What is MakerDAO?
MakerDAO is an Ethereum-based smart contract platform that allows you to issue the DAI stablecoin secured by crypto assets. The name of the platform comes from the term market maker.
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The mission of the project built on the principle of TAO is “creating stability in the world of decentralized things.” This stability is realized through DAI – a key element of the ecosystem and the first decentralized stablecoin on the Ethereum blockchain. The ERC-20 standard token is used in popular Ethereum wallets and is represented on the largest exchanges.
Who created MakerDAO?
The creator of the MakerDAO platform is the Dane Rune Christensen. He studied biochemistry and international trade, after which he became a co-founder of the international recruitment company Try China.
In 2014, Christensen founded and led the Maker Foundation, headquartered in Santa Cruz, California.
In March 2015, Christensen, former Amazon software engineer Andy Milenius, and a number of other developers began work on creating a decentralized platform that allows users to borrow cryptocurrency-backed stablecoins.
On March 26, 2015, Christensen published an article in which he introduced the concept of eDollar, a stablecoin on the Ethereum blockchain. The motivation for the creation of the stablecoin was partly the inability of BitUSD to attract market makers, which led to a lack of liquidity.
Christensen proposed motivating market makers, later named Keepers, by rewarding them with Maker (MKR) utilitarian tokens for providing liquidity.
How has the MakerDAO platform evolved?
In the first iteration of the platform, the central elements were Single Collateral Dai(SCD,“monosecured Dai”), launched in December 2017. The only asset used as collateral for loans was Ethereum.
Soon after the start of SCD operation, the volume of generated stablecoins reached $ 100 million The value of the collateral decreased by 94% over time, but the system remained healthy, and the DAI token kept the peg to the US dollar in the ratio of 1 to 1.
Although the SCD platform proved viable, the creators of the project decided to move to the concept of Multi Collateral DAI (MCD) with a multi-collateral DAI token and the ability to implement other key changes.
In October 2018, the American venture capital company Andreessen Horowitz (a16z) invested $ 15 million in MakerDAO.
At the end of 2018, the Maker Ecosystem Growth Foundation (MEGF)was created to oversee the $200 million Maker Development Fund, headed by nine executives appointed by Christensen.
According to Andy Milenius, the CTO of the project at that time, disagreements arose among the members of the MEGF board on the distribution of funds, since Rune Christensen wanted to establish full control over the development fund, which had hithready been under the supervision of several parties.
MEGF CEO offered a choice of:
- A “red pill” to those who were willing to accept his leadership and focus on aspects such as regulatory compliance and integration into the existing financial system.
- The Blue Pill for those who did not want to remain within the formal organizational structure and were willing to lose funding over time, but continue to work on the MCD on a voluntary basis.
However, a third faction emerged, which sought an alternative to these proposals and called itself the “Purple Pill”. According to Christensen’s opponents, he tried to usurp power and impose his vision for the further development of the project at the expense of decentralization.
Christensen accused the group of conspiracy and fired five MEGF board members who were part of the Purple Pill. They challenged the decision in court. The Maker Foundation has left business development director Ashley Sharp and CTO Andy Milenius.
On November 18, 2019, Maker introduced a multi-tabular version of the Dai (MCD) stablecoin. The old version of the coin was renamed Sai.
Platform participants voted for the Basic Attention Token (BAT) as the first additional collateral option. Along with new options for providing generated Dai stablecoins, the Dai Savings Ratesystem was launched, which allows you to earn on interest from deposited stablecoins.
There was also a release of the Oasis DeFi hub, designed to provide users with access to MCD. The Oasis Borrow interface allows you to store collateral in special vaults, and Oasis Save allows you to freeze DAI on a smart contract at a certain interest rate.
In December 2019, the developers of MakerDAO fixed a critical vulnerability that could lead to the loss of more than 10% of the total collateral of DAI token holders.
On December 31, 2019, the Maker Foundation registered the Dai Foundation in Denmark, which protects the trademarks and intellectual property of the Maker community.
At the end of December 2019, the process of transferring project management into the hands of the community began, which was completed in March 2020. As a result, the Maker Foundation transferred all MKR management tokens to users. Holders of the asset have gained full control over a special smart contract that gives the governing community the opportunity to vote for the emission and destruction of tokens, as well as for future changes in the set of rights of this contract.
