MakerDAO: A Beginner's Guide to Decentralized Stablecoin
If you are familiar with cryptocurrencies, you may have heard about MakerDAO. MakerDAO allowed for the creation of a stablecoin, which is a cryptocurrency that is backed by a stable asset or a basket of assets. This ensures that the value of the cryptocurrency stays stable over time which makes it attractive for people who want to avoid fluctuations in the value of their crypto investments. In this article, we will explore what MakerDAO is, how it works, and its pros and cons.
What is MakerDAO?
MakerDAO is a decentralized organization that runs on Ethereum blockchain. It allows people to create, buy, and sell a stablecoin called DAI. DAI is designed to maintain a 1:1 peg to the US dollar, which means that one DAI will always be worth one US dollar. It is backed by collateral, which is mainly Ethereum, that is held in a smart contract called the MakerDAO collateralized debt position (CDP).
How Does MakerDAO Work?
The MakerDAO system involves creating a collaterized debt position (CDP) that acts as collateral to mint DAI. The user locks up Ethereum as collateral and borrows DAI against it. The amount of DAI that can be borrowed depends on the amount of collateral that has been locked up. The user can then use the DAI to buy other cryptocurrencies or use it for other purposes. In order to get the Ethereum back, the user has to pay back the DAI.
The key concept behind MakerDAO is the use of incentivization to keep the system stable. The value of the collateral on the smart contract is required to always be higher than the amount of DAI that is borrowed against it. If the value of Ethereum drops, the smart contract will automatically liquidate some of the Ethereum in order to reduce the amount of DAI that is being borrowed. This allows users to get their Ethereum back and avoids the system becoming insolvent.
Another feature of MakerDAO is the use of stable fee rates. Anyone who uses the system has to pay a fee for the use of the smart contract. MakerDAO's fee rates are stable and are proportional to the stability fee which is set by the MakerDAO governance process. Fees are paid in MKR, the native token of MakerDAO. MKR also acts as a governing token in the MakerDAO ecosystem.
Pros and Cons of MakerDAO
Like any crypto project, MakerDAO has its pros and cons. Here are some of the main ones below.
Pros
- Stablecoin: The main advantage of MakerDAO is that it offers a stablecoin. The stability of the coin is a major advantage if you want to avoid crypto price volatility.
- Decentralized: MakerDAO is a decentralized project that runs on the Ethereum blockchain, which means that it is not controlled by any central entity. This ensures that no one can manipulate the system for their own benefit.
- Transparent: MakerDAO is an open-source project, which means that anyone can inspect the code to see how it works. The team behind MakerDAO is also transparent about their development process and roadmap.
- Community-driven: MakerDAO has a strong community behind it that is dedicated to developing the system and ensuring its success.
Cons
- Collateralized: MakerDAO is collaterized, which means that it requires users to lock up Ethereum as collateral to mint DAI. This can be a disadvantage for people who are not holding Ethereum.
- Volatility: While DAI is designed to maintain a 1:1 peg to the US dollar, it is still subject to volatility just like any other cryptocurrency.
Conclusion
MakerDAO is an innovative project that offers a stablecoin in a decentralized way. The MakerDAO system is designed to maintain stability through incentivization and collateralization. The project has a strong community behind it and is transparent and open-source. While it is not without its limitations, MakerDAO is an exciting project that is worth watching for anyone interested in stablecoins and decentralized finance.