Salomon Kisters
Aug 15, 2022
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Cryptocurrencies have evolved over the years from being the simple digital currency used for exchanging goods and services to specialized mediums of exchange. Developers and organizations that issue cryptocurrency are constantly finding more ways to implement blockchains to bring new tech products to the market.
Stablecoins are a recent form of cryptocurrencies that have been coined (pun intended) to fulfill the role of a value exchange token. As the term suggests, their purpose is to remain at a stable value with a fiat currency while facilitating the exchange of other cryptocurrencies. Many stablecoins are pegged to a currency like USD, usually in a 1:1 ratio. An example is the DAI coin, which we are covering in this article.
Stablecoins effectively function as a digital version of fiat currency and allow users to hold digital assets with a stable value while trading other cryptocurrencies such as BTC and ETH in their wallets. Due to the volatile nature of cryptocurrencies, trading can be risky, and crypto holdings can lose value overnight on a bad market run.
Stablecoins provide a reliable way to exchange liquidity without needing to use physical funds locked in conventional bank accounts. Think of them as crypto coins that work like real money (USD, for example). Our explanation is a simple one, as a lot is going on behind the scenes to keep stablecoins live up to their name.
Table of Contents
What is DAI?
DAI is an algorithmic stablecoin operated by MakerDAO. MakerDAO is a decentralized autonomous organization (DAO), a company that works like a blockchain-based financial institution but is operated as a computer program governed by the holders of the token currency native to the blockchain. The computer program that runs the DAO contains all the rules for its smart contracts.
For DAI’s parent DAO, the native cryptocurrency is MKR. This cryptocurrency is crucial in maintaining DAI’s stability, as we’ll explain later.
The DAI cryptocurrency was launched on December 18, 2017, on the Ethereum blockchain to maintain its closeness to USD. DAI is named after a Chinese letter, which the MakerDAO founder Rune Christensen translated as “to lend or provide capital for a loan.”
DAI’s maker protocol is written in Solidity, a commonly used developer language for Ethereum-based programs. Through this protocol, DAI uses a system of smart contracts to maintain its parity with the USD.
As the cryptocurrency is operated by a DAO, there is no need for an intermediary to exchange DAI coins, and it operates over a transparent, seamless, and permissionless blockchain network. You can view the network stats on daistats.com.
How Does the DAI Coin Work?
At its core, DAI is an ERC-20 token that can be bought through centralized and decentralized crypto exchanges. DAI is basically a collateralized loan against cryptocurrency assets in MakerDAO’s Oasis financial lending app.
It’s important to mention that the DAI-USD peg is soft, meaning the value fluctuates to an extent, but the DAI value remains close to the USD market value. The DAO uses algorithms in the DAI blockchain that are designed to automatically adjust the value of the assets to keep the 1:1 peg with USD. This is done by:
- Controlling the supply of DAI coins in the market,
- Controlling the interest rate in the DAO smart contracts
- The adjustment of assets used as collateral for generating DAI
There are several mechanisms through which the DAO can control these parameters. Here are some of the main ones discussed next.
Vault and Keeper Accounts
Users can open a maker vault account on this app and generate DAI coins against Ether (ETH) or other cryptocurrencies as collateral. These DAI coins function as debt positioning option contracts and are returned after a set period.
The value of ETH used will always exceed the value of DAI issued to you (also called overcollaterization). If the value of your ETH deposit falls below the value of DAI issued, your ETH deposit will be liquidated. Maker vault accounts are liquidated with a ratio of 1.5 collateral for 1 DAI.
To ensure that undercollateralized accounts have enough cryptocurrency funds to receive liquidation, the maker offers keeper accounts. Keepers are special user accounts that stake their cryptocurrency holdings to provide liquidity to pay off the collateral of vault accounts that lose their value over time. Therefore, keeper accounts maintain a steady supply of DAI in circulation to match the USD value.
If a user who has borrowed DAI against collateral repays it along with any accrued interest, then the DAI coins are destroyed, and the collateral deposit in the account is available for withdrawal.
DAI Savings Rate
Users who hold DAI can lend it to other users and earn interest by depositing it into DSR smart contracts, which is dependent on the DAI savings rate (an effective interest rate).
