What is DAI: understanding Maker's crypto-backed stablecoin

Launched by a Decentralized Autonomous Organization (DAO) named MakerDAO in November 2019, Dai (DAI) is a crypto-collateralized stablecoin that's soft-pegged to the US Dollar at a 1:1 ratio. DAI is issued through an Ethereum-based decentralized application (DApp) named the Maker Protocol.

Every unit of DAI is modeled on Ethereum’s popular ERC-20 token standard, which is widely used for the generation of fungible tokens. Since DAI aims to consistently maintain its USD peg, it remains protected from the crypto market’s volatility. Unlike its competitors such as USDC and USDT, which are fairly centralized stablecoins, DAI claims to be fully decentralized in nature, backed only by crypto collateral.

DAI aims to be a better, smarter currency that can be used by anyone, anywhere, anytime, without any discrimination. In fact, the makers of DAI claim it’s the world's first truly decentralized, stable, and unbiased currency. That many businesses and individuals actively use it to tap into digital money’s benefits is a testimony to that claim.

DAI is quite unique and stands out in the stablecoin market because its issuance and governance are entirely managed by MakerDAO, through the latter’s native governance token Maker (MKR). Maker Foundation, which MakerDAO launched in 2018, created the Maker Protocol, and actively supports MakerDAO in governing the DAI stablecoin. Both entities work together to manage the financial risks associated with DAI and make sure it remains an efficient, transparent, and stable crypto asset. DAI has witnessed significant growth since its launch, emerging as the third-largest stablecoin by market cap as of late 2023.

What is DAI?

As the world’s first unbiased, stable, and decentralized currency, DAI is a stablecoin that claims to offer financial freedom with zero volatility. Governed entirely by a community of MKR token holders, DAI has a constantly growing ecosystem with over 400 DApps and services. As the third-largest stablecoin in the world by market cap, DAI is widely accepted within the Ethereum ecosystem. It offers crypto natives an alternative to fiat-backed stablecoins like USDT and USDC.

How DAI works

The workings of DAI are closely related to how the MakerDAO and Maker Protocol system works. DAI is governed by MKR token holders, in a democratic and decentralized environment, through MakerDAO governance proposals. New DAI coins are minted through Maker Protocol DApp by depositing BTC or Ethereum-based assets as collateral. The deposited assets are stored in Ethereum-based smart contracts known as Maker Vaults, managed by the Maker Protocol.

It's important to note that the minimum collateralization ratio varies based on the deposited crypto asset. For instance, it's 165% for Chainlink (LINK), but only 101% for Gemini USD (GUSD). While this serves as the primary means of organically acquiring DAI stablecoins, a large majority of people simply buy DAI off the market from crypto exchanges like OKX, or receive them in the form of payment from other DAI holders.

The issuance of DAI through Maker Protocol works almost like a loan. Whenever a borrower repays their loan with DAI and claims back their crypto assets, the concerned DAI coins are burnt and removed from circulation. Only a small percentage of tokens, collected as interest payments, find their way back into the circulating supply.

As DAI coins are generated using the ERC-20 token format on the Ethereum blockchain, they inherit all of the latter’s security features.

Liquidations

Liquidation is a process that's triggered automatically whenever a Maker Vault’s collateralization ratio falls below the minimum threshold level, or in other words, when the Vault becomes undercollateralized. When this happens, the debt is repaid through a collateral auction. The DAI tokens received from the auction are used to cover the vault’s outstanding obligations, including the stability fee and liquidation penalty. Any leftover collateral is returned back to the Vault, and can be freely withdrawn by the concerned user or borrower.

If the collateral auction fails to raise enough DAI to cover the Vault’s outstanding obligations, the deficit becomes the Maker Protocol debt, which is repaid with the DAI available in the ‘Maker Buffer’. If there’s not enough DAI in the Maker Buffer too, the protocol triggers a Debt Auction where MakerDAO’s MKR tokens are minted and sold for DAI, to cover this debt.

Source: itovault.com

To explain this with an example, let’s assume the current minimum collateralization ratio for ETH Vault is 150%. A user deposits $1,500 worth of ETH as collateral into the vault, followed by generating 750 DAI. As a result, their initial collateralization ratio becomes 200%. Now, if the ETH price drops and the collateralization ratio falls below 150% as a result, the Vault will be automatically liquidated to avoid any loss to the Maker Protocol system.

Where's DAI used?

