maker_dao_spotlight
CEX.IO Spotlight: MakerDAO
Feb 14, 2022

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Key information (February 15, 2022)

  • Circulating Supply — 977,647 MKR
  • Max Supply — 1,005,577 MKR
  • Sector — Lending
  • Token Type — ERC-20
  • Token Usage — Governance & Source for Recapitalization
  • Consensus Algorithm — proof of stake 
  • Genesis Block Date — November 25, 2017
  • All-time high — $6,247.16
  • ATH Date — May 4, 2021

 

What is MakerDAO?

MakerDAO is a decentralized organization built on the Ethereum blockchain. Its main aim is to facilitate lending and borrowing of cryptocurrencies without the need for any central authority. 

Generally, it’s a two-token smart contract system that manages borrowing and lending as well as governance.

The first token is Dai, a crypto collateral backed stablecoin that is soft-pegged to the U.S. dollar and offers stability to the network. The Maker protocol offers token holders the ability to collateralize ethereum (ETH) and other Ethereum based tokens in return for Dai token loans. These loans are also repaid in Dai tokens and managed through a collateralized debt position (CDPs). 

The other token is the MKR which is used as a governance token by granting its holders voting rights. This is where the Decentralized autonomous organization (DAO) part of the name comes from. DAO means that the protocol is governed by rules written in the Maker protocol. MKR token holders are the decision-makers of the Maker protocol. They are supported by the entire MakerDAO community and various external parties. 

The MakerDAO community ascribe to the belief that a decentralized stablecoin is required for businesses to realize the full advantages of a digital currency. The Maker protocol is a key player in the Decentralized finance (DeFi) sector — a term used to refer to financial tools and services that do not rely on any central authority to coordinate.

 

A brief history of the MakerDAO network

The MakerDAO project was started in 2015 by a Danish developer and current CEO, Rune Christiansen, who built the Maker protocol under the banner Maker Foundation. The Foundation’s key role was to direct the development and manage the project’s efforts.

Initially, Christiansen announced his original concept of Dai tokens on a Reddit post stating, “introducing eDollar, the ultimate stablecoin built on Ethereum.” Later in August 2015, the project achieved a milestone with the launch of its Maker token (MKR). MKR established the basis of governance on the protocol, and a DAO was coming into shape.

On December 10, 2017, the first formal whitepaper was released, and the MakerDAO community introduced the idea of Multi-collateral Dai (MCD). Later, on December 19, 2017, the first version of the Maker was launched based on the single-collateral stablecoin SAI, as the first iteration.

Less than a year later, in September 2018, the first MKR vote was held on the governance portal, ushering an era of increasingly active Maker governance in the network.

On February 11, 2019, the platform reported that Dai tokens in circulation reached 76 million, a 20% monthly growth. Later that year, Christiansen announced the launch date of MCD, and on November 6, 2019, the Debt ceiling of Sai tokens was increased to 120 million Sai tokens. In the same month, MCD was launched, and Dai tokens would now be generated (minted) from various crypto assets approved by the Maker governance.

One month later, the total number of multi-collateral Dai tokens surpassed single-collateral Dai tokens (Dai) as users swapped Dai tokens for upgraded Dai tokens. With a sign of complete decentralization, the Maker foundation began transferring control to the community on December 31, 2019.

In February 2020, a new whitepaper was published, and in March of the same year, the transfer of control to the community was finalized. On April 27, 2020, a new board of directors was formed, including external legal teams and fintech experts. Later that year, in September, the debt ceiling of Dai tokens was increased to 1 billion, and Dai tokens could now be generated from various crypto assets approved by Maker Governance.

 

Business use cases of the Maker protocol

By harnessing the power of blockchain, the Maker protocol has unlocked a versatile digital currency through its decentralized Dai stablecoin. Unlike traditional fiat currencies, Dai token is borderless and unbiased. As of this writing, over 9 billion Dai tokens have been minted and being used in many ways. 

Primarily DAI tokens are used for:

  1. As a hedge of inflation of local markets, since it’s pegged to the dollar, Dai token helps users maintain the dollar value of their money.
  2. As a decentralized finance (DeFi) system that provides financial services and tools that are only available to traditional intermediaries. Users and organizations can borrow, lend coins or even earn interest on the Dai tokens they lock in smart contracts.
  3. Organizations also use Dai to stay stable during times of high volatility in the cryptocurrency market.
  4. As a stable medium of exchange, Dai is also used for debt repayment, cross-border payments, and payments of goods and services. For instance, UNICEF accepts Dai donations from all over the globe.
  5. Last but not least, Dai can be traded against other cryptocurrencies.

 

An overview of the Maker protocol and its features

 

maker_ecosystem

Source: MakerDao docs

Before we dive deeper into Maker’s architecture, two terms are often used interchangeably but in the real sense have different meanings. Understanding them will give you a clearer insight into how the Maker protocol works.

The Maker protocol is the smart contract or decentralized application (dapps) running on the Ethereum blockchain. It facilitates lending and borrowing on Maker. 

