02
Mar
20

Decentralized Autonomous Organizations (DAO) – MakerDAO (MKR) explained

Maker is a decentralized autonomous organization (DAO) and its crypto project is called MakerDAO. It is one of the most successful projects built on Ethereum‘s smart contract platform. Maker’s sole aim is to offer a cryptocurrency and a network unfazed to the crypto’s extreme price volatility. Though it is mainly focused on decentralized exchanges, Maker is backed by many of the well-known exchanges.

 

Maker is an exciting crypto project, but with so much going on inside its network, it can be a ‘little’ hard to understand. It will be easier to start with Maker’s crypto coins and then explaining how it works and what it has up its sleeves.

 

The first thing to note here is that Maker has two primary tokens – DAI and MKR (pronounced Maker). So, let’s start with DAI first.

 

DAI – Maker’s Exchange Token

 
DAI is the Maker system’s stablecoin that exists in the Ethereum blockchain. The primary role of a stablecoin is to beat the market volatility that other crypto coins face. DAI is pegged to the dollar (USD) at a 1:1 ratio. This means that it’s objective is to stay stable relative to USD and therefore 1 DAI is equal to 1 USD.
 

How DAI Differs from Other Stablecoins?

 

Stablecoins are backed by money or value that is reserved somewhere else to fight against price volatility. This reserved asset is known as collateral. Stablecoins such as Tether or TrueUSD use USD as collateral, and this money is held in a bank account. Note that the bank or the account holder is the custodian of the collateral here.

 

So if the accounts get frozen, or it doesn’t comply with regulatory norms, or in case of any fraud, the tokens are not redeemable anymore. Also, you have to trust that the correct amount of USD is in place and it’s not artificial inflation. This means the decentralized stablecoins are backed by a centralized asset.

 

Maker solves this issue by storing the asset or collateral in the blockchain itself. DAI is also pegged to USD, but instead of USD, a certain amount of ETH (Ether token) is locked as collateral in Maker Smart Contract for every DAI token withdrawn. The Maker’s algorithm automatically adjusts the ETH-to-DAI value ratio of a contract in case of any price volatility of ETH token.

 

This removes the need to trust the custodian and wave off any complicacy of the legal system, making it decentralized.

 

How does It Work?

 

DAI uses an autonomous smart contract to eliminate price volatility. This core smart contract in the Maker system is called Collateralized Debt Position or CDP.

 

To generate or issue DAI tokens, first, CDP needs to be created on Maker’s platform. As soon as this contract is funded with ETH as collateral, DAI token can be created. But there is an upper limit to how much DAI can be created or borrowed. This depends on the collateral amount. As of now, for every DAI created, there must be 1.5 times (or 150%) ETH in value locked in CDP. Note that this value may change in the future.

 

DAI is borrowed as a loan and to get the locked ETH back, an equal amount of borrowed DAI needs to be returned to the CDP plus a nominal stability fee.

 

It will be easier to explain how CDP works with a few examples. The current price of ETH token is about $279. So let’s assume it to be $300 for the sake of explanation.

 

  • So let’s say, you have deposited 1 ETH (worth $300) in the CDP. So, you can draw up to 200 DAI (since 150% collateralization rate means 300/1.5 = 200 and assuming DAI price is $1) against your $300.
  • If you have drawn the maximum number of DAI allowed, and the ether price falls below $300, then the CDP automatically gets closed. This is because there is not sufficient capital (150%) locked against withdrawn money. There are only two ways you can avoid closing the CDP – either you need to put in more ETH into the CDP or should have taken less DAI in the first place.
  •  

    Let’s check a few scenarios that you may encounter in a CDP life cycle.

     
    # Scenario 1: ETH Price Goes Down
     

    You have taken out 100 DAI against your 1 ETH (still worth $300) deposit, i.e. less than the 200 DAI limit (300/1.5 = 200). This means your CDP is collateralized at 300%. So as long as ether’s value doesn’t drop below $150 (or 150% collateralization), your CDP is open and safe. So later, when you would like to close the CDP or want your ETH tokens back, you pay back the borrowed 100 DAI with the addition of a 5.5% annual stability fee.

     

    Note: the stability fee was initially set at just 0.5% and later rose to 3.5% in January 2019. However, in Q2 of 2019, the fee shot to 19.5% leading the DAI value more than $1.05 per coin.

     
    # Scenario 2: ETH Price Below Limit
     

    You have taken 200 DAI, so the CDP is now at 150% collateralization. If the ETH price drops to $200, then the CDP is now under-collateralized by $100 (since $200 DAI*1.5 = $300 > $200) or 100% ($200 ETH/$200 DAI). Since you don’t have enough collateral, a third party will liquidate your CDP on your behalf and charge a penalty. The ether inside the CDP is auctioned off for Dai until there is enough Dai to pay back what was drawn from the CDP. This ensures that Dai always has sufficient collateralization.

