MakerDAO Review

What is MakerDAO?

MakerDAO is a decentralized autonomous organization standing behind an Ethereum-based Maker Protocol that powers one of the most popular modern stablecoins, DAI. Maker is one of the oldest and most successful projects built on Ethereum.

It’s hard to overstate the meaning of MakerDAO and DAI for the growing DeFi ecosystem. The need for stablecoins comes from the high volatility common to the cryptocurrency market. And although there are plenty of other real-word-money-pegged assets available for an average DeFi user, DAI stood out among all of them by simply being the only stablecoin that accepted various cryptocurrencies as collateral.

Founded in 2014, the MakerDAO project came a long way since its very idea was first pronounced by its co-founder Rune Christensen in a Reddit post from March 2015. It all started with a vague concept of eDollar, which later evolved into DAI, one of the most demanded stablecoins on the global DeFi market. 

There was a transitional iteration when a single-collateral stablecoin Sai was introduced in December 2017. Just like its future predecessor, Sai stablecoin was pegged to the US dollar, but only Ether could be used as collateral. The next big step for the protocol was made in November 2019 when a multi-collateral DAI as we now know it went live on-chain. 

The DAI stablecoin owns its name to the Chinese symbol 貸, meaning ‘to lend’ or ‘to provide capital for a loan’. In turn, the name MakerDAO was chosen as a reference to a global money-making market that the project originally intended to become.

How does MakerDAO work?

Maker Protocol is basically a massive decentralized application built on the Ethereum blockchain that allows anyone to lend or borrow the DAI stablecoin against various digital assets. Its main purpose is to bring stability into the cryptocurrency market by deploying the DAI stablecoin as a decentralized and unbiased cryptocurrency, pegged to the US dollar.

DAI was the first stablecoin to accept digital assets as collateral. Due to the high market volatility, it uses an overcollateralized model, allowing users to borrow DAI against other Ethereum-based assets monetizing in stablecoins roughly 66% of the provided collateral. The rate is set through a vote by the MakerDAO community and may vary depending on the asset. Still, such conditions are comfy for the majority of DeFi users as long as they can get a stable asset for their trading strategies and are not compelled to sell their holdings.

All collateral assets are locked into smart contracts known as Maker Vaults for the time of the loan. For each supported asset type, a separate vault needs to be created. When the vault is locked it generates a certain amount of DAI in return for the collateral and transfers it directly to the user. To withdraw the collateral the user needs to repay their debt along with a certain stability fee, which is always paid in DAI. The closing of a vault destroys all the DAI tokens being backed by it.

Maker Vaults are non-custodial, meaning the user interacts with them directly through smart contracts, while Maker Protocol itself doesn’t own any assets stored in its vaults. There is a certain flexibility in borrowing from MakerDAO. For instance, it is possible to retrieve part of the collateral by returning some amount of DAI. And vice versa, the vault’s owner can add more collateral whether to receive more stablecoins or as a preventive measure to avoid possible liquidation.

DAI was meant to substitute real-world money in digital space so it adopted all its functions. The stablecoin may be a store of value even in a highly volatile market, and it is widely used in transactions as a medium of exchange. Aside from being borrowed on Maker Protocol, DAI can be bought or sold on various exchanges, received as payment, and stored in a wallet.

How to use MakerDAO?

To interact with the MakerDAO app users need to have a web3 digital wallet MakerDAO supports. Such wallets are MetaMask, Coinbase, Trezor, Ledger, and many others. The frontend UI for the MakerDAO app is Oasis. When connecting to it with their wallets, users have to choose the vault corresponding to the cryptocurrency they want to use as collateral for minting DAI. Transactions need to be confirmed through the wallet before being completed.

Users also have access to a Flash Mint Module, which represents a smart contract that can mint DAI up to a limit set by the project’s governance as long as they pay it all back in the same transaction with some fees. MakerDAO can be used for arbitrage trading through the DeFi space with no upfront capital.

Nevertheless, Maker Protocol is not limited to lending and borrowing services. The platform also has a built-in staking feature for DAI holders called the DAI Savings Rate (DSR). It is an Ethereum smart contract that allows users to earn interest on the deposited DAI.

An upgraded version of Maker Protocol Multi-collateral DAI initially supported ETH and BAT tokens. Since its launch, this list was remarkably extended as MKR holders have the power to propose and vote on new types of digital assets supported by the protocol.

