The MakerDAO stablecoin, DAI, is pegged to the $1 US Dollar, not by holding US dollar reserves in a bank account equivalent to the amount of tokens in the system like the stablecoin Tether, but, rather, by holding in a smart contract collateralized assets, such as Ethereum, another cryptocurrency, and, in the future perhaps, tokenized real world assets. Holders can earn on the DAI they own. A decentralized and publicly controlled governance system manages the DAI interest rate –– that is, the cost of generating DAI––and the return on DAI.
“You can directly impact the supply and demand,” said Christensen. “For instance, if the price of DAI is below $1, then [we] need to contract the supply, we need to make DAI more scarce, and we need to make it more appealing for people to hold DAI. So, the governance process then comes to consensus around [making] it more appealing to hold DAI. That means the DAI savings rate needs to go up, and we need to make it less appealing to generate DAI, because we want to contract supply.”
In order to support the DAI price, the system also needs to increase its stability fee, which is the cost of borrowing DAI with collateral or generating DAI through the protocol. “This way it’s kind of a balancing act, where these rates keep changing as long as DAI is not trading close to $1 and then, as they change, they push it in the direction of $1.” This is how DAI has managed to stay stable and pegged to the US dollar for more than two years.
The science behind MakerDAO is based on basic microeconomics and applied in a novel way with blockchain.“What I found when I designed the MakerDAO protocol is that, on the one hand we need to draw on these basic concepts in microeconomics like supply and demand, and the fact that if you increase demand for a stablecoin, that should drive the price up. You want to increase demand for the stablecoin when the price is below $1. Similarly, if you decrease supply by making it more difficult to generate the coin or make it more expensive to borrow, that will push the price up. You can also do the opposite: if the price of the stablecoin is too high, you can actually decrease demand or you can increase supply.” Christensen argues there’s also some parallels with biochemistry.
“You can really compare it to homeostasis,” he says. “If the stablecoin deviates away from $1, there needs to be a response that then brings it back in line and then cuts off the response, so it goes back to $1 and then there’s no more change in the rates and the system.”
While many think the Maker protocol is complicated, and that there are many moving parts, Christensen argues it is an elegant mechanism that has been simplified as much as possible. “The basic mechanics of how it’s controlled and the incentives of the people running the governance, the MKR token holders, all comes together to create a system that is able to, on the one hand, be fully decentralized and fully transparent without a central authority having some sort of special access to the system, and, at the same time, provide the stability that people are used to from the regular banking system and the regular financial system.” MKR represents the utility token, governance token and recapitalization resource of the Maker system.
Heretofore, Maker users have conducted on the platform risky operations around leverage. “We’re now seeing this even greater group of people come into the system and start using the protocol, not for this very advanced use case of accessing leverage, but, rather, just as a stability hedge, if they think that their own currency has too much inflation or maybe because they [want] the low risk, but still decent yield, that the DAI savings rate and DeFi offers. This can be a very appealing financial product to have access to in addition to what they have access to locally.”
The Maker protocol is designed to ultimately be completely controlled by a decentralized governance process, by the MKR holders, and separate from the MakerDAO foundation and the original development team. “One of the things that’s really important is the decentralized governance of the protocol,” said Christensen. “That the community’s able to run it completely on its own, and that the community also has the ability to grow the system as they want to grow it.” That includes adding new stablecoins beyond the US Dollar.
“I would expect that the first one will be the euro,” said Christensen. Next comes other major world currencies, such as the Renminbi and other major Asian currencies. The goal in the long run is for every single currency to be in stablecoin format in the Maker protocol, and potentially assets beyond stablecoins, too, such as synthetic assets including stocks or commodities.
“We want to make all of these things available to everyone, instead of just [to the] very few people, relatively speaking, that today have access to the global financial system, while billions of others are left completely on the fringes,” he said.
In order to make DeFi available to everyone, Maker has long planned multi-collateral DAI, which Christensen calls the full realization of the Maker protocol. The company has been working on it for the past five years.
“Single collateral DAI [was] really more of an initial version that we decided to create so that we could start testing out what a decentralized stablecoin would look like in practice,” said Christensen. “And we could allow the ecosystem around the stablecoin to begin forming. But, now, with the launch of Multi-Collateral DAI, we actually have the full system live. That means we can start accessing the full range of features that decentralized finance makes possible. That includes [using] multiple collateral types.”
Multi-collateral DAI, according to Christensen, is Maker’s main feature, but he also points to other features as important, including the DAI savings rate. “This is the first time there is a low risk savings return available in crypto on a USD denominated stable coin,” he says. “And, in many ways, the DAI savings rate is actually what’s more exciting in the short run, because the multi-collateral feature, while it is the most important, will take a couple of months, and even years, to fully roll out and see its potential.”
The system has the capability to support any number of collateral types in the long run. “Today it actually only supports two collateral types, Ethereum and then the Ethereum-based token, called Basic Attention Token (BAT).” BAT was founded by Brandon Eich, the creator of JavaScript, a high-level programming language.
Once multi-collateral DAI becomes reality, and the community and ecosystem around the protocol has grown, Maker will be ready to take the next step. “What’s going to start happening is a lot more new assets are going to be onboarded and that will include all the different Ethereum-based tokens and cross-chain assets like Bitcoin,” said Christensen. “What’s most exciting is that it will also start to include Ethereum-based tokenized real world assets that will be brought onto the Ethereum blockchain, and then used as collateral in the Maker protocol.”
It will be possible to use things like gold and real estate, as well, says Christensen. “Tokenized gold in, let’s say, a vault in Singapore, for instance, or real estate in America, where the deed is tokenized, and that token is then used as collateral, in order to get a low rate loan from a decentralized protocol, or even do things like trade finance. Small businesses [can access] the blockchain, in order to get a direct line of credit that’s based on their invoices, which are then tokenized.”
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