     
    # Scenario 3: ETH Price Goes Up
     

    You have taken 150 DAI out. So your CDP is collateralized at 200% ($300 ETH/ $150 DAI). Suppose Ethereum price increases to $450, so now your CDP has 300% ($450 ETH/$150 DAI) collateralization. This in turn now allows you to withdraw up to 300 DAI instead of 200. If you decide to take out 50 DAI more, then the collateralization will become 225% ($450 ETH/200DAI).

     
    # Scenario 4: Steep ETH Price Drop
     

    What if the ether price drops sharply below the one-to-one collateralization ratio within such a short time frame that the system can’t respond in time? To handle such a situation (though less probable) Maker has the MKR token in place as an insurance policy.

     

    Before checking out DAI’s value index and detailing on MKR, there’s one interesting and very important topic to discuss. DAI is just north of hitting its 100 million supply cap and that leads to Maker announcing its next update – DAI 2.0.

     

    Multi-collateral DAI – A New Version of DAI

     

    As much as exploring this one in detail is fun, the scope of this article limits that.

     

    Till now, Ether is the only option Maker gave to use as collateral in CDP. This makes the stability of DAI and CDP dependent solely on Ether. To address this, the Maker team has finally released the Multi-collateral DAI in December last year.

     

    The former Single Collateral DAI is now referred to as SAI and multi-collateral DAI or MCD as simply the new DAI. You can upgrade your SAI to DAI through the migration portal and avail the new features that come with it. SAI will be phased out slowly.

     

    As evident from the name, Multi-collateral DAI (MCD) is the new version of DAI where Maker allows you to use ETH as well as other ERC-20 type crypto coins as collateral. Note that this also brings Wrapped Bitcoin (since WBTC is an ERC-20 type token) into the fold of Maker.

     

    The Maker team has given approved Basic Attention Token (BAT) to join ETH as collateral. Five others – Augur (REP), DigixDAO (DGD), Golem (GNT), OmiseGo (OMG), and 0x (ZRX), are waiting in line for Maker’s approval. Eventually, every ERC-20 token (hopefully) will be offered as collateral.

     

    So, what has changed with DAI 2.0?

     

    DSR – The New Feature in the Block

     

    With DAI Saving Rate or DSR feature, the new DAI holders now have the option to hold their DAI into a special smart contract and earn from it. Once you lock your DAI in DSR smart contract, the Maker system automatically gives you additional DAI based on a variable saving rate – just like earning interest from your savings account in a bank. The DSR saving rate is currently set at 2%.

     

    While comparing with Coinbase’s latest reward program on USDC, MakerDAO’s CEO Rune Christensen said, “The DAI Savings Rate is likely to be higher than the USDC rate but it will also fluctuate. It will depend on the supply and demand of the MakerDAO platform.”

     

    Does DSR Make DAI More Attractive?

     

    What makes DSR a game-changer for Maker are –
     

  • Total User Control – Maker gives total control and full custody of the DAI in the DSR contract to the holder.
  • Completely Liquid – There’s no minimum deposit amount required, neither you have to pay monthly fees, maintain a minimum daily balance, or adhere to any withdrawal limits. Also, you can get your DAI, both capital and earned savings, out anytime you want.
  • Ease of Use – There’s no charge for opening the contract. The entire process is simple and takes just a few steps. Once crypto exchanges integrate it fully, earning becomes seamless.
  • Various Use Cases – You can either lend the DAI earned or use those to protect your savings from inflation. Also, developers can completely integrate DSR into their own decentralized apps.
  •  

    CDP Changes to Vault

     

    Maker has changed the name of CDP to Vault to avoid any confusion that may arise due to the multi-collateral nature of the new DAI. So Vault is where you would deposit your collateral and generate DAI as usual.

     

    But this is just not a mere name change as it reflects Maker’s position on collateral use. For each type of collateral, a separate Vault of its own is created. This means, if you use ETH as collateral to create DAI, then that’s your ETH Vault. And if you want to use BAT as collateral, then Maker protocol creates a different BAT Vault. You can have both or more and Vaults with different levels of collateralization as well.

     

    Note here that once you return the DAI extracted from the Vault, that particular Vault doesn’t close – it simply remains empty in the blockchain, ready to be filled up later.

     

    DAI’s Value Index

     

    Single Collateral DAI or SAI

     
    Single Collateral DAI or SAI has a current market cap of $21,261,391 USD. There are currently 21,236,963 coins in supply. Being a stablecoin, SAI’s value must be very close to $1, but so far price has varied between $1.37 USD (Feb 03, 2018) and $0.720637 USD (Jan 11, 2018). The Return of Investment (ROI) of SAI is 9.40% in the last 24 hours.
     
