TL;DR
DAI is a decentralized Ethereum stablecoin that is issued by the Maker Protocol and the Maker DAO, a decentralized autonomous organization. To generate DAI, users lock their crypto tokens in a Maker Vault at a certain Liquidation Ratio. For example, a 120% Liquidation Ratio requires $1.20 of crypto collateral value for each $1 of DAI. The DAI is overcollateralized to account for crypto's volatile prices and a stability fee is also charged. If your collateral were to drop below the liquidation ratio, then your crypto is liquidated and used to recover any losses.
The price of DAI is pegged to the US Dollar by collateralizing a mix of other cryptocurrencies that are deposited into a smart contract vault every time a new DAI is minted. The DAO uses a mechanism to make sure the DAI remains stable and pegged. These are the Stability Fee and the Savings Rate. The Stability fee affects the supply of DAI by changing the cost to mint DAI which can affect the supply. Similarly, the Savings Rate affects investors' demand for the coin, since it changes the returns on staking DAI.
DAI has similar features to other stablecoins. It can be used to transfer money worldwide and to hedge against large crypto market swings. Further, you can also use DAI by investing in the Savings Rate contract and earning interest on it.
Introduction
One of the defining features of DAI is that there isn't a single entity or authority that is responsible for the creation of this stablecoin. Instead, MakerDAO and the Maker Protocol manage the creation of new DAI in a decentralized method, using smart contracts on the Ethereum blockchain. This system insures stability above all else and can issue new DAI tokens to users at any time.
Further, stablecoins are a widely popular option for investors during times of high market volatility. As such, DAI plays a key role in this. DAI accounts for nearly 8 billion of nearly 180 billion stablecoins out there. It has become popular for investors to use since they mimic the price of a fiat currency while operating like cryptocurrencies.
However, what exactly is DAI and how does it work? Not to worry we answer those questions down below.
What Is DAI?
DAI is MakerDAO's stablecoin that is pegged to the dollar and one of the largest stablecoins by market cap out there. DAI accounts for nearly 10% of the entire stablecoin supply as illustrated in the chart below. This ERC-20 has an unlimited supply, so long as it is backed up by collateral.
Rather than maintaining a vault of fiat reserves, MakerDAO uses crypto-collateralization to maintain its peg. The idea that crypto can provide the backing for a stablecoin might seem puzzling, as it's known for its volatility. Simply, DAI users deposit crypto through smart contracts called Maker Vaults. They then receive stablecoins, but the digital currency they deposit to the Maker Vaults has a much higher value. Consequently, the crypto collateral is more tolerant of downward price movements.
How Does DAI Work?
In order to understand how DAI works, we need to go over collateral. Collateral in finance is when you provide something of value when taking out a loan. You can use a home, car, or something else that is relatively stable and maintains its value. This is used to cover the loan if you can't repay it. For example, if you wanted to take out a loan from a pawn shop, then you would need to hand over jewelry or something of that nature.
When it comes to DAI, it requires collateral. What kind exactly? Crypto! This is one of the differences between this stable coin and others. Mainly that stablecoins like BUSD or USDC require fiat currency as collateral. Users can hand over fiat currency and receive tokens in return. They can return back those tokens for fiat currency. This provides an opportunity for arbitrage which keeps the token pegged to the dollar.
Crypto as Collateral
On the other hand, a token like DAI requires crypto as collateral rather than fiat. A smart contract with a programmed set of rules manages these funds. The amount that needs to be collateralized depends on the protocol. The ratio would usually depend on the crypto's volatility and risk.
Overcollaterization
Further, crypto collateral is usually a risky business. Imagine taking out a loan against a home. You know the home will maintain its value relatively stable over a period of time. There are times when the housing market experiences some tumultuous times, but for this example, we will assume that the value of the home is relatively stable. Banks are more willing to lend to someone and use a home, like the example above, fiat currency, or precious metals as collateral because of its price stability. In the event that you can't pay back the loan, the bank can use the collateral to recover back the loan.
The idea of over-collateralization becomes more apparent when we imagine lending someone $100 for $100 worth of ETH. If ETH were to drop sharply, then the lenders risk losing the collateral that can cover their loan. The answer to this dilemma would be to ask for more ETH in return for $100 USD. They could ask for $300 worth of ETH in exchange for $100 USD. That way if the price of ETH were to drop, it would need to drop a significant amount before the collateral matches the amount of money loaned.
Collateralized Debt Positions
For years, MakerDAO has used over-collateralization in order to maintain a reasonably reliable peg. The DAI generation process is controlled by smart contracts, so it works efficiently without human intervention. Whenever you borrow DAI stablecoin, you lock up your crypto in a Collateralized Debt Position (CDP) smart contract. CDPs set a Liquidation Ratio, such as 1.5x, which means you'd have to provide $150 in ETH for $100 in DAI. Users can add more to reduce risk. A penalty fee will be assessed if the collateral amount falls below 150% (1.5x). Eventually, the user faces liquidation if they fail to repay their DAI with the added interest rate (the Stability Fee).
