I want to start off by defining a stablecoin. I don't want to bore you with the Wikipedia definition so a stablecoin is a cryptocurrency that has low volatility by being backed up with fiat currencies, different assets like gold, silver, etc.
Our subject for today is DAI, a USD-pegged stablecoin through the use of its proprietary CDPs ( Collateralized Debt Positions). A CDP enables the creation of DAI stablecoins against the collateral (currrently ETH) that you lock up in the CDP until you pay back the DAI generated.
In simpler words the process goes like this:
- User deposits the collateral in a smart contract
- User receives a portion of the collateral in form of DAI
- When the users wants to recover his/her collateral he needs to return the DAI and pay a stability fee (currently at 16.50%/year)
- DAI is destroyed(burnt) by the smart contracts and returns the collateral to the user
USD Pegging Maintenance
The DAI remains pegged to the US Dollar because of the way it is backed by collateral. This is an economics law, it works like this: if the DAI price raises above $1 the users are incentivised to generate more DAI(undersupply). Inversely the CDPs owners will profit and repay their "loans" at a discounted rate when DAI price dips below $1.
Furthermore this is where arbitrage traders come in and profit directly from the market price of DAI. They know that the ecosystem behind DAI will keep the value around $1 so every time the price fluctuates
I like to make charts on pretty much everything I catch so here you go, technical analysis on a stablecoin. As you can see the DAI price fluctuates quite often, but not more than 2-5%. Of course there are exceptions like in October 2018 where the price was almost 10% above the $1 peg. As an arbitrage trader you have a few opportunities each month to increase your USD value.
In conclusion DAI is a great choice to get out of the crypto markets in times of uncertainity or liquidity demand while preserving your precious cryptocurrencies!
For more information about the underlying mechanisms of DAI and MakerDAO check out the following article by https://www.publish0x.com/dai-fans/everything-you-need-to-know-about-makerdao-and-dai-xxwwjp