    SAI is ranked 146th cryptocurrency by market cap.
     

    Multi-collateral DAI –

     

    Multi-collateral DAI or MCD commands a market cap of $121,576,217 USD. There are currently a total of 122,263,491 DAI in existence out of which 121,814,719 DAI is in circulating supply. MCD is currently trading for $0.998042 USD with an ROI of 0.07% in the last 24 hours.

     

    MCD or DAI 2.0 holds 45th rank in cryptocurrency by market cap.

     

    MKR – Maker’s Control Token

     

    MKR token plays some crucial roles in the Maker system. Like DAI, MKR also resides in the Ethereum blockchain, but that’s where the similarity ends. MKR is what keeps the entire Maker network under control.

     

    How does MKR Work?

     

    MKR acts as a governance token, a utility token, as well as a recapitalization resource. Let’s check each aspect of MKR token one by one.

     

    1. Governance Aspect – MKR tokens are used for voting purposes and implementing policies in the Maker system. The token holders can make proposals and vote on any proposed decision regarding the maker network. These decisions are mostly regarding risk control and safety parameters such as –

     

  • What should be the annual borrowing fee or stability fee?
  • How much collateral should back each CDP i.e. what’s the collateralization ratio?
  • Decide on an emergency shutdown of the protocol in case of any unforeseen situation like a flash crash of the price of Ether.
  •  

    Now, what if someone buys MKR in bulk for malicious voting practice? To avert this, Maker exercises a delay between the pole outcomes and its implementation.

     

    2. Utility Aspect – As a utility token, MKR is used to pay the fee for creating CDP to create DAI. When you close a CDP, in addition to the borrowed DAI, you pay back the stability fee in MKR coins. Note that whenever MKR is used to pay a fee, it gets burned out of the circulating supply, thus bringing the price of MKR up. As the price keeps increasing less, MKR will be used to pay for transactions.

     

    3. Recapitalization Aspect – Besides being governors, MKR holders must act as insurers as well. If the Maker system is poorly governed, it may cause a situation where collaterals in the CDPs aren’t enough to cover the amount of DAI in existence – a situation known as “flash crash of Ether.” Then the Maker system automatically creates or mints new MKR tokens and sells it in the open market to raise capital to fill in the collateral deficit.

     

    This brings down the value of MKR token in the market. So if the Maker system breaks down, it’s the token holders’ money and their position on the line. This compels them to govern the system responsibly. That’s the reason MKR token holders don’t want to set the collateralization ratio too low as they are the buyers of last resort.

     

    MKR’s Value Index

     

    At the time of writing, there are 987,267 MKR tokens in the circulating supply. As mentioned, the number keeps dropping as they are used to paying fees and increasing when the Maker system generates for sale. This, in turn, regulates the price of the token.

     

    At the time of writing, MKR token is priced at $552.06 USD, collecting a 2,398.18% ROI (Return of Investment). MKR price hit the top at $1,773.92 USD on Jan 18, 2018, and its lowest of $21.06 USD on Jan 30, 2017. The market cap of MKR is $545,035,611 USD.

     

    MKR ranks 25 among crypto coins by market volume.

     

    Maker’s Insurance Policies

     

    here are two types of risks for any stablecoin – Collateral Risk and Irrational Market Risk. We have already discussed how Maker tackles collateral risk in the Recapitalization Aspect section of MKR. The following are the two primary methods Maker employs to insure against Irrational Market Risk.

     

    1. Incentivisation and Token Issuance – Being a stable coin, DAI token value is very close to $1. What if DAI price falls substantially, say, for example, to $0.1. Maker deals with the situation through incentives. If DAI price goes down, CDP owners will purchase cheap DAI from exchange to repay their outstanding loan for cents on the dollar. If DAI price goes above $1 then CDP owners/creators will issue more DAIs to bring back the price. This will go on till there’s no arbitrage issue.

     

    2. Global Settlement – After the necessary measures are taken, if DAI value is still persistently low though all collateral is in place, then the Maker system can trigger Global Settlement. This measure is also a threat to anyone who wants to short-sell DAI to keep its price low. This is an emergency shutdown kept as a last resort.

     

    It ensures that DAI and CDP (Vault) are frozen, every DAI is redeemed for $1 USD and collaterals are returned to the custodians. Though DAI ceases to exist, MKR holders may decide to either re-initiate or introduce a new stablecoin. Maker has given the decision to initiate Global Settlement to a select group of trusted individuals holding the global settlement keys.

     

    Where to Trade Maker Coins?

     

    Both DAI and MKR tokens can be purchased from the crypto exchanges.

     

    DAI Token –

     
    Both SAI and DAI stablecoins can be purchased with 12 cryptocurrencies. For this section only we will refer to both coins as DAI. You can also buy both coins with Tether and USD Coin (USDC) stablecoins. DAI is most popularly exchanged with USDT (69%), followed by USDC (24%), ETH (3%), BTC (2%), with other coins accounting for the remaining 2%.
     
