A Deep Dive Into MakerDAO
Last week, we announced that Maker (MKR) and Dai trading is officially live on CoinList. Users can now buy, sell, convert, send, receive, and store MKR and DAI directly in their CoinList wallets. We have long been believers in MakerDAO, and were excited to sit down with the Maker team to discuss the project and its progress.
1. What is the Maker Protocol, also known as the Maker system?
MakerDAO is a decentralized organization dedicated to bringing financial stability and transparency to the world economy. MakerDAO enables the generation of Dai, the world’s first unbiased currency and leading decentralized stablecoin. Dai mitigates volatility through an autonomous system of smart contracts called the Maker Protocol, as well as through decentralized community governance.
The Maker Protocol, built on the Ethereum blockchain, enables a stable store of value. Current elements of the Maker Protocol are the Dai stablecoin, Maker Collateral Vaults, Oracles, and Voting. MakerDAO governs the Maker Protocol by deciding on key parameters (e.g., stability fees, collateral types/rates, etc.) through the voting power of MKR token holders.
A critical part of MakerDAO is the vast and dynamic Maker community. From MKR holders and Dai users to developers and supporters, the Maker community includes people and organizations that actively participate in building or supporting MakerDAO.
One notable community participant is the Maker Ecosystem Growth Foundation (the “Foundation”), which is tasked with bootstrapping MakerDAO to fuel growth and drive the organization toward complete decentralization. While the Foundation provided development support through the launch of Multi-Collateral Dai (MCD), it is currently spearheading efforts to decentralize future development.
With hundreds of integrations and one of the strongest developer communities in the cryptocurrency space, MakerDAO has become the engine of the decentralized finance (DeFi) movement. Maker is unlocking the power of the blockchain to deliver on the promise of economic empowerment today. Visit www.makerdao.com.
2. MakerDAO includes a two token model, MKR and DAI. How are these tokens different and how do they interact with each other?
Dai lives completely on the blockchain, making it borderless and available to anyone, anywhere. Though currently on the Ethereum blockchain, Dai is built to be blockchain agnostic.
All Dai is backed by a surplus of collateral that has been individually locked by Maker Protocol users into audited and publicly viewable Ethereum smart contracts. Anyone with an internet connection can monitor the health of the system anytime at daistats.com.
Dai extends the power of traditional currency with the benefits of the blockchain: It can be freely sent to others, used as payments for goods and services, or locked in a smart contract to earn savings.
MKR is the governance token of the Maker Protocol. As a governance token, MKR is used by its holders to vote on a number of different things. Voting is used to execute changes to parameters inside of the Maker Protocol like Stability Fees, the DSR, Debt Ceilings, among many others. Voting is also used to make decisions on the non-technical aspects of the protocol like asset priority lists, governance processes, role mandates, and even electing individuals to fill specific roles. To learn more about governance in the Maker Protocol visit the Governance FAQ.
3. According to the network’s documentation, DAI is created through smart contracts called Maker Vaults. Can you please elaborate on how DAI generation works and how it normally operates?
The Maker Vault is a core component of the Maker Protocol, which facilitates the generation of Dai against locked up Collateral.
Vault usage collectively alters the total supply of Dai. Users create Dai by generating it against their Collateral and in-turn destroy Dai when repaying their generated Dai balance. This process happens on-chain, which enables full auditability of circulating Dai and the Collateral backing it.
Vaults are required to be overcollateralized and have a Liquidation Ratio that Vault owners need to uphold to avoid the Liquidation of their positions. Additionally, a Debt Ceiling is imposed globally on the Maker Protocol, as well as individually on each Vault type.
Any user who wishes to generate Dai may deposit Collateral into a Vault and do so, paying a Stability Fee on the generated Dai balance.
Vault users are free to generate or pay back Dai and can add or withdraw Collateral with no time-constraints. As long as Vault owners maintain a minimum Collateralization Ratio, specified for each Vault type as the Liquidation Ratio, they may interact with their Vaults freely. If a Vault’s Liquidation Ratio is breached, the position gets Liquidated. To read more about Liquidation, visit the Liquidation FAQ. If a user wishes to reclaim the full amount of their Collateral, they will need to pay the full amount of Generated Dai back along with the Stability Fees owed.
For a granular view on the collateral locked in each user’s Vault and the overall health of each individual Vault, please visit: defiexplore.com/.
4. What assets can currently be used as collateral in Maker Vaults? How are the parameters for each collateral type determined?
Currently, a Maker Vault can be created with ETH, BAT, WBTC, KNX, ZRX, USDC, TUSD, with additional collateral types being considered on a regular basis. The parameters for each collateral type are discussed, debated and voted upon by decentralized MKR holders. For an up-to-date list of possible vault collateral types please visit: www.daistats.com To learn more, or participate in MKR governance, including discussing collateral types and parameters, please visit: forum.makerdao.com
5. What happens when a user’s Maker Vault becomes undercollateralized? What happens to the collateral and who settles the outstanding debt?
Dai is soft-pegged to the US Dollar, with the additional benefit of being fully backed by real value in the form of various collateral assets. Liquidation helps to ensure that Dai is always backed by an appropriate amount of collateral by closing-out Vaults that are under their minimum required Collateralization Ratio for their given collateral type.
Liquidation is the process of selling collateral to cover a user’s generated Dai and related fees. A Vault can be Liquidated if the value of its collateral falls below the required minimum level, called the Liquidation Ratio. During the Liquidation process, enough collateral is sold to cover the debt along with a Liquidation Penalty, leaving the remaining collateral, if any, available for withdrawal by the Vault owner.
