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Stablecoin DAI: a decentralized finance stablecoin

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Stablecoin DAI is a decentralized finance stablecoin. This means no central authority or company backs it. Rather, it is supported by the Ethereum blockchain and a system called Collateralized Debt Positions (CDPs).

DeFi is a financial system built on top of blockchain technology. It allows individuals to access financial services like lending and borrowing, without involving traditional financial institutions. DAI is used as a stablecoin in many DeFi applications.

DAI is an open-source project

DAI is famous for its stability which is brought about by its collateral, the value of which the system constantly monitors. This makes it reliable for traders who want to hedge against cryptocurrency price volatility. Businesses and individuals can also use it as a stable store of value.

DAI is also an open-source project. Anyone can contribute to its development, and a strong community of developers is working on improving and expanding its capabilities. However, this is done through a process called voting which you’ll learn more about soon.

But before then, it is worth mentioning that Dai is pegged to the US dollar. Some of the perks of this project include:

Decentralization: DAI is a decentralized stablecoin. It is not issued or controlled by a central authority. Instead, it is created and maintained by a decentralized network of participants on the Ethereum blockchain.

Stability: Another general feature of DAI is its stability. Being pegged to the US dollar, it is designed to maintain a consistent value of $1.00. This has made it a store of value for the conduct of transactions stably and predictably.

Flexibility: Unlike many other stablecoins backed by a specific asset, DAI is supported by a diverse pool of collateral. This means it is not tied to the performance of any one asset, making it more flexible and resilient to market fluctuations.

Transparency: DAI’s code can be reviewed by anyone, which makes it an open-source project. Transparency builds trust in the protocol and ensures that it functions as intended.

Security: DAI is built on top of the Ethereum blockchain. This makes it a safe and secure option for storing value and conducting transactions.

The type of Dai that operates on the Ethereum blockchain is Multi-Collateral DAI or MCD. It is the upgraded version of the Single-Collateral DAI or Sai, the original Dai that existed when at the launch of the project in 2015. MCD is the current stablecoin, and it boasts improved stability and more use cases.

Collateral is the difference between the new and old stablecoin versions. First-generation DAI was collateralized by only ETH, but the recent update in 2019 allows various crypto assets including ETH, BAT, Augur, and USDC to be used as collateral for the recent Dai. This makes the coin more resilient to price fluctuations in any particular asset.

Another notable difference is in the governance system. Second-generation DAI has a better governance system.

With single-collateral DAI, a simple majority vote from the Dai Stablecoin System was the only way to modify the system. With MCD, everyone can contribute through a more complex voting system called the Vote Contract.

A vote contract considers the voter’s collateral position. It allocates voting rights based on a collateral holder’s portfolio. This governs the decision-making process, and it is seen as a more fair and more representative way to control the system. Think about it – you would naturally care for a project in which you have high financial interests.

Dai has various real-world uses. It is a medium of exchange, a store of value, a hedging tool, and a stablecoin in DeFi applications. Its decentralized nature and stability make it an appealing option for individuals and organizations looking for a reliable way to hold and transfer value.

How is Dai created?

Now, how is Dai created? First, you must collateralize a certain amount of Ether (ETH) by locking it in the Maker smart contract. Then, use the collateral to generate a loan of DAI through a process known as “opening a CDP,” or collateralized debt position.

The value of the locked collateral determines how much Dai you can create. In other words, the value of DAI is directly tied to the value of the collateral backing it.

The number of DAI you can generate is determined by the collateralization ratio or the value of the collateral relative to the value of the loan. For example, if the collateralization ratio is 200%, you can generate a 50 percent DAI loan of the collateral value.

Next, you’ll pay interest on the loan as a stability fee, which is charged in DAI. The stability fee is an incentive for you to pay back your loans, which reduces the supply of DAI and ensures its value remains pegged to the US dollar.

To pay back the loan and close the CDP, you must return the borrowed DAI and any accumulated stability fees. Then, you’ll get your collateral back.

In addition to generating DAI through the opening of CDPs, the MakerDAO system also has a built-in mechanism for automatically adjusting the supply of DAI to ensure that its value remains stable.

This is called dynamic debt ceiling. It is the maximum number of DAI that can be outstanding at any given time. If the DAI supply surpasses this mark, the MakerDAO system automatically increases the stability fee to incentivize users to pay back their loans and reduce the supply of DAI.

However, if the supply falls below the debt ceiling, the stability fee reduces to encourage the creation of new DAI by opening CDPs.

The value of Dai is also maintained through the Dai collateral auction. It is a process involving the sale of cryptocurrency assets that have been pledged as collateral for the issuance of Dai. The steps are triggered when the value of the cryptocurrency assets falls below the maintenance margin.

Here’s how the collateral auction works:

When the value of the collateral falls below the maintenance margin, the network automatically initiates a collateral auction to sell off a portion of the collateral to bring the value of the collateral back above the maintenance margin.

The auction is conducted on a decentralized exchange or Dex where bidders can place bids for the collateral. It goes on for a set period, during which bidders can place bids for the collateral. At the end of the auction, the highest bidder wins and receives the collateral.

The proceeds from the sale of the collateral are used to buy back Dai, which the system burns to reduce the supply of Dai in circulation. This helps to maintain the stability of the Dai price.

The Dai collateral auction is an essential part of the Dai system, as it helps to ensure that the value of the collateral remains sufficient to back the issuance of Dai.

Overall, DAI is designed for stability and there are many systems in place for this. It does not experience price volatility like other cryptocurrencies like Bitcoin or Ethereum. This makes it a good store of value, a means of exchange, and pretty much every other thing you need money for.

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