The MakerDAO refers to the community governing the Maker protocol, the MKR token, and core units. Simply, it’s like the social layer of the Maker system.

With that in mind, let’s proceed and look at the features of the Maker protocol.

 

The Dai stablecoin

 

maker_transactions

Difference between how traditional fiat loans are issued and how Dai token loans are issued

 

The Dai stablecoin is a decentralized, unbiased, crypto-backed crypto that is pegged to the U.S.. dollar. This means that each Dai token has roughly the same value as one dollar. 

Since the cryptocurrency market is highly volatile, MakerDAO uses Dai to facilitate lending and borrowing. Moreover, since Dai is stable, it determines lending rates and payable amounts.

If a user wants to borrow Dai, they will first have to deposit ethereum tokens based assets approved by the MakerDAO into a Maker vault smart contract. The smart contract locks the crypto deposit and creates a collateralized debt position (CDP). The CDP ensures that any loan against your locked crypto tokens is always over collateralized. In most cases, this is often a 150% collateralized ratio. 

So if you deposited $1,000 in ether at a collateralization rate of 150%, the maximum you would receive is $400 worth of Dai tokens. 

Unlike many cryptocurrencies, the Dai token has a few properties that make it quite similar to money:

  • It’s a store of value
  • It’s a medium of exchange
  • It’s a suitable unit of account
  • And a standard of deferred payment, meaning it can be used to track debt.

 

Maker vaults and collateral assets

All accepted crypto-assets can be collateralized to generate Dai tokens in the Maker protocol through the market vault smart contracts. These smart contracts is deployed on multiple platforms such as the Oasis Borrow, Bitcointrade, Coinbase, Swissborg, and Buenbit, to mention a few. Here users can create vaults and generate (mint) Dai tokens.

Generating Dai tokens creates an obligation that you will have to repay the Dai tokens and any stability fees that accrue before withdrawing your capital locked in the vault. 

Vaults are inherently non-custodial, meaning that users have total control of their coins. 

Interacting with a Maker vault

  1. Create and collateralize a vault by depositing and locking ethereum via one of the platforms mentioned above.
  2. Generate Dai tokens from your collateralized vault and transfer them to your preferred digital wallet
  3. Spend your Dai tokens or save them on the Maker protocol to earn interest.
  4. To retrieve a portion or all the collateral, pay down the debt and the stability fees. It is crucial to note that the stability fees accrue over time and can only be paid in Dai. 
  5. With the Dai returned and the stability fee paid, you can now withdraw all or some of your collateral back to their wallet.

Financial perspective

Maintaining the stability of Dai stablecoin is the main goal of the Maker protocol. This is accomplished through:

Dai price stability mechanism

1 Dai = 1 USD, approximately. 

But how is this 1:1 ratio maintained?

Well, this boils down to the Daily Savings Rate (DSR). The DSR is a variable accrual rate earned by locking in your Dai tokens in a DSR smart contract. Its main purpose is to allow the Maker governance to influence the price of the Dai token by altering the demand and supply ratio of Dai tokens through a monetary policy.

When Dai token price dips below the peg price, the system makes it more attractive for users to close their CDPs at lower rates by repaying their debt. This reduces the supply of Dai tokens as the Dai tokens are burned creating an upward pressure that pushes the Dai token prices up.

If the prices go above the peg price, the system lowers the DSR, making it less attractive to buy Dai tokens and more attractive to open CDPs. As a result, the total supply of Dai tokens generated increases pushing the Dai token price lower.

 

Overcollateralization, collateralized debt position and daily savings rate

Cryptocurrencies are very volatile, and your investment today might be worth less than 50% tomorrow. Cryptos like BTC and ETH often see dips of up to 50% during bear markets, while others like Dogecoin experienced dips of over 80%. In such cases, the principal might end up being less than what was borrowed. This can be extremely challenging and risky to crypto lenders. Unlike gold and fiat currencies, most cryptocurrencies are not a good measure of debt repayment. 

As we mentioned above, to open a CDP position, your debt has to be collateralized at a rate not less than 150%. The basic idea behind this is that when borrowers want to mint Dai stablecoins, they have to provide more collateral than the amount they will take out as Dai token debt. This way, even if the market dips, the position will still be covered.

It is important to note that if the collateral falls below 150%, users incur a hefty penalty fee. Most users often top up their collateral overtime to stay safe to prevent this. 

If the collateral rate falls below 150%, the Maker protocol will start to subsequently sell off some of the collateral using an internal market-based auction mechanism known as Collateral Auction. The Dai tokens received from the auction are used to cover out the outstanding debt to maintain a 150% collateralization rate.

 

dai_stablecoin

From Fast&Clean

The MKR Token

Besides being a governance token, MKR is also a recapitalization source. If the system debt exceeds the surplus, the MKR token supply might be increased through a Debt Auction system to buy back more of the collateral and recapitalize the system. This inclines MKR holders to responsibly govern the system and prevent such a situation as it might lead to MKR token dilution. 

