DeFi Cornerstone: Deep Interpretation of Stabilizing Coin Dai

Recently, Dai has appeared frequently in our field of vision.

Dai is currently the largest decentralized stable currency in the market, and the most eye-catching DeFi project of the past year.

Dai is a decentralized stable coin introduced by MakerDAO. It is automatically generated by mortgage ETH in the “CDP Smart Contract” and its price is stable at 1:1. Unlike the USDT, Dai does not need to anchor the real world legal currency, but rather to design a decentralized economic system to keep Dai's price spontaneously at a stable level.

Since its launch in late 2017, 2% of ETH has been locked into the CDP of the Maker system, accounting for 90% of the DeFi lockout, which means that approximately 2.1 million ETHs are used as collateral. Dai's liquidity and active addresses have grown by 20% per month, with liquidity approaching 100 million and active addresses reaching 8,000. Even in the cold winter of Ethereum's 90% cryptocurrency, Dai's performance is still strong.

Dai's two magic weapons for maintaining stability: the automatic excess mortgage + target rate feedback mechanism, once praised.

However, in the near term, Dai is decoupled from the ideal stable price of the US dollar, and there is a trend of continuous increase. Since February, the “4” loan interest rate has been continuously raised in just 2 months, from 0.5% to 1%. , to 1.5%, 3.5%, and now 7.5%, can not help but raise questions from the outside world.


Encrypted world needs stable currency

The roller coaster-style ups and downs have made cryptocurrency almost impossible to become an ideal medium for daily payments and consumption. Ask, who can accept bitcoin for wages, and wake up the next day, the value shrinks by 10%?

Encrypting the world requires a cryptocurrency of stable value to hedge against extreme price volatility and promote the adoption of cryptocurrencies in the real world.

To this end, various types of stable coins have appeared on the market, such as Nubits, which are controlled by algorithms, USDT issued by the US dollar, and regulated stable currencies such as GUSD and PAX.

As the earliest blockchain platform to support smart contracts, Ethereum itself is due to the rise and expansion of financing needs, and has the best developer ecology.

In the past year, the DeFi ecosystem began to take shape in Ethereum, and various decentralized financial applications and Dapps began to be built on Ethereum. DeFi code is open source, transparent, interoperable, and allows for finance, assets and value. Maximizing free flow allows this financial ecology to unleash its unprecedented vibrancy.

DeFi, the decentralized finance, is built on top of open source agreements, meaning that contracts can be called, combined, and form new intelligent assets, which contribute to the formation and rapid development of the ecology.

Just as the Internet builds an information infrastructure parallel to the real world, the blockchain will create a financial infrastructure that is parallel to reality, and this ecology requires a stable currency as a medium of trading. Obviously, the ETH price fluctuates greatly and is not an ideal stable currency.

Whether it is an exchange, a derivative, a loan, or a forecasting market, almost all real-world financial services can find a corresponding decentralized version on Ethereum.

Dai was born in this context, issued by MakerDAO on December 17, 2017, the first decentralized stable token on the Ethereum, 1:1 anchored in US dollars.

As the base currency of the system in Ethereum, Dai has driven and promoted the development of the entire open financial ecosystem.

Compared with the widely criticized mainstream stable currency USDT, Dai is generated by smart contracts on the blockchain, meaning that the chain is transparent, no license is required, and there is no need to worry about the excessive issuance of USDT. All generation and redemption records are on the chain and anyone is audited on the chain

Pan Chao, head of MakerDAO China Community, said to 31QU: “It can be said that Dai has no competitors in Ethereum, and Dai is different from other target users of stable currency services. Other stable currencies are mainly used as deposit channels and must be pledged for one dollar to be issued. The new stable currency, while Dai's model is different, it is a stable currency that pledges the issuance of encrypted assets, and does not need to occupy real resources. In this sense, it has a large-scale expansion capability."

“In the future, ERM20 stable currency such as TUSD can be directly incorporated into Dai's system to increase the market value of DAI as collateral. Therefore, the emergence of various stable currencies is actually good for Dai.”

So, how does Dai, who does not need to pledge US dollars, maintain 1 Dai = 1 USD?


Dai's release and stability

To understand Dai's logic, we first need to understand the "CDP Smart Contract."

In the Maker system, there is a “CDP Smart Contract” that implements the mortgage logic. When you send ETH to this smart contract, the system will generate a corresponding number of Dai according to the value at that time according to a certain discount.

To make it easier to understand, we imagine the Maker system as a bank loan system. When you are tight, you need a sum of money to get a turnaround, you can go to the bank to mortgage your belongings, and then get a cash.

Only in the Maker system, this bank is not operated by people, but by smart contracts. You are not mortgaged in real life, but encrypted assets Ethereum. You don’t get cash, but stable coins. Dai.

When a bank issues a loan, it will give us a discount on the mortgaged property. In Maker's mortgage system, the system will ask you to set a mortgage rate of at least 150%.

