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Maker MKR: A Platform for DeFi Loans by Minting the Decentralized DAI Stablecoin

By 2sats | 2sats | 21 Jan 2022

*obligatory not financial advice*


What is Maker?

The Maker Protocol is a dApp on Ethereum that allows the creation of the popular and decentralized DAI stablecoin.

Although USD is one of the worst shitcoins, there is a demand for using it simply because it’s the standard currency and it is very useful in DeFi applications like decentralized exchanges. Tokenizing paper money helps with the adoption of DeFi, but most popular stablecoins depend on a centralized middle man. USDT for example is handled by such a middle man that is allegedly backing the tokens with bonds and real world USD but they haven't really been transparent about their holdings and depending on a centralized entity destroys the entire point of using DeFi. Also such centralized stablecoins are at risk of being targeted by regulators. The DAI stablecoin is a decentralized alternative for an USD pegged token.

DAI is also collateralized but by cryptocurrencies instead of US dollars. The Maker Protocol allows its users to lock up a collateral in ETH, Wrapped BTC, AAVE, COMP, UNI, MATIC, BAL, Uniswap LP tokens and many more different tokens. Once you deposit a collateral you can mint DAI and use it however you want. Maker itself has a DAI savings tool that lets DAI holders earn a share of the fees in DAI, the savings rate is much better than most high yield savings accounts for real life US dollars.



The minters can use this as a DeFi loan to gain liquidity without selling an asset they are bullish on or for leveraged trading. This is not without risk, because should the value of your collateral fall so much that your DAI is at risk of no longer being collateralized, the Maker Protocol will sell the collateral and use it to burn the amount of DAI you have minted. This ensures that every DAI is backed by more than enough crypto at any point in time.

Here is an example about how this works. ETH has a minimum collateralization ratio of 145%, which means that if you supply a collateral of $145 worth of ETH you can mint a maximum of 100 DAI. If you mint the max amount of DAI and ETH keeps its value or rises, you will be able to use your DAI for whatever you want, for example to buy more ETH if you want to leverage your investment. If you want your collateral ETH back you will have to pay back your loan in DAI with interest. Should the value of your ETH fall to $135 it will get liquidated to cover for your loan. In that case you will no longer have to payback your DAI and can just keep it, but your ETH is gone. You will also receive the surplus of $35 too, minus a liquidation fee.

Part of the fees goes to a treasury that can be used to cover for loans in case your collateral drops in value faster than the protocol can react to sell it. Should your collateral fall even more in value before the protocol can react, it will mint MKR governance tokens and start selling them to cover the loan. This makes sure that DAI is always fully backed despite the extreme volatility that the crypto market can have.

Stablecoins are never 100% stable, their price does fluctuate a little bit if their liquidity on a DEX is low for example. That’s why there are some methods of regulating the supply and therefor the price. The protocol always lets you mint DAI under the assumption that its value is $1, so you could sell it with instant profit by arbitrage trading should it be trading for a slightly higher price on Uniswap, which would stabilize the price and supply again. Should the value fall below $1, the borrowing fees will increase to discourage people from minting more DAI which will lower the supply and fix the price again.

Maker offered one of the first decentralized alternatives for a tokenized US dollar and for lending. Since then other solutions launched too, like the Terra LUNA blockchain and its algorithmic UST stablecoin and Aave and Compound that both offer decentralized loans which means there is less need for minting DAI to get liquidity, and Venus even unites the features of both Compound and Maker. Still the Maker Protocol is well established in the DeFi market, has lots of liquidity and its DAI token is popular and can be used in many other dApps on Ethereum.



The MKR Token

MKR is the native governance token of Maker. It is used to vote on changes to the protocol like how high the fees should be, how high the collateralization ratio for a collateral asset should be and which tokens should be allowed as collateral.

There was an initial supply of 1,000,000 MKR and there is no max supply. A part of the collected fees are used to buy and burn MKR tokens and should the value of a collateral drop too low too fast more MKR tokens will be minted and sold to cover for the outstanding debt. This means that MKR holders have a strong incentive to govern the platform properly because if Maker works well it will prevent an inflation of their token and possibly even make it deflationary.

The entire initial supply was pre-minted by the founders and sold to investors. This is a bit unfortunate because other DeFi protocols like Uniswap or Aave are distributing their tokens to their users which gives them more incentive to use the platform and makes them a part of the governance process.

The value of MKR directly depends on how much liquidity is locked in its smart contracts. If more people are minting DAI, it will increase the value of MKR and it could also lower its supply with constant burning. However, should collateral assets lose their value too fast it would put the MKR token at risk because this could cause an increase in its supply, this makes MKR especially vulnerable to sudden bear markets. The competition isn't small either; Terra allows the creation of decentralized stablecoins for various fiat currencies without the need of a collateral, and Venus lets its users mint a stablecoin and also supports lending of other tokens like Aave. Still since DAI already is well established there will be plenty of people that will use Maker and it’s also improving further, like by adding more collateral options like liquidity pool tokens.

MKR is listed on many big centralized exchanges like Binance and Coinbase. Coinbase also supports the DAI stablecoin and lets its users earn interest on it. DEXes like Uniswap and Sushiswap support both MKR and DAI. You can hold and use both tokens with any Ethereum Wallet like MetaMask.




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