DAI is a stablecoin whose rate is pegged to the US dollar. DAI is a representative of crypto-backed stablecoins. Thus, if fiat-backed stablecoins oblige the issuing company to hold a fiat amount equal to the issued stablecoins, then in the case of DAI, it is provided not with fiat funds but with cryptocurrency. Find out how it works in our article.
What Is DAI?
DAI is the brainchild of the MakerDAO DeFi project. Within MakerDAO, there is a specialized vault that allows users to lock cryptocurrency in order to get DAI. Locking occurs with a pre-set liquidation ratio. In simple words, if the liquidation ratio is 130%, then the user will need to deposit $130 to issue 100 DAI. As part of the protocol, the user can deposit any ERC-20 assets as collateral as part of the protocol. You may wonder why it is necessary to deposit a larger amount. The answer is, on the surface, cryptocurrencies are many times more volatile than fiat, so crypto-backed stablecoins have no choice but to be overcollateralized. Users are also forced to pay a Stability Fee in order to hedge the risks associated with volatility.
According to Data Stats, at the moment, DAI in circulation are overcollateralized by 160% with a variety of cryptocurrencies, of which the most significant are:
- 52% — USDC stablecoin;
- 23% — ETH;
- 25% — WBTC, USDP, and other cryptocurrencies.
How Can DAI Boost Your Income?
DAI is a great way to increase your capital. For example, if you have some amount of Ethereum and bet that the value of ETH will grow in the near future, then you will not really want to spend it. In return, you can deposit ETH as collateral and get DAI. Next, you can spend your DAI on anything or invest in potentially profitable coins (even in the same ETH). As a result, you are trading ETH with leverage: if its dollar price increases by 10%, your profit on the invested equity will be even greater (after all, you are partially investing as if “in debt”).
Why Don’t Use Fiat Collateral?
Another question is, “Why to complicate everything so much and not use fiat as collateral?”. It is because crypto-backed stablecoins are more decentralized and, therefore, more secure. The DAI stablecoin, according to all crypto canons, formally has no controlling legal entity — it is managed by MakerDAO, a decentralized autonomous organization of MKR tokens holders. The mechanism for linking the cost of 1DAI to $1 is built on smart contracts in the Ethereum network and is completely decentralized. The protocol uses two key indicators to adjust the DAI rate: the stability fee and the liquidation ratio. Let’s take a closer look.
How Does DAI Remain Stable?
MakerDAO, as the name implies, is a decentralized autonomous organization. The Maker Protocol manages the DAI issuance. Within the project framework, holders have the right to vote for an increase or decrease in the amount of the liquidation ratio and the amount of the stability fee. The size of these key indicators is regulated in order to manage the supply and demand of DAI and, therefore, to ensure a one-to-one peg to the US dollar. How it works, we will analyze in more detail:
- When the cost of one DAI token falls below $1, the protocol increases the amount of the stability fee, thereby encouraging users to return funds and burn DAI. As demand increases, the price rises to the required level.
- If the price of one DAI token exceeds $1, the protocol lowers the cost of the stability fee. This encourages users to lock their funds for the issuance of DAI. Thus, the supply increases — the price falls.
How To Get DAI?
A user can issue any number of DAI stablecoins by providing crypto collateral. Here’s how it works:
A user connects their wallet to the Maker platform and deposits an amount of collateral that must exceed the number of DAI issued. The user can choose the conditions by themselves, but the amount of the deposit is determined by the platform. For example, to get $100 in DAI tokens, you can deposit $200 in ETH cryptocurrency. This will reduce the risks from the fall in the rate of the collateral cryptocurrency. After that, the smart contract locks the cryptocurrency that the user has deposited, issues the specified amount of DAI, and sends it to the wallet. The user can use the funds in any way: trade them, add them to liquidity pools, issue loans or make deposits to DAI — there are no restrictions. If the user wants to return his assets, he needs to deposit the borrowed DAI tokens to unlock the crypto assets and return them to his wallet. After that, the returned DAI stablecoins are burned.
Important: If the collateral value falls and is approximately equal to the borrowed amount of DAI, then it is automatically liquidated, after which the users will no longer be able to unlock their funds. This is the main risk of issuing DAI stablecoins with the provision of volatile cryptocurrencies.
Store, receive, and send your DAI within the SimpleHold wallet to save you time and get the best experience in managing your crypto! It can be an extension within your favorite browser and also a mobile app on both platforms — iOS and Android.
What Can I Do With DAI?
Stablecoin can perform all the basic functions of money on the Internet:
- You can use DAI to make payments for goods or services, trade, or sell. DAI is a kind of digital analog of the dollar.
- You can use DAI to accumulate. DAI stablecoin is resistant to market fluctuations and almost does not depreciate over time.
- You can use DAI as means of deferred payment. For example, in Maker Vault, a deposit is repaid with the help of DAI, and a commission is paid.
- You can use DAI as a means of a value measure. This means that the price of any goods or services can be expressed in DAI, as in dollars or euros.