What is DAI?

The DAI cryptocurrency (DAI) is an ERC-20 token that has been designed to function as a stablecoin or stablecoin whose value is anchored to the dollar. This currency is issued in a decentralized way thanks to the collateralization of guarantees that serve to guarantee its issuance at all times. 

Lto DAI cryptocurrency, it is a stablecoin or stablecoin, whose value is pegged 1: 1 against the US dollar. That is, 1 DAI = 1 $ USD, and thanks to this, DAI has become one of the most relevant projects in the crypto world, and especially in the world of cryptocurrencies. decentralized finance (DeFi).

The currency and the entire protocol that supports its operation was designed by MakerDAO, one of the most successful projects in the ecosystem. In fact, MakerDAO is a project that has demonstrated unparalleled transparency, technical and economic quality. All this has made it become the stablecoin, or stablecoin, that does not need to provide collateral in fiat, making this one of the preferred tokens in the DeFi world.

But what else is behind DAI? what led to its creation? And most importantly: what are the objectives of it?

The origin of DAI, the first decentralized stablecoin

The origins of DAI begin with the creation of MakerDAO in 2014. Since then, the project aimed to create a DAO in order to sustain a stable currency within Ethereum. The idea was something totally new, something like this had never been built and its developers took enough time to design a clear proposal of how to do it without failing.

All this previous analysis made December 2017 all that effort came to light with the creation and start-up of the first version of DAI (now known as SAI). With this, it became the first structure of a highly decentralized stablecoin. His control was governed by smart contracts or smart contracts and not by fiat in a bank account. Furthermore, all its variables were decided by a DAO, in which Maker token holders (MKR) could participate.

The birth of DAI gave a huge boost to the DeFi ecosystem, which was only a few months old and was proof that something big was yet to come. Since then, this has been one of the most eye-catching stablecoin projects in the crypto world. Its transparency, its wide acceptance and the enormous flexibility of its operation have made it a model of development within the crypto world.

Goals behind the creation of DAI

Now, what objectives really led to the creation of DAI? In response to this we can say that the main objective was to create a secure medium to store value. As we well know, coins like BTC and ETH, suffer from marked volatility given the growth period of the sector in which we find ourselves. This volatility is not a problem in economic systems that seek to generate profits by taking advantage of this characteristic. But in use cases such as loan, savings or money transfer platforms, this volatility is counterproductive and even unwanted.

Faced with this situation, DAI proposes a solution. Thanks to a collateral guarantee system, it is possible to generate DAI with a value 1: 1 against the dollar using highly volatile cryptocurrencies. In this way, the coins generated can be used to carry out fixed and stable value operations on other platforms, with the assurance that said coins are guaranteed by a deposit. Thus, regardless of whether the value of cryptocurrencies rises or falls, the value generated will always be the same, and in the worst case, there are guarantees to avoid loss of value.

Without a doubt, a new idea that allows us to develop new functionalities that take advantage of the potential of the blockchain. Especially those that need a stable and decentralized means of exchange of value. A medium that can be freely exchanged and reconverted without problems, in the last case necessary to recover the value of your guarantee.

At this point DAI meets these needs and opens the doors to such developments. In fact, thanks to DAI your holders can obtain a constant return on their holdings. And all this thanks to collateralization, the creation of autonomous feedback mechanisms and external actors duly incentivized to maintain the dynamism of the system.

In short, DAI is the fundamental piece to generate a solid and functional decentralized lending platform on the Ethereum blockchain. And this has certainly helped the DeFi ecosystem grow in the way that it has.

Analyzing the operation of DAI

Now, to understand the question How does DAI work ?, the first thing we must examine are the different elements that make its creation possible. First, we have the Maker protocol from MakerDAO. This is a protocol that works on a series of smart contracts that are executed on Ethereum and are responsible for orchestrating the operation of DAI and the DAO that controls its different parts.

The Maker protocol is responsible for maintaining the stability of the reserves that maintain DAI with a value of 1: 1 with respect to the dollar, as well as the control of issuance and burning of the stablecoin. In addition, it also controls interest rates, stabilization rates, penalties, auction systems, governance, voting system and decision making. Simply put, the Maker protocol is the heart of DAI, and its development and evolution is in the hands of the MakerDAO community, and which we discuss more fully in this article.