DAI functions just like the digital version of the US dollar and has multiple use cases, as explained below.

As a store of value

One of the most important facts about DAI is that since it’s a USD-pegged stablecoin, backed by crypto collateral, it doesn’t depreciate much and maintains its $1 value most of the time. That's why many people employ it as a safe store of value during volatile market conditions.

As a medium of exchange

Any asset that represents a standard of value and is commonly used for the sale, purchase, or trading of goods and services can be classified as a medium of exchange. In this context, DAI being a digital representation of USD is regularly used for various online and offline transactions worldwide. According to MakerDAO’s official website, over 400 apps and services, including games, decentralized finance (DeFi) portals, crypto wallets, merchant solutions, and more, have already integrated DAI into their offerings.

As a standard of deferred payments

DAI is actively used for settling debts while using the Maker Protocol, for example, when users pay stability fees with DAI, before closing their Vaults. This feature is another example of how DAI is different from other stablecoins.

As a yield-generating medium

There are various third-party DeFi applications in the market, including on the OKX platform, that let you earn attractive yields through your DAI holdings. You can locate them on OKX in the ‘Earn’ section accessible through the ‘Grow’ header menu option at the top. Meanwhile, you can even lock your DAI into a Dai Savings Rate (DSR) contract through the Oasis portal or various Maker Protocol gateways, to earn regular rewards.

As a means for making in-game purchases

Since DAI is an ERC-20 based stablecoin, it has widespread application within the Ethereum ecosystem. There are many popular games on Ethereum that allow in-game asset purchases with DAI.

As a unit of account

Any asset that's used as a standardized measurement of value for determining the prices of goods and services can be considered a unit of account. Although DAI isn’t often used as a valuation means in the off-chain world, it serves that function within the Maker Protocol and in certain DApps. Here, the services provided are priced in DAI rather than in USD or another fiat currency.

DAI founders and history

DAI is managed and issued collectively by MakerDAO and Maker Protocol, both founded by Rune Christensen, a Danish entrepreneur. Christensen is a widely recognized personality in the crypto and blockchain world. He graduated with a Biochemistry degree from Copenhagen University in Denmark and studied International Business at the Copenhagen Business School. Before he created MakerDAO and laid the groundwork for DAI stablecoin, Christensen co-founded and managed a recruitment company named Try China International.

Much of DAI's history can be traced back to the introduction of MakerDAO’s first formal white paper in December 2017. It introduced the world to SAI, the Single Collateral Dai stablecoin which used only Ether (ETH) as collateral for its issuance. The white paper also detailed how MakerDAO’s stablecoin generation system would evolve to make room for multiple crypto collateral. This was accomplished with the launch of Multi Collateral Dai (DAI) in November 2019, and was accompanied by a new white paper for the project.

DAI tokenomics

Since DAI is generated and issued to users on demand, there’s no cap on its maximum supply. The number of circulating DAI keeps changing depending on how many new tokens are minted and burnt by the Maker Protocol.

Source: coingecko.com

As the chart above shows, the total DAI outstanding in the market has varied over the years. It remained well under 200 million tokens from the time of Dai’s launch in 2019 untill around mid-2020. The stablecoin then picked up good momentum with increased market adoption. The total number of DAI issued crossed the 10-billion mark in February, 2022. As of December 2023, DAI’s total circulating supply stood at 5.3 billion tokens.

How is DAI created?

New DAI tokens are minted and issued by the Maker Protocol whenever users deposit crypto collateral in the Maker Vaults. The Maker Protocol can be accessed through multiple user interfaces, including the Oasis Borrow site or those created by the community. These interfaces include MyEtherWallet, Zerion, Instadapp, and others. It's possible to use a wide range of Ethereum-based assets like ETH, MANA, GUSD, LINK, MATIC, and BTC for generating DAI.

Although creating a Vault isn’t complicated, users must repay DAI along with a stability fee to free up collateral from the Vault later. However, Vaults are non-custodial in nature, with users having complete control over their deposited assets as long as the Vault doesn’t become under-collateralized.

Below is a simple breakdown of the process for creating DAI:

Source: messari.io

• Step 1: Creating and collateralizing the Vault

• Step 2: Generating DAI from the collateralized Vault

• Step 3: Repaying the debt along with the Stability Fee

• Step 4: Withdrawing your collateral

Keep in mind that each deposited collateral asset will have its own Vault. As a result, it’s not uncommon for users to have multiple Vaults in the system, each with a specific crypto collateral and its own level of collateralization.

