Understanding Dai Stablecoin and Its Mechanisms

Dai stablecoin is a decentralized, cryptocurrency-pegged stablecoin that's designed to maintain a stable value relative to the US dollar. It's created and managed by the MakerDAO protocol.

The MakerDAO protocol is built on the Ethereum blockchain and uses a combination of smart contracts and a decentralized governance system to manage the supply of Dai. This system ensures that the value of Dai remains stable.

Dai's stability is maintained through a process called "liquidation", where borrowers who fail to repay their loans are penalized by having their collateral seized and sold. This mechanism helps to maintain the value of Dai by preventing the creation of excessive new tokens.

The Dai stablecoin has a unique mechanism for maintaining its value, which is more complex than traditional stablecoins.

Collateralized Debt Smart Contracts are the backbone of the Maker Platform, allowing users to leverage their collateral assets to generate Dai.

These smart contracts, known as Collateralized Debt Positions (CDPs), hold collateral assets and permit users to generate Dai, but this also accrues debt that effectively locks the deposited collateral assets inside the CDP. Active CDPs are always collateralized in excess, meaning the value of the collateral is higher than the value of the debt.

One of the primary use cases of CDPs is margin trading by CDP users, who can use their collateral to take on more risk in the market.

In the event of liquidation, the Maker platform buys the collateral of a CDP and sells it in an automatic auction, which enables the system to settle CDPs even when price information is unavailable.

The system raises enough Dai to cover the CDP's debt through a Debt Auction, where the MKR token is diluted and sold to bidders in an auction format.

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CDPs hold collateral assets deposited by users and permit them to generate Dai, but generating Dai also accrues debt.

The debt effectively locks the deposited collateral assets inside the CDP until it is later covered by paying back an equivalent amount of Dai.

To create a CDP, users first send a transaction to Maker to create the CDP, and then send another transaction to fund it with the amount and type of collateral that will be used to generate Dai.

Active CDPs are always collateralized in excess, meaning that the value of the collateral is higher than the value of the debt.

Here's a breakdown of the CDP interaction process:

The Maker Platform determines when to liquidate a CDP by comparing the Liquidation Ratio with the current collateral-to-debt ratio of the CDP.

Liquidation occurs when a CDP hits its Liquidation Ratio, and the Maker Platform will automatically buy the collateral of the CDP and subsequently sell it off.

In Multi-Collateral Dai, during a liquidation, the Maker platform buys the collateral of a CDP and subsequently sells it in an automatic auction.

The auction mechanism enables the system to settle CDPs even when price information is unavailable.

DAI's value is primarily derived from the demand for it, which in turn is based on the amount of collateral deposited into the Market platform. The supply of DAI is constantly changing as more users deposit collateral.

The collateral-to-loan ratio of 66% ensures that DAI is loaned out efficiently. This ratio is crucial in maintaining the stability of the DAI ecosystem.

There is no cap on the total supply of DAI, allowing the supply to fluctuate based on the amount of collateral stored in every CDP on the network at any given moment.

The supply of DAI is based entirely on demand, meaning its value is primarily derived from the amount of collateral stored in CDPs on the network.

DAI's value is directly tied to the amount of collateral deposited by users, with a collateral-to-loan ratio of 66% determining the amount of DAI created and loaned out.

There is no cap on the total supply of DAI, allowing it to adapt to changing market conditions and user demand.

This dynamic supply mechanism ensures that DAI remains connected to the underlying value of the collateral backing it, maintaining its stability and value.

The constant flux of DAI's supply is a key characteristic of this decentralized stablecoin, making it well-suited for a rapidly changing financial landscape.

The Dai Savings Rate is a crucial tool in maintaining the stability of Dai. It's a global system parameter that affects how much Dai holders can earn in return on their holdings over time, as well as the base borrowing cost for generating Dai from CDPs.

If the market price of Dai is above 1 USD, the Dai Savings Rate will decrease, stifling demand and reducing the market price of Dai down towards the 1 USD target price.

The Maker Governance community evaluates public market data and proprietary data provided by market participants on a weekly basis to determine whether an adjustment to the Dai Savings Rate is necessary.

During Single-Collateral Dai, the Dai Savings Rate will not be available, and instead the Stability Fees on CDPs will be adjusted directly to balance supply and demand and protect the stability of Dai in the marketplace.

If the market price of Dai is below 1 USD, the Dai Savings Rate will increase, boosting demand and increasing the market price of Dai up towards the 1 USD target price.

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In the early days of the Maker Platform, Pooled Ether (PETH) was the only collateral type accepted, obtained instantly by depositing ETH into a special smart contract.

This temporary mechanism was created to provide a stable foundation for the platform. PETH is essentially a claim on the total pooled ETH.

During the first phase of the Maker Platform, users needed to obtain PETH to open a CDP and generate Dai. This was done by depositing ETH into the special smart contract.

If there's a sudden market crash in ETH, the Maker Platform automatically dilutes the PETH to recapitalize the system. This means that the proportional claim of each PETH token goes down relative to the total pooled ETH.

