As the decentralized finance (DeFi) world grows, cryptocurrencies offer an alternative to traditional financial systems. Yet, one persistent challenge remains—crypto market volatility, where prices can swing wildly in minutes. This is where stablecoins, such as DAI, make a difference. DAI, pegged to the US dollar, provides a stable alternative to traditional currencies in DeFi. This guide dives into what DAI is, how it works, and why it stands out in the crypto space.

About MakerDAO

The Maker Protocol, a decentralized system on the Ethereum blockchain, allows users to create a stablecoin called DAI. DAI is pegged to the US dollar and is backed by various collateral assets, which are approved by the Maker community through a governance process. This community-driven approach ensures that DAI remains stable and transparent.

MakerDAO, the organization behind the Maker Protocol, is a decentralized autonomous organization (DAO) governed by MKR token holders. These token holders have the power to vote on key decisions that affect the protocol, such as the types of collateral accepted and the fees charged.

The Maker Foundation, a separate entity, initially built and launched the Maker Protocol. However, it is transitioning towards a fully decentralized model, with the DAI Foundation playing a role in safeguarding the community’s intangible assets. This collaborative effort aims to ensure the long-term stability and success of the Maker Protocol and DAI.

Source: MakerDAO | An Unbiased Global Financial System

What is DAI Stablecoin?

Definition and Characteristics
DAI is an Ethereum-based stablecoin created by MakerDAO that maintains a 1:1 peg with the US dollar, designed to shield investors from typical crypto volatility. It’s a “decentralized” stablecoin, meaning its issuance and price stability aren’t controlled by a central entity but managed through smart contracts and collateralized assets.

History and Development
MakerDAO launched DAI on Ethereum in 2017. Initially, DAI was backed solely by Ether (ETH), but as of 2019, it became multi-collateralized, supporting additional assets like BAT (Basic Attention Token) and WBTC (Wrapped Bitcoin). This approach allows DAI to maintain its stability through diverse collateral sources.

How Does DAI Stablecoin Maintain Its Peg?

Collateralized Debt Positions (CDPs)
DAI’s peg is maintained by a unique model called Collateralized Debt Positions (CDPs). Users deposit assets like ETH into a smart contract, creating a “vault.” This collateral backs the DAI they borrow, with over-collateralization ensuring stability even when markets fluctuate.

Smart Contracts and Stability Mechanisms
Smart contracts handle liquidations if the collateral value drops, thus preventing significant devaluation of DAI. This automatic liquidation stabilizes the ecosystem by ensuring collateral is always sufficient to cover DAI in circulation.

Role of MKR Token Holders
Governance of DAI is led by MKR token holders. These individuals vote on parameters like the “DAI Savings Rate,” which impacts DAI’s demand, and help maintain the peg by ensuring that the system’s mechanics function effectively.

A realtime chart of DAI on CoinMarketCap.

The Benefits and Use Cases of DAI

Use in Decentralized Finance (DeFi)
DAI powers DeFi applications, facilitating lending, borrowing, and trading. Platforms like Aave and Compound integrate DAI for their services, making it a staple for DeFi enthusiasts. It also allows for yield farming and other decentralized investment opportunities.

Global Financial Inclusion
DAI opens financial access for individuals in countries with unstable fiat currencies by providing a stable, accessible store of value. Its decentralized nature allows people to participate in a stable economy independent of traditional financial institutions.

Payments and Transactions
Due to low volatility and transaction fees, DAI has become popular for everyday transactions. It’s accepted on centralized and decentralized platforms, making it a flexible option for those looking to use crypto in daily payments.

Risks and Challenges of Using DAI Stablecoin

Volatility of Collateral Assets
DAI’s stability relies on the volatility of its collateral assets, like ETH and WBTC. A drop in these assets’ values could lead to liquidation events, impacting DAI’s peg. Over-collateralization, however, helps mitigate this risk by requiring more collateral than the loan value.

System Complexity
New users may find DAI challenging to understand due to the intricacies of CDPs and other mechanisms. Managing a CDP requires knowledge of over-collateralization ratios and risks of liquidation, which could be a barrier for entry.

Systemic Risks and Governance
Since MKR token holders govern DAI, there’s potential for governance-related risks. A poor decision or governance failure could affect DAI’s stability, which underscores the importance of decentralized and transparent decision-making.

How to Acquire and Use DAI

Purchasing on Exchanges
DAI can be bought on major exchanges like Binance, Coinbase, and Kraken, as well as on decentralized exchanges (DEXs) like Uniswap. This broad availability makes it accessible for both new and experienced users.

Creating DAI Through Collateralization
Users can generate DAI by locking assets in a Maker Vault. This process allows users to mint new DAI against their collateral, provided they meet the necessary collateralization ratios.

Storing DAI
DAI can be stored in various wallets, such as MetaMask and Trust Wallet, which are compatible with Ethereum. For added security, users may also store DAI in cold wallets like Ledger or Trezor.

Comparing DAI with Other Stablecoins

DAI vs. Centralized Stablecoins (USDT, USDC)
Unlike centralized stablecoins such as USDT and USDC, which are fiat-backed and controlled by a single issuer, DAI’s value is maintained through a decentralized system of collateralization and smart contracts, offering transparency and autonomy.

DAI vs. Algorithmic Stablecoins (e.g., USDT)
DAI’s model differs from algorithmic stablecoins, which rely on algorithms rather than collateral for stability. DAI’s collateralized model generally provides more resilience in volatile markets, as evidenced by its stability over time.

Future of DAI and MakerDAO

Planned Upgrades and Expansions
MakerDAO continually improves the DAI system, including adding new types of collateral and expanding its ecosystem in DeFi. These upgrades aim to make DAI more resilient and accessible in both emerging and developed markets.

Global Adoption and DeFi Integration
DAI’s role in DeFi is expected to grow as the industry matures. Its potential to drive financial inclusion and be a stable asset in volatile economies highlights its lasting value and potential for adoption across borders.

As a crypto-collateralized stablecoin, Dai is collateralized with Ether. Any Ether holder can create Dai using MakerDAO DApp.

Visit: What is Dai (DAI) Stablecoin Cryptocurrency?

Conclusion

DAI has proven itself as a dependable, decentralized stablecoin in the crypto world. With its innovative collateral-backed model and governance by MKR holders, DAI remains a powerful asset within DeFi, accessible to users globally. As more people seek stable, decentralized alternatives to traditional finance, DAI’s utility is likely to expand, reinforcing its role in the future of Web3 finance.