Stability Fee
The Stability Fee is an annual percentage yield calculated on top of how much Dai has been generated against a Vault’s collateral. The fee is paid in Dai only and then sent into the Maker Buffer.
Why Is DAI Important?
DAI is incredibly important in the area of finance and commerce. To put it simply, retailers and individuals don't just want to accept payments in a currency that can change its value overnight. DAI provides the price stability to facilitate this sort of transaction.
Further, because DAI is a cryptocurrency, it has all the added benefits of blockchain technology. In other words, you can use DAI to transfer it worldwide at low costs and faster transaction speeds.
Needless to say, stop me if you've experienced this before, you buy a crypto coin, then it has huge gains followed by a downward spiral. The world of crypto is incredibly volatile, accounting for the largest market swings. You can use DAI, to lock in some of those gains without the worry of your portfolio tanking into oblivion.
Properties of DAI
Money generally has four properties which are the following:
A store of value
A medium of exchange
A unit of account
A standard of deferred payment
DAI leverages these properties in the following ways:
Store of Value
A store of value is an asset that keeps its value without significant depreciation over time. Because Dai is a stablecoin, it is designed to function as a store of value even in a volatile market.
A Medium of Exchange
A medium of exchange is anything that represents a standard of value and is used to facilitate the sale, purchase, or exchange (trade) of goods or services. The Dai stablecoin is used around the world for all types of transactional purposes.
Unit of Account
A unit of account is a standardized measurement of value used to price goods and services (e.g., USD, EUR, YEN). Currently, Dai has a target price of 1 USD (1 Dai = 1 USD). While Dai is not used as a standard measurement of value in the off-chain world, it functions as a unit of account within the Maker Protocol and some blockchain Dapps, whereby Maker Protocol accounting or pricing of Dapp services is in Dai rather than a fiat currency like USD
Standard of Deferred Payment
A unit of account is a standardized measurement of value used to price goods and services (e.g., USD, EUR, YEN). Currently, Dai has a target price of 1 USD (1 Dai = 1 USD). While Dai is not used as a standard measurement of value in the off-chain world, it functions as a unit of account within the Maker Protocol and some blockchain Dapps, whereby Maker Protocol accounting or pricing of Dapp services is in Dai rather than a fiat currency like USD
Use Cases for DAI
Maker Protocol can be used by anyone, anywhere, and requires no personal information. Here are a few examples of how Dai is being used around the world:
Self-Sovereign Money Generation
According to the World Bank’s Global Findex Database 2017, about 1.7 billion adults around the world are unbanked. In the United States, 32 million households are either unbanked or underbanked, which means they either don't have any bank accounts or they use alternatives to traditional banking (for example, payday loans or pawn shop loans) deal with their finances.
As the world’s first unbiased stablecoin, Dai allows anyone to achieve financial independence, regardless of their location or circumstances. It aims to "bank the unbanked".
Leverage
Imagine having $2000 worth of Ethereum and you are incredibly bullish on this coin. You think it will go up however you don't have the funds to invest in Ethereum. Instead, what you can do is use the $2000 worth of ETH you currently have as collateral, mint DAI, and invest in ETH. Once you generate the funds you can sell the ETH in DAI and retrieve back your collateral.
Savings Earned Automatically
Dai holders everywhere can better power their journeys to financial inclusion by taking advantage of the Dai Savings Rate, which, as detailed earlier, builds on the value of Dai by allowing users to earn on the Dai they hold and protect their savings from inflation.
Fast, Low-cost Remittances
Money sent out of the country, whether it is for the purchase of goods or services or to send to family and friends, can be subject to high service and transfer fees, long delivery timelines, and frustrating exchange issues due to inflation. People around the world use the Dai stablecoin as a medium of exchange because of its value and efficiency.
Stability in Volatile Markets
As noted above, Dai is both a readily accessible store of value and a powerful medium of exchange. As such, it can help protect traders from volatility.
How To Buy DAI?
You can buy DAI on Binance.
Log In/ Create An Account
If you haven’t done so already you can create an account with Binance. Keep in mind that Binance is a KYC platform so you need to provide some form of ID. If you have an account already you can just log in.
Search For DAI
Once logged in click on trade and search for "DAI" in the search box.
Select Amount and Buy
Once you find the token select the amount you want to purchase and select confirm the order.
Final Thoughts
As the dominant crypto-collateralized stablecoin, DAI has been a proven success. The system mitigates the volatility of crypto all without fiat collateralization, which is quite a feat. One of the longest-running and largest DAOs that paved the way for many others. Staying true to decentralization, no one can say it's a boring project!
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