What is DAI, and how does it work?
Cryptocurrency will never be widely used as a medium of exchange for regular, in-person transactions as long as the ecosystem is plagued by extreme price swings.
This is a succinct explanation of how Maker DAO and Dai operate. There are many intricate parts to the system, but if one wants a quick summary of how Maker provides Dai its stablecoin qualities, I think these are the primary mechanics at play.
Despite the fact that bitcoin has come a long way since its beginnings, a few fundamental issues are preventing its use as a legitimate form of payment. One issue is that a single coin’s price can change significantly over the course of a day, let alone an hour. Could you picture trying to pay your rent or buy groceries while the value of USD or CAD fluctuated by hundreds or even thousands of dollars in a single hour? If you had the necessary number of US dollars ($1200) for rent, all of a sudden it would only be worth $900.
During the 2017 bull run, cryptocurrency saw a tremendous increase in popularity. As a result, there was a lot of buzz and investor FOMO, which led to a domino effect of more investors buying in as the price of several cryptocurrencies soared—which only served to drive prices even higher. What goes up must, however, come down. Early in 2018, the market began to decline quickly as investors were weary of the present cryptocurrency prices and most of them were unsure of what they were getting themselves into.
A small minority of investors choose to invest in cryptocurrencies because of their sound technological foundations, but this group is insufficient to reverse the present trend of pure-hype investments. Imagine if investing in cryptocurrencies offered a way to ensure consistent profits, presented little chance of losing your initial investment, and contributed to history by promoting a technology you thought had the potential to change the world. And while your initial investment was safe, you could still engage in high-risk, high-reward activities if you like riding the highs and lows of the cryptocurrency market.
The MakerDAO team has been working on the Collateralized Debt Position (CDP), a financial cryptocurrency concept, since 2014. It provides a potential remedy for the excessive volatility that cryptocurrency now experiences through the stablecoin known as Dai. A cryptocurrency that is anchored to another reliable asset is known as a stablecoin. Pegging is the process of tying one currency’s exchange rate to the value of another. The Dai stablecoin is linked to the US dollar in this instance. For this developing industry, having a stablecoin opens up a wide range of new financial opportunities that weren’t previously feasible owing to volatility. Since Dai is based on Ethereum, it not only provides stabilisation but also transparency and decentralisation.
Back to CDPs now. Numerous systems are in place to guarantee that the Dai remains in relation to the US dollar. An effective decentralised margin trading platform is made possible by Maker’s smart contract platform on the Ethereum blockchain, which supports and stabilises Dai through a number of dynamic feedback mechanisms known as CDPs. A user uses a CDP to place an asset as collateral for a loan into a smart contract. The user can then produce the equal USD amount in Dai that they want to borrow after the CDP has the assets that they have placed. After then, users can use Dai anyway they like, just like any other cryptocurrency. They can exchange Dai, pay with it, or even use it.
You will never owe more than what you originally borrowed plus interest because Dai is tied to the US dollar. For illustration, suppose you put 2 ETH ($105 USD at time of writing) into a CDP and borrow 100 Dai. You would be required to repay the 100 Dai plus accrued interest before receiving your entire 2 ETH. Although there are already various methods for borrowing non-stable coins, given the current state of the market, you risk owing twice as much as you invested.
Assume that after depositing 10 AssetCoins, 100 NonStableCoins (NSC) were created and borrowed at their current market price of $2 USD. When you return to repay the loan, if the price of NSC has fallen to $1 USD, you would now owe 200 NSC in addition to accumulated interest. As you can see, this is a fantastic advantage for any investor because you will always know exactly what you owe.
Another scenario: You want to invest in the extremely risky AmazingICO (AICO), but you don’t want to risk losing all of your ETH by sending it in. You may put 10 ETH (now worth $1050 USD) into a CDP, convert that amount to Dai, and then send the 1050 Dai to the AICO. In the event that AICO fails, you can decide to sell it back into Dai in order to reduce your losses, but you would then only have Dai worth $800.
however, good news! You still have 10 ETH in a CDP safe. You would need to find a means to raise the $250 USD required to repay your loan plus interest in order to get your ETH back, but you’re glad you kept it as the price of ETH has been exploding while you were waiting for the value of your ICO to rise, making your 10 ETH now worth $2100! That was sufficient to make up for your losses in AICO.