work?
By depositing DAI into a DAI Savings Rate contract, you receive an annual percentage yield (APY). The APY figure is variable and determined by the stability fee. The MakerDAO’s community chooses the price through voting.
The stability fee is a percentage of the value of the deposited DAI charged in exchange for stabilizing the DAI’s value. The fee changes based on market conditions, but the goal is to keep the value pegged to or near $1.00.
A high stability fee means there is a high demand for DAI. This increases the rate of the APY. When the stability fee is low, it implies less need for DAI, and the APY will be lower.
You can earn passive income on your idle DAI by taking advantage of the DAI Savings Rate.
It’s as easy as depositing DAI into the DAI Savings Rate contract to start earning the current APY on your deposit immediately. However, the system locks the DAI in the smart contract until you withdraw it.
So far, MakerDAO has been highly successful, with a market capitalization of $119 million and a strong community of users and developers.
In conclusion, MakerDAO is a revolutionary project that modifies the traditional financial system and empowers users to take control of their financial futures. It aims to help individuals and institutions secure loans or assets that aren’t volatile or subject to the regulations of centralized finance.