3.5 billion Google searches are made every day & 20% of them are the items that’ve never searched before. This leaves us with 700M things that people are asking for the 1st time. This is the opportunity generated EVERY DAY!

Same goes in the crypto world where no project is 100% perfect and the imperfections engenders new opportunities. Let’s talk about one problem, which is more than a bottle neck for crypto to go global as a medium of exchange and store of value. Crypto volatility. This is something that has also been the reason for the risk in crypto investment. Suppose you borrow in Bitcoin and the current market value of the coin is let’s say $10k. You are expected to return the loaned Bitcoin after couple of weeks and you find the market value of the coin soared to $12k or dropped to $9k while returning the loan. This volatility makes the scope of the project limited. The figure shows the fluctuation in one day value of Bitcoin.

These are the imperfections that make it hard to deal in crypto but have given rise to coins which tend to maintain its value over time called Stablecoin. This concept is called Collateralized Debt Position or CDP-a financial cryptocurrency concept & has been in development by MarkerDAO project which is offering DAI as a possible solution to coup volatility in crypto. Stablecoin like DAI is a crypto that is pegged into currency (USD or GBP) or assets. They could be both centralized as well as decentralized. I have written pretty detailed guide over the top and could be read here Stablecoins – A Complete Guide

DAI is the first decentralized stable coin that is based on Ethereum Blockchain. It is actually a very great source of stability and since it is backed in excess by collateral all the time, so you do not have to worry about fluctuation in the value of your coin. The coin is actually pegged into USD and the value is pretty much stable due to that reason. Being pegged into USD means the value of DAI is pegged by the regulatory authority to the value of the dollar. The table below depicts the DAI price chart (DAI to UST).

We have around 87 million DAI in circulation in the crypto market right now. In an analysis, DeFi Plus calls MakerDAO the most popular decentralized finance app in crypto space. The token’s value is however supported by as much as $300 million worth of ether locked in the system of MarkerDAO.

But this is after a long four months that DAI started maintaining a consistent dollar valuation. The famous data scientist Alex Svanevik in an interview in May 2019 had said that there has been a surge in trading prices of DAI on the leading Coinbase from $0.95 on 8th of April to between $0.98-$1 range in May and June. He further added that this may be considered “super close to the $1 peg”. Today on Aug 26th, it was trading at a value above $1 as visible from the table given below.

To this rise in the value of the coin, the COO of RealTPlatform David Hoffman quoted that DAI could be moving to a “whole new phase”.

How does Marker System Work?

There are many operational mechanisms which make sure DAI stays relative to USD. This is made possible by the smart contract platform that is offered by Maker on Ethereum blockchain and which through a series of dynamic feedback system or CDP stabilizes and backs DAI. Through CDP, user can generate DAI by depositing some asset into the smart contract. Suppose you have ETH or any asset and you want to create DAI. Simply deposit your asset or ETH to smart contract for loan and once the CDP holds your deposited asset, you can easily generate DAI equal to the value of the asset in USD.

You may use DAI in any way possible like any other currency. The best part is when you are returning the loan, you would have to return the same DAI borrowed plus some interest on the DAI. Suppose the value of the asset (ETH in our case) was $100 at the time of depositing the asset, and you borrowed 100 DAI. This is called collateralization ratio which refers to the amount of Dai that you can create relative to the ETH you put in the smart contract. While returning the loan, you have to return 100 DAI plus some interest on DAI to get back your ETH. This means the graph for the loan you take in DAI stays horizontal to the x-axis that is you would have to pay the same dollar amount plus some interest on the DAI borrowed.

The concept of interest in stable coin is pretty interesting and has given rise to a sought of price war between companies offering stablecoins.

The problem with non-stablecoins is volatility. You just cannot be sure about the dollar amount that you would have to return if you borrow in NonStableCoin or any asset with high volatility. You could end up owing 2x than your initial loan.

What happens when the value of asset (ETH) collateralized fluctuates?

So there could be both rise and fall in the value of asset deposited into the smart contract. The rise in the value of the asset results in more stability of DAI, the fall is however gloomier.

When the value of the asset deposited into smart contract goes up, DAI becomes stronger resulting in further collateralization of the system. There are other ways that contribute to increased stability. This happens when demand for DAI rise than the supply of the coin. The simple demand law of economics 101 holds here. Moreover, there is a concept called Target Rate Feedback Mechanism under which Market incentivize the creation of DAI for users if the price of the coin should trade above $1.

