What is Maker (MKR) and DAI

Maker (MKR) is a smart contract platform that has also released the DAI, which is a stablecoin substitute for Tether. Maker is both decentralized and trustless and its smart contracts and platform are used to ensure the value of DAI remains stable and pegged to the U.S. dollar. It accomplishes this through market mechanisms and economic incentives.

The Maker stablecoin is fully visible on the Ethereum blockchain and presents users with a transparent stablecoin that does away with the need for third-party audits and centralized organizations.

Maker Review: The Maker Dual Coin System

The Maker platform is somewhat unique in its use of two coins, Makercoin (MKR) and Dai (DAI).

Maker (MKR) is used to govern the Maker platform, and it has a volatile price which is determined by market supply and demand. DAI is a stablecoin, with its value tied to the U.S. dollar, and it is suitable for making payments or as a collateral or savings instrument.

DAI Compared with Tether

The most used stablecoin is Tether, but there have been questions regarding the bank reserves being held by Tether, which has increased the need for a transparent stablecoin such as DAI. The two stablecoins have some similarities, but also some striking differences.

Similarities

  • Pegged – Both are soft-pegged to the U.S. dollar in a 1:1 ratio;
  • Asset Type – Both are collateral-backed assets;
  • Mineability – Neither coin is mineable.

Differences

  • Collateral Asset – While Tether is backed by fiat U.S. dollars held in bank reserves, DAI is backed by overcollateralized Ethereum smart contracts.
  • Price Stabilization – The stability of Tether comes from the stated ability to exchange Tether for U.S. dollars at a ratio of 1:1. DAI gets its price stability from external market factors like collateralized debt positions  and external economic incentives.
  • Blockchain – Tether is a Bitcoin based coin, while Dai is an Ethereum based coin.
  • Decentralization – Tether is essentially centralized as it can only be created or destroyed by the Tether Limited company. In contrast, Dai is decentralized since Dai can only be created and destroyed by individual users.

Why We Need Stablecoins

Users have quickly learned that cryptocurrencies in general are not suitable as a means of payment or for use as collateral due to their incredible volatility. In order to overcome this volatility, and to avoid the need to constantly switch from cryptocurrencies to fiat currencies stablecoins were born. With stablecoins traders and investors can avoid the volatility of cryptocurrencies and remain close to the market.

DAI Use-Cases

The Maker team has identified four solid use cases for Dai:

  1. Gambling Markets – Gaming and gambling are huge global markets, but using volatile cryptocurrencies to make bets simply doesn’t make sense. If volatile cryptocurrencies are used in gambling, the gambler is exposed to currency risk as well as the risk of the bet itself. By using a stablecoin such as Dai a gambler isolates the risk to only the bet risk.
  2. Financial Markets – The financial sector requires a stable asset for use as collateral in derivative smart contracts. In addition, the collateralized debt positions that Maker uses offer permissionless decentralized trading leverage.
  3. International Trade – Another attractive feature of stablecoins such as DAI is the ability to mitigate foreign exchange volatility and costs by removing middlemen from the transaction process.
  4. Transparent Accounting Systems – The use of a transparent accounting system means corporations, governments and other organizations can increase their efficiency and lower the chance of theft and corruption.

MKR Functions

The MKR coin has three essential functions on the Maker platform:

  1. Utility Token: Any of the fees that accrue from the CDPs that generate DAI can only be paid for with MKR. When these fees are paid for the MKR is burned or destroyed, which means MKR supply will steadily decrease as DAI is generated. This means as the demand for DAI increases, the demand for MKR should also increase, sending its price higher.
  2. Governance Token: Those holding MKR coins are able to participate in the voting process that governs risk management and logistics in the Maker system. This voting is done via a mechanism called continuous approval voting.In continuous approval voting, every holder of MKR can use their holdings to vote for any of the proposals submitted. Each MKR holder is also able to submit their own new proposals. In addition to casting votes at any time on proposals, users are also able to withdraw votes at any time. Those proposals with the most votes become the “top proposal” and can then be implemented as changes to the system. Because bad governance will dilute the value of MKR tokens, the interest of voters should remain aligned with the interests of the entire system.
  3. Recapitalization Resource: In the event that some part of the collateral portfolio becomes under-collateralized the Maker system will automatically create more MKR and sell them on the open market. This effectively raises capital instantaneously to address the under-collateralized portfolio and returns the Maker system to solvency.

How the Maker System Works

The first task a user must perform when interacting with the Maker platform is to create a collateralized debt position. This requires the user to leverage his or her Ethereum by creating one of Maker’s unique smart contracts called Collateralized Debt Positions (CDPs). This creates DAI, which the user is free to use. The DAI also generates interest over time, which is known as the Stability Fee.

Currently, the Maker platform will only accepted Pooled Ether (PETH) as a collateral type for CDPs. This means users must first exchange their ETH for PETH before creating a CDP.

The Four Stages of the CDP:

  1. Creating the CDP. The user first sends their PETH to collateralize a CDP.
  2. Generating Dai. The user can then specify how much DAI is required from the CDP. As the DAI is paid out an equivalent amount of PETH is locked away in the smart contract. The PETH remains locked away like this until the DAI debt is paid off.
  3. Debt Reconciliation. In addition to paying off the DAI debt, the user must also pay off the Stability Fee that acts as interest on the debt. While the outstanding debt must be paid back in DAI, the Stability Fee must be paid off in MKR.
  4. Withdrawing Collateral. Once the debt and Stability Fee have been paid in full the user can recover their PETH collateral by sending a transaction to Maker.

