MakerDAO: The History and Role of the Building Block of DeFi

Anderson Evie
By Anderson Ezie
Joel Taylor
Edited by Joel Taylor

Published March 25, 2022.

2 gold MakerDAO  DAI cryptocurrency coins on a blue background with binary in the background

MakerDAO is an open-source Decentralized Autonomous Organization (DAO) and financial lending and borrowing application on the Ethereum blockchain. The protocol is partly Governed by the Maker Foundation, although it is fast moving towards a self-governed system. Developers across the globe started working on the MakerDAO between 2014 and 2015 to build the initial version of its codebase and decentralized architecture. After two years of development, the Maker platform released its first documentation.

The project was described as a system for creating the DAI stablecoin on the Ethereum blockchain using collateralized debt positions embedded in smart contracts. The project developers were a decentralized team of individuals and organizations that included developers from the Maker Foundation, partners of the foundation, and other entities. DAI, Maker’s stablecoin was initially a single collateral asset, SCD called Sai. It became protocol started supporting multiple collaterals with issued Dai backed according to their volatility of the collateral asset. The decision was reached through scientific voting, another feature of Maker that keeps the platform decentralized.

What Is the Maker Protocol?

The Maker protocol comprises two main assets and other ERC20 assets that serve as collateral on the MakerDAO platform. The first asset MKR is the governance token of Maker that can be used to vote on 1MKR:1 vote basis on changes to the protocol. The MKR token is also used to protect the system from arbitrary decisions that can affect the parameters set to ensure the sustainability of the MakerDAO protocol.

As the governance token of MakerDAO, MKR ensures stability through decisions on adding collateral asset types and defining the parameters for this collateral. MKR holders decide on modifying and adding risk parameters for new collateral asset types. MKR is also crucial in modifying DAI savings rate, choosing oracle feeds, the trigger of emergency shutdowns to protect the system, and upgrading the system. The DAI stablecoin functions as an on-chain decentralized stable currency with the complete features of fiat money and can be owned through minting by locking collateral assets such as Ethereum in Maker Vaults within the protocol or by buying Dai from exchanges.

Minted DAI was kept at a minimum of 150% collateral ratio, which meant that if you were to $500 worth of Dai, you would need to keep a minimum of $750 worth of ETH or other collateral in the vault. With the approval of the Multi Collateral Dai or MCD collateral contract in 2019, the minimum collateral ratio is now 175%. Minters of DAI through collateral vaults must pay a stability fee and the amount of Dai generated to liquidate their vault and reclaim their assets. There is also a 13% liquidation fee paid on liquidated vaults which the protocol keepers can initiate an auction mechanism to settle fees when the need arises fully.

Maker was established to create a price-stable cryptocurrency that gets its backing on-chain from crypto assets instead of fiat or physical assets. Dai is a neutral collateral-backed cryptocurrency that is free from the volatility of Bitcoin. According to the protocol whitepaper, Dai serves to create leverage positions for traders who want to hold their collateral assets such as ETH and gain exposure to the same or other cryptocurrencies while remaining fully collateralized and retaining their original assets. Remittances can also be settled in a stable digital asset using Dai and charitable contributions that want to stay transparent using the advantages of blockchain technology. Dai can also be used to wager on the future prices of assets without exposure to the volatility of the original asset in prediction markets. As one of the first protocols to run reliable price-feed oracles on the Ethereum blockchain, Maker also hopes that its oracles will be used by future DeFi projects to ensure the security of their system.

The stability mechanism of MakerDAO and the Dai stablecoin is pretty complex. Still, it is important to note that MKR also acts as a stability mechanism that keeps the peg of Dai as close as possible to the US dollar. The Dai Saving Rate (DSR) is the parameter that determines the amount earned in APY on Dai savings. MKR holders reduce the DSR, which is normally around 6% APY when the price of Dai moves above the peg. Doing this will reduce the supply of Dai by reducing the demand since users will be less interested in minting new Dai at such low yields. The demand for circulating Dai will push the price back to the peg. MKR holders also increase the DSR when the price of Dai falls below the peg, thus causing demand to put pressure on the price of Dai until it reaches the 1:1 peg with the dollar.

Who Can Access DAI Stablecoin?

Anyone can access Dai using Ethereum or other collateral ERC20 assets supported by the Maker protocol. These assets are used to create a collateralized debt position which is essentially a smart contract on the Ethereum blockchain that holds the collateral in a vault. Minting Dai simple even though the explanation sounds a bit technical. Dai can simply be minted on Oasis or other supported platforms decided by MakerDAO that forms the community ecosystem. It is also possible to own Dai by purchasing it on popular exchanges.

The Founder of MakerDAO

Rune Christensen, a Danish biochemist, and businessman, is the identifiable co-founder of MakerDAO. On Rune’s profile on the popular professional networking platform LinkedIn, Rune describes MakerDAO as the first stablecoin on the blockchain that eliminates volatility through a system of smart contracts. Rune owns two bachelor's degrees, one in Biochemistry specializing in complex chemical machines from the University of Copenhagen and another in International business from Copenhagen Business School.

What Makes MakerDAO Special?

Maker’s DAI is without doubt Ethereum’s native stablecoin even though there are now multiple stablecoins on the Ethereum blockchain today. It is the most widely used and longest-running protocol on the Ethereum blockchain. It is the 6th protocol by total value locked or TVL in the collateralized debt position, CDP category on the Ethereum blockchain with over $23 million in value. According to sources, Andreessen Horwitz, renowned venture capital, invested $15 million in Maker DAO to buy 6% of the total MKR supply as a part of its early investment through its a16z cryptocurrency fund.

Created the core layer of DeFi

MakerDAO laid the groundwork of ideas that led to creating several protocols on the Ethereum blockchain. The launch of DAOs like Curve, Uniswap, and other protocols that were based on collateralized lending, exchange, swapping, and the allocation of value on-chain attests to the groundbreaking work of MakerDAO in DeFi. Newer protocols, successful and unsuccessful on the Ethereum blockchain, have often cited MakerDAO for their careful economics and stabilization mechanism. Developments in algorithmic stablecoins are also offshoots of MakerDAO. The key mechanisms of DeFi as we know it today, including AMMs, vAMMs, and other smart contract-based models and stability mechanisms, are similar to the collateral debt mechanisms and other stability contracts on the Maker protocol.

How DAI, ETH, and MKR Work Together

Dai is the stablecoin created when collateral debt positions or vaults are opened on the Maker protocol. It offers users a stable asset while allowing them to lock volatile assets as collateral in the issuing vaults. Dai is also used to pay stability fees charged by MakerDAO. It is the primary asset of the protocol. To mint Dai, however, you must add ETH to the vault. Although the collateral has now been extended to include other ERC20 assets with varying liquidation parameters, ETH was the primary collateral asset and the reason for the name Sai which was initially the appellation for what is now known as the Dai stablecoin. MKR is the governance token and restabilization asset for the MakerDAO protocol. It triggers liquidation, suggests proposals, and protects the system from sudden events such as uncoordinated and abrupt liquidation which can endanger the protocol. You need ETH to get DAI and need MKR to sustain the setup that allows the creation of the crypto-collateralized stable asset.