To make sure that the required surplus of collateral exists at all times, a class of users called Keepers are incentivized to maintain a constant watch for Vaults that become under-collateralized. These Keepers are a special category of Maker Protocol users. They are the actors in the system who are incentivized to make sure that the outstanding Dai supply remains fully collateralized and solvent.
Liquidation occurs through an Auction Mechanism built into the Maker Protocol.
The simplified order of operations looks like this:
- A Keeper detects an undercollateralized Vault and triggers a Liquidation.
- All of the collateral is put up for auction to cover the outstanding Dai+Stability Fees + Liquidation Penalty
- Once bids reach the Dai amount equaling to the outstanding Dai + Stability Fees+Liquidation Penalty, the auction reverses and bidders now compete by offering to accept less collateral for the Dai they bid in the previous phase.
- Once the auction completes bidders receive the sold collateral, the winning bidder’s Dai is burned, and the Vault owner may withdraw leftover collateral if any remains.
For a more detailed guide on how Auctions and Keepers work see The Auctions of the Maker Protocol on our Documentation Portal.
6. Beyond the Collateral Auction, there are two other types of auctions used to maintain the network, a Surplus Auction and a Debt Auction. How do these auctions work and what is the role in maintaining the system?
If the Collateral Auction does not raise enough Dai to cover the Vault’s outstanding obligation, the deficit is converted into Protocol debt. Protocol debt is covered by the Dai in the Maker Buffer. If there is not enough Dai in the Buffer, the Protocol triggers a Debt Auction. During a Debt Auction, MKR is minted by the system (increasing the amount of MKR in circulation), and then sold to bidders for Dai.
If Dai proceeds from auctions and Stability Fee payments exceed the Maker Buffer limit (a number set by Maker Governance), they are sold through a Surplus Auction. During a Surplus Auction, bidders compete by bidding increasing amounts of MKR to receive a fixed amount of Dai. Once the Surplus Auction has ended, the Maker Protocol autonomously destroys the MKR collected, thereby reducing the total MKR supply.
7. How does DAI typically maintain it’s USD peg?
Dai is not a hard-pegged currency, so it does not perfectly track the value of an existing fiat currency. Rather, it maintains a free-floating peg that experiences extremely low volatility against a fiat currency, currently the US dollar.
It achieves this stability through a combination of external market forces, complementary internal economic incentives, and policy tools controlled by MKR token holders. Many different market actors behaving in their own self-interest, yet working in concert, contribute to its stability. These actors include MKR holders, arbitrageurs, Vault owners, Keepers, and market makers.
If Dai demand consistently exceeds Dai supply, or vice-versa, it creates a signal that MKR holders may need to adjust the Dai Savings Rate, which is a tool for influencing Dai demand and steering the monetary policy of Dai. Raising the Dai Savings Rate ostensibly increases the demand for holding Dai; lowering the rate decreases the demand for holding Dai. This ideally translates to a stable Dai peg.
Stability Fees for various Vault types are another policy tool used to help Dai stability but are primarily used for covering the risk premium of different Vault types. Decreases in a Stability Fee, reflecting the cost of borrowing, can incentivize the additional creation of Dai. Similarly, increasing Stability Fees can reduce the rate of Dai generation.
Arbitrageurs also contribute to the short term stability of the peg by taking advantage of price differences across various Dai markets.
Vault owners are able to participate in maintaining the peg by taking advantage of opportunities when spikes in demand push the Dai price higher than $1. This allows a Vault owner to issue Dai that can be used to purchase assets with an additional variable amount of purchasing power. Inversely, when Dai is trading below a dollar, Vault owners are incentivized to purchase Dai in open markets and pay down their Dai balances at a discount.
8. In regards to MakerDAO's governance, how does governance work and who is able to participate?
MakerDAO is governed by a decentralized group of MKR holders. Anybody with MKR is entitled to a vote. The primary responsibility of MKR holders is to ensure the stability of Dai and the overall health of the Maker Protocol. It is also in MKR holders’ interest to focus on improving and growing the Maker Protocol by building out the governance processes and infrastructure that enable the effective management of the system. This includes, but is not limited to, establishing risk assessment standards for onboarding new Collateral and Vault types, ratifying Protocol role mandates (e.g., risk teams, governance facilitators, etc.), electing appropriate parties, establishing standards around vote types, and much more.
Another important responsibility for MKR holders is to communicate publicly about their views on the various issues that Maker governance is addressing at any given time. Participating seriously in forum discussions and voicing opinions, and the reasoning behind them, is important because of the public and decentralized nature of the protocol and its governance. To participate in Maker Governance, please join us on our forum at: https://forum.makerdao.com.
9. How is MKR involved in recapitalizing the Maker Protocol?
While not a typical “recapitalization” as considered in the context of corporations, the Maker Protocol utilizes the Debt Auction (in Maker parlance, a “Flop Auction”) when the system Buffer falls below outstanding and undercollateralized Vault Dai debt. MKR is minted by the system (increasing the amount of MKR in circulation), and then sold to bidders for Dai as described above.
10. The Maker Protocol also has this concept of a DAI Savings Rate contract. How does this contract work and how is this different than a normal savings account?
The Dai Savings Rate (DSR) is an option to earn savings simply by holding Dai. Any Dai holder may lock Dai in a smart contract to earn additional Dai.
The savings earnings one receives from the Dai Savings Rate come directly from the Maker Protocol. Dai is taken from the Maker Protocol, where it charges fees for generating Dai from Vaults (known as Stability Fees), to fund the Dai Savings Rate function.
The Dai Savings Rate is determined through governance by MKR token holders. The rate is chosen based on a number of parameters, including, but not limited to, the current supply and demand of Dai and the current stability fees charged on Vaults.
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