The Magic Behind MakerDAO

The Magic Behind MakerDAO

By jeffthebaker | Baker Crypto | 11 Mar 2019

Last post I wrote, I gave an introduction to Decentralized Autonomous Organizations with a special emphasis on MakerDAO (which is, in my opinion, the best DAO on the market). There was a lot of information crammed into that post, so below I will write a more palatable explanation of how MakerDAO works.

To start- let's remind ourselves of an overview of what MakerDAO works. MakerDAO represents a peer-to-peer lending ecosystem that is entirely owned and populated by its participants, and orchestrated through the DAO protocol rules. MakerDAO made headlines recently when 2% of all ETH was locked up in their lending system.

How it Happens

Lending from MakerDAO is as simple as going to the CDP portal and initializing your loan. For now, you can use Ether as collateral for loans, but in the future, other currencies are planned to be integrated as well. You can lock as little or as much ETH as you like, and you can withdraw value equal to any amount up to 66% of the amount you lock. When you lock Ether, it is transfered to Pooled Ether (pETH) the locked Ether is pooled as a metric to defend against flash crash and stabilize the collateral pool against other mass market concerns.

When you take out a collateralized loan, you are paid in DAI, the stablecoin of Maker that is pegged to 1 USD. Because you can only withdraw up to 66% of what you lock, there is always enough funds locked as reserves to back the DAI. This makes DAI the first fully transparent, decentralized stablecoin on the market.

The DAI is yours to use as you please, you can take it to whichever exchange supports DAI and trade it for any cryptocurrency. Alongside this activity, your Ether continues to fluctuate in value. As long as your ETH is valued high enough to cover the value of the DAI loan, you are in the clear. If, however, your ETH falls below the value of the loan, you will be liquidated and lose access to your ETH.

Why use Maker loans?

Maker loans are best for people who are bullish on Ethereum but looking for exposure to other currencies. Traditionally, if there was a project you were looking to invest in, you'd have to sell your ETH in order to buy the project's coin or token. With Maker, you can maintain your positions on ETH while simultaneously gaining exposure to other coins. 

The Other Components

While the CDP system is pretty novel, it's not the only metric of Maker that gives it value. There are several other key distinctions that help Maker work seemlessly on the scale of 2% of all ETH (and growing!). Because Maker is a DAO, the governance of the organization is left up to MKR holders. MKR holders determine additions, revisions, and adjustments to the protocol. The value in MKR comes from ownership of the DAO itself.

Additionally, there is a burn component in MKR that value is derived from. Whenever DAI is returned and CDPs are closed, a small burn fee of MKR is required. Until recently, that burn was equivalent to 0.5% in MKR. However, MKR holders recently voted to increase this fee to 3.5%. At time of writing, over 550 MKR has been burned (over US$350,000 worth). With the new fees, the yearly burn is projected to exceed 4,000 MKR.

Here is a great resource to see the network stats and fluctuations of MKR.

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Skin in the game since 2013. Perpetual gem hunter and crypto optimist :) Experienced as a freelance writer and marketer for numerous projects and news sites over the course of my stay in the space.

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