Key Takeaways
- Stablecoins address cryptocurrency volatility by pegging to stable assets like the US dollar.
- Early stablecoins (e.g., Tether/USDT) were centralized and backed by company reserves.
- Decentralized models like DAI and Terra emerged to create a decentralized financial system.
- DAI uses crypto over-collateralization, where users lock assets like ETH to mint new DAI.
- MakerDAO governs DAI through decentralized community voting.
Introduction
Cryptocurrencies introduced revolutionary possibilities but also brought price volatility. Stablecoins solve this by pegging their value to stable assets like the US dollar. Early stablecoins like Tether (USDT) relied on centralized reserves, but the push for decentralization led to algorithmic models like Terra (now defunct) and DAI. This article explores DAI’s origins, mechanics, and unique features.
What Is the Cryptocurrency DAI?
DAI was launched in December 2017 by MakerDAO, founded in 2014 by Rune Christensen. Unlike fiat-backed stablecoins, DAI employs crypto over-collateralization: users lock cryptocurrencies (e.g., ETH) in smart contracts to mint DAI. The minted amount depends on the collateral’s value and a predefined over-collateralization ratio (e.g., 125%), ensuring a buffer against price swings.
Governed by MakerDAO’s decentralized autonomous organization (DAO), DAI’s stability relies on community-driven decisions, such as adjusting risk parameters or adding collateral types.
How Does DAI Work?
DAI maintains a soft peg to the US dollar through:
- Collateralized Debt Positions (CDPs): Users deposit crypto (e.g., ETH) into smart contracts to mint DAI, up to a loan-to-value (LTV) ratio.
Stability Mechanisms:
- Decentralized Oracles: Provide real-time price data.
- Target Rate Feedback Mechanism (TRFM): Adjusts fees to incentivize arbitrage when DAI deviates from $1.
What Gives DAI Value?
DAI is over-collateralized by ~25%, with backing assets including:
- Stablecoins (USDC, USDP).
- Cryptocurrencies (WBTC, ETH).
Total collateral: $8.52B (vs. DAI supply: 6.78B).
Collateralized Debt Positions (CDPs)
CDPs are smart contracts where users lock crypto to mint DAI. Key features:
- LTV Ratio: Ensures collateral exceeds borrowed DAI.
- Dynamic Supply Control: Adjusts DAI supply to maintain the peg.
Stability Fee
An annualized fee on outstanding DAI debt, adjusted to stabilize the peg:
- Increases if DAI trades below $1 (reducing supply).
- Decreases if DAI trades above $1 (encouraging minting).
DAI Savings Rate (DSR)
Users earn interest by locking DAI in MakerDAO’s contract:
- Funded by Stability Fees.
- Enhanced DSR (EDSR): Temporary boosted rate during growth phases.
What Makes DAI Unique?
- Decentralization: No single entity controls reserves.
- DeFi Integration: Widely used in lending, borrowing, and trading protocols.
- Transparency: All transactions are verifiable on-chain.
DAI vs. USDC: Stablecoins Compared
| Feature | DAI | USDC |
|--------------|-----------------------------|----------------------------|
| Backing | Crypto over-collateralization | Fiat reserves |
| Control | Decentralized (MakerDAO) | Centralized (Circle) |
| Regulation| Algorithmic | Compliant with financial laws |
Pros of DAI:
- Decentralized, transparent, and interoperable with DeFi.
- Earns interest via DSR.
Cons of DAI:
- Exposure to crypto volatility.
- Complex governance for beginners.
DAI and the USDC Depeg Event
In March 2023, DAI briefly fell to $0.88 after USDC (a backing asset) depegged. MakerDAO responded by:
- Automatically adjusting fees to reduce DAI circulation.
- Voting in May 2024 to retain USDC as a primary reserve.
👉 Learn more about stablecoin depegging
FAQ
Is DAI backed by fiat currency?
No. DAI is backed by crypto assets (e.g., ETH) and stablecoins like USDC.
How many DAI tokens are in circulation?
~4.78B (as of writing).
Is DAI equal to USD?
DAI aims to maintain a $1 peg but may fluctuate slightly.
Is DAI safe?
Yes, due to over-collateralization and decentralized governance.
👉 Explore DAI’s latest updates
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