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MakerDAO: the dollar on Ethereum

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Stablecoins are crypto tokens with low-value fluctuations, making them much more stable than, for example, cryptocurrencies such as Bitcoin and Ethereum. The most popular are those whose value is pegged to the US dollar (USD).

Generally, a stablecoin anchored to the value of the American dollar is obtained by keeping a deposit of real American dollars as collateral, and by issuing a certain number of tokens equal to the locked dollars. As a result, there is parity between the stablecoin tokens and the dollars, so that each token can be converted at any time into 1 USD.

This is how many stablecoins anchored to the US dollar work, including initially also Tether (USDT), which is the most widely used stablecoin in the world. But such a design has at least a couple of critical points, one of which is in stark contrast to the decentralized nature of cryptocurrencies. Certainly, the convenience of being able to have a sort of “crypto-dollar” leads many users to overlook this criticality, however, since the way to overcome it has been found, it is important to illustrate it carefully in order to understand the reason why the idea of MakerDAO was born.

Stablecoins: 2 Disadvantages

  1. The first criticality comes from the fact that, in reality, not even the value of the dollar is 100% stable. However, over the years it has now amply demonstrated to experience very little fluctuation, far lower than the values of actual cryptocurrencies such as BTC and ETH. Besides, there is virtually no financial asset whose value does not fluctuate, because even gold does not have a fixed value. Therefore this first criticality can be considered of little importance, apart from the fact that being able to rely on a crypto token whose value is stable enough, helps especially those who operate within this market with speculative intentions or those who intend to use these new currencies as a means of payment.
  2. The second critical point is much more relevant. The problem lies in the fact that there is no decentralized way to lock up and retain US dollars, so stablecoins collateralized in USD require that a single individual, or a group of individuals, take the commitment not only to carefully store the dollars locked up to guarantee the value of the token but also to ensure that there are enough. In other words, If those who are responsible for storing the dollars that guarantee the value of the token behave incorrectly, or dishonestly, or make mistakes, even in good faith, there is a risk that the real value of the token will deviate from that of the dollar, causing the stablecoin to lose its purpose.

The Idea behing MakerDAO

Source: Cryptodesknews

MakerDAO was born precisely as an attempt to overcome this limit, namely to solve the problem of the necessity to identify a person responsible for the storage of funds to cover the value of the token of the stablecoin. The solution identified is of a decentralized nature, although it can’t use US dollars as collateral since as of today there is no way to store them in a truly decentralized way.

The main concept of MakerDAO consists in not using as collateral a currency that is not — and cannot be — decentralized but to use one that is already natively decentralized: Ether (ETH), the token native to the Ethereum network. Maker itself is actually a DAO, or “Decentralized Autonomous Organization”, an entity whose activity and executive power are created and managed through codified rules thanks to special smart contracts that run on the Ethereum blockchain.

Using these smart contracts, and the Ethereum network, not only was it possible to create the management structure of Maker’s DAO, but it was also possible to lock and store ETH in a decentralized way to cover the value of the stablecoin created by MakerDAO: DAI. As a result, the DAI stablecoin is decentralized, created and managed with decentralized smart contracts on the Ethereum network, and collateralized with the decentralized Ether (ETH) cryptocurrency.

However, if DAI had been created as a token backed 1:1 by ETH, its value would not have been stable. That is, it would not have been a stablecoin, but a derivative of Ether, a sort of token that would have represented the same Ether cryptocurrency.

To ensure that DAI was actually a stablecoin, even though it was collateralized in ETH, a complex mechanism was created that does not entail parity with ETH, but with the American dollar. Therefore DAI is a stablecoin token whose value is kept artificially close to that of the US dollar, but without being collateralized in USD. From the technical point of view, it is an ERC-20 token, issued with a smart contract on the Ethereum blockchain, and exchangeable with wallets that support ETH and ERC-20 tokens.

Thanks to special oraclesthat collect data from various public exchanges on the rates between various cryptocurrencies, and in particular those between ETH and USD, the decentralized smart contract that regulates its issuance and management uses an algorithm that guarantees that its value remains more or less around that of the US dollar, with minimal fluctuations with respect to parity, making it tradable with ETH at a variable rate so that the fractions of ETH tokens that can be obtained in exchange for 1 DAI always have a value of approximately 1 USD at the time of exchange.

Source: Provable

For this reason, the stablecoin created and managed by Maker’s DAO can be defined as “the dollar on Ethereum”.

But the most important thing is that the entire management of DAI, of Maker’s DAO, of the ETH collateral, and of the smart contracts on which it is based, is decentralized, unlike other stablecoins pegged to the US dollar which are centralized tokens, even if they are tradable on the Ethereum blockchain. As a result, DAI is a token that operates on the Ethereum network and allows the creation and exchange of a decentralized algorithmic stablecoin that is immune to the behaviour of individual operators or token owners, and whose value is approximate to that of the American dollar (USD).

However, there are a couple of critical issues related to DAI, and in particular, the fact that the oracles that acquire exchange rate information are not completely decentralized, and that the stable value of the token is secured by a collateral, ETH, with an unstable value that could even potentially disappear, but so far no real problems related to these critical issues have emerged.

If anything, given that DAI has been in existence for several years now, and has brilliantly overcome, for example, the collapse of the ETH price in 2018, it is possible to state that these criticalities have not caused any problems so far suggesting that they could actually turn out to be serious.

Therefore, although the token created by MakerDAO is not the only crypto-dollar existing on Ethereum, to date it remains the only one that is decentralized, despite having recently been split into two tokens, one of which, SAI has remained identical to the original, but under a new name, while the one created from scratch, DAI, has acquired the old name of the stablecoin, with the difference that it can be collateralized not only in ETH but also in other ERC-20 tokens such as BAT.

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