DAI: The Decentralized Stablecoin

By jwrandolph | DAI Fans | 5 Jun 2019

$6.38 tipped


We are in the midst of the longest crypto bull run since 2017. If you’re like me, you’re feeling good about the assets that you have going way up in value, and maybe, also feeling bad that you didn’t buy more a month ago. Among all these coins that are going up 50% or more over the past couple months, there is a token on the Ethereum blockchain which hasn’t appreciably increased in value at all. In fact, it has been hovering around the same price point during its whole lifetime.

I’m talking about DAI. Out of all the different crypto assets out there, there is one class which always stays the same price called stablecoins, and DAI is a part of this class. The value of DAI is always pegged to 1 USD (United States Dollar), meaning even if the entire cryptocurrency market were to drop 50% in price tomorrow, the value of 1 DAI would still be 1 USD.

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In the above image, you can see how the price of DAI isn’t completely stable. This is because price and value are different metrics. The value of DAI is always* 1 USD, however, the price that it is exchanged (bought or sold on marketplaces) slightly varies. This is due to many factors, but most importantly the effects of supply and demand on DAI. If there is greater demand for DAI than there is supply, its price increases. However, if there is a greater supply of DAI than this is demand for it, the price drops. This is true of any stablecoin, cryptocurrency, and everything else that is bought and sold.

The price of DAI never varies by much. Its highest price has been $1.09, and its lowest about $0.95. If you think that this is significant for a stablecoin, you are right. But, these prices spikes were short-lived because of the protocol which immediately worked to return the price to $1 (more on that later).  

DAI is set up to be a completely decentralized, and trustless stablecoin. Since every DAI transaction is on the blockchain, you can personally see every single transaction that affects the price and value of DAI. This degree of transparency is incredibly important for stablecoins because if there is enough doubt about the true value of the coin, the entire system will collapse.

The capability of you, me, and everyone else to be able to scrutinize the DAI smart contracts, as well as all activity related to the cryptocurrency ensures that collectively, we are much more likely to find any problems that could exist in the project.

How Is DAI Kept At A $1 Peg?

Unlike many fiat currencies, and other stablecoins, DAI is completely, and verifiably, backed up by real value. Ethereum is collateralized (or other locked in) for every DAI that is created. This is done through a collateralized debt position, or CDP. Anyone can create DAI, as long as they have the collateral to back it up. The value of DAI is kept at $1 through automated wallets called keepers, which execute algorithms expressed through DAI smartcontracts. Although human users can do what they like to create, trade, or destroy DAI, it is up to these algorithms to keep the true value of DAI at $1. This is done in many of the same ways that a human user can interact with DAI, however, the keepers access all the data on the supply, demand, and value of DAI, and act to return the true value of DAI back to 1USD.

The keepers are completely decentralized, and cannot be directly affected by any one person. However, some things are kept stable by human MKR holders by setting different parameters—most notably the stability fee (annual interest rate)—through voting.

What Can You Do With DAI?

Trade/Means of Exchange

First, since DAI is an ERC20 cryptocurrency, it is fully transferable between parties. In other words, DAI can be used to trade for other cryptocurrencies on exchanges. In fact, DAI is often used as the main currency, along with ETH or WETH on many exchanges, such as IDEX. DAI is unique in that it is one of the most versatile cryptocurrencies I have seen. It isn’t just being traded on online exchanges, it is also being used on many dApps as a stable means of exchange. There are even real-world applications for using DAI, which is truly rare in the crypto world. I used a coin built on top of the DAI protocol, called BuffiDAI, at the ETHDenver convention last February to pay for meals, and these folks used DAI to pay for drinks at a bar. At this rate, DAI will potentially be the major means of exchange on the Ethereum blockchain.

Hold

At this stage in cryptocurrency, the price of every single token and coin that isn’t a stablecoin can decrease or increase rapidly. If you are investing in cryptocurrency but want to reduce the risk of losing money if the cryptomarket drops, then getting DAI is a wise decision. It will allow you to continue to interact with other cryptocurrencies (for example, by trading) while having a stable value in your wallet. Often paying with cryptocurrency is more efficient than using fiat currency, and if this is true for you, DAI is a wonderful option.

Borrowing

The last use of DAI that I’ll talk about is one which I don’t think gets enough attention. With DAI, you can take out completely decentralized loans on the blockchain. By locking in ETH as collateral, you can open a CDP and withdraw a lesser value of DAI.

For example, if you locked in $150 worth of ETH, you could withdraw up to $100 of DAI.

Now that this DAI is withdrawn, you can do with it what you like, but you must be able to pay it back, plus a stability fee (basically an annual interest rate) if you want to recover your ETH. Since the price of ETH fluctuates, but the price of DAI practically doesn’t, if the price of ETH increases, you can borrow more DAI in you CDP. However, if the price of ETH drops enough, your CDP could be automatically closed, and your ETH returned to you, minus a significant penalty. 

Why Is DAI Important?

Aside from being a practical way to keep stable cryptocurrency value, a versatile means of exchange, and a way to borrow on the blockchain, DAI is very special because of one more reason. MakerDAO, the organization which created DAI in 2017, is an organization which intends to be completely decentralized. The DAO in MakerDAO stands for “Decentralized Autonomous Organization”, meaning a completely decentralized network which still gets things done. Already, many of the decisions which significantly affect DAI are decided by MakerDAO’s governance protocol. Anyone who holds MKR—the other token created by MakerDAO—can vote on what will happen next in the organization. Currently, there is still some centralization within MakerDAO due to development and marketing efforts, but, as shown by the very real functionality of the governance dashboard, MakerDAO is well on its way to becoming completely decentralized.

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What’s Next?

In sum, DAI is a decentralized stablecoin pegged to the USD. It is incredibly innovative and useful, especially for the Ethereum blockchain, as a means of exchange, a way to keep a stable cryptocurrency value, and as a way to create loans on the blockchain. The story of DAI and MakerDAO gets increasingly interesting as the project continues to develop. Multicollateral DAI (MCD) is development which will hopefully become a reality soon. When it is, users will be able to not just put ETH down as collateral for CDPs, they will be able to lock in many other cryptocurrencies to generate DAI.


Learn More Here:

*Currenly the peg of Dai is 1USD, but this can change if the MakerDao community votes to change the peg.


jwrandolph
jwrandolph

I love writing and learning about crypto!


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