All you need to know about DAI and Stablecoin

All you need to know about DAI and Stablecoin

By AE22 | Cryptocurrencies market | 19 May 2020


First of all, WHAT IS A STABLECOIN?

Stablecoins are just as the name implies. They are a cryptocurrency that has stability as their primary feature. They are pegged to the value of another asset and will hold the same value with that asset through time. Stablecoin can be pegged to any assets such as commodities, a price index, a real asset and even other crypto. However they are mostly pegged  to fiat currencies like US dollar or the British Pound. 

So, when you say that a stablecoin is pegged to the US dollar it means that one unit of that crypto will always be equal to one US dollar.

1 DAI = 1 USD  why? --> the dynamics of stablecoins ensure that any deviation opens up arbitrage opportunities. How this works depends whether they are use a collateralized crypto debt like DAI.

If the US dollar depreciates from trade wars, actual wars or just through inflation so too will the pegged value of your stablecoin.

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There are 2 different types of stablecoin:

1. centralized type

2. decentralized type

Centralized type: Are stablecoins that usually backed by fiat currency that is held by some central entity. This could be an exchange,  a trust or some other form of organization. Perhaps the most centralized stablecoin you've heard of is Tether or USDT. Tether claims that for every one Tether they have put out on the market there is one dollar in their bank account.  Also, there are a lot of centralized stablecoins: USDC, PAXOS, TrueUSD etc. 


DAI 

Dai was launched  in 2017 and was developed by MAKER (is a decentralized autonomous organization (DAO) that was build on the ethereum blockchain. Maker is trying to develop a line of decentralized stablecoins that will be tied to other assets. They've issued 2 tokens namely the maker MKR and the DAI stablecoin. 

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Dai is able to maintain the peg through a careful balance of economic incentives and game theory. Essentially the system creates arbitrage opportunities every time there is a deviation from the one to one peg. By arbitrage opportunity I mean a risk free way to make a few bucks from said miss pricing. The mechanics behind this are really quite ingenious. Users can borrow DAI by placing their cryptocurrency into what the maker teams calls a vault. In the days of single collateral DAI this was termed a collateralized debt position (CDP). Currently the collateral can be Ethereum or Brave BAT token. The user locks their ETH into the vault in order to unlock the DAI. They can just as easily send the DAI back along with a fee in order to unlock the collateral that they posted. This is all managed in the vault through the use of a decentralized smart contract. 

As a holder of ETH you can use your crypto and generate DAI for only 1 dollar. If DAI is being sold on an exchange for more than 1 dollar you can quickly unlock the DAI and sell it for a quick profit.  

Also, the mechanism works the other way. If the price of DAI falls on the open market below the 1 dollar peg someone who has borrowed DAI can buy it and then use it to unlock their Ethereum in the vault.

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What happens if the value of the collateral falls? What happens if the price of Ethereum collapses tomorrow? 

The maker team had anticipated it and built in a number of safety mechanisms. 

The first line of defense against this sort of risk is over collateralization. The vaults are over collateralized which means that more crypto is required to be tied up than you can unlocking DAI. For example: if the collateralization ratio is set at 150% so 150 dollars in ETH is required to unlock 100 DAI. If the value of the collateral (ETH) increases then the borrower can unlock more DAI up to the collateral threshold. If the value of the collateral falls then borrwers can choose to either repay borrowed DAI or deposit more collateral as their position of approaches the liquidation level. When this liquidation level is hit the maker system will trigger an auto liquidation. 


FINAL THOUGHTS ON DAI

I can say that DAI is one of my favorite stablecoin on the market. Cryptocurrency is supposed to be decentralized and having to rely on a singular entity to maintain a stablecoin is the antithesis of that. 

DAI has an extraordinary liquidity and track record.

DAI is well positioned at the forefront of this increasingly hot market. 

 

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