Bitcoin was invented and developed with fulfilling the global needs of stable currencies. People need a tool to protect their money due to governments failing to maintain stable value in their currencies.
End users still feel unstable while holding cryptocurrencies because of high volatility. The stablecoin market emerged to fulfill the needs since 2018.
Stablecoin needs to have 3 characteristics:
- Decentralization,
- Capital Efficiency,
- Collateralization
Maker chooses 2 of 3 characteristics, Decentralization and Collateralization, to build “Dai” stablecoin.
PULSE data (defipulse.com) shows that up to now, the Maker has locked a total of $332.2 million USD, and the locked amount accounts for 55.86% of the entire DeFi ecosystem.
DAO’s full name is “Decentralized Autonomous Organization”. MakerDAO is a DAO project and one of the representatives of the DeFi project in blockchain industry.
We are not going to repeat the contents in the white paper (https://makerdao.com/en/whitepaper#overview-of-the-dai-stablecoin-system), because that would be a pretty much “copy and paste”. However, we only take a few bullet points out of the body of the paper.
Overview
- Endorsement by Smart Contract, CDP (Collateralized Debt Positions),
- Collateral assets (digital assets, Ether https://coinmarketcap.com/currencies/ethereum/) for availing a loan,
- An Ether CDP with a collateral-to-debt ratio of greater than 150%,
- The loan is issued in the form of “Dai” Stablecoin,
- “Dai” anchors the US Dollar, 1 Dai = 1 USD,
- Use the collateral and price feedback to stabilize the price of Dai at $1 USD,
- MKR holders acting ultimate debt-buying roles.,
- Global settlement is a “reset button” indirectly controlled by MKR token holders providing ultimate security.
Issuance mechanism
At present, only Ether (https://coinmarketcap.com/currencies/ethereum/) is supported. In the case of Ethereum, the issue is divided into three steps. Let’s supposed we are applying collateral-to-debt ratio as 200% hereinafter.
- Dai anchors the US Dollar, 1 Dai = 1 USD.
- Deposit $2 Dollars worth Ether on CDP with amount and type (ratio: 200%), so CDP is considered collateralized.
- Dai is generated from collateralized CDP.
- Deliver $1 Dai
Stability mechanism
The stability mechanism written in the white paper is pretty much built on top of a theoretical hypothesis, please see the following bullet points about that.
- Using overcollateralization to guarantee the value of Dai, each Dai has an Ether endorsement of $2 worth,
- Using the interest rate system to maintain Dai price stability,
- When the Dai is less than $1, the interest rate rises, the demand for collateral loan is restrained and decreased. The consequences lead to the supply of Dai is decreasing, and the value of Dai is increasing.
- When the Dai is higher than $1, interest rates fall. The demands of Dai issuance is increasing. It would lead to the value of Dai is decreasing.
- The MakerDAO has the authority to manage the Dai, and the holder of the MKR acts as the ultimate debt-buying roles to ensure the stability of the Dai;
- Global settlement is the last step which is pretty much like “reset” phase of the system. When Black Swan Events happen, the community can decide whether to make a global settlement.
Dai is issued based on cryptocurrencies collateral (Ether at the moment). The underlying of Dai is essentially built on the demand for collateral loan. If I’d like to spend 5 bulks on a bottle of beer, I could retrieve $5 Dai by making my $10 worth Ether as collateral assets on CDP. However, basically I could use other stablecoin to make payments such as GUSD, USDT, etc., from Maker’s end users’ points of view, they do not really care about you are a stable currency or not, they only care about collateral loan. It’s absolutely a collateral-loan driven product. Whether Dai is stable or not is pretty much irrelevant.
In short, the demand for loans determines the circulation of “Dai”.
The Ceiling of the Circulation
The valuation model that is often in the cryptocurrencies is the equation of MV = PQ. It came from traditional monetary theory, but use different explanation in the token world.
In the world of cryptocurrencies, simply think of PQ as the total market cap of the tokens. It does matter whether the circulation supply multiplied by current price is able to cover the market capitalization. Let’s assume that the market cap of Ether is 20 billions US Dollars, and collateral-to-debt ratio is 200%. Moreover, there is 50% Ethers are collateral assets on CDP, which is worth 10 billion Dollars. It will lead to generated 5 billion dollars worth “Dai”.
The USDT(https://coinmarketcap.com/currencies/tether/) is priced at USD 1:1. Easily and apparently, US Dollars could be collateralized at any time to retrieve USDT according to strong market demands at present. Theoretically and practically, USDT does not have a ceiling yet. Dai has an obvious ceilings and it is difficult to meet the requirements coming from a potential high-growth market.
Is “Dai” a kind of securities whose melt value is much greater than the legal value?
…. Will talk about it later…
…. To be continued…