Security of the Maker protocol

The Maker protocol deploys an Emergency Shutdown mechanism used as a last resort to protect the protocol from emergencies such as malicious governance actions, hacking, security breaches, or long-term market irrationality. 

When a breach is detected, MKR voters instantly trigger an Emergency shutdown by depositing MKR into the Emergency Shutdown module (ESM). This prevents any delays in the shutdown process and it’s initiated immediately. 

There are three phases of the Shutdown:

  1. The Maker protocol shuts down to prevent further vault creation or manipulation of existing vaults, and freezes price feeds. The frozen feeds ensure that users can withdraw the net value of their collateral — that which does not back any debt. 
  2. Next, a post Emergency auction process that is slightly longer than normal auctions is initiated. This guarantees there are no outstanding actions at the end of the auctioning process.
  3. Lastly, Dai token holders claim their remaining collateral by repaying their debt at a fixed rate corresponding to the calculated value of their assets based on the Dai target price. 

Maker’s governance framework

In the Maker protocol, all decisions and upgrades are managed by the community of MKR tokens holders. They take on the responsibility of governing the platform to ensure it operates effectively and continues to thrive. Each MKR token gives its owner one vote per proposal. 

MKR holders can vote to do any the following:

  • Adding new cryptocurrencies as collateral
  • An adjustment to the operation model
  • Modify the Dai Savings Rate
  • Choose an Emergency oracle
  • Trigger Emergency Shutdown
  • Upgrade the system
  • Stability fees  

The system is designed to reward prudent management. If MKR holders make good decisions and the system performs well, stability fees paid by users will accumulate a surplus. If that surplus goes above a certain threshold, the excess Dai is auctioned in return for MKR, which is then burned or permanently removed from circulation. These auctions incentivize token holders as they may benefit from a decrease in MKR supply and increased MKR prices.

The Maker protocol also includes some key external actors that help maintain operations

Keepers – these are market participants that help the Dai token maintain its target price by providing liquidity when needed. They participate in Debt Auctions, Collateral Auctions, and when Maker Vaults are being liquidated.

Price oracles – provide real-time information about the market price of the collateral assets in Maker vaults to know when to trigger liquidations

Emergency oracles – are selected by MKR holders, and they act as a last line of defense on the governance mechanism or security. They are able to freeze oracles and vaults to prevent further attacks.

DAO Teams consist of experts contracted through the Maker governance to provide certain services to the network. 

MakerDAO’s Dai and MKR Tokens

The Maker protocol is a two token system — Dai token and the MKR token.

At the moment, the Dai token has three main uses on the MakerDAO network

Stability token – Dai tokens seek to maintain price stability against a specific peg.

Lending and borrowing – debts are issued and repaid using Dai tokens.

Paying stability fees – staked collateral always incurs a fee that depends on the period and the collateral rate percentage. Any incurred fees are paid using Dai tokens.

As a vehicle for saving – Maker protocol allows users to earn interest from locking up their Dai tokens in the DSR smart contract.

The MKR token, on the other hand, has two main use cases:

Governance token – MKR tokens give holders voting rights on various decisions and upgrades on the network.

As a recapitalization source – MKR tokes are also used to recapitalize the network when the Maker protocol runs at a deficit.

 

maker_infographic

Token distribution

The MakerDao network launched with 1,000,000 MKR tokens. About 40% of the total MKR tokens were first distributed as salaries for founding team members and to early token buyers from the community. These tokens were distributed through three private sales that raised $12 million, $15 million, and $27.5 million, respectively. Later 5%-10% MKR was sold for ETH to fund development. Over the years, the Maker Foundation has been releasing small portions to the community.

Currently, the development team holds 9% of the total supply of MKR tokens, while the MakerDAO community owns 91%.

 

Token Circulation

MakerDAO has a maximum supply of 9,158,755,112 Dai tokens and 1,005,577 MKR tokens. All the Dai tokens have been minted and are currently in circulation. However, this number is always changing slightly depending on the Dai price to USD price ratio.

On the other hand, 977,647 MKR tokens have been minted so far. 901,310 MKR tokens are in circulation, while the MakerDAO team currently owns 93,556 tokens. 

 

Issues and challenges on the MakerDAO network

The Maker protocol is the leading project in the DeFi space with over $15 billion locked. However, unlike most stablecoin, which are backed by the U.S. dollar, the Dai stablecoin is backed by crypto assets. This presents a significant challenge during a time of high liquidity. In the case that a drop in a crypto collateral price outpaces the Maker’s automated auctions, some of the Dai debt might be left un-collateralized, bringing significant stress to the system. So, while decentralized finance might be the way to go, some features and parameters still need to be addressed before cryptocurrencies can be used to fully back CDPs on MakerDAO.

 

Find out more about the Maker Protocol

On CEX.IO, you can find multiple options to earn with MKR. You can buy, hold and trade MKR tokens without a lock period, so you can withdraw or add more funds at your own pace. You can also trade your cryptocurrency with DAI.