The MakerDAO Collateralized Debt Position (CDP) is a smart contract which runs on the Ethereum blockchain. It is a core component of the Dai Stablecoin System whose purpose is to create Dai in exchange for collateral, which it then holds in escrow until the borrowed Dai is returned.
The CDP engine ensures that Dai can only be created when users lock up collateral, and that Dai is always removed from the market when users return Dai tokens to free their assets. CDP’s alter the total supply of outstanding dai, creating new Dai when new CDP’s are opened and destroying existing Dai when existing CDP’s are closed. This cycle of controlled minting and burning allows the contract to account for the total supply of the stablecoin, thus proving that the portfolio of backing collateral always guarantees the value of circulating Dai.
The amount of collateral in a CDP is always set to be significantly higher than the amount of the debt, so stability seekers who wish to use Dai as a predictable store of value can be confident that 1 DAI is worth approximately 1 USD in underlying assets.
However, if the peg begins to drift due to extreme market instability, an attack on the governance system, or other ‘black swan’ type scenarios, a Global Settlement will be triggered. This graceful winding down of the system will ensure that the Dai token can be redeemed for collateral even in the face of a system wide failure.
Some benefits of owning a CDP
There are no time limits, minimum repayment schedules, or shifting term-based rates involved with owning a CDP. Users are free to draw Dai, or add additional collateral, whenever they choose.
No Credit History Requirements
There are no restrictions related to prior borrowing history or cumbersome application processes. Anyone can access to the system simply by creating an Ethereum address.
No Counterparty Risk
Because the system runs as an ownerless, autonomous smart contract, all transactions are recorded on a public blockchain. Users are able to interact with a transparent financial system without having to trust a counterparty institution to successfully manage, or release their funds.
As the system is managed through code on a blockchain, there is very little operational overhead, few intermediaries and limited opportunities for rent-seeking. This allows the Maker Foundation to charge extremely low fees when judged by industry standards.
Decentralized Margin Trading
Users can choose to lock up their Ether, draw DAI, and purchase more Ether to add to their original position. This allows them to take a margin position. Be very careful to stay well above your liquidation price if you choose to do this, as the more you leverage your position, the more exposed to market fluctuations you become.