How Do DAI Tokens Work?

Dai is the first decentralized stablecoin that aims to maintain its value with the US dollar in a 1:1 ratio. Discover how Dai works and its various benefits.
By 

Josiah Makori

 on August 24, 2022. 
Reviewed by 

Michelle Meyer

Dai is the first decentralized stablecoin, as opposed to a semi-centralized stablecoin like USDC, that aims to maintain its value with the US dollar through a 1:1 peg. It strives to solve one of the major challenges facing the mass adoption of cryptocurrencies—volatility. Unlike other stablecoins issued by centralized entities, Dai is the native currency of the Maker Protocol, a decentralized autonomous organization (DAO) built on the Ethereum network.

How Is DAI Created and Destroyed?

Dai is created when a user borrows against locked collateral and is destroyed when the user repays their loan. For example, if you lock ETH or any other accepted crypto in the Maker Protocol, you will receive a loan in the form of new Dai tokens. When you repay the loan, the protocol burns the Dai tokens and gives you your collateral.

Importantly, the Dai ecosystem is governed through a democratic system of governance. Here, every change and decision affecting Dai is executed after approval by most token holders.

What Is DAI Pegged To?

Dai is pegged to the US dollar on a 1:1 ratio by leveraging the Target Rate Feedback Mechanism (TRFM). When the Dai price is below $1, TRFM rises and pushes the price upwards.

When the price increases, Dai holders make profits, and the demand for Dai increases. As the demand rises, the supply of Dai begins to reduce because users borrow tokens from the market via Collateralized Debt Positions (CDPs). Therefore, they make the Dai price rise to its target price again.

Benefits of Dai Over Other Collateralized Stablecoins

Here are the main benefits of Dai over other centralized stablecoins:

  • Complete financial independence Dai is managed by the Maker Protocol, eliminating intermediaries from the equation. This means Dai tokens cannot be censored or frozen.
  • Self-sovereign money generation You can create Dai by locking collateral in the Maker Protocol to eliminate counterparty risks instead of trusting a custodian with it.
  • Savings Dai holders can put their assets into use and earn the Dai Savings Rate (DSR) by depositing Dai in smart contracts. You can access these contracts via the OKEx Marketplace, and by using crypto wallets such as Oasis Save and Argent wallet.
  • Convenient, fast, low-cost remittance Unlike most stablecoins, you can use Dai to repay loans and perform cross-border and other online payments cost-effectively.
  • Transparency minting mechanism Unlike in centralized stablecoins where custodians might mismanage the locked funds (remember the collapse of TerraUSD), Dai embraces transparency through the use of smart contracts in managing its reserves.

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