What is Dai (DAI) and why is it so popular?
Today, the cryptocurrency industry is teeming with thousands of different coins and tokens, all of which claim to offer investors something, be it utility, a store of value or otherwise.
One of these cryptocurrencies, Dai (DAI), has risen through the ranks to become one of the most popular coins in the world. But what exactly is DAI, how does it work, and why is it now so well known?
What is Dai (DAI)?
Dai is a stablecoin that was launched in 2017 as part of the MakerDAO ecosystem. MakerDAO is a peer-to-peer cryptocurrency lending platform that was launched two years before Dai. Individuals can both borrow and lend funds in the form of DAI using MakerDAO, and the platform is fully decentralized.
MakerDAO is currently one of the most popular DeFi projects in the crypto industry, along with other big players like Uniswap and Yearn Finance. In fact, MakerDAO currently has over two million ETH locked to user deposits, so it’s safe to say that it has become a very successful DApp.
Both MakerDAO and Dai exist on the Ethereum blockchain, as do many other stablecoins like Tether and USD Coin. This makes Dai an Ethereum (ERC-20) token that you can buy on most crypto exchanges, such as Coinbase, Binance, and KuCoin. And, because Dai is an ERC-20 token, it can be stored in a wide range of well-known wallets, including MetaMask, Atomic Wallet, and Exodus. The existence of MakerDAO on the Ethereum blockchain also allows it to support smart contracts, which we will discuss later.
The MakerDAO DApp
The Maker Protocol, also known as the Multi-Collateral Dai (MCD) system, underpins the entire MakerDAO ecosystem. This borrowing system requires crypto collateral deposits on behalf of the user. When the security is deposited, DAI is generated. Each Dai token is collateralized accordingly, with the token being deposited by the borrower.
Initially, users could only generate DAI using Ether as collateral, but that changed recently. You can now use various cryptos as collateral, including Basic Attention Token, Compound Token, and USD Coin, all of which exist on the Ethereum blockchain. And, as more collateral cryptos are added to the MakerDAO system, the risk of DAI losing its peg decreases.
However, to receive DAI via MakerDAO, over-provisioning is required. This means you have to deposit more into Maker’s Collateral Chests, or Maker’s Chests, than you get back. These vaults are smart contracts that lock up the deposited collateral assets. Then, if the price of the crypto collateral drops, you will need to deposit more to keep your DAI.
Note that this is a guarantee, so you don’t lose any money by depositing it in Maker Vaults. However, if your secured crypto loses enough value while it is deposited in the vaults, MakerDAO will ask you to liquidate it. And, if you wish to liquidate your warranty by choice, you will need to return the DAI you originally received from MakerDAO.
Is the Dai algorithmic?
While the Dai itself is pegged to the US dollar at a ratio of 1:1, it is not backed by it, or any other type of physical reserve. In fact, Dai is only backed by other cryptocurrencies. This is another factor that differentiates it from other stablecoins like Tether and USD Coin. Dai maintains its anchor thanks to the guarantee.
You could technically call Dai an algorithmic stablecoin, but that’s not strictly true because it’s collateralized. This potentially makes DAI a less risky investment, as unsecured algorithmic stablecoins can crash easily and worryingly (as you may have seen in the LUNA/UST crash).
On top of that, DAI is a completely decentralized asset, unlike many other popular stablecoins like Tether. Therefore, no central authority determines the circulation of Dai. Since Dai is a stablecoin, it should be kept in mind that it is not a crypto that will increase in value and make a huge profit for its investors. Stablecoins are designed to withstand market fluctuations affecting typical cryptos via their peg. This makes Dai more reliable in the long run, but not a get-rich-quick asset.
But MakerDAO is not just a lending platform. People can also earn interest by locking up their DAI funds in a Dai Savings Rate (DSR) smart contract. Currently, MakerDAO offers a rate of 0.1% on deposited DAI.
The Maker Token (MKR)
MakerDAO also has an additional ERC-20 token, called Maker (MKR). This acts as a governance token, meaning those who own MKR funds can vote within the MakerDAO ecosystem to have a say in what changes are made and how the project progresses. For example, MKR holders could vote on changing the DSR savings rate and liquidation penalty or adding new collateral cryptos.
This governance system allows the Maker Protocol to be controlled by its users instead of a central authority. Maker currently has a fairly high value of over $900 and, as you might have guessed, is not pegged to any other asset, so it is not a stablecoin like Dai. MKR can also be used as a utility token to pay interest fees on the MakerDAO platform.
But Maker has an additional purpose, and it’s sort of a hopeless remedy. We mentioned earlier that there is always a chance that the price of deposited collateral will drop, and if that price drop exceeds a certain threshold, something has to be done. Of course, liquidating collateral is the first course of action, but if too many loans are liquidated at once, more MKRs are created and then sold so the loans can be repaid. Thus, DAI and MKR are of crucial importance in the functioning of MakerDAO.
The Dai ecosystem and MakerDAO
The cryptocurrency industry is notoriously risky and unpredictable, so the stablecoin investment option allows individuals to have a bit more confidence in the long-term trajectory of their funds. Additionally, Dai’s focus on reliability and stability makes it a particularly strong option for those looking to invest in cryptocurrency for use in the DeFi world. And, as the DeFi industry continues to diversify and prosper, we could see Dai and MakerDAO become even more mainstream.