With the rapid advancement of cryptocurrencies, stablecoins seem to the feature of the cryptocurrency boom as they will soon replace the need of fiat currency in the crypto world. The problem of crypto-price volatility has seen institutional investors along cryptocurrency startups develop a deep interest in the development of stable with the aim of solving this problem. Stable coins are designed in such a way to ease market price volatility therefore useful in trading cryptocurrencies substantially. This means that instead of cryptocurrency traders holding on to the volatile nature of other non-stable cryptocurrencies such as Bitcoin and Ethereum, they can trade in stablecoins to avert enormously loses due to market price instability.
Notable examples of stablecoins include Tether (USDT), TrueUSD (TUSD), and Dai (DAI) among others.
DAI is a stablecoin created by MakerDAO (also the developer of MKR token) with an ambition of developing a decentralized stablecoin that will shift in accordance to market changes in so doing stabilizes its price against other cryptocurrencies. This guide will delve into Dai looking at its functionality, price stability mechanism and uses.
• Marker is a decentralized platform focusing on decentralized exchanges and has a two-token system: Makercoin (MKR) and Dai (DAI) both of which are ERC-20 tokens.
• Dai is a stablecoin pegged to the US Dollar at a 1:1 ratio. Dai’s market price is stabilized by the Maker platform which uses the MKR token, CDP smart contracts along with other price stabilization mechanism to achieve and maintain Dai price stability.
• MKR holders have voting rights and can choose when to create or destroy Dai stablecoin and therefore are incentivized to run the platform.
• A high level of transparency along with a more decentralized Marker platform gives Dai a competitive advantage over Tether in the stablecoins battle.
What is Dai (DAI)?
Dai is a stablecoin which is collateral-backed with a stable value relative to the US Dollar. Dai is based on the Maker smart contract platform which stabilizes the value of Dai to one U.S. dollar by employing several mechanisms such as external market mechanisms and economic incentives. The Maker platform eliminates the need of a third party and offers a stable coin system that is fully backed by the Ethereum platform.
What is Marker?
Marker is a smart contract platform developed on Ethereum and uses Dai coin to run its operation. The Marker platform consists of two coins: Makercoin (MKR) and Dai (DAI).
MKR is an ERC-20 token on the Marker Ethereum blockchain and cannot be mined like other cryptocurrencies. MKR is primarily employed to achieve Dai’s price stability to 1 US Dollar as it’s created or destroyed in response to DAI price fluctuations.
Unlike Dai which is a stablecoin, Makercoin’s price is volatile and is used primarily used to pay for transactions on the Marker system along with collateralizing the system.
Marker operates on the principle of margin trading. Marker backs and stabilizes the value of Dai via a dynamic system of Collateralized Debt Positions (CDPs), independent feedback mechanisms, and appropriately incentivized external factors. In essence, Marker is a utility token with its price increases with every usage of Dai
Maker offers a platform for cryptocurrency traders to leverage their Ethereum assets to generate Dai on the Maker platform. Once Dai has been generated, it can be used just like any other cryptocurrency. For instance, it can be exchanged with other coins, used as a means of payment for products and services, or stored in wallets as long-term savings. The ability to generate Dai on the Marker platform makes it a robust decentralized margin trading platform.
Additionally, Marker holders have the opportunity to choose the risk management and business logic of the Marker system.
Margin trading is a crucial element of the Marker platform, and it’s vital for stabilizing the Dai coin. Each Dai issued by the Marker platform contains a CDP-Secured Debt Position (Collateralized Debt Position), linked to the Ethereum smart contract. CDP provides higher security along with lower prices for the Dai stablecoin thereby minimizing its price volatility ensuring that it remains stable.
How is Dai Created?
Basically, Dai is a loan taken against Ethereum where Ethereum users use the MakerDAO dApp to request for Dai loans against their ETH holdings. The process of taking a loan begins with ETH integrating to the ERC20 token to form wrapped ETH (WETH). This “tokenizes” or makes ETH similar to the ERC20 token. Then, WETH joins a large pool of Ethereum that functions as collateral for all Dai created to form “pooled ETH” (PETH). Next, a Collateralized Debt Position (CDP) is created by locking up PETH in turn allowing users to withdraw Dai against PETH which now acts as their collateral.
The ratio of debt in the CPD increases as Dai is created until a certain limit where no more Dai can be withdrawn against the CDP. Once Dai has been created, it can be used just like any other ERC20 token.
How does Dai maintain its Price Stability?
As mentioned above, Dai has two main functions on the Marker platform:
• Used to calculate the collateral-to-debt ratio of a CDP
• Used to determine the value of collateral assets Dai holders receive in the case of a global settlement.
To achieve price stability, Dai employs some mechanisms as discussed below:
1. Target Price
Dai target price is pegged at a 1:1 ratio to the USD.
2. Target Rate Feedback Mechanism
The Target Rate Feedback Mechanism (TRFM) is usually employed in the occurrence of severe market instability to break the 1:1 ratio to the US Dollar while still maintaining the same denomination. In this mechanism, TRFM enables the Dai Stablecoin System to automatically adjust the Target Price to cause the prevailing market forces to maintain the stability of the Dai market price around the Target Price. The change of the Target Price concerning the prevailing market conditions is determined by the Target Rate. If the Target Rate is favorable, more Dai is held, and if it’s negative, more Dai is borrowed.