Outside of that, DAI's operation falls on the Maker Vaults (formerly known as CDP). These Maker Vaults allow us to interact with the Maker protocol, giving us the opportunity to generate DAI by depositing collateral assets within them.. When we make a deposit, the Maker Vault tells us (according to the token we use) the collateralization variables, interest rates, stability and the liquidation relationship of our position. By accepting all these values, we will then be blocking our tokens and receiving DAI in an address of ERC-20 token designed for that task. In short, Maker Vaults are our gateway to DAI issuance, and the system is controlled entirely by smart contracts.

Similarly, Maker Vaults also take care of the reverse process: DAI can be sent and collateral received back, resulting in DAI burning. As you can see, how this system works at a high level (without going to the technical part of smart contracts) is quite simple. However, from its inception in 2017 until now, DAI has evolved quite a bit. Perhaps its greatest evolution has been to accept new collaterals and thereby provide new stability options to the system, something that we will explain below.

DAI and SAI What are their differences?

In November 2019, MakerDAO took a big step forward by updating the Maker protocol. The update changed the way we could generate DAIs within the system. Before that date, the only way to generate it was to deposit Ether, within a contract CDP (Collateralized Debt Position) and from there get our coins. However, MakerDAO changed this and opened the doors to be able to use other different tokens to use as collateral and generate DAI.

The new MakerDAO creation was named after ICD-DCM or Multicolateral ICD. The idea was simple: accept new tokens apart from Ether so that they serve as collateral and create DAIs with them. In this way, greater liquidity was added to the system and a new stability scheme was promoted in the protocol. This was radically different from how DAI did things in principle, because the only accepted collateral was Ether, and that was a situation that proved to be counterproductive for stability.

At first, DAI-MCD received a lot of criticism. However, MakerDAO continued with its roadmap. Now in his possession were SAI (the first version of DAI, with collaterals in Ether nothing more) and DAI-MCD (which accepts multiple collaterals).

To bridge the gap and abandon SAI MakerDAO launched the migration portal. With it, all SAI holders should transfer their funds to the new protocol, and abandon the old one. This last situation is something that is still in process, since SAI's smart contracts continue to work, although the token has already lost acceptance in most of the exchanges and DEX that exist.

How is DAI created?

The creation of the currency depends on two actors:

1. The user and the collateral they will use
2. The Maker Vault

At this point we will explain in the simplest way possible how these three elements allow you to generate this currency safely.

First of all, you as a user must have capital that you will use to generate DAI. Said capital must be in some of the currencies accepted as collateral by the Maker protocol. They are currently: Basic Attention Token (BAT), USDC, WBTC, TUSD, KNC, ZRX, MANA and ETHER.

If you have any of these tokens in your possession (note that they are all Ethereum ERC-20 tokens) then you can interact directly with the Maker Vaults to generate the coin. Otherwise, if you have any other cryptocurrencies (such as Bitcoin) you will have to change those currencies to one of the tokens in order to carry out the process.

Next comes the process of interacting with the Maker Vaults. The easiest way to interact with Maker Vaults is through Oasis. This DApp allows you to easily create Vaults using wallets such as MetaMask, Trezor or Ledger, plus it has official MakerDAO development support, which makes it very secure.

Once there, all you have to do is select one of the DApp options and connect it to your wallet. In this case, we will be using MetaMask, and we will choose the Borrow option (to borrow).

With this you will already be inside the system.

To start the generation of coins, you must start the process by clicking on «Get Started». You will then be sent to a new page where you will choose the collateral that you will use to generate the DAI. You must choose one of the available options, being attentive to the different levels of collateralization and commissions that will be deducted for the operation.

Once the collateral has been chosen, you must start the Vault, make the deposit of your guarantee and accept the data of the process. With this we will have in our possession the DAI that we want.

Smart contracts everywhere

All this process that we have told you here is possible thanks to the Maker protocol and the smart contracts that establish its operation. In the whole process there is no custodian or intermediary withholding guarantees. In other words, the entire process occurs between the user and the contract. A true decentralization that aims to maintain the highest possible security and privacy. In fact, you don't even need to enter personal data into the system, this is unnecessary, all you need are ERC-20 or Ether tokens, and you can now create and use DAI for whatever you want.

