As an up-and-coming technology, cryptocurrencies still come with plenty of volatility as prices fluctuate along with demand and user adoption. This is why stablecoins were created to give users a more reliable way for transacting value exchanges through the blockchain.
Stablecoins are cryptocurrencies that are pegged to a real-world currency (often the US dollar) and different stablecoins have different ways of maintaining their value peg. Some of the more popular stablecoins, including USD Coin (USDC) and Tether (USDT), maintain their peg in a centralized manner by being backed by reserve assets kept in banks and financial institutions. But others like Dai (DAI), are known as ‘decentralized’ or ‘algorithmic’ stablecoins that maintain their price stability through more innovative and complex processes.
DAI was launched in 2017 by MakerDAO, a decentralized autonomous organization (DAO) with a goal to create a stablecoin which does not require an intermediary to be issued. As a DAO, it does not rely on traditional corporate leadership, but instead utilizes another cryptocurrency, MKR, to facilitate the governance of the Maker Protocol and execute the smart contracts that keep DAI running.
Being decentralized, DAI is marketed as “the world’s first unbiased currency” which any individual or business can freely utilize.
Stablecoins, such as DAI, play a huge role in the crypto ecosystem as it provides a “safer” alternative to more volatile cryptocurrencies. It provides users an easier way to buy and sell their preferred cryptocurrencies, as well as interact with different decentralized finance (DeFi) protocols.
How does DAI work?
DAI keeps its peg with the dollar through collateralized debt positions (CDPs), unlike other stablecoins like USDT or USDC that use currency reserves like cash, bonds, or short-term deposits to back the value of their stablecoins.
Simply put, CDPs are smart contracts that hold assets as collateral for anyone who wishes to generate DAI. These collaterals can be in the form of cryptocurrencies such as Ethereum (ETH) and other Ethereum-based assets. These CDPs are also “overcollateralized” which means that only a percentage of the value deposited is issued to the borrower in DAI. This is done as a safeguard to ensure that there are always enough assets to back the value of DAI even if the collateral fluctuates in value due to market movements. Afterwards, users are then able to use DAI across multiple DeFi protocols to earn yield. Borrowers typically try to find ways to generate more yield from interest that they have to pay on borrowed DAI. This gives borrowers a safety net since the value of DAI remains stable even if the dollar value of their deposits go down.
Once the amount of borrowed DAI has been returned to the protocol, the collateralized deposits can also be redeemed.
What can you do with DAI?
DAI can be used in various ways. Aside from being a medium of exchange for buying or selling cryptocurrencies, you can also deposit DAI and earn yield for it through different DeFi products, gaming apps and savings platforms.
As a stablecoin, some also use Dai as a ‘volatility hedge’ during times of market uncertainty since it is less prone to the price fluctuations than other crypto assets.
DAI’s relationship with MKR
It is important to remember that holders of MKR tokens determine changes to how DAI functions. Holders of MKR can vote on proposals regarding which cryptocurrencies can be used as collateral, or adjust their corresponding risk parameters.
But MKR also plays an emergency function as another layer of protection for holders of DAI. In the unlikely event of extreme market movements causing the overcollateralized assets to lose value, the Maker Protocol will automatically ‘recapitalize’ by minting new MKR tokens to sell and prevent insolvency.
DAI’s circulating supply is currently at 5.45 billion as of March 2023. DAI has no maximum supply as new tokens are issued to meet current market demand. As a stablecoin, its market capitalization will always be equivalent to its current supply as long as DAI maintains its one-dollar peg.
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