As the fallout from the Terra collapse continues, the worst losses have come from CeFi players using and marketing defi (e.g. Celsius, Voyager, Vauld, Blockfi). DeFi players have largely held up amid this turmoil so today, we’re throwing back to one of the oldest DeFi projects - Maker and its stablecoin DAI.
The Maker protocol was originally started in 2014, it launched DAI (a decentralized stablecoin softly pegged 1:1 to USD) in 2017 and upgraded to be multi-collateral (multiple cryptocurrencies can be collateral) in 2019.
Why does this exist?
In its whitepaper, they argue while Bitcoin is successful as a cryptocurrency for many reasons, its highly volatile nature makes it a bad medium for exchange (i.e. paying for anything is hard when if the price changes constantly). Thus, DAI was born to be a stablecoin functioning like a digital dollar - being both a store of value and a medium of exchange
Originally, DAI could only be generated by overcollateralizing with ETH (i.e. to receive $1 worth of DAI $1.5 worth of ETH needed to be locked up). Today, MakerDAO has chosen to accept more ERC-20 tokens as collateral including WBTC, USDC, LINK, etc.
How does it work?
To generate DAI, a user puts collateral into a vault (smart contract) and generates DAI in exchange for locking up the collateral. If the value of the collateral drops past a liquidation ratio (i.e. if I generated $1 worth of DAI and had < $1.5 worth of ETH locked up), the vault gets liquidated (it’s a bit more complicated than this but this is more or less right)
How does DAI maintain its peg?
DAI is complex, but to simplify, it largely maintains its peg through two mechanisms:
Changing the Dai Savings Rate (DSR) (this is essentially interest rate in normal monetary policy except instead of central banks deciding the rate, all MKR holders as part of MakerDAO decide the rate):
If 1 DAI is > $1, MKR holders can vote to decrease DSR → less demand for DAI, price should go down, if 1 DAI is < $1, MKR holders can vote to increase DSR → more demand for DAI, price should go up
Free market arbitrage (this is essentially money supply in normal monetary policy):
If DAI is > $1, vault owners are incentivized to mint more DAI and sell at this premium (collateral is exchanged for DAI), this increases the supply of DAI, price should go down, if 1 DAI is < $1, users are incentivized to buy DAI at the discount and pay down down collateral debt in vaults (DAI is exchanged for collateral), this decreases supply of DAI, price should go up
In a very self-aware move, a risk Maker admits to having is that it’s quite complicated and the average user may favor an easier to understand system. Having read this, would you agree?
Interesting bonus mechanism:
Emergency Shutdown: If MKR holders agree it’s all over for DAI, then the Emergency Shutdown process commences. Essentially, all collateral can be redeemed at the rate of 1 DAI equalling $1, and once it’s all gone, it’s gone. This would happen due to a serious emergency such as a horrendous security breach or black swan events like all collateral value going to zero.
Neither GC nor any of its advisory clients, including all GC-managed investment vehicles, holds any form of ownership or financial interest in the cryptocurrency or digital asset described in this post. GC has not performed any due diligence, research, analysis, or evaluation of the potential merits, if any, of this cryptocurrency or digital asset project and GC cannot verify any claims made by any promoter or supporter of the cryptocurrency or digital asset described. Nothing in this post should be seen as, nor is it intended to be, a recommendation or suggestion to invest in, purchase, sell, hold, trade, or participate in this or any cryptocurrency or digital asset project. GC in no way endorses or encourages anyone to circumvent or violate any applicable laws, rules, and regulations, including any applicable Anti-Money Laundering/Know-Your-Customer (AML/KYC) and related banking and financial regulations. (See Disclaimer below for further details.)
Disclaimer
Views expressed in “posts” (including podcasts, videos, newsletters, and social media) are those of the individual GC personnel quoted therein and are not the views of General Catalyst Group Management, LLC, “GC”) or its respective affiliates. GC is an investment adviser registered with the Securities and Exchange Commission. Registration as an investment adviser does not imply any special skill or training. The posts are not directed to any investors or potential investors, and do not constitute an offer to sell — or a solicitation of an offer to buy — any securities, cryptocurrencies, or any financial instrument or property, and may not be used or relied upon in evaluating the merits of any investment.
The contents in here — and available on any associated distribution platforms and any public GC online social media accounts, platforms, and sites (collectively, “content distribution outlets”) — should not be construed as or relied upon in any manner as investment, legal, tax, or other advice. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment. Any projections, estimates, forecasts, targets, prospects, or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Any charts or figures provided here or on GC content distribution outlets are for informational purposes only, and should not be relied upon when making any investment decision. Certain information contained in the content has been obtained from third-party sources. While taken from sources believed to be reliable, GC has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. In addition, posts may include third-party advertisements or links to websites not associated with GC in any way; GC has not reviewed such advertisements or websites and does not endorse any content contained therein. All content speaks only as of the date indicated and is subject to change at any time.
Under no circumstances should any posts or other information provided on this website — or on associated content distribution outlets — be construed as an offer soliciting the purchase or sale of any security or interest in any pooled investment vehicle sponsored, discussed, or mentioned by GC personnel. Nor should it be construed as an offer to provide investment advisory services; an offer to invest in an GC-managed pooled investment vehicle will be made separately and only by means of the confidential offering documents of the specific pooled investment vehicles — which should be read in their entirety, and only to those who, among other requirements, meet certain qualifications under federal securities laws. Such investors, defined as accredited investors and qualified purchasers, are generally deemed capable of evaluating the merits and risks of prospective investments and financial matters.
There can be no assurances that GC-managed investment vehicle’s objectives will be achieved or investment strategies will be successful. Any investment in a vehicle managed by GC involves a high degree of risk including the risk that the entire amount invested is lost. Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by GC and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by GC is available here: https://www.generalcatalyst.com/portfolio/. Past results of GC’s investments, pooled investment vehicles, or investment strategies are not necessarily indicative of future results. Excluded from this list are investments (and certain cryptocurrencies or digital assets) for which the issuer has not provided permission for GC to disclose publicly. GC has no special role in any of cryptocurrency or related projects or power over their management. To the extent any GC-managed investment vehicle has any form of ownership or financial interest in a cryptocurrency, digital asset, or related project, GC does not undertake to continue to have any involvement in these projects other than as an investor and token holder, or holder of a form of economic or ownership interest, or right to a future ownership interest, and other token holders should not expect that it will or rely on it to have any particular involvement.
For other GC site terms of use, please go to https://www.generalcatalyst.com/terms-of-use/. Additional important information about GC, including our Form ADV Part 2A Brochure, is available at the SEC’s website:
http://www.adviserinfo.sec.gov