The end of support for Sai was planned from the moment of the launch of the multi-security system. On March 30, 2020, the Maker Foundation launched a vote regarding the shutdown of Sai. After approving the proposal, the community established a transition period from April 24 to May 12, during which users could transfer their debt positions to a multi-resecury system. Sai holders had the ability to convert tokens on third-party platforms like Uniswap.
On March 12, 2020, against the background of the collapse of Ethereum quotes, attackers withdrew more than $ 8 million from the MakerDAO system. The incident prompted the community to accelerate the full transition to MCD.
In April 2020, investors filed a class action lawsuit for $ 28 million against the Maker Foundation and several affiliated structures with it. They were accused of deliberately distorting the risks associated with collateralized debt positions (CDP). Later, the Maker Foundation reported on the changes made to the MakerDAO system to prevent similar crises in the future.
On May 3, 2020, MKR holders approved the use of tokenized Wrapped Bitcoin (WBTC) and tBTC as collateral.
On May 11, 2020, the MakerDAO community stopped the monosecury SAI (Single-Collateral DAI). The service has completed the transition to a multi-collateral stablecoin Dai (Multi-Collateral Dai, MCD or DAI). The remnants of the old type of tokens were automatically converted into Ethereum.
Thanks to the transition from SAI to DAI, it became possible to issue a stablecoin not only secured by Ethereum, but also ERC20 tokens WBTC, tBTC, Basic Attention Token (BAT) and USD Coin (USDC).
How does MakerDAO work?
MakerDAO is an ecosystem of two tokens: the DAI stablecoin and the Maker utility token (MKR).
DAI
The DAI token is pegged to the US dollar in a 1:1 ratio and is backed by various digital assets. The scheme of issuing this stablecoin can be compared with the issue of gold-backed money. The difference is that cryptocurrencies are used instead of a noble metal: the user sends a certain amount of ETH or other tokens to a smart contract, which issues the token. The system is called Vaults.
Liquidation is the process of selling collateral to cover funds in DAI that users generate from their Vaults.
The liquidation price is the price at which Vault is liquidated. Users can lower the liquidation price by depositing additional collateral or returning DAI to Vault.
The viability of the system is maintained by Vault liquidations in the event that the value of the security of debt positions falls below the Liquidation Ratio.
The liquidation rate is the minimum collateral level for each Vault type. If it is not achieved, the Vault is considered unsecured and must be disposed of.
The Maker Protocol Oracles provide a system with price data used to track vaults’ inconsistencies with the liquidation rate. The latter is established on the basis of the collateral risk profile and the Stability Fee. There may be different types of Vaults for each collateral, with different liquidation rates and stabilization fees.
Liquidation rate = (collateral x collateral value) ÷ generated by DAI × 100
For example, a Vault with a 150% liquidation rate would require a minimum of $1.50 in collateral value for every $1 generated by DAI.
If the value of the collateral drops to ≤ $1.49, it is liquidated to cover the generated DAI. In addition, a so-called liquidation fine is imposed.
DAI tokens are actually collateralized debt to MakerDAO. At the same time, the collateral always exceeds the size of the loan.
If the value of the collateral falls below a certain cost of the loan, an auction begins, in which the participants of the network, called liquidators, buy back the collateral for DAI. After that, the system burns the resulting stablecoins, reducing emissions. Such a mechanism is designed to ensure a peg to the dollar.
Savings rate DAI
Savings rate DAI (DAI Savings Rate/DSR) is a variable rate of accrual from DAI tokens locked in a DSR smart contract.
Vaults users receive accruals automatically, while retaining control over their tokens. In the DSR smart contract, there is no limit on the withdrawal and deposit of funds and liquidity restrictions. The rate is set and adjusted by holders of MKR tokens through the on-panel management system.
DSR is a global parameter that can go down or up, affecting DAI demand. An increase in DSR motivates users to hold more DAI, a decrease leads to a drop in demand for tokens.
These changes are reflected in the market price of DAI. If the stablecoin is trading below the dollar rate, then the DSR can be raised to increase the demand for DAI, and, accordingly, its price. If DAI is trading above the dollar price, the DSR can be lowered to reduce demand for the stablecoin and lower its price.
