Uno of the projects DeFi largest in the crypto world is MakerDAO, a DAO whose governance is controlled by the holding of tokens called Maker. On the other hand, MakerDAO is also responsible for the creation and development of the Maker protocol, whose purpose is to allow and control the emission of DAI, a stablecoin or stable currency anchored to the dollar whose impact on the crypto world is undoubted today.
All this executed on a series smart contracts on the blockchain of Ethereum. But how does MakerDAO do all these things? What has allowed you to position yourself as the largest DeFi project in the crypto world? These and more questions you can meet in this work dedicated to explaining everything about MakerDAO.
Origin of MakerDAO
The origin of MakerDAO leads us to the work that Rune Christensen started in 2015 for the creation of MakerDAO. In fact, Christensen's first work was revealed on Reddit, in the post "Introducing eDollar, the ultimate stablecoin built on Ethereum". In that post, Christensen talked about the idea of creating a DAO on Ethereum, and using it to issue a stablecoin pegged to the dollar.
The idea, similar to The dao, sought to create a community to exercise the governance of an investment protocol that would provide unique opportunities to those who participated in it. His idea was developed and with it the Maker Foundation, a foundation whose fundamental role is to direct the development and management efforts of the project. Thus, this foundation, in which Rune Christensen holds the role of CEO, started the MakerDAO project in 2014. Later, in August 2015, the project reached its first milestone when it launched its Maker (MKR) token, which established the foundations of the governance of the protocol.
But it was not until December 2017, when the MakerDAO and DAI first whitepaper, the first stablecoin governed by a DAO in the entire crypto world was born, and the doors were opened to a new world of financial opportunities on blockchain technology.
In said whitepaper, it was clear the operation and objectives of MakerDAO, which we can summarize in:
Create an autonomous system controlled by smart contracts, which manages collateralized debt positions (CDP) using Ether, with which to issue a stable currency anchored to the price of the dollar, and thus, provide new financing options in the nascent blockchain financial ecosystem.
In this way, any holder of Ether could convert their tokens into DAI, a stable currency and thus could protect themselves from the volatility of the price of Ether. But also, it allowed you to earn money by making loans or saving in that currency using other protocols.
Goals behind MakerDAO
The main objective behind the creation of MakerDAO is create a decentralized operating and governance infrastructure that allows the creation of a stable currency with global reach. This scheme includes feedback and incentive mechanisms that allow those who invest in the protocol to maintain its operation and expansion.
Secondly, MakerDAO seeks to create a mechanism that facilitates access to decentralized finance (DeFi) using cryptocurrencies. A mechanism that encourages people to transform their Ether (and currently using other currencies as well) to DAI. As a result, they can enjoy access to a stable currency that is widely accepted in other protocols. In this way, MakerDAO increases the efficiency and transparency of financial markets through a decentralized and transparent currency.
How does MakerDAO work?
Now, how does MakerDAO create all these functions? To understand the scope and vision of MakerDAO we must first understand its parts, and from there explain, how they complement each other to generate the huge community that it is now.
In this sense, let's begin to clear some concepts about MakerDAO.
The Maker Protocol
First of all we have the Maker protocol, which is a protocol built on smart contracts running on the Ethereum blockchain. The objective of this protocol is allow the operation of a platform for the generation and control of a stablecoin called DAI.
Additionally, the Maker protocol also handles Maker Vaults, oracles, and voting within the entire system. Maker allows you to control the fundamental parameters of the system, including stability fees, interest rates and rates, collateral assets, among others.
The configuration of all this is done in a democratic way, so each change proposal must have the vote of the majority of the MKR token holders. This prevents the protocol from falling into the hands of a few or from being manipulated in some other way.
The Stablecoin DAI
The second element that allows MakerDAO to function is its stablecoin, DAI. This stablecoin can only be generated using the Maker protocol under certain conditions decided by the community that governs the protocol. With this, DAI becomes an impartial and decentralized stablecoin.
DAI is not just any stablecoin. DAI is a stablecoin that does not depend on banks and does not have collateral in fiat, as it uses cryptocurrencies as collateral instead. Without a doubt something incredible and that allows to have a stable currency for those who seek stability without giving prominence to central banks and without taking value from the ecosystem of cryptocurrencies. In addition, DAI can be stored in wallets that support the standard ERC-20 token of Ethereum, since it is also a token of this type.
On the other hand, to generate DAI a user must block Ether (or another currency accepted by the protocol) within the Maker Vaults. The Maker Vault will use said cryptocurrencies to generate a collateralized debt position (CDP) and thus generate the corresponding DAI. It can even be saved as savings using a Maker Protocol feature called the DAI Interest Rate (DSR).