Fall in the value of the asset deposited into the smart contract makes problems. The value of DAI falls below $1 and the system could possibly collapse if the value of ETH held as collateral falls below the value of the amount of DAI it is backing. Such a situation is tackled by Marker by liquidating CDPs & by auctioning off the ETH deposited into the smart contract. ETH in CDP is auctioned off until there is enough DAI available to pay back what was lost from CDP. In simple words, CDP is liquidated in case of insufficient collateral.

Target Rate Feedback Mechanism:

However Marker is very able to maintain stability and keep DAI stable through a mechanism called TRFM. Target Rate Feedback Mechanism TRFM is an automatic mechanism which is employed by DAI to maintain stability. As 1 DAI has a target price of 1 USD, the change that is needed in the price of DAI overtime to approach this target price during market ups and downs is determined by the Target Rate. The onset of TRFM breaks the fixed peg ratio ie 1DAI/$1USD but it is important to push back the price of DAI where it needs to be. So when the target price of DAI is less than one USD, an increase in TRFM occurs which pushes up the price of DAI again to the value where it should be. When this happens, the generation of ADI through CDP gets more expensive.

This rise in the value simultaneously increase the demand for DAI and cause the users who hodl DAI gain profits. The rise in demand for DAI and the reduced supply in the market as users try to buy from the market and borrow from CDPs eventually pushes up the price of DAI to reach its target price.

Moreover, there are certain dynamics that determine the TRFM and TR. In most cases, it is the market forces in the form of demand for and supply of DAI that determine both TRFM and TR. In addition, the sensitivity parameter of the TRFM could also be set by the Marker voters which in turn determine the degree of response of TRFM whenever the target price of DAI deviates from the value it needs to be at.

A Sensitivity Parameter of “10% in 15 min” means that the Target Rate can change the price of DAI in the market to a maximum of 10% only in 15 minutes. This makes the max hourly change by TRFM in price of DAI as much as 40% per hour.

One might also argue why is the change restricted to only 40% per hour and not more than this. SO this restriction is important to control the system in case of hack. The restriction actually provides the time to trigger a global settlement in case there is hack that grants attacker control over the Oracles. It is due to this reason that the SP is set to a max of 10% in 15 minutes by Marker Voters.

Global Settlement:

So despite so much development and improvement in programing in the blockchain space, one cannot overlook the prevalent cyber threats and hacks that often cost companies millions of dollar. The recent hack of Binance is the perfect example when more than 7k Bitcoins were transferred from the exchange which cost more than $40M to the exchange. To keep the system secure and escape such a scenario, Marker has developed a process called global settlement. In case there is a hack that grants the hacker control over the Oracles, triggering the global settlement freezes the system. This means the owners and users of DAI and CDP get the exact value of the asset they have deposited into the smart contract. So if I have 110 DAI and 1 ETH = $110, I can exchange my 110 DAI for one ETH through a smart contract. THe whole process if fully decentralized.

So who triggers the global settlement?

Selected and trusted individuals have access to the global settlement keys and it is they who trigger the global settlement.

One might think it makes the system centralized. No, this does not make it centralized because triggering the global settlement just freezes the system and it does not give the individuals having GSK (global settlement keys) the option to interact with the system on your behalf and hence cannot steal your DAI or ETH. It just end up exposing you again to the volatility of your asset (collateral).

Importance of global settlement:

Global Settlement plays important role in the equilibrium price of DAI. To understand this, let’s assume a situation in which intrinsic demand for DAI is zero. The only value of DAI would come from its future claim on ETH collateral. AS a result, the market value of 1DAI would be equal to the probability of GS. This means if the aggregate expectations of having a GS is 90%, the equilibrium price of DAI would be $0.9 USD and would be stable at the value provided the aggregate expectation of having a GS stays 90% without any fluctuation. The stability will results in demand for DAI and hence a price rise to its target price as long as supply of DAI to the market stays below the demand for DAI. So the probability of GS is vital to the equilibrium market value of DAI.

Benefits of using DAI:

There are many benefits which makes it a game changer.

  • It is equal to $1 USD with negligible fluctuations.
  • It could be traded freely like any ERC20 token.
  • If you have an Ethereum wallet, you can accept, own and transfer DAI without getting a third party involved in the process and it therefor cuts the cost of transactions. DAI makes it free to transfer your dollars across border without any fees.
  • It is fully decentralized and hence no government bogy or regulatory authority can control it.
  • It is secure, transparent and resilient.

This is the beauty of blockchain and it has actually taken the economics and commerce to a whole new level.