Introducing MakerDAO

The monetary policy and other core mechanisms behind MakerDAO.

Nov 23, 2020

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TLDR below. Not financial advice.

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General Conclusion

MakerDAO is a driver in the Defi ecosystem. It uses ETH as collaterals to create DAI, a currency soft-pegged to USD. In this article, we dive into the monetary policy and other core mechanisms behind MakerDAO.

This is part of an interview with Doo Wan Nam, the APEC Business Development of the Maker Foundation.

Introduction of Maker

MakerDAO is a 2-token ecosystem built on Ethereum.

DAI, stable coin soft-pegged to USD
MKR, governance token to govern how DAI is managed.

MakerDAO is backed by collateral using a smart contract, CDP. CDP = collateralised debt positions.

In a decentralised ecosystem, 3 things need to be clearly defined:

Rules of the ecosystem
Automated mechanisms
Non-automated mechanisms

MakerDAO has designed the economics of the token ecosystem and it ensures the robustness amongst the decentralised participants.

Decentralised monetary system

We talk about free and open systems. But when it comes to businesses and merchants, the important aspect is a stable medium of exchange.

Building on Ethereum network, MakerDAO uses $ETH as collaterals to produce $DAI, the stable currency. For this to happen, the system overcollateralises $ETH to allow $DAI to maintain the US$1 peg.

Stablecoin is needed especially for mainstream adoption of cryptocurrencies. If you think about more traditional finance like trading, financing, buying and selling or saving, we rely on the stability of money value.

DAI Stablecoin System

To describe the stable coin system, as many are probably familiar we have what previous called CDP, now we call it to Vault.

Vault

Vault is basically the minting that you have your cryptocurrency as collateral to mint it.

To describe in traditional finance, it is using your house as collateral to borrow money. Instead of your house, you are now using ETH in DeFi.

A lot of people ask "why anybody would do this kind of collaterals mechanism?". If I want to turn my assets into money, why don't I sell it instead?

Because sometimes you want to maintain the exposure to underlying assets.

Go back to real estate.

If you believe that this building is going up 10x next year, it has a lot of potentials. You don't want to sell this building. But you need money now.

Are you going to sell your building just to get this money now? Probably not. What are you going to do If you're going to put it as collateral and then borrow money?

Maker vault systems are very similar. For example, there are a lot of people who are very optimistic about ETH. But they need some money now. So, they use ETH as collateral and mint DAI.

We actually have some people in Korea where they actually use ETH as collateral to mint DAI. This DAI can be used to buy real buildings and real estate. We also have some people who buy cars and others.

And some people use it for leverage as well. For example, you can have ETH as collateral, mint Dai, use Dai to buy something.

Basically, you're leveraging yourself in more decentralised matters.

Core monetary components

In the vault, you have cryptocurrency as collateral. You get to mint DAI. As part of governance, the MKR token holder gets to vote on several risk parameters like stable fee. The stable fee helps to maintain the price of the Dai to 1 USD.

Banking the unbanked

Not only is DAI used in crypto markets, but it also integrates people who do not have access to finance. As more innovative solutions exist, it will also help to reduce the fees involved like transaction fees.

Such technology includes:

Wallets like Argent to help people access cryptocurrencies instead of being a tech geek
Layer 2 solutions to make it faster, easier and cheaper to transfer funds

The DAI saving function also allows users to earn returns on the DAI owned. This is similar to savings accounts for people. This allows the unbanked to earn from their savings.

We are actually seeing a lot of people and also a lot of partners using DAI and this is not just within DeFi. We are also seeing, for example, blockchain gaming as well as global organizations and many others so we're seeing more integrations as well as a high DAI transaction.

Real-world use cases

For example, we talked about the Oxfam case where people try DAI. Because it's decentralised as well as transparent. We're definitely gonna see more cases like this as well as access for more.

TLDR: For DeFi to grow, we need an asset with a stable value to allow for trade. MakerDAO solves this by creating DAI, a coin soft-pegged to USD. Upon minting DAI from ETH, users can use DAI in the "real world" like car and mortgage payments. Or use DAI in other DeFi protocols.

Get smart: When users deposit their collateral inside the MakerDAO system and receive the corresponding DAI, the user can use the DAI for whatever purpose they want.

Get smarter: Another token in Maker is MKR, a governance token. That is used to vote for stability fee and other governance issues.