Dai

What Is DAI?

Dai (ticker: DAI) is a decentralized stablecoin. Like other stablecoins, it offers stability in a volatile crypto market. At the same time, it has the advantage of decentralization, which many other stablecoins, like the USDT) do not.

The initial release of DAI was in December 2017. Since then, it has become one of the most popular cryptocurrencies in the world.

Who Created DAI?

The creator of DAI is MakerDAO, a decentralized governance system that includes holders of Maker, or MKR. MKR is the governance token for DAI, which means that people who hold MKR in their wallets get to vote on the future of the DAI project.

DAO is a general abbreviation that stands for Decentralized Autonomous Organization.

So, who created MakerDAO? Rune Christensen, a Danish entrepreneur, first started MakerDAO in 2014. However, it took several more years until MakerDAO released the DAI token.

Dai is on the Ethereum blockchain. Its founders wanted to create a stablecoin that is entirely decentralized, not relying on any specific organization to set its price and ensure it remains stable. Therefore, Dai uses a unique algorithm system to maintain its worth.

How Does DAI Work?

The price of DAI is closely related to the cost of the USD. In other words, one DAI will always be around $1, give or take. However, unlike other stablecoins like the USDT and USDC, its price can fluctuate because it doesn’t use actual dollars in its reserves to ensure its price remains the same as the USD.

Instead, DAI uses a complex algorithm that aims to keep its price around a dollar. It does that by providing loans to people who want to borrow DAI. You can borrow DAI and spend it at merchants who accept DAI or use your borrowed DAI to buy other cryptocurrencies.

Either way, you will need to provide collateral for your loan. Dai initially accepted only Ethereum as collateral, but you can now provide other cryptocurrencies as collateral as well. These collateral tokens are what back the DAI.

Because Ethereum and other cryptocurrencies can fluctuate in price, you will need to provide a more considerable amount than what you’re taking out. The minimum collateral is 1.5x what you’re borrowing.

In other words, if you borrow $100 worth of DAI (100 DAI tokens), you’ll need to provide $150 in Ethereum as collateral. However, if the price of Ethereum drops and your collateral is worth less than 1.5x what you borrowed, the system will automatically sell your collateral.

Therefore, you should put more significant amounts as collateral, such as 2x or even 3x your loan, to ensure you can get it back later.

That’s only half of the story. While you now understand what the DAI ecosystem uses to back its tokens, how does it ensure the price remains the same as the USD? It does that by using a complex algorithm that regulates the amount of interest borrowers must pay.

In addition to providing collateral, borrowers of DAI must pay yearly interest until they pay back their loans in full. This interest goes into a surplus reserve. The interest rate fluctuates, though.

When there are many DAI tokens in circulation (a lot of people have borrowed DAI), there is the possibility that the price of DAI will drop and lose parity with the dollar. That’s because when supply is up, demand goes down, leading to a price reduction. Therefore, when the cost of DAI goes down to less than a dollar, the ecosystem automatically raises interest rates.

With interest rates increasing, more borrowers will start returning their DAI tokens to avoid paying extra interest. When they return their DAI, the system will burn those DAI tokens and remove them from circulation.

The flip side is true as well. When the price of DAI increases to more than a dollar, the system will lower interest rates, so more people borrow DAI. With an increased supply, the price will drop to a dollar again. Thus, the system avoids price disparity.

There’s much more to DAI than that, but that’s the basic explanation of how it works. You can explore more of the protocol by reading the whitepaper.

What Is the DAI Coin Used For?

Because DAI is a stablecoin, it’s an attractive option for merchants looking to accept cryptocurrencies. You can use DAI to purchase products online or send money to family and friends.

What Is DAI Trying To Solve?

Dai aims to solve two problems in the cryptocurrency market. The first is the lack of stability. Most cryptocurrencies are volatile and can drop in price from one day to another. It can be hard to use a currency as a form of payment if it can lose its value overnight. Dai remains stable, eliminating that problem.

Furthermore, it is a decentralized stablecoin. Tether (USDT), for example, is a popular stablecoin that is not decentralized. Instead, a central organization (Tether) controls the USDT, which leads to problems like a lack of transparency.

What Makes DAI Unique

DAI is unique in that it allows people to borrow DAI and pay a low interest rate.

Unlike other stablecoins that have the same price as the USD, it doesn’t actually rely on USD reserves. Instead, it depends on other crypto reserves for backing, eliminating fiat currencies altogether.

It also uses auctions to auction off the collateral it holds when borrowers default on their loans or when automatic liquidation occurs (when the price of the collateral drops to below 150% of the borrowed amount).

Suppose the auction doesn’t make up for the amount of DAI the system lent out. In that case, it uses the money in its surplus reserves, which it gets from interest and from auctions that do bring in extra money, to make up for the defaulted loan.

Remember, DAI liquidates collateral as soon as it drops to below 1.5x the borrowed amount, which means that in most cases, auctions bring in a surplus.