MakerDAO

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What is MakerDAO?

MakerDAO is a decentralized blockchain protocol that enables users to borrow and lend cryptocurrencies. Launched in 201, the platform operates on Ethereum.

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The blockchain protocol functions as both a lending and borrowing service and a decentralized autonomous organization (DAO).

The decentralized finance (DeFi) platform is powered by two crypto assets:

  • The Dai (DAI) stablecoin
  • The MKR token

MakerDAO allows users to take out crypto loans using other cryptocurrencies as collateral. These loans are disbursed in the form of its native stablecoin, DAI, which is generally overcollateralized.

History of MakerDAO

The MakerDAO protocol was conceptualized in 2015 by current CEO and founder Rune Christensen, an entrepreneur from Denmark.

Below, we provide more succinct historical details.

Year Event(s)
2015 MakerDAO is conceptualized by Danish entrepreneur Rune Christensen.
2017 MakerDAO launches on the Ethereum mainnet, with ETH being the only supported asset for collateral.
2018 Andreessen Horowitz invests $15 million in MakerDAO and purchased 6% of all MKR tokens in circulation.
2018 Maker Foundation is formed in Copenhagen to help with the development of the MakerDAO ecosystem.
2019 The MCD upgrade is launched.
2019 An internal struggle breaks out due to growing calls for the adoption of other forms of collaterals besides cryptocurrencies.
2020 DAI surges beyond its $1 peg to $1.11. MKR tokens are burnt to bring back the value to the preset peg.

How Does MakerDAO Work?

  • MakerDAO’s operation initially centered on ether, allowing users to deposit ETH to generate the DAI stablecoin. As the protocol expanded, it broadened its scope to accept various ERC-20 tokens for obtaining the DAI.
  • To access crypto-backed loans, DeFi users need to lock up a different cryptocurrency as collateral. Each crypto loan is repaid in DAI, and the entire process is overseen through a mechanism known as a Collateralized Debt Position (CDP).
  • A CDP is a loan agreement between the user and the decentralized application (dApp). It is usually ratified using smart contracts – bits of computer codes that carry out preset commands.
  • The CDPs are tasked with creating (minting) new DAI tokens once a preset amount of another digital asset has been deposited as collateral.
  • The digital assets are locked as CDPs in MakerDAO’s Vaults until the debt is resolved. Once the original loan amount is paid back, the initial digital asset is repaid to the user’s crypto wallet.
  • CDPs are easily accessible, and anyone can create one. Upon establishment, the received DAI can be used for trading, hedging, purchasing other cryptocurrencies, or earning yields on other DeFi-supported protocols.

In the event of DAI loss and non-repayment, the CDP faces liquidation, prompting the protocol to sell the deposited collateral to cover the outstanding debt.

What Makes MakerDAO Unique?

MakerDAO, with six years of operation under its belt, has not only endured multiple crypto market downturns but has also distinguished itself through its unique protocol design.

One key factor setting MakerDAO apart is its DAI token, which contrasts other stablecoins like USDT and USDC.

DAI’s value is not tethered to cash reserves; rather, the MakerDAO protocol uses various mechanisms to consistently support and uphold the value of the DAI token, including over-collateralization, stability fees, automatic liquidation, and MKR dilution.

Below, we provide a brief overview of each of these distinctive mechanisms:

  • Stability Fees: These are charges levied for creating new DAI tokens from MakerDAO’s vaults. These fees are paid using the MKR tokens and are often adjusted based on the prevalent needs of the protocol at particular periods. Hence, the stability fee can either be increased or decreased. For instance, if the DAI value rises above the $1 peg, the stability fee is increased to reduce CDPs. The reverse happens when the stability fee is reduced.
  • Overcollateralization: This distinctive approach is a trust-building measure, ensuring that crypto users deposit excess collateral compared to the DAI they aim to create within MakerDAO. The minimum collateralization ratio is fixed at 150%.
  • Automatic Liquidation: This occurs when a user’s collateral ratio drops below the 150% minimum ratio. In the event this happens, the MakerDAO smart contracts automatically begin to sell the deposited collateral to cover up for the debt. This feature incentivizes users to always maintain the recommended collateral ratio.
  • MKR Dilution: When a substantial number of liquidations occur, MakerDAO responds by minting MKR tokens and offering them on the open market to cover the collateral losses. This process reduces the quantity of MKR tokens in circulation and impacts the holdings of token holders.

