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DAI is a decentralized stablecoin that facilitates lending, borrowing, and investing in decentralized applications (dApps).
The cryptocurrency market has a reputation for being highly volatile. For example, some of the most significant cryptocurrency tokens, such as Bitcoin or Ethereum, surge and plummet daily. These spikes often bring traders huge ROI or crippling debt.
Nevertheless, not all cryptocurrencies experience this level of volatility. For instance, stablecoins rarely experience massive oscillations. Instead, their values remain constant with their pegged counterparts, which are often fiat currencies.
DAI is one such cryptocurrency token, and it is pegged to the US Dollar. Therefore, 1 DAI is and always aims to remain $1. In this short guide to DAI, we look at how this crypto work and its benefits for investors.
What Is DAI?
DAI is one of the first fully decentralized and collateral-backed, stable cryptocurrencies. Its developers built it on the Ethereum blockchain under the ERC-2o standard. Most importantly, its goal is to maintain a 1:1 stable value to USD. And, it manages to do so by locking other crypto assets in smart contracts.
It’s worth noting that some stablecoins are under the control of central authorities. Conversely, DAI has a decentralized nature as the native token of the Maker Protocol. This allows it to use smart contracts that run on the Ethereum blockchain network without central control.
Another of DAI’s unique features is that it doesn’t use a company’s reserves as collateral for its circulating supply. For instance, some stablecoins, such as Tether, claim to have 1 USD for every USDT in circulation. However, this token uses collateralized debt in Ether (ETH) to provide backing for each of its tokens in the market.
The Maker Protocol enables borrowers to lock ETH and other crypto-assets by leveraging smart contracts on Ethereum. This way, they collateralize it, which generates new DAI tokens as loans.
Stablecoins like DAI offer traders a powerful tool when it comes to avoiding the volatility of cryptocurrencies. For example, when a trader moves the token’s value, they reduce their risk of exposure to volatility. On the other hand, their portfolio is in danger if a drop occurs in the prices of BTC or ETH.
DAI can also remove transaction costs and delays that occur within the cryptocurrency market when using fiat currencies. Additionally, this token offers users the ability to access loans for only a small, additional fee.
A Very Brief History of DAI
Rune Christensen launched the Maker Foundation in 2014. The Maker Protocol is an open-source project aiming to become a decentralized alternative to centralized stablecoin protocols.
In 2017, the developers launched DAI on the Maker Protocol. Also, they designed it as a method through which businesses and individuals could access non-volatile, stable, and secure lending.
Who and How Generates New DAI?
The platform generates new DAI whenever someone takes out a loan on MakerDAO. Conversely, the protocol burns it when the borrower pays back the loan.
MakerDAO uses ETH as collateral for DAI. In return, this enables Ether holders to create new tokens within the MakerDAO decentralized application (dApp). Users can achieve this by sending Ether to a collateralized debt position (CDP). As a result, they receive a portion of the token’s supply.
Essentially, a CDP is a smart contract that runs on the blockchain. Also, the Collateralized Debt Position (CDP) has been in development since 2014 by MakerDAO. Furthermore, it offers an alternative to high crypto volatility.
Users can provide ETH to receive DAI. Next, they have to repay their loans if they wish to get back their Ether. This way, DAI becomes a loan against Ethereum and not against USD.
However, the process doesn’t stop here. For instance, ETH holdings need to become WETH (Wrapped Ethereum). This way, WETH becomes part of the Ethereum pool, which becomes collateral for all issued DAI tokens.
The CPD ratio continues to increase until it reaches a specific limit. That threshold represents the maximum DAI available for withdrawal. However, because cryptocurrencies can be volatile, DAI can sometimes become over-collateralized to prevent liquidation.
This leads to the supply of DAI depending on the demand for the token. For example, when a user deposits ETH as collateral, the platform creates new tokens for the loan. As a result, this increases the asset’s supply.
Lastly, MakerDAO uses smart contracts to keep DAI’s price in check. For instance, if the token’s price gets too high or too low, the protocol automatically burns or generates new tokens.
DAI provides an alternative stable currency and a means of financial inclusion for people living in economically unstable locations. Additionally, DAI is transparent and permissionless. So, it ensures that users have greater access to their funds. Using DAI is fast and cheap, allowing users to transact globally from one wallet to another.
Through DAI and Ethereum, transactions can occur at any time of the day, on any day of the year. Additionally, the MakerDAO system has conducted consistent audits and ensures a high level of security on its platform. This means that developers verify smart contracts and underlying protocol mechanisms. Most importantly, this token has seen a lot of usage within decentralized finance (DeFi), bringing stability to projects.