When the TRFM is not employed, the Target Rate remains fixed at 0%; therefore the Target Price does not change with time causing Dai’s value to mirror the Dollar’s value. But when the TRFM is engaged, both the Target Rate and the Target Price changes dynamically to balance the supply and demand of Dai by automatically adjusting user incentives for generating and holding Dai. TRTM minimizes Dai’s price volatility by lowering its price to the Target Price and providing real-time liquidity during demand shocks. TRFM causes the market price of Dai to remain below the Target Price, in turn, increasing the Target Rate causing the creation of Dai with CDPs to become more expensive. An increased Target Rate also pushes the demand of Dai to extremely high levels. Price stability is therefore achieved with the combination of reduced supply and an increased demand causing Dai’s market price to be pegged to the Target Price
3. Sensitivity Parameter
The Sensitivity Parameter is a parameter used to determine the size of Target Rate change in response to Dai target/market price deviation. Unlike the Target Price and Target Rate which are controlled by market dynamics, sensitivity parameter is determined by MKR voters who set its magnitude when TRFM is engaged. Sensitivity Parameter is used to engage or disengage the TRFM. When the Sensitivity Parameter and Target Rate are both zero, Dai’s market price is pegged to the prevailing Target Price.
4. Global Settlement
This is the final mechanism (last resort) that can be employed to achieve price stability. Global Settlement shuts down and unwinds the Maker platform while making sure that all users, both Dai holders, and CDP users, receive the net value of assets they are entitled to. This mechanism is only effected via voting of MKR voters and can only be engaged during serious emergencies such as long-term market irrationality, hacking or security breaches, system upgrades among other compromising situations.
How to Store Dai and Makercoin
Dai and Makercoin are both Ethereum Tokens observing the ERC-20 standard and therefore should be stored in an ERC-20 compliant wallet such as MyEtherWallet. They can also be stored in hardware wallets such as the Ledger Nano S and Trezor.
Dai and Tether Compared
Tether is yet another Stablecoin pegged to the U.S Dollar and shares some features with Dai. However, Tether’s controversy concerning lack of transparency in their dollar reserves has given Dai a competitive advantage in the cryptocurrency space. Recent internet findings have revealed that both Dai and Tether shared c-suite executives such as Chief Strategy Officer Phil Potter raising questions whether the two coins are related. Nevertheless, Marker seems to be transparent about the development of its blockchain project. For instance, unlike Tether Limited, Marker has a known physical location and responds to users concern via semi-weekly interactive session recordings posted on their MakerDAO Sound Cloud Page.
Additionally, Maker’s mechanism of achieving and maintaining Dai’s market price stability is unique and unquestionable. Dai is created using CDP smart contracts, in turn, collateralizing the assets. Unlike Tether which is backed by the fiat currency, Dai is backed by ETH with the CDPs functioning to ensure that there is always ETH assets available to cover the DAI supply. Additionally, in the event of total system crash or security breach, Maker has a well laid down procedure, i.e. Global Settlement that ensures MKR is liquated and users receive the value of assets they are entitled to. Marker is also partnering with other crypto startups such as OmiseGo, Digix, and Request Network to realize the growth of Dai to replace fiat currencies in the crypto world. Below are some fundamental similarities and differences between Dai and Ether.
• Price-Both mirrors the price of one U.S. Dollar.
• Mineability-Both coins cannot be mined
• Asset Type-Both are collateral-backed assets
• Collateral Asset-Tether is backed by fiat U.S. Dollars in receives while Dai is backed by overcollateralized Ethereum smart contracts.
• Blockchain-Tether employs Bitcoin blockchain via the Omni Layer protocol while Dai is based on the Ethereum blockchain.
• Price Stabilization-Tether’s price stabilization mechanism is entirely based on the ability of a user to exchange one Tether for one U.S dollar. On the other hand, Dai’s price stabilization mechanism employs external market forces such as collateralized debt positions( CDPs), external economic incentives and autonomous feedback mechanisms.
• Decentralization-When clearly analyzed, Tether appears more centralized as compared to Dai since Tether Limited exercises control over Tether as it can destroy or create it. On the other hand, Dai appears more decentralized as it can only be created and destroyed by an individual user.
What are some of the Uses of Dai Stablecoin?
Attributed to its stability, Dai has some importance to the cryptocurrency space. Below are some of its uses.
1. Financial Markets- Dai is used in financial markets to derive smart contracts and options which are of great importance to the financial sector. Additionally, Marker’s collateralized debt position provides permissionless decentralized trading leverage.
2. Cryptocurrency Gambling Markets-Volatile, unstable cryptocurrencies such as Bitcoin, cannot be used to place long-term bets as they not only expose the gambler to the bet’s risk but also the underlying asset price risk. The price stability of Dai will enable a gambler to isolate the bet’s risk from their underlying assets.
3. International Trade-Dai minimizes the effects of foreign exchange volatility in turn substantially lowering the cost of international transactions. Additionally, the use of Dai in foreign exchange eliminates intermediaries in international trade transactions.
4. Transparent Accounting Systems- Dai’s price stabilization mechanisms are highly transparent and verifiable. These mechanisms can be used employed by governments, organizations to increase transparency in turn significantly lowering corruption instances.
With raising transparency concerns of Tether, Dai seems to have a competitive advantage of providing a transparent viable stablecoin substitute. Dai as a stablecoin also offers additional functionality by providing a smooth interface which enables USD to be instantly moved in any amounts across borders without any transactions fees and third-party interference. The fact that Dai based on the Marker platform is fully decentralized and inspectable builds trust among cryptocurrency users and would soon replace fiat currencies in the crypto world as long as it maintains its USD peg.