CDP Risk Parameters

CDPs have four key risk parameters and the value of these are voted on and arrived at by MKR holders to maintain the stability of the Maker platform. They are as follows:

  1. Debt Ceiling – This is the maximum amount of debt that can be created by a single type of CDP.
  2. Liquidation Ratio – Collateral-to-debt ratio at which a CDP becomes vulnerable to liquidation.
  3. Stability Fee –  Additional fee calculated as an annual percentage yield on top of the CDP’s outlying debt. Payable in MKR.
  4. Penalty Ratio – Ratio for the maximum amount of Dai that can be raised from a liquidation event.

Price Stability Mechanisms

The Maker Stablecoin System uses external market factors and economic incentives to peg Dai to the value of a dollar.

The Target Price of DAI

The target price has two primary functions on the Maker platform:

  1. Calculate the collateral-to-debt ratio of a CDP;
  2. Determine the value of collateral assets in a case of a global settlement.

Target Rate Feedback Mechanism

It is possible to automate the Target Rate Feedback Mechanism (TRFM) if markets become extremely unstable. If this occurs the DAI stablecoin system will adjust the Target Rate in sucha manner that the market price of Dai will also stabilize near the Target Price.

The downside is that activating the TRFM breaks the peg to the U.S. dollar, but it is still desirable because it provides an incentive for market participants to keep DAI at the Target Price.

Market Price Below Target Price

If the market price of DAI drops below the Target Price the TFRM increases the Target Rate. This effectively makes it more expensive to create DAI. It also increases the capital gains from holding DAI. By increasing the capital gains, the demand for DAI is also increased.

This means that an increased Target Rate will reduce the supply of DAI while at the same time increasing demand for DAI. Basic economic theory tells us that this should act to increase the market price of DAI back towards the Target Price.

Market Price Above Target Price

If the market price of DAI climbs above the Target Price the TFRM acts to decrease the Target Rate. This has the opposite impact as raising the Target Rate. So, DAI generation become less expensive, and capital gains from hold DAI decrease.

So, a decrease in the target rate increases the supply of DAI while also decreasing demand for DAI. Basic economic theory specifies this should result in a lower market price for DAI until it reaches the Target Price.

Global Settlement

As a last resort, the global settlement option shuts down the entire Maker system in the event of a dire emergency. This is meant to ensure that all of the users on the platform receive the net value of the assets they own.

To invoke global settlement, MKR voters will vote on the situation to determine if global settlement is necessary. Some events that could lead to global settlement include system upgrades, a security breach, or long-term irrationality in markets.

Risks to the Maker Platform

Maker is not a perfect system and acknowledges that there are some risk factors in the implementation of its platform. In addition, it has come up with some actions that can help to mitigate these risk factors if they become an issue.

Below are the five top risk factors to the Maker platform:

  1. Malicious hacking attack – This is always a concern in cryptocurrencies, and if the smart contracts on the Maker platform have any vulnerabilities a hacker could steal the collateral being held in Collateralized Debt Positions.
  2. Black Swan event – An unexpected crash in Ethereum could cause a similar crash in the Maker system where it would be impossible to maintain price controls on system assets.
  3. Competition – Making DAI completely decentralized has also introduced a degree of complexity to the stablecoin system. It’s possible that the market could ignore DAI in favor of a simpler stablecoin, even if that means accepting centralization.
  4. Irrational Markets – It’s possible for Maker users to lose confidence in the system over time if a prolonged period of market irrationality occurs.
  5. Maker Team Failure – Always a concern with any platform, the Maker team acknowledges that human error is always a risk factor that could result in adverse outcomes.

DAI and MKR Price History

DAI is soft-pegged to the U.S. dollar, so its value remains close to $1, moving back and forth over that level, but rarely straying from the range of $0.99 to $1.01. To generate DAI you need PETH as well as an Ethereum browser such as MetaMask and the Dai platform.

The earliest price listed for MKR on Coinmarketcap.com is $252.48 on November 20, 2017. The highest price was $1,773.92 recorded on January 18, 2018. As of late October 2018 MKR is trading at $691.10 after hitting a 2018 low of $291.36 on September 12.

MKR had many private offerings and was previously sold publically in a forum, but has since moved to the decentralized OpenLedger platform. The largest marketplace for MKR is the decentralized OasisDex exchange, which must be accessed through an Ethereum browser. You can also purchase MKR from OKEx, Ethfiniex, the Bancor Network and several other smaller exchanges.

Because both MKR and DAI are Ethereum tokens they can both be stored in an ERC-20 compatible wallet such as MetaMask or MyEtherWallet. For better security a hardware wallet should be used for storage.

The Maker Team

Maker was founded over three years ago and has rapidly grown from a small team to a major project with over 60 global members. The CEO and founder of Maker is Rune Christensen, a young Danish entrepreneur who has been leading Maker since its beginnings. The CTO of the company is Andy Melenius, who was previously with Amazon Web Services. The President and COO of Maker is Steven Becker, a South African with extensive experience in finance, derivatives, alternative investments and risk management.

Maker Review: Conclusion

With the integrity of Tether in question, DAI could be the next great stablecoin. And don’t forget about MKR, which has been a very good investment over time, especially when picked up on the dips. There is a lot of belief behind the Maker team, and it shouldn’t be surprising given the team’s success in creating a fully transparent stablecoin that is fully decentralized and trustless. This is one project that has a very good probability of being around for a long time, and providing benefits to the entire blockchain ecosystem.

Maker Rating: 3.5 - Review by

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