Introduction to MakerDAO

    2023, Nov 21

    Introduction

    MakerDAO is a decentralized autonomous organization managing and issuing the stablecoin DAI, which is designed to maintain a 1:1 peg with the US Dollar.

    Dai principle

    Unlike traditional fiat-backed stablecoins that rely on a centralized entity to hold reserves, Dai is generated through a process called collateralized debt positions (CDPs). Users lock up collateral, typically in the form of Ethereum (ETH), in a smart contract, and in return, they receive Dai. This process ensures that Dai is always backed by collateral, maintaining its stability.

    General concept

    Collateralized Debt Positions (CDPs)

    CDPs are at the core of MakerDAO’s operation. When a user wants to generate Dai, they create a CDP by locking up a certain amount of collateral. The collateral is held in a smart contract, and based on the value of the collateral, a user can generate a specific amount of Dai. This mechanism allows users to access liquidity without having to sell their assets, providing a decentralized alternative to traditional lending platforms.

    Vaults and Stability Fee

    The collateral held in CDPs is stored in MakerDAO’s Vaults.

    For the old Single-Collateral Dai version, the mechanism can be described thus

    The stability of Dai is maintained by adjusting the stability fee, an interest rate charged on the generated Dai. If the value of the collateral falls, the stability fee is increased, encouraging users to close their CDPs and reduce the circulating supply of Dai. This dynamic system helps to stabilize Dai and ensures that it remains pegged to the US Dollar.

    For the new version which introduces the MCD system, you can read the documentation on maker DAO

    Reference: stability fee

    Governance and MKR Token

    MakerDAO operates as a decentralized autonomous organization (DAO), meaning that the community plays a crucial role in decision-making. The governance of MakerDAO is facilitated through the MKR token, the native governance token of the platform. MKR holders have the power to vote on proposals that impact the protocol, such as changes to the stability fee, adding new collateral types, or modifying the parameters of the system.

    Liquidation example

    Example with ETH = $3,000 and a collateral ratio required of 1.5

    1) Deposit 1 ETH into Maker 1) Borow 1,000 DAI

    Collateral ratio = 3’000 / 1’000 = 3

    1. Price of Ether drops to $1,400
      1. Collateral ratio drops to 1.4 du to 1,400 / 1,000 = 1.4 < 1.5
      2. Take my 1 ETH and auction it off (dutch action)
      3. Raise enough DAI to pay back my borrow + liquiditation fee
      4. Leftover collateral send back to me (owner of the position that was liquidited)

    Reference: owen Thurm - How Does DAI & Maker DAO Work? - DeFi 101

    Smart contracts

    List of the main smart contracts

    Contract Description
    Collateral Module The collateral module is deployed for every new collateral type added to Vat. It contains all the adapters and auction contracts for one specific collateral type.
    Core Module Contains the entire state of the Maker Protocol and controls the central mechanisms of the system while it is in the expected normal state of operation. One of its primary components is the Vat contract. The core Vault, Dai, and collateral state is kept in the Vat.
    Dai Module Contains the DAI token contract and all its key functionalities.
    Emergency Shutdown Module It has the ability to trigger the Shutdown of the Maker Protocol.
    Flash Module Allows anyone to mint Dai up to a limit set by Maker Governance with the one condition that they pay it all back in the same transaction with a fee. It is very similar to the concept of flashloan
    Governance Module Contains the contracts that facilitate MKR voting, proposal execution, and voting security of the Maker Protocol.
    MKR Module Contains the MKR token, which is an ERC20 token that provides a standard ERC20 token interface. It also contains logic for burning and authorized minting of MKR.
    Oracle Module An oracle module is deployed for each collateral type, feeding it the price data for a corresponding collateral type to the Vat.
    Proxy Module Contains contract interfaces, proxies, and aliases to functions necessary for both DSR and Vault management and Maker governance.
    Peg Stability Module (PSM) Enables quick swapping of DAI with other stablecoins at a rate of 1:1 by creating a pooled collateralized-debt position with 100% collateralization ratio and 0% stability fees.
    Rates Module Accumulates stability fees on Vault debt balances, as well as interest on Dai Savings Rate (DSR) deposits.
    Shutdown Stops and gracefully settles the Maker Protocol while ensuring that all users, both Dai holders and Vault holders, receive the net value of assets they are entitled to.
    System Stabilizer Module Corrects the system when the value of the collateral backing Dai drops below the liquidation level (determined by governance) when the stability of the system is at risk.

    Secondary contracts

    Contract Module Description
    Vat CoreModule The Vat is the core Vault engine of dss. It stores Vaults and tracks all the associated Dai and Collateral balances. It also defines the rules by which Vaults and balances can be manipulated.
    The contract Vat is included in the Core Module contract
    Spot CoreModule The Spot liaison between the oracles and the core contracts. It functions as an interface contract and only stores the current ilk list. A ilk is a given collateral type

    Reference: makerDAO - Maker Protocol smart contract system

    Vocabulary

    Term Short Definition
    Risk Parameters system variables system variables adjusted through MKR governance to control various types of risk.
    Important parameters for each collateral type:Stability fee , Debt ceiling and Liquidation ratio
    ilk collateral type each has its own set of risk parameters
    urn vault an ethereum address can control one urn per collateral type
    gem unlocked collateral gem is collateral that is not yet locked in a Vault but still recorded in the system
    sin system debt unit a debt balance that is tracked during liquidation process
    dai stablecoin a good debt token

    Reference: Maker Protocol 101

    Risks and Challenges

    MakerDao faces different challenges:

    • Its reliance on Ethereum as the underlying blockchain exposes MakerDAO to network congestion and scalability issues.
    • Additionally, the stability of Dai is contingent on the collateral backing it, and extreme market volatility can pose risks to the system.

    References

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    # blockchain # makerDAO # DAI # stablecoin # ethereum

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