A Guide to Maker and MakerDAO

The decentralized financial system is home to various blockchain-based protocols. At press time, the total value of locked assets in DeFi stands at $87.42 billion. Ranking as the second protocol is MakerDAO, which has locked assets worth $13.27 billion.

MakerDAO operates like a money market economy with borrowers and lenders. As such, the platform enables users to access lending services. The DeFi protocol began functioning in 2014 with Rune Christensen as the CEO. Like many other platforms, MakerDAO runs on Ethereum’s blockchain network.

In today’s world, a small number of individuals usually qualify for loan services. The traditional system uses specific eligibility criteria, which usually locks out most customers from receiving funds. MakerDAO works differently to expand its lending services to everyone.

How MakerDAO Works

MakerDAO operates with two types of digital assets known as DAI and MKR. DAI is the protocol’s stablecoin which handles issues of volatility in cryptocurrencies. The ERC-20 token achieves its stability from the U.S dollar.

Whenever users need a loan, the MakerDAO ecosystem generates DAI coins. Hence, users get a loan in the form of DAI when they lock ETH in smart contracts. In some cases, Ethereum’s value can fall below the DAI amount. When such a scenario happens, the ETH collateral is going to compensate for the DAI loan. That way, MakerDAO can manage the risk of liquidation.

After creating DAI, individuals can use it as a regular payment medium. The DAI is also transferable between various Ethereum wallets. Multi-collateral DAI works as the new version of the stablecoin asset. Before, users could create DAI with Ethereum only.

The new version enables users to produce DAI with not only ETH but also the Basic Attention Tokens. Today, the protocol has 18 collateral assets: USDC, USDT, PAX, and many more. Since DAI is an ERC-20 token, developers can use it when designing a payment system.

As such, DAI powers decentralized applications with a stable token. Currently, there are more than 6 billion DAI tokens in circulation. DAI undergoes a burning procedure after borrowers pay back the loan.

Stability Fees

Stability fees apply when users take out a loan from their collateralized ETH amount. Minting DAI attracts a certain interest rate. So, a rise in the stability fee limits users from borrowing DAI.

The opposite is true since more users create DAI tokens if the stability fee decreases. As such, the interest rate controls DAI’s supply and helps to keep the DAI-USD peg stable.

DAI Savings Rate

The DAI Savings Rate began to function in November 2019. It is an interest rate that caters to all DAI tokens in a smart contract. The DSR concept uses stability fees to pay for the interest rates.

If the DSR level goes up, the buying pressure of DAI in exchanges also increases. It makes investors buy DAI and deposit it into the DSR contract for interest. At the same time, a decrease in the DSR encourages a low demand for DAI.

The Role of MKR Token

The MKR token’s task is to ensure the DAI stablecoin remains stable. Thus, the creation and burning of MKR rely on DAI’s price momentum. When the collateral rises, the ecosystem generates MKR tokens to cover the DAI loans. At the same time, MakerDAO cuts out a certain supply of MKR if DAI’s value remains intact.

Aside from stabilizing DAI, MKR also works as a governance token. MKR holders can take part in voting for various proposals. The recommendations usually aim at improving MakerDAO’s ecosystem. Some of the proposals that MKR holders vote on include:

  • Adjustments to the DAI savings rate
  • An overall upgrade of the MakerDAO system
  • The type of oracle to use – Oracles help the Maker protocol in acquiring real-time market data.
  • The digital assets to add as collateralized assets and create more DAI – The MKR community can discuss the new crypto’s risk parameters.

Holders’ voting powers depend on the amount of MKR tokens they have. In return, holders earn MKR fees for participating in the governance system. MKR is tradeable across different exchanges and can be stored in ERC-20 wallets.

MakerDAO Goes Full Circle

In July 2021, Maker moved to a fully decentralized system. Migrating to a decentralized platform means that the Maker community is in charge of every decision. There is no central authority governing the protocol’s operations. Thus, welcoming the decentralized autonomous organization meant eliminating the Maker Foundation.

Millions of users can get on board and be part of the platform’s development journey. Complete decentralization also means that users can earn from participating in the governance system. According to Rune, shifting to a decentralized organization was always the protocol’s primary goal.

The Emergency Shutdown

Maker activates the emergency shutdown procedure when a cyber-related attack occurs. The compromise could include issues such as hacks, dishonest governance practices, and security breaches.

A system upgrade is the second scenario where the emergency shutdown applies. MKR holders usually vote on whether the shutdown needs to take place. The voters start by depositing MKR into the Emergency Shutdown Module (ESM).

After that, the protocol shuts down if the majority of holders vote in favor of the procedure. That way, the platform can counter any internal or external risks.

Final Word

Maker’s product focuses on extending loans to users worldwide. The traditional financial system requires various qualifications to acquire lending services. MakerDAO follows a different path as it requires users only to hold digital assets. Possessing digital currencies as collateral means that users can get loans in the form of DAI.

The DAI token also ensures investors get a loan with a stable asset. Through DAI, users can secure an income with the DSR model. Security is a priority on Maker, especially with the emergency shutdown procedure in place.

Hence, an investor’s holdings remain safe from attackers. More importantly, Maker allows any individual to be part of the protocol’s decision-making process.

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