Note: Mortgage rate = value of collateral / value of lending, which is the value of ETH / the value of Dai.

Not less than 150% means that the value of the collateral (ETH) is at least 1.5 times the value of Dai, which guarantees that the value of the collateral is always greater than the value of the lent Dai, so that each Dai generated is behind The amount of assets supported.

"This is overcollateralization." Pan Chao told 31QU, "This is a prerequisite for maintaining Dai's stability, because there are always assets at the bottom."

When the value of the collateral falls to a certain threshold (such as the mortgage rate of 150%), the price of the collateral cannot support the value of the corresponding Dai. At this time, the borrower needs to make up the collateral or repay Dai in time, otherwise the system will perform automatic liquidation.

The Ethercoin mortgaged in the CDP will be auctioned at a price below the market until the loan is paid off, in the process, a 13% penalty and handling fee will be incurred. In order to encourage users to actively participate in the liquidation of non-performing assets, the “Keeper” who actively participates in the liquidation of poor quality CDP can obtain 3% risk-free income to maintain Dai's solvency and credit.

When the collateral price rises, it means that the mortgage rate is higher. The average mortgage rate of the CDP contract is close to 300%, which means that the guarantee is very sufficient and the system has no risk.

If there is an extreme black swan incident, the mortgage assets will suddenly fall below the threshold when the system is too late to respond. What should we do then?

Mo Pan, there is also the last gatekeeper in the Maker system, that is, when the value of the collateral collapses enough to redeem Dai, the global liquidation will be initiated, and the MKR holder will be responsible for the repurchase, so that the Dai holder can Return the assets of the equivalent dollar.

The MKR token is the native token of the MakerDAO system and can be used to pay for Dai's stable costs, and MKR holders can participate in the management of the entire MakerDAO system.

Just as the bank will auction the collateral to pay off the borrower's loan, the MKR holder, as the beneficiary of the system, enjoys the dividend right and should bear certain risks. When the black swan incident occurs, MKR will issue an additional repurchase of Dai. Use equity to make up for the insolvent part.


Why is Dai so popular?

Why is Dai so popular? Another expression of this question is, what can people do with Dai?

Like traditional finance, Dai's core uses are nothing more than deposits, loans, asset management, and payments.

If you are optimistic about ETH for a long time, you can get liquidity by pleasing Dai and use Dai for daily consumption and payment.

For example, as a mortgage, someone bought a car through the Dai model and opened a coffee shop.

In addition, in cross-border transfers and supply chain finance, Dai acts as a bridge to connect the real economy.

International supply chain company Tradeshift uses Dai as a payment method and explores the tokenization of the bill for the financing of Dai.

At present, Dai and the digital asset transfer company Wyre have opened the channel of digital currency and legal currency. The previous international transfer through Bitcoin and Ethereum can be carried out by Dai, which eliminates volatility, and the company can obtain USD, EUR, GBP, AUD, Instant exchange of Hong Kong dollars and Renminbi.

Pan Chao told 31QU that Dai can also be used for charity, real estate investment, etc. “The advantage of using Dai is that it can make cross-border investments, disclose contract details, and automatically reap the rewards”.

▲ During EthDenver, Dai's BuffiDai was used as the local currency during the event for offline payments, purchases, and donations to UNICEF.

According to the Planetary Daily, DAI even supports the purchase of contractual US dollar assets USStocks.

USStocks is an ERC-20 token issued by the UMA Protocol. It anchors the Standard & Poor's 500 and can be regarded as a derivative of the US stock market. It is currently on the decentralized exchange DDEX and can be purchased with DAI. USStocks over-collateralized MakerDAO to ensure that users can obtain liquid assets equivalent to S&P500 at any time.

However, for the most attractive users, still use Dai to add leverage to do more Ethereum.

For example, I see more ETH, and I firmly believe that ETH will rise in the future. At this time, I have ETH worth 150 US dollars, pledge Dai in the CDP to generate 100 US dollars, and continue to buy 100 US dollars of ETH. I have a total of 250 (plied 150 US dollars + buy 100 US dollars) US dollars ETH.

After a while, the ETH price doubled.

If I don't do anything, my ETH value doubles and I have $300 ETH.

At this time, because I used Dai as a lever, I have ETH worth $500, plan to redeem ETH's $100 Dai and 0.5% of the fee, leaving 398 US dollars of ETH.

That's right, I probably earned 100 more knives. This is the legendary plus leverage to do more ETH.

And this is only a double leveraged benefit. If you pledge the ETH multiple times, you can get the effect of multiplying the asset several times. Do more ETH with multiple leverage, just pay very low interest (paid by MKR, future year) It may be 0.75%), which can be said to be a very cost-effective encryption asset credit tool.

It is precisely because of the need for more leverage, Dai has propped up the financial applications of the entire Ethereum. With the launch of more and more projects that integrate Dai, Maker's volume is getting bigger and bigger.

