Could MakerDAO be the first true stablecoin?

Posted: 24 January 2018 3:40 am

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When all other cryptos lost big last week, DAI stayed stable.

Last week was truly a bloodbath in the cryptocurrency space, with tens of billions of dollars wiped out of the market cap. Despite this, one currency was able to keep its head above water: Maker's DAI.

DAI, which aims to be a true "stable coin" holding a consistent value, managed to keep within just a few percent of 1 US dollar. Other alleged stablecoins such as Tether also managed to stay around the 1 USD mark, however they work very differently to DAI.

Where Tether and other coins are "backed by USD", which theoretically enables their stable price, DAI is completely based on the blockchain.

This is the holy grail for stablecoins, as when you have a token that is backed by USD in a bank account, you've essentially just got glorified digital USD. It's all centralised, and if the USD disappears, so does the value of the stablecoin.

This is what makes DAI's stability so impressive - while every other blockchain-based crypto was moving downwards in double-digit percentages, DAI stayed roughly the same.

How does MakerDAO work?

Think of DAI like the cash the bank gives you when you take out a mortgage, except the house you use as collateral is ether through an Ethereum smart contract. If the value of your ether goes down, you then need to pay back the DAI you own to make up for it, or your ether goes up for auction.

This ether is essentially what is used as the first line of guarantee to keep DAI stable. When the price of ether drops to a certain threshold level, it is sold off to retain the price of DAI.

This works for small drops, but for large drops there needs to be a second layer. This is where Maker's MKR token comes into play.

The MKR token itself is actually now worth more than Ether at US$1,400 each, according to CoinMarketCap at the time of writing. Owners of MKR act as the governance of the Maker smart contracts, and in return for regulating the coin, owners of MKR are paid a fee.

However, there's a catch for MKR holders. If there is a large discrepancy with the value of DAI, due to not selling off ether soon enough, the MKR token acts as a buyer of last resort. If there is not enough ether in the system to act as collateral, then MKR is created and sold on the open market.

This means that it's in the MKR holders' best interest to correctly keep DAI stable, as it will be their money that gets lost, not the DAI, if things starts turning sour.

MKR got its first big test last week, as its market cap lost over US$300 million to keep DAI stable. It has since bounced back up.

Why are stablecoins important?

For day-to-day transactions to truly reach their potential on the blockchain, you need some stability. No one is going to issue a loan, credit or want to transact regularly with a currency that could have its value move by 25% the next day.

A stablecoin is much more useful in transactions, as there is no benefit to hold it for a potential long-term gain as you might with the likes of bitcoin or ether.

It also opens up the ability for decentralised exchanges: an exchange where users always remain in control of their own funds. Here, traders would be able to buy against a stablecoin, rather than needing a central USD or the high fees of bitcoin and ether. This could make trading safer and easier for new cryptocurrency adopters.

Disclaimer: This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service or offering. It is not a recommendation to trade. Cryptocurrencies are speculative, complex and involve significant risks – they are highly volatile and sensitive to secondary activity. Performance is unpredictable and past performance is no guarantee of future performance. Consider your own circumstances, and obtain your own advice, before relying on this information. You should also verify the nature of any product or service (including its legal status and relevant regulatory requirements) and consult the relevant Regulators' websites before making any decision. Finder, or the author, may have holdings in the cryptocurrencies discussed.

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