DAI vs other stablecoins: how it fares against the competiton

Almost every stablecoin pegged to the US dollar is DAI’s competition. It's the third-largest stablecoin in the industry by market cap as of December 2023, with only Tether (USDT) and USDC ahead of it. The asset also faces strong competition from the likes of True USD (TUSD), Frax (FRAX), and Pax Dollar (USDP). To put DAI’s market cap in perspective, while it currently stands at $5.3 billion, USDT and USDC are more popular options and have market caps of $89 billion and $24.4 billion respectively.

Source: coingecko.com

The biggest difference between DAI and its main competitors is that it’s the only stablecoin fully backed by crypto collateral, and is also fully decentralized in nature. USDT is largely centralized and backed by Tether’s reserves, which at the time of writing consist of cash and cash equivalents, US Treasury Bills, precious metals, short-term deposits, corporate funds, secured loans, commercial papers, and other investments. Meanwhile, USDC is fiat-collateralized and backed mainly by cash reserves and US Treasury Bills.

DAI partnerships and investors

There's no collated data available on who owns the majority of DAI tokens. However, the biggest takers of all stablecoins are well-known market makers and liquidity providers of the crypto trading industry.

There are several big names like Andreessen Horowitz, 1Confirmation, Paradigm Capital, Polychain Capital, Walden Bridge Capital, and Iconium who are invested in MakerDAO.

Besides being a favorite of the investor community, DAI has also forged strong partnerships with multiple entities including:

• Popular third-party Vault portals like InstaDapp, DeBank, and Zerion.

• Wallets such as MetaMask, KeepKey, Trezor, Ledger, Freewallet, Guarda Wallet, and Atomic Wallet.

• Apps, tools, and integrations like Bounties Network, Pool Dai, Sablier, and Atstake.

• Payment processors and merchant solutions like Coingate, Dexpay, WooREQ, and Gilded.

• DAI spending platforms including OpenSea, Aave, Unicef, Wirex, Swarm, and CelerX.

• DAI lending platforms including RAY, Celcius, DyDx, and Compound Finance.

• Crypto exchanges like OKX and others.

• Vault monitoring tools such as CDP Simulator, Makerscan, DeFi Explore, and EthView.

More details on the Dai ecosystem can be found here.

DAI strengths, weaknesses, opportunities, and threats

Strengths

One of the biggest strengths of DAI is that it’s a fully decentralized stablecoin backed by MakerDAO. Both MakerDAO and Maker Foundation have worked tirelessly to take DAI to great heights, making it one of the top five stablecoins in the world by market cap at the close of 2023. DAI is also heavily integrated into the Ethereum DeFi ecosystem, and remains the first choice for traders who prefer staying away from stablecoins managed and controlled by centralized entities or so-called trusted third parties.

Source: theblock.co

Weaknesses

The vulnerabilities and inefficiencies of MakerDAO’s governance system are one of DAI’s biggest weaknesses. DAI’s stability heavily depends on oracles that regularly feed crypto price details to the system and are chosen by MakerDAO’s governance mechanism. These oracle feeds are vulnerable to manipulation by MKR holders, which can have a negative impact on DAI’s value.

Meanwhile, since DAI is entirely collateralized by crypto assets, any drop in their market value increases the risk of under-collateralization followed by liquidation, which can lead to a user losing their collateral assets. This scenario happened during an event popularly known as ‘Black Thursday’ or ‘Black Swan’ in DAI’s history. On March 12, 2020, a large number of DAI CDPs (Collateralized Debt Positions) were automatically liquidated because of a sharp drop in the ETH price.

Source: kaiko.com

Opportunities

MakerDAO has a big opportunity to overcome DAI's inefficiencies and make a strong push towards a top three position for DAI in the stablecoin market. One way to achieve this is by adopting a more evolved and efficient peg-maintenance model that effectively combines a seigniorage algorithm with its collateralization aspect, such as the one used by FRAX. Additionally, considering the speed at which the crypto and blockchain industry is growing globally, it’s all the more reason for MakerDAO and DAI to make that push.

Threats

Besides being one of its weaknesses, the fact that DAI is heavily reliant on the underlying crypto collateral for its stability poses a major threat, particularly during highly volatile market conditions. The constantly changing crypto and stablecoin regulations around the world also add pressure on DAI. Regulatory changes that impact the operational and cost efficiency of stablecoins like DAI could be extremely harmful to the project and its dollar-pegged peers.