The DAI and MKR tokens

MakerDAO employs a two-token model to keep the protocol stable. DAI is a decentralized stablecoin using Ethereum’s ERC20 token standard. The protocol’s second token, MKR, was introduced to leverage the value of DAI circulating and to control the liquidity of the whole network. While the price of DAI is always pegged to the US dollar, MKR’s value is volatile and changes through time. 

MKR is mainly used as a governance token. MakerDAO uses a system of scientific governance under which all important issues related to the protocol are resolved among MKR holders via Executive Voting and Governance Polling. Users can lock a certain amount of tokens in vote contracts to have a say in community decisions. That may be a proposal to support new assets on Maker, or changing liquidation rates for some tokens. Each MKR token locked equals one vote.

Is MakerDAO safe?

All DAI transactions are completely transparent and publicly visible on the Ethereum blockchain. This leaves users with a reliable system where any DAI token in circulation is always backed by excess collateral. But what if the market’s turbulence would cause a significant drop in the value of collateral assets? In such unfortunate cases, the game gets risky and the liquidation process comes along. 

Each vault has the required minimum level of collateral value, known as the Liquidation Ratio, which may vary depending on the asset in question. Under a liquidation process, a certain amount of collateral is being sold from auction to cover the debt with accrued stability fee as well as to pay the liquidation penalty. This penalty is paid in DAI by a vault’s owner.

There is an even more substantial risk for MKR holders that appears when the total collateral amount is not sufficient to cover the price of DAI in circulation. In such cases, MKR tokens are minted and sold to cover the deficit and stabilize the protocol by reducing the MKR value. Thus, the safety of MakerDAO is fully placed on the shoulders of MKR holders, who are in charge of the protocol and motivated to avoid such drawbacks.

In July 2021, Rune Christensen announced that the Maker Protocol has become fully decentralized. It means that full control of the protocol and the MakerDAO team is now in the hands of the MakerDAO Community. The Maker Foundation, created in June 2018 to facilitate the development and future evolution of the protocol, will slowly dissolve after successfully completing its mission. Rune Christensen promised that he will step away from being the CEO of the Maker Foundation to once again become an independent MakerDAO community member.

With the announced dissolution of the Maker Foundation, there is still one legal entity left involved in the protocol’s well-being - the DAI Foundation, a stand-alone Denmark-based organization created to manage things that can’t be decentralized by the means of technology. The DAI Foundation is not involved in the governance of Maker Protocol as it serves solely as a guardian for the project’s intellectual property, such as trademarks and open-source copyrights.

Partners 

There are over 400 projects in the Maker DAO ecosystem. Most of them are small useful tools created by the community, while some are crucial to use MakerDAO.

There are a number of interfaces created for users to access the Maker Protocol and borrow DAI including Maker-native Oasis Borrow, as well as side platforms like AAVE, Compound, DDEX, DeFi Saver, and dYdX. One may use some of the independent interfaces built by the community such as Instadapp, Zerion, or MyEtherWallet.

DAIStats service tool lets anyone monitor the network and see what’s going on on MakerDAO. Another useful tool, MakerBurn, helps to watch the system’s surplus and the burnings of MKR tokens.

As long as DAI is an ERC-20 token, it can be held in any Ethereum-supporting wallets, such as Anchorage, Coinbase Custody, Ledger, MetaMask, MyCrypto, or Trezor.

In July 2021, MakerDAO Protocol launched the official DAI token bridge on Optimism. The solution runs smart contracts using the Optimistic Virtual Machine (OVM). The idea of a bridge is to aggregate many transactions in a rollup block. When published in bundles on the L1, transactions receive scaling thus cutting fees for users. It is possible to instantly deposit DAI to L2 Optimism, but the withdrawal prevails by a 1-week wait period.

What's next?

According to the MakerDAO community forum, the developers are currently focused on implementing a multichain strategy, working to bring DAI to the Ethereum L2 solutions. Since the official DAI token bridge was launched on Optimism, Maker is also considering integrating with Arbitrum in a similar way, while working with Starkware and zkSync to bring DAI on these chains. Polygon, Klaytn, Avalanche, and Binance Smart Chain (BSC) are among other networks MakerDAO is looking to expand on while struggling with the lower security issue.

Links

https://docs.makerdao.com/

Author:

Kate Stormina

Last updated: Aug 21, 2023