In this way, DAI fulfills the following functions:
- Reserve of value
- Exchange medium
- Unit of account
- Deferred payment reference
About DAI, its characteristics and how to generate it we will talk more in depth in another article dedicated to this stablecoin.
In order to generate, support and maintain a stable DAI value, it is necessary to collateralize its value using different tokens that can be deposited in the Maker Vaults. In this way, the Maker protocol ensures that each DAI has a real value support that allows supporting the issuance of each DAI in the ecosystem.
Of course, the collaterals accepted on MakerDAO are tokens that are part of the Ethereum ecosystem. The acceptance of the same passes through the vote of those who control the protocol and they are only approved with the majority of votes in favor.
However, at MakerDAO the collaterals started with something much simpler. At first, the only accepted collateral was Ether, but in 2019, with the release of the new MCD (Multi-collateral DAI) protocol, other tokens began to be accepted. Currently the accepted tokens are Basic Attention Token (BAT), USDC, wBTC, TUSD, KNC, ZRX, MANA and ETHER.
The collateralization values for each token are different, and are decided by the governance of the protocol. So for example, when writing this article the collateralization value of Ether is 200%. That is, for every $ 10 in Ethereum, only $ 5 in DAI is created. This difference is what allows the DAI price to remain stable in the face of the rises and falls of cryptocurrency prices.
As you have noticed throughout the article, Maker Vaults (previously known as CDP) play a fundamental role in the operation of MakerDAO. They are the warehouses that keep cryptocurrencies that act as collateral for DAIs.
With them it is possible to interact in two ways:
- Send cryptocurrencies as collateral and obtain DAI.
- Send DAI and obtain collateral cryptocurrency.
In any case, the interaction with the vault is done in a decentralized way and without intermediaries, it is the user who interacts directly. Maker Vaults also have a schedule and rules of operation. For example, if we have sent tokens as collateral to a Maker Vault to generate DAI, this collateral will be available there, unless the price of the token we have used fluctuates beyond a point known as the “Settlement Ratio”. In case this happens, the system will liquidate the position.
Liquidating the position means that the Maker Vault will sell your cryptocurrencies trying to maintain the positive and stable relationship of the DAI as much as possible. In essence, what you seek is to avoid losses to the protocol and those who support it. This settlement is done by an automatic auction carried out by the Maker protocol under conditions that are clearly described in the interaction of users with the Maker Vaults.
Maker Clearance and Reservation Auctions
Settlement auctions and Maker reserves are two loss and damage control mechanisms for the protocol. The first one allows the system to liquidate the positions of those Maker Vaults where the liquidation relationship is negative, thus avoiding large losses in the system and maintaining DAI stability.
The objective of this is to fully cover the Vault obligations and the liquidation penalty, selling as little collateral as possible and returning the rest to the original owner of the Vault. However, under conditions of large price declines in collateralized tokens, the auction may be insufficient to cover the position. At that point, the Maker Reserve takes action placing the remainder of the position. And if this is not enough, then a debt auction is generated, in which the system increases the amount of MKR tokens to put them up for sale, and from there extract the money necessary to pay off the debts.
This elaborate mechanism is what allows DAI to maintain stability in the face of radical price changes in its collaterals or guarantees.
Governance of the protocol
The governance of MakerDAO is handled by the well-known Maker Governance Framework (MGF), which is based on rigorously examined and reproducible scientific models. All of these models have been created by experts with a proven track record in the traditional financial space.
The framework itself can be divided into two main components:
- Governance proposals: Symbolic votes used to probe community sentiment towards specific models or data sources.
- Executive Proposals: It is used to ratify the Risk Parameters determined by the models and data accepted by the Government Proposals. Executive votes result in status changes within the DAI Credit System and occur every quarter.
This distinction encourages the governance debate to become a consensus-building exercise for compromise, where communication channels force participants to focus on the underlying reasoning, theories, and data of risk assessments, rather than a polarizing popularity contest on specific risk parameters tokens.
Another important point in the governance of MakerDAO is the role of the Maker Foundation. As we have mentioned, the fundamental role of this foundation is to direct the development and management efforts of the project. But additionally, the Maker Foundation is dedicated to expanding the project, seeking institutional and financial support for the protocol, as well as helping to maintain the evolution of the protocol hand in hand with the community.
Therefore, given the governance model of the protocol, neither MKR holders nor the Maker Foundation will have special powers to arbitrarily dictate the risk parameters of the system, they can only affect changes through demonstrable scientific arguments and based on facts. . That is, all actors within MakerDAO must create consensus on the way forward for the project as a whole.