Stability Fee
Stability Fee is an additional fee that is constantly charged to DAI holders using Vaults.
Part of the stabilization fee is used to maintain the work of the Maker Protocol, including covering the costs of the DSR, Risk Teams and other mechanisms.
The stabilization fee on vaults of all types changes based on the voting results of MKR holders who manage the protocol. Their decisions are based on Risk Teams recommendations that assess the risk of the collateral used in the system.
Risk Teams can update the stabilization fees they offer when the underlying asset or the entire system changes in a fundamental way.
Stability Fees accumulate on the internal balance of the Maker Protocol. As soon as the maximum level of liquidation balance is reached, the system automatically sends DAI to the Residual Auction (Surplus Auction). During the auction, Keepers offer a higher price in MKR for DAI. The winner of the auction receives the stablecoins, and the MKR paid to them are incinerate.
As stated in the white paper of the project, the target cost of DAI on the Maker platform has two main functions:
- Calculate the collateral-to-debt ratio of Vault;
- Determination of the value of collateral assets in a global settlement situation.
In the event of serious market instability in future versions of the platform, aTarget Rate Feedback Mechanism (TRFM)may be activated. It does not imply a fixed peg of DAI to the dollar, but changes the target rate, motivating market participants to maintain the DAI rate at the level of the target value.
When the TRFM mechanism is enabled, the target parameters change dynamically, balancing the supply and demand for DAI. The feedback mechanism moves the market price of a stablecoin in the direction of a changing target price.
When using TRFM, the target rate rises if the DAI market price falls below a certain mark. Against the background of rising prices, the generation of a stablecoin with the help of collateral debt obligations becomes more expensive. It also increases the attractiveness of DAI retention, contributing to the growth of demand for the coin. The combination of reduced supply and increased demand causes the market price of the stablecoin to rise, approaching the target mark.
Conversely, if the market price of DAI exceeds the target price, the target rate decreases, leading to an increase in the attractiveness of generation and a decrease in demand for holding the stablecoin. As a result, the market price of DAI decreases, approaching the target price.
DAI Applications
Maker gives an example of four areas that can benefit from the use of DAI stablecoin:
- Gambling Markets. Long-term bets do not make sense to make using volatile cryptocurrencies. This carries not only the risk of a decrease in the size of the rate, but also a decrease in the prices of underlying assets. Using a stable asset in price allows you to limit the risk to the usual probability of losing.
- Financial Markets. Stable collateral is well suited for derivatives based on smart contracts.
- International Trade. The cost of cross-border payments can be quite high. By eliminating intermediaries, DAI allows you to reduce costs to an adequate level.
- Transparent accounting systems. With verifiable transactions, DAI enables organizations to improve operational efficiency and reduce the likelihood of abuse.
Maker (MKR)
In addition to the DAI stablecoin, the platform uses Maker (MKR) – the native token Maker Protocol.
Maker Protocol is a set of smart contracts through which DAI is issued.
This is one of the first applications of decentralized finance, which became widespread. The platform remains one of the largest in the Ethereum segment.
In 2017, the Maker Foundation issued 1,000,000 MKR tokens. They were distributed among the first users and sold out during three rounds of closed sales (totaling $ 64.5 million).
Similar to the gas in Ethereum, MKR acts as a “fuel” to pay off commissions for using the system’s smart contracts. After paying the commission, MKR tokens are burned.
MKR is destroyed when the liquidation balance of the Maker Protocol system exceeds the minimum threshold. The surplus DAI is sold at auction for MKR tokens, which are then burned. Conversely, when the Maker Protocol has a deficit and the system’s debt exceeds the maximum threshold, MKR tokens are created that are sold at auction to recapitalize the system.
The primary responsibility of MKR holders is to ensure the stability of the DAI rate and the health of the system as a whole.
In addition, MKR performs a management function – the token is used in voting for risk management mechanisms and business logic of the platform. Every MKR holder has the right to vote and the opportunity to create a new offer. The proposal with the highest number of votes automatically receives the status of “important”, thereby affecting the further development of the entire project.
