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What is MakerDAO and How Does DAI Work?

MakerDAO is exactly what it sounds like –it’s a DAO, a decentralized autonomous organization and its purpose is to make DAI. DAI is a digital dollar backed by locked up cryptoassets like ETH, BAT, WBTC, KNC, and more.

What Maker figured out years ahead of the explosive rise of DeFi is that a stablecoin could be established by incentivizing locking up value in what was once called a CDP (collateralized debt position). Today CDPs are called Vaults.

Say I own ETH and I believe the value of ETH will continue to rise over time. I don’t want to sell ETH because I believe ETH is a store-of-value, like BTC or gold. If I can borrow against the value of ETH in DAI, then I can have the best of both worlds– remain exposed to the upside of ETH long term while spending less of that value in the short term with DAI. While I’ve minted or borrowed that DAI, I pay an interest rate, just like you would borrowing from a bank, but it’s all automated by the code in Maker.

In MakerDAO, you can deposit and lock up your ETH as well as other popular liquid cryptoassets, and in exchange you can borrow up to 66% of every dollar you deposit. This means if you deposit $100 of ETH, you can borrow up to 66 DAI, but the code ensures I keep my word of maintaining that loan or else I will get liquidated by Maker. If I don’t hold up my end of the bargain, my ETH gets auctioned to others in the Maker community willing to buy my ETH so that Maker can remain solvent and pay back my owed debt.

The key takeaway: MakerDAO remains one of the most successful DeFi projects built on Ethereum with over $7.1 billion in TVL while more than 2 billion DAI have been minted to date (February 2021).

Despite the volatile markets over the last few years including a 95% drawdown in the price of ETH from all-time highs, DAI’s peg to the US dollar held, a testament to some of the best incentive design in the DeFi game.

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