If demand for DAI is high, the DAI savings rate can be increased to incentivize DSR contract users to hold their DAI deposits. A decrease in DAI supply can result in lowering the DAI saving rate.
Stability Fee
A stability fee is another way to control the price of DAI. It is charged when generating DAI coins. A lower stability fee can incentivize maker account holders to create more DAI and increase its supply, and vice versa.
MKR Token Holders
Members who have a stake in MakerDAO own MKR tokens. MKR token holders can leverage their tokens to govern the DAI blockchain. They can use MKR to make policy interventions that help to stabilize the value of DAI. For example, MKR holders can vote on policies such as:
- Changing the value of the DAI savings rate
- Addition of new cryptocurrencies for collateral
- Adjustment of existing collateral percentages
- Approval of new members joining the organization
MKR holders are also required to add collateral to the DAI blockchain. Additionally, the auction of excess DAI from the supply can result in the destruction of MKR tokens. This incentivizes MakerDAO stakeholders to govern the organization’s policies properly and ensures that the value of DAI remains as stable as possible.
Advantages of DAI
Stability
Users in countries that need to keep USD holdings but have no way to keep safe USD deposits can use DAI to store USD equivalent currency. Residents of countries with unstable currencies benefit greatly from DAI holdings.
Security
DAI also offers the advantage of using secure cryptocurrency wallets for deposits, ensuring that the funds are safe from theft. However, we advise you to take the necessary precautions to keep your crypto wallet and associated accounts secure from unauthorized access.
Low Barriers to Entry
DAI is available in many countries and crypto exchanges. It does not require a minimum account balance. For this reason, DAI is an attractive option for anyone with a low amount of funds or users who want to start with small cryptocurrency investments.
Bypassing Withdrawal Limits
Many governments in low-income countries have imposed daily withdrawal limits on funds in conventional bank accounts. Citizens in these countries can only withdraw a limited amount of currency. Through DAI, users can withdraw additional funds over these limits.
Passive Income
DAI holdings can earn account holders some extra funds through interest payments. This is set by the annual savings rate and is a bonus for anyone having extra funds to invest in maker accounts.
Reliable Operations
Wire transfers and bank clearing processes can take a long time for some banks. DAIs blockchain technology is always available online through a decentralized network of servers. It also has fast payment processing times. As a result, customers can receive instant payments at any time.
Expanding Ecosystem
DAI is expanding its use cases by partnering with many app developers and service providers. DAI owners can gain access to new regional markets and technical services for personal or business purposes. You can learn more about DAI apps here.
What Makes DAI Special?
While there are many stablecoins in the market, some with exceptional backing, there are three things that make DAI special.
Decentralized Governance
Unlike other stablecoins, which are usually backed by a reserve of fiat currency managed by an investment company, DAI is operated by a DAO. It is, therefore, independent of central government or private intermediaries. We can say that its governance is democratic, with many independent stakeholders working to keep it stable.
Diversified Collateral
Most stablecoins are backed by fiat currency. DAI, on the other hand, is backed by multiple cryptocurrency holdings (ETH, BAT, WBTC, for example) based on the assets of MKR stakeholders. This minimizes the risk for token holders, while also improves the stability of DAI.
Interest Earnings
DAI holders can earn on their cryptocurrency through smart contracts. This is a good incentive for users who buy DAI and MakerDAO backers. Both types of users have a means of generating passive income from their DAI holdings, with the original backers acting as guarantors for the lending contracts.
Finale: A Stablecoin for Everyone
DAI was originally created with the vision of a stable cryptocurrency that could be used interchangeably with USD, by anyone, anywhere, and anytime. From what we have seen, DAI may have already achieved this goal.
We hope this guide gives you a good idea about the DAI coin. If you want to know how you can use DAI for your business, visit OriginStamp.com for a free consultation on productive blockchain-integrated solutions.
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Please note that the Content may have been generated with the Help of AI. The editorial content of OriginStamp AG does not constitute a recommendation for investment or purchase advice. In principle, an investment can also lead to a total loss. Therefore, please seek advice before making an investment decision.
