DAI Explained: A Beginner's Guide (2024)

DAI is a decentralized stablecoin with a 1:1 value ratio to the US dollar. It is based on the Ethereum blockchain and is issued by MakerDAO, an Ethereum-based protocol. The stability of its value is maintained through a system of smart contracts and decentralized participants who are incentivized to perform maintenance and governance functions. Price stability is maintained through game theory and economic incentives that keep its value close to 1 USD.

To keep the value of DAI pegged to the US dollar, MakerDAO uses an algorithm that adjusts the interest rate on the DAI loans (known as the stability fee) based on the supply and demand of DAI. If the supply of DAI is too high relative to demand, the stability fee will increase, which makes it more expensive to create a new DAI and should reduce the supply. If the supply of DAI is too low relative to demand, the stability fee will decrease, making it cheaper to create a new DAI and should increase the supply.

DAI is always over-collateralized, meaning that the amount of underlying assets is higher than the amount of DAI created. For example, if ETH is worth 1,000 USD and the collateralization ratio is 170%, you can create 588 DAI. To generate DAI (minting), users deposit collateral into Maker vaults and retrieve it once the loan is repaid. DAI can be acquired through brokers, exchanges, or as payment, and can be used for transactions, savings through a feature of the Maker protocol called the DAI Savings Rate (DSR), or as a store of value just like any other cryptocurrency. This is the method through which DAI becomes accessible in circulation, and how individuals acquire access to liquidity.

All DAI in circulation is backed by excess collateral and all transactions are transparent on the Ethereum blockchain. DAI is available on 34 different blockchains, including Ethereum, Polygon, BSC, and Solana.

Pros and Cons

The MakerDAO team is led by co-founder Rune Christensen and consists of 115 employees, including CEO Jesus Perez, CTO Ethan Bennett, CFO Torben Jorgensen, and others in various roles such as legal, marketing, sales, and operations. MakerDAO also has 33 developers on Github. Among the team, Mariano Conti is a prominent member who helped launch and maintain both Single-Collateral DAI and Multi-Collateral DAI, as well as playing a key role in developing the DAI Stablecoin System and DAI Credit System, from smart contracts to price feed keepers; and infrastructure to user interfaces. He was also part of the DappHub initiative.

Reserves

DAI's total crypto assets used for on-chain collateralization

Security

The stability of DAI is ensured by a surplus of collateral that has been securely placed in transparent Ethereum smart contracts, which are audited and publicly accessible. The system's status can be easily monitored by anyone by visiting DAIstats.com.

DAI is special as it is secured by various stablecoins and digital currencies. The bulk of DAI's backing comes from centralized stablecoins such as USD Coin (USDC) and Ethereum (ETH), then Pax Dollar (USDP), Wrapped Bitcoin (wBTC), and additional cryptocurrencies.

DAI is known for being one of the decentralized stablecoins that is collateralized by other crypto assets, unlike Tether (USDT), which is backed by real-world assets such as the US dollar. Essentially, DAI holds other crypto assets including other cryptocurrencies and crypto loans on the blockchain through smart contracts. This process involves a predetermined ratio that only allows new stablecoins to be created when a specific value threshold of backing has been met. This threshold is always higher than the total value of the stablecoins in circulation. This excess collateralization serves as a safety net in the event of a sudden decline in the value of crypto assets. However, some people have criticized DAI for not being fully decentralized due to its reliance on the centralized USDC, which is backed by fiat currency.

All the smart contracts from DAI have been audited on several occasions by Trail of Bits, Callisto Network, and CER.live.

Another factor contributing to trust in DAI is the addition of staked ETH as collateral on the protocol.

DAI's stability during a volatile market, particularly when other popular stablecoins failed to maintain their value, is a major factor that gives investors confidence in the MakerDAO ecosystem. This stability is maintained through the use of Peg Stability Modules.

The history of DAI, a stablecoin supported by MakerDAO, dates back to 2014 when Rune Christensen founded the Maker Foundation and launched the open-source MakerDAO to spearhead the decentralized finance movement.

As a lending protocol, MakerDAO realized it needed a stable digital currency, leading to the publication of the first MakerDAO formal white paper in December 2017. The white paper introduced the DAI Stablecoin System, which allowed anyone to generate DAI by leveraging ethereum as collateral through unique smart contracts known as Collateralized Debt Positions (CDPs). This resulted in the launch of Single-Collateral DAI (SCD), also known as SAI, in December 2017.

In November, 2019, the DAI Stablecoin System was upgraded to support multiple collateral asset types, in addition to ETH. This was made possible through the decentralized governance process, where MKR holders vote on the approval of collateral assets and their corresponding risk parameters.

Since its launch, DAI has become the fourth largest stablecoin by market cap, exceeding 5 billion USD, and its circulating supply has remained below 10 billion USD. The fact that DAI held its dollar peg during a tumultuous market when other stablecoins lost theirs, has further built trust in the MakerDAO ecosystem. Today, MakerDAO implements a variety of security measures for DAI, including support for staked ether as collateral and various layer-2 contracts, further solidifying its position as a reliable and secure stablecoin.

DAI is a unique stablecoin that sets itself apart from others in several ways. Firstly, as an ERC-20 token, DAI is easily accessible to purchase and trade on both centralized (CEX) and decentralized (DEX) exchanges such as Binance, Coinbase and Uniswap.

Another key feature of DAI is its decentralized nature, allowing anyone to issue new stablecoins through MakerDAO’s open-source protocol on the Ethereum blockchain. This is made possible by borrowing DAI through the opening of Maker collateral vaults, available via Oasis dApp, one of MakerDAO’s many decentralized apps.

• A short-term disadvantage of DAI is that it is backed by a potential insolvency from exchanges, as is the case with the Gemini exchange
• The stability of DAI may be at risk if it continues to rely on centralized stablecoins that may not be reliable. The use of vulnerable assets as collateral could lead to a decrease in demand for DAI
• A liquidity crisis in other lending platforms, similar to the situation with Earn, would have adverse effects on DAI's stability.