The following are the number of ETH locks in each DeFi project. Considering the overwhelming advantage of Dai, the first one is to remove the data after Dai.

Then, after seeing the addition of Dai, other projects are basically invisible to the naked eye, and the green part accounts for 90% of the total DeFi ecological locking amount, which is absolutely overwhelming.

Interestingly, Maker also produced a series of secondary lending markets that further increased Dai's lending and liquidity.

Pan Chao told 31QU: "Users mortgaged Ethereum to generate Dai, which is the primary market. Then, these people then loaned DeFi to others to form a secondary market for Dai."

There are two projects with the most outstanding achievements in this field, one of which is the Digital Asset Mortgage Lending Agreement Compound, which has locked 134,000 Dais. The other is the peer-to-peer lending agreement Dharma, which has locked 131,000 Dais. It is worth noting that the picture below is Dharma's data just online.

In these free markets, you can lend the generated Dai to the users who need it again to get interest.

In this regard, Pan Chao said, “The existence of these secondary markets will allow more people to participate in arbitrage and make Dai's price more effective. In the future, Dai will increase deposit interest.”

To sum up, Dai built a Maker's credit ecosystem through an excess pledge mechanism. There are three types of users. The first one is people who see ETH. They mortgage encrypted assets and leverage them for Dai. The leveraged Dai product, which is used as a by-product of the stable currency, is used by people with stable currency requirements, such as payment and quiz betting. This is the second type of user. The third type of user is the MKR managed token holder who maintains the system, takes on certain risks, and earns revenue through dividends.


Two big interest rate adjustments

However, is Dai really so stable?

Recently, Dai’s price has continued to fall below the anchorage of $1 due to supply and demand problems. Since February, in just two months, the loan interest rate has been raised four times, from 0.5% to 1% to 1.5. %, 3.5%, and now 7.5%, has raised questions from the outside world. Is the Maker system really effective?

Dai's currency price has been below $1 since 2019, and the signs of disengagement continue to increase.

The latest time, Maker's decentralized autonomous organization MakerDAO voted and finally decided to increase the stability fee from 3.5% to 7.5%. It is hoped that Dai supply will shrink and the price will return to $1 relative to continued demand.

Raising the interest rate of the stabilization fee will increase the cost of holding Dai, which will encourage investors to choose to redeem the collateral and reduce the circulation of Dai in the market. At this time, the market becomes the buyer's market, and the price may rise; the reverse operation is Dai. The number has increased and the price has fallen. This is the theoretical basis for Dai's 1:1 anchoring with the US dollar. This mechanism actually draws on the way the central bank regulates interest rates through open market operations.

After the last interest adjustment, the price on Coinbase quickly bounced back to $1.

According to Beneath Network data, since January 2018, Dai's users have "sold DAI" much more than "hold or buy", and the volume of both has gradually shrunk, and the gap has gradually widened.

This means that most users tend to mortgage Dai ETH for Dai (for consumption or investment) rather than wanting to trade organically through stable currency (or buying Dai directly from the exchange).

One possibility is that the large amount of possession of the stable currency Dai is leveraged, rather than the purpose of holding a stable currency, the supply demand in the market will be out of balance.

Rune Christensen, founder of Maker DAO, also proved this statement, “because of the lack of organic demand, the speculative price decline has caused a dangerous feedback loop.”

Pan Chao’s answer further confirmed the statement. “ At present, Dai only supports a single mortgage ETH, which has led many people to borrow ETH from Dai. They are expecting the arrival of the bull market, and ETH will increase in value. This has led to the generation of more and more Dai. Excessive liquidity and low prices. This is only a special phenomenon at a certain point in time. In the future, we will introduce multilateral mortgage assets, including electronic gold, stable coins, and more other currencies, which will help maintain the stability of Dai. ”


DeFi, the decentralized finance, is another name called Open Finance.

Open finance is built on top of open source agreements, meaning that contracts can be called, combined, and form new intelligent assets, which contribute to the formation and rapid development of the ecology.

Endemic to the Ethereum ecology, as a medium of exchange, the decentralized stable currency Dai, in the short period of one year of birth, has entered our field of vision in a posture that is as strong as a broken bamboo. At the core of this, an emerging open financial ecosystem is gradually becoming visible, including the decentralized crypto asset lending agreement and forecasting market that can borrow Dai again.

In fact, Dai is much more than just a stable currency. It is a credit system. By designing a decentralized economic system, Dai's price is spontaneously maintained at a stable level.

As more members reach out to this credit system, it will release the vitality of open finance as never before, and at the same time, it will increase the complexity of the entire financial ecology, especially as a support for the entire Ethereum's open financial volume. The basic currency, every policy adjustment and governance, not only affects Dai itself, but also affects the DeFi community and ecology at a broader level.

Text / 31QU Thor

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