What Maker does with its Vaults is take your money, generate with this money a certain amount of money stabilized by your guarantee and with the surplus of it allows the system to remain stable against the drop or rise in the price of the ERC token -20 or of the Ether you have used. It is basically a “lifeline for your DAI”, so if the price of the token you have used to generate DAI goes down, your generated DAI will still be worth the same ($1 USD), because the excess will cover the drop, thus avoiding losses .

Surely you have already seen that it works very similar to a bank mortgage, only that even in the worst case, the liquidation of your position will seek to cover the debt of the DAI issuance, and reimburse you as much money as possible ( while the banks take everything you have).

As a summary we can say that a Maker Vault simply saves your warranty in the Maker system, and this in return gives you DAI to spend. The amount of DAI generated is relative to the amount of warranty you have placed in the Maker Vault. The relationship changes with respect to each type of collateral you use and even the relationship changes over time according to the decisions of the MakerDAO Governance.

So for example, if the ratio to generate DAI is 150% (as in the case of using Ether), this means that for every $ 1,5 in Ether, you will get $ 1 in DAI. If for example you send $ 125 in Ether, you will get about $ 50 in DAI from them. The rest of the money is blocked there and is an excess guarantee to compensate for the drops or rises that the price of Ether may have.

Pros and Cons of DAI

Among the pros that we can find in this currency can be mentioned:

1. It is a secure, decentralized stablecoin with a long history of security.
2. It does not depend on banks, being a totally different stablecoin than USDT. In other words, there is no constant risk of the bank closing or seizing the account that supports the entire protocol, nor is it required to trust that these funds exist in the bank.
3. It facilitates the creation of decentralized means of exchange and financing. In fact, DAI is one of the most accepted currencies in the DeFi world and DEX nowadays.
4. Its proven stability system generates confidence in its operation. Even in the worst case scenarios, MakerDAO has been able to maintain stability at acceptable values, and in fact, has improved stability over time.
5. It is easily accessible and respects the privacy of its users. Anyone can access the system without the need for KYC or give their data to a third party.
6. Ability to generate credit and interest for said credit, which makes it a powerful option to invest.
7. It is currently one of the largest DeFi ecosystems in the world, with a value that exceeds 1400 billion dollars (September 2020).
8. It is a widely supported stablecoin in many exchange houses.

However, on the negative side we can mention:

1. It's a bit complex on a technical level, which makes it a bit difficult for people who are just starting out in the DeFi world to access it.
2. The limited variety of currencies as collateral is seen as a system problem. In fact, tokens like Compound or YFI are not yet accepted as collateral, while MANA (a token with less scope) is.
3. There are risks when using a Maker Vault. Remember that to generate DAI you must transfer ownership of your assets to a smart contract that can sell your assets in the event of a market recession. Any DAI generated vault has a settlement price, the price of the underlying asset at which the vault would be liquidated. Using a vault for leverage presents additional risk. The reward potential is greatest through leverage, but the loss potential is also magnified. It is a common practice among users to maintain a high collateral ratio to protect themselves from market risks and therefore liquidation.
4. A smart contract is transparent and immutable, but it can be hacked. Nothing guarantees that it could not happen like the famous hack of The DAO.

DAI use cases

However, DAI as a currency allows opening the doors to different use cases, and among them we can highlight:

Financial independence for all

As we already mentioned, DAI is a stablecoin that we can access from anywhere in the world, simply by accessing its DApp. It is not dependent on any commercial bank, central bank or government. This means that anyone in the world can transform their cryptocurrencies, and thus access other financial functionalities within DeFi.

So millions of people can, from the comfort of their home, access loans, savings systems, investment pools, and other financial tools that are otherwise unattainable through traditional means.

Fast and low-cost remittances

Another great use case is international remittances, that is, sending money between countries, normally used by immigrants to send money to their relatives.

Now anyone can transform their money into DAI and carry out a transaction anywhere in the world, something possible thanks to its wide acceptance. The best? All this can be done in minutes and with a low cost per transaction (when Ethereum allows it), in addition to doing it without intermediary companies, or any intermediary beyond the one that provides you with DAIs.

Bridging the DeFi world

Another cool use case is its ability to unite the DeFi world. DAI is a decentralized, reliable and safe currency that has been with us for many years.

In that sense, nothing better for DeFi than a true decentralized currency governed by the community and with which everyone can freely access the services that DeFi can offer. That is where it works as a connecting link between the different protocols.