MKR holders vote on four key Vault risk parameters to ensure the stability of the Maker system:
- Debt Ceiling – The maximum amount of debt that can be created by a single vault type;
- Liquidation Rate – the ratio of collateral to debt at which the Vault becomes vulnerable to liquidation;
- Stability Fee – An additional fee calculated as the annual interest rate on top of Vault’s principal;
- The penalty ratio is an indicator of the maximum amount of DAI that can be charged in the event of debt liquidation.
Thus, MKR holders are the highest authority in MakerDAO. They manage the system and participate in the distribution of profits, but are forced to indicate losses if the decisions made are unsuccessful.
What are the risks associated with MakerDAO?
The creators of MakerDAO describe the largest risk factors of the platform and offer a list of actions to mitigate their consequences.
- Malicious hacking attack. If there is any vulnerability in smart contracts, an attacker can try to take a pledge from the Maker platform.
- Competition. The decentralized DAI Stablecoin system is quite complex, so users may prefer simpler centralized stablecoin systems.
- Irrationality of markets. Prolonged periods of irrationality of markets can lead to a loss of confidence in the stability and liquidity of the system. To solve this problem, it is necessary to attract a large pool of capital. This will make markets more efficient and efficient.
- Regulatory risks. According to representatives of the US Securities and Exchange Commission (SEC), some stablecoins may be subject to securities laws. According to the SEC classification, one stablecoin can be tied to real assets like gold or real estate, another to fiat currency, and the third can use various “financial mechanisms that support price stability.” The third category, which includes DAI, may become the object of close attention of the regulator.
How is MakerDAO evolving?
In August 2020, MakerDAO joined the Global DeFi Alliance, an international consortium of centralized and decentralized financial service providers and platforms. The purpose of the consortium is to promote projects in the field of decentralized finance, as well as the development of the ecosystem, including through the unification of “disparate DeFi communities in the Asia-Pacific and Western regions.” The organization was headed by Huobi DeFi Labs.
In June 2020, MakerDAO members voted to add tokenized trading invoices, royalties for streaming music, and ZRX, MANA, tBTC and Uniswap Dai Liquidity Token as collateral for loans at DAI.
In September 2020, Maker Token Holders (MKR) refused to compensate losses to holders of collateral in MakerDAO liquidated during the March market crash. From September 8 to 22, 38 voters with 87,899 MKR participated in the compensation plan survey. The option against damages won 65% of the vote (more than 57,000 MKR).
At the end of August 2020, the MakerDAO community voted to add LINK, LRC and COMP tokens as new options to enable the release of the DAI stablecoin.
As of July 2021, the list of collateral tokens includes Ether, USD Coin, Wrapped Bitcoin, Paxos Standard, Chainlink, Trust token, UNIV2DAIETH, Yearn, UNIV2DAIUSDC, UNIV2WBTCETH, UNIV2UNIETH, UNIV2USDCETH, Uniswap, renBTC, Basic Attention Token, Decentraland, 0x, Aave, Loopring, Gemini dollar, UNIV2WBTCDAI, Balancer, Compound, UNIV2LINKETH, Kyber Network, UNIV2ETHUSDT, Tether, USD Coin, UNIV2AAVEETH, UNIV2DAIUSDT.
In April 2021, real estate recovery investment firm New Silver partnered with Centrifuge to use MakerDAO as a financing facility and opened a $5 million credit line to issue DAI.
It is assumed that the diversification of the collateral portfolio will make DAI more reliable. The Maker team emphasizes that in the future, with the approval of MKR holders, almost any tokenized asset with acceptable risk parameters can be added to DAI’s collateral portfolio. You can learn about the criteria for selecting new collateral here.
In 2020, DAI’s capitalization grew more than 20 times thanks to the hype around DeFi. MakerDAO became the first DeFi protocol with a total value of blocked funds (TVL) of $ 1 billion.
At the beginning of 2021, against the background of the rapid growth of Ethereum, the total value of blocked funds (TVL) on smart contracts of the MakerDAO DeFi project reached $ 3.15 billion. in May, the figure approached $ 9 billion.
You can monitor the status of your MakerDAO system using daistats.com.
On July 20, 2021, MakerDAO creator Rune Christensen announced that the DeFi platform has “gone through a full cycle of development” and is now completely decentralized. The Maker Foundation fulfilled its commitment to the development of the project and transferred to the DAO the right to make all strategic and operational decisions. The Maker Foundation will be abolished in a few months.
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