This is why crypto traders must be mindful of the potential loss of collateral if they're personally minting DAI through the Maker Protocol and depositing crypto assets. As a smart contract that can potentially cause forced liquidation, crypto traders should be wary since any sharp price drops in the deposited cryptocurrencies can under-collateralize your position.

DAI roadmap

DAI’s roadmap has guided various upgrades and improvements to its system to make DAI a strong stablecoin. DAI’s origins can be traced back to the successful launch of its predecessor Single-Collateral Dai (SAI) in December 2017. SAI becoming a well-known stablecoin with Ether as its only collateral, paved the way for the launch of Multi-Collateral Dai (DAI) in November 2019.

In February 2020, the Maker Protocol’s Governance Security Module delay was changed from 0 to 24 hours in a critical update, which allowed for a timely Emergency Shutdown when faced with an attack. Almost a year and a half later, following multiple improvements to the Maker Protocol, Rune Christensen announced in July 2021 that MakerDAO and DAI were fully decentralized. MakerDAO, along with Maker Foundation, continues to develop DAI in the hope of strengthening its position as a time-tested stablecoin. MakerDAO is also working on bridges with several Ethereum layer-2 solutions to widen DAI’s reach and make it more cost-efficient, scalable, and efficient.

DAI updates, news, and highlights

In important DAI news, in April 2022, MakerDAO announced the deployment of Maker Protocol on StarkNet, a well-known layer-2 scaling solution for the Ethereum blockchain. It was the first time the protocol had been launched on an Ethereum roll-up which used zero-knowledge technology. Prior to this, the protocol had integrated with optimistic roll-ups like Optimism and Arbitrum in 2021. The rationale behind these integrations was to enhance DAI’s multichain capabilities while also improving its transaction throughput and reducing transaction costs.

A little later in June 2022, it was reported on Cointelegraph that MakerDAO was voting on a proposal to use around 500 million DAI in its reserves to help ride out the ongoing bear market. This proposal came to be known as the Dai Savings Rate and planned to allocate 500 million DAI towards a combination of minimum-risk US Treasuries and corporate bonds, to earn yield for the platform.

Where to buy DAI?

The most convenient way to buy or trade DAI is through an exchange that offers plenty of spot pairs to choose from. A quick way to check last-traded crypto prices against DAI is through a DAI to USD converter.

How to store DAI?

You can safely store purchased DAI tokens in your native crypto wallet. The wallet should include robust security features like multi-factor authentication, SSL encryption, and more, to safeguard your crypto assets. Any crypto assets you hold on OKX, including DAI, are entirely yours. You're free to transfer them to an external wallet of your choice. DAI being an ERC-20 token can be stored in any Ethereum compatible wallet such as MetaMask, MyEtherWallet, Trezor, Ledger, KeepKey, Freewallet, Trust Wallet, Atomic Wallet, and others.

The final word and next steps

DAI offers a great amount of utility and flexibility, combined with the price stability of USD. Any DAI that you hold can be freely and seamlessly used across the crypto ecosystem, in several different ways, including:

• Deposit of idle DAI holdings into DeFi products to potentially generate rewards

• To make in-game asset purchases

• As a stable asset, to safeguard gains made from crypto trading, or to simply hedge against market volatility

• Using DAI to trade other crypto assets

FAQ

Which crypto assets can I use as collateral to create DAI stablecoins?

You can use a wide range of Ethereum-based crypto assets like Gemini USD (GUSD), Polygon (MATIC), Chainlink (LINK), and Decentraland (MANA), alongside Bitcoin (BTC), to generate DAI.

How is DAI governed?

DAI is governed by the Maker ecosystem’s participants who hold MKR tokens. They can float governance proposals and vote on them by locking their MKR tokens in a voting contract.

How is DAI secured?

DAI, being an ERC-20 token, is secured thanks to the safety features of the Ethereum blockchain.

What is Maker Foundation?

Formed by MakerDAO in 2018, Maker Foundation created the Maker Protocol that's used for generating DAI tokens. Maker Foundation also actively supports MakerDAO and DAI to keep them fully decentralized.

Is it possible to mine DAI?

No, DAI tokens can't be mined. The most organic way to acquire them is by generating them through Maker Protocol, after depositing crypto assets as collateral.