What is the DAI stablecoin?

What is DAI ?

DAI is a decentralised cryptocurrency created and regulated by Maker DAO (Decentralised Autonomous Organisation). Its value is soft-pegged to one US dollar which makes it a stablecoin. As of July 2021, there were roughly 5.5 billion Dai in circulation, making it the fourth largest stablecoin by capitalisation.

How to get DAI ?

DAI is readily available for purchase on all major exchanges like Kraken and Coinbase as well as decentralised exchanges. You can simply deposit your fiat currency and exchange it for DAI or sell some of your crypto assets instead.

Additionally, you can generate and borrow DAI by opening a Maker collateral vault through Maker DAO’s Oasis Borrow dashboard¹ and deposit Ethereum-based assets as collateral. It works in a similar fashion to traditional collateralised loans.

When you decide to return the borrowed DAI, your collateral is unblocked with a fee deducted. All of this is implemented with smart contracts which makes Dai a truly decentralised stablecoin. More on that later.

How is DAI kept stable ?

The same rule of supply and demand applies to cryptoassets. When DAI’s price dips below its nominated value of 1 USD, Maker DAO increases interest rates on the loans, thus incentivising the customers to get rid of their Dai and close the loans. The returned Dai are destroyed which limits the supply, thus driving the price up. An exact opposite mechanism is initiated when DAI becomes more expensive than 1 USD.

As the owners of the protocol, Maker DAO can bring certain changes to the Dai smart contracts and, for example, control the types of accepted collateral, collateralisation ratios, and the interest rates for borrowing or storing Dai.

But how is this still decentralised ? Well, any changes you make to smart contracts are visible to all the blockchain participants. Hence, Dai adopts the transparency and reliability of blockchain as a whole.

Why is DAI a better stablecoin?

USDT and USDC are other popular stablecoins you may have heard of. The issuance and regulation of these tokens are controlled by the governing companies, which makes it hard to define such cryptocurrencies as decentralised.

USDT is issued by Tether, for example. Every USDT token that Tether mints must be backed by a real US dollar in a bank account. This means that for every newly-generated token, there must be a person or an organisation providing real money to back the tokens.

In 2017-18, Tether was accused of minting non-backed tokens for itself. The accusations further suggested Tether had used the tokens to buy Bitcoin and manipulate its price ². And in 2019, Tether accidentally minted $5 billion worth of its stablecoin but promptly destroyed them.

Centre, the company that issues the stablecoin USD Coin (USDC), has also gained some notoriety. On June 16 2020 it blacklisted an Ethereum network address holding $100,000 in USDC in response to a law enforcement request. Since Centre created that address in the first place, they had some control over it which allowed for freezing to happen. This would be impossible to accomplish on a truly decentralised blockchain like Bitcoin.

Such problems are inevitable for tokens such as USDT and USDC – they are controlled by physical companies and so far we either do a bad job of auditing them or force them to interfere with blockchain.

DAI, on the other hand, is independent. Its issuance is governed by smart contracts – programs which are stored on the blockchain, and are immutable. No person or legal authority has a physical ability to interfere with Dai coins or addresses.

DAI is also a backed currency, with cryptocurrencies used instead of fiat. DAI is an over-collaterised token which means the value of crypto assets you use as a collateral exceeds the amount of DAI you receive (usually by 50%) under such loan. This is a compromise that Maker goes with because of the volatility of cryptocurrency.

Why is DAI so popular in DeFi ?

Simply put, DAI is decentralised and smart contracts can interact with each other. This gives ground to what’s called composability in DeFi. Composability is the ability for applications and protocols to interact with one another in a permissionless way — meaning they are constantly interacting and leveraging each other’s code, and therefore each other’s utility.

Ethereum smart contracts are a bit like Lego blocks – you can combine them with ease and automate interaction between different projects.

As of today, more than 400 DeFi apps have integrated Dai. One of the key uses of Dai is to provide liquidity for various DeFi projects such as decentralised exchanges (Uniswap). Owners of Dai are motivated to lock their assets in liquidity pools by subsequently earning trading fees in exchange for creating a market.