    Both versions of coins can be bought with USD, EUR and RUB fiat currencies, but it’s problematic and comparatively costly (ranges between $1.02-$1.05). Apart from Kraken, which offers DAI/USD and DAI/EUR pairs, only a few less popular exchanges support it. For example, the DAI/USD pair is supported by Ethfinex, EXMO, Sistemkoin, etc. Some exchanges also offer the option to purchase with credit cards directly.
     
    DAI coins can be purchased in 28 exchanges, with DAI in 24 exchanges and SAI in 8 exchanges. Kyber Network and FatBTC are the only two exchanges that seem to offer both. Overall, IXX ($33.89M) and Coinbase Pro ($12.13M) are the two exchanges leading the market trade volume. Other major and popular exchanges for DAI are HitBTC ($3.3M) and Kraken (about $1.2M).
     

    MKR Token –

     

    MKR can be exchanged with 9 major cryptocurrencies as well as Tether, with CNY Tether (60%), ETH (22%), USDT (16%), and BTC (1%) being the major coins of exchange. DAI can be used to purchase MKR token, and it’s a major coin-pair of choice as well! You can also purchase MKR with fiat currencies like USD, EUR, and RUB.

     

    The MKR token is available for trade on 23 exchanges, with CoinW ($8.1M USD) and BKEX ($4.82 USD) leading the chart with major share. You can buy MKR in BKEX with ETH and USDT, while CNYT is used for CoinW. Other exchanges are OKEx, BitAssets, OceanEx, FatBTC, etc.

     

    How to Store Maker Coins?

     

    Maker coins, both DAI and MKR being ERC-20 type token, can be saved in wallets supporting Ethereum-based tokens.

     

  • Web-based Wallets – Opt for MyEtherWallet for active trading with small sums. MetaMask is another web-extension wallet that is good for DAI storage.
  • Mobile Wallets – Trust and Exodus wallets are available for Android and iOS. Ethos Universal Wallet is another option to consider.
  • Hardware wallets – Ledger Nano X, Ledger Nano S, Trezor, KeepKey are good choices.
  • Multi-platform Wallets – Atomic Wallet is your best bet here.
  •  

    Use Cases of Maker

     

    There are various use cases of Maker. Some of them are as follows –
     

  • Instead of volatile crypto coins, Gambling applications in blockchain need a stablecoin for transactions that can minimize the potential additional risk. Therefore, the predictive market is a prime choice for DAI.
  • As decentralized finance or DeFi naturally turning out to be the prime playground for crypto, Maker has managed to grab a major chunk. According to DeFi monitoring resource DeFiPulse, the total value of funds locked in DeFi applications has reached an all-time high of $793.1 million (3.2 million ETH), of which over 57% ($453.5 million or 2.5 million ETH) is in the MakerDAO system.
  • Maker provides the option of permissionless leveraged trading such as leverage, hedging, derivatives, and financial markets. This means less corruption and improved efficiency with Maker’s transparent accounting system.
  • Maker has inspired the creation of several other DeFi protocols including crypto lending and borrowing platforms Compound and dYdX.
  •  

    Thanks to the addition of multi-collateral DAI, DSR, Positive feedback Loop the use case area will become wider.

     

    Future of Maker

     

    The year 2019 proved to be great for Ethereum and so did for most projects that run on it. Maker is one of those few which experienced significant traction, growing at approximately 20% month-to-month rate. The number of addresses holding or transacting DAI doubled in mid-2019 compared to January 2019. In June 2019, DAI volume shrank (95 million to 83 million) as the stability fee was hiked substantially. But the year-end stat shows a steady growth of addresses holding DAI, compounding by 27% per month on average.

     

    So far, Maker hasn’t shown any slowdown in traction in 2020. The adoption of DAI continues to accelerate, thanks to Maker bringing DSR and other features with its multi-collateral version. Also, there are more than 400 various active integration partners, ranging from remittance systems and global payments to gaming and esports. With Maker’s track record, adding more partners to their portfolio is going to be much easier.

     

    Conclusion

     

    Maker already has a brilliant system in place, offering a practical stablecoin for daily trading, a highly secured environment, and robust protection against market volatility. The team has kept adding new features that have opened the door for new possibilities and use cases. Maker continues to prove its mettle since the beginning and when coupled with various open finance projects it has an immense potential to offer much more.

     

    The discussion done here clearly points that after Bitcoin and Ethereum no other projects have shown and lived up to its promises. Expect Maker to bring out exciting things in the future, with some experts even claiming it to be a prime candidate for leading the future of cryptocurrency.

    Rajarshi Mitra
    Blockchain Researcher