New Update: Multi Collateral Dai (MCD)

While MakerDAO boasts of some of the most robust stop-gap mechanisms to maintain its lending services, the dApp has successfully brought credit systems into the DeFi landscape.

One key advantage is its inclusive nature, allowing individuals worldwide, regardless of their demographics or location, to access capital if they meet the specified deposit requirements. This vastly opens up a new funding channel for both businesses and individuals to tap into.

In addition, the protocol launched the Multi Collateral Dai (MCD) upgrade on 18 November 2019.

This upgrade comes with a number of new features, including:

  • Support for all Ethereum-based tokens approved by MKR token holders.
  • The introduction of a Dai Saving Rate (DSR) enables users to earn yields on their savings by locking their Dai stablecoins into DSR smart contracts.
  • Payment of stability fees for every new block, as against periods of repayments.
  • Launch of Oasis Trade, now Summer.fi.

MakerDAO Tokens (DAI & MKR)

The DeFi lending protocol operates through a combination of DAI and MKR tokens.

The DAI stablecoin is fiat-backed and tracks the value of the US dollar on a 1:1 basis. The stablecoin is soft pegged to the US dollar and backed by the collateral locked in Maker Vaults.

Here are some of the benefits of using the DAI stablecoin:

  • Users can take out loans against unrealized gains without triggering a taxable event.
  • The DAI stablecoin is more stable.
  • Yields of up to 8% via the Dai Savings Rate smart contract.

The MKR token serves as a major backstop to the DAI. MKR is used in voting on network proposals and the general direction the DeFi protocol is headed.

DAI primarily serves as the lending asset, while the MKR token plays a distinct role as:

  • A support system to ensure the value of DAI is pegged to $1.
  • A stakable asset to secure the network.
  • A governance mechanism where others determine the direction the crypto lending platform heads towards.

The concept of over-collateralization is pivotal to MakerDAO’s operation. Overcollateralization entails users locking up a significant amount of collateral that exceeds the loan’s value.

As of October 2023, the minimum collateralization ratio for Vault on MakerDAO is 150%. Vaults are smart contracts that receive collateral from investors and, in exchange, generate the DAI stablecoin.

Here is an example:

  • A user would need to lock up $150,000 worth of cryptocurrency (such as ETH) as collateral in order to access a $100,000 loan in DAI stablecoin.
  • Once the loan expires, the user must repay the DAI and a stability fee to access their collateral. In many ways, the stability fee is comparable to the interest paid to a bank for a loan.
  • However, it is recommended that users deposit more than 150% of the collateral ratio to prevent automatic liquidation.

Automatic liquidation is when a user’s collateral is used to settle their debt if they cannot pay the loan on time or the deposited asset’s value crashes significantly.

The Bottom Line

MakerDAO has established itself as a premier crypto-backed lending service over the past half-decade. The platform has maintained a strong market presence despite growing competition from other Ethereum-based protocols.

However, it has not been smooth sailing for the DeFi platform. Global macro events like the Covid-19 pandemic have also negatively impacted the protocol. It is also plagued with issues of slow transaction speed, given its reliance on the Ethereum network.

Nonetheless, MakerDAO is still one of the most robust and stable Defi lending services. Its resilience in the last six years and rise to the top of the DeFi lending ecosystem shows the huge potential it possesses.

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Jimmy Aki
Crypto & Blockchain Writer
Jimmy Aki
Crypto & Blockchain Writer

A graduate of the University of Virginia, Jimmy previously worked for BeInCrypto, Bitcoin Magazine, Decrypt, Cryptonews and other major publications. Alongside writing for Techopedia, Jimmy is also a trained economist, accountant and blockchain instructor with hands-on work experience in the financial sector.