After the Maker Platform is upgraded to support multiple collateral types, PETH will be removed, and regular ETH will be usable as collateral alongside other new collateral types.

The Maker Platform has a robust risk management system that allows MKR token holders to vote on key decisions. This system is designed to mitigate risks and ensure the stability of the Dai stablecoin.

MKR token holders can vote to add new CDP types, which can include new collateral assets or unique sets of risk parameters. This allows the Maker Platform to adapt to changing market conditions and introduce new features.

The risk parameters for CDPs are determined by MKR holders through voting, with one MKR giving its holder one vote. These parameters include the debt ceiling, liquidation ratio, stability fee, liquidation penalty, auction duration, and auction step size.

The debt ceiling is the maximum amount of debt that can be created by a single type of CDP. The liquidation ratio determines the collateral-to-debt ratio at which a CDP becomes vulnerable to liquidation.

MKR holders can also vote to modify existing CDP types, change the Dai Savings Rate, and choose the set of trusted oracles. The Dai Savings Rate affects the interest rate earned on Dai, while the set of trusted oracles determines the price feeds used by the Maker Platform.

MKR holders can choose the set of Emergency Oracles, who have the ability to unilaterally trigger an Emergency Shutdown. This is a crucial mechanism that allows the Maker Platform to survive attacks against the oracles or governance process.

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Here are the key risk parameters for CDPs:

The Maker Platform's risk management system is designed to be robust and adaptable, allowing it to respond to changing market conditions and ensure the stability of the Dai stablecoin.

The Maker Protocol's governance system is quite unique and relies heavily on the MKR token. MKR token holders vote on proposals to modify the internal governance variables of the Maker Platform.

The voting process is done through the election of an Active Proposal by MKR voters, which is the smart contract that has been empowered by MKR voting to gain administrative access. Any Ethereum account can deploy valid proposal smart contracts.

MKR voters can cast approval votes for the proposal they want to elect as the Active Proposal, and the smart contract with the highest total number of approval votes is elected. The modifications to the internal governance variables are delayed for 24 hours by the Governance Security Module.

In the long run, more advanced forms of Proposal Contracts can be used, including Proposal Contracts that aren’t single-use. This allows for greater flexibility and upgradeability in the Maker Governance mechanism.

The Maker Governance Process establishes a rough consensus in the governance community before any votes are cast, making the voting process more of a formality. The MKR token plays a crucial role in the governance of the Maker Platform, particularly in the Dai Stablecoin System.

MKR will replace PETH as the recapitalization resource in the Dai Stablecoin System after the upgrade to Multi-Collateral Dai. This means that MKR will be automatically diluted and sold off to raise funds when CDPs become undercollateralized due to market crashes.

DAI governance takes place both on-chain and off-chain through the MakerDAO system. MKR token holders vote on proposals using the Maker Protocol’s on-chain governance system, with two different types of voting: Governance Polls and Executive Votes.

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Emergency Shutdown is a last resort process that can be used to protect Maker against attacks to its infrastructure. It stops and settles the Maker Platform while ensuring all users receive the net value of their assets.

In the event of a serious emergency, such as a hacking attempt or long-term market irrationality, Emergency Shutdown can be triggered by depositing MKR into the emergency shutdown contract. A minimum of 50,000 MKR is required to trigger the shutdown.

During Emergency Shutdown, CDP users can immediately withdraw the net value of their collateral, and Dai holders can claim collateral directly at a fixed rate based on the target price of Dai.

Here's a step-by-step breakdown of the Emergency Shutdown process:

In Single-Collateral Dai, the mechanism for liquidation is a Liquidity Providing Contract, which trades directly with Ethereum users and keepers according to the price feed of the system.

Emergency Shutdown is a last resort process to protect Maker against attacks to its infrastructure. It stops and settles the Maker Platform while ensuring users receive the net value of their assets.

In the event of a serious emergency, such as long-term market irrationality or hacking, Emergency Shutdown can be triggered. This is done by depositing MKR into the emergency shutdown contract, requiring a minority quorum of 50,000 MKR voters to initiate the process.

CDP users can immediately withdraw the net value of their collateral from the moment Emergency Shutdown is triggered. This is a key feature of the process, allowing users to recover their assets quickly.

Here's a step-by-step breakdown of the Emergency Shutdown process:

Emergency Oracles, selected by MKR voters, have the authority to unilaterally trigger an Emergency Shutdown. This provides an additional layer of security and control in the event of an emergency.

Keepers are independent actors, often automated, that contribute to decentralized systems in exchange for profit opportunities.

Their role in the Dai Stablecoin System is crucial, as they participate in Debt Auctions and Collateral Auctions when CDPs are liquidated.

Keepers are incentivized to trade Dai around the Target Price, selling it when the market price is higher and buying it when the market price is lower.

By doing so, they profit from the expected long-term convergence towards the Target Price.

In the context of the Dai Stablecoin System, keepers are essential for maintaining the stability of the system.

They help to ensure that the Dai supply is adjusted according to the market conditions, preventing any potential imbalances.

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