What Is Maker Protocol (MakerDAO)?
The Maker Protocol is a decentralized credit system on the Ethereum blockchain.
It offers a fully-collateralized stablecoin, Dai, and attempts to minimize volatility through a system of incentives and penalties.
MakerDAO Explained
Maker Protocol comprises:
- The Single-Collateral Dai (SCD) system locks ETH as collateral in smart contracts called Collateralized Debt Positions (CDPs). This collateral is then used as a buffer to generate DAI.
- The Multi-Collateral Dai (MCD) system expands the assets that can be used as collateral beyond ETH.
In the protocol, users lock collateral into smart contracts that generate Dai in proportion to the value of their collateral.
The smart contract can be “closed” anytime by paying back the generated Dai plus a stability fee.
If any user’s collateral falls below the required minimum level (called the liquidation ratio), their collateral will be auctioned off to restore it to its proper value.
In this way, all users are incentivized to maintain their collateral above the required level.
In addition to stability through a Target Rate feedback mechanism, the protocol also adds liquidation methods that minimize the risk of a black swan event.
The Governance Token
MKR is the governance token of the Maker Protocol, which backs and stabilizes the value of the Dai stablecoin.
MKR holders can vote on changes to the protocol, including adjustments to stability fees or risk parameters.
MKR holders also can create new Dai by burning MKR or destroy Dai by issuing more MKR.
Maintaining appropriate levels of Dai in circulation at all times is paramount for its role as a decentralized stablecoin.
Dai is a decentralized stablecoin and is soft-pegged to the USD. As a user, you can hold Dai in your cryptocurrency wallet by depositing collateral assets into Maker Vaults. MakerDAO’s token Dai has a steady value of 1 USD.
The Decentralized Stablecoin
Recently, MakerDAO moved to fully decentralization, mitigating the need for a middle man.
MakerDAO combines loans with a stable currency, allowing borrowers to predict the amount they’ll have to pay back.