A beginner's guide to MakerDAO, the DeFi lending platform that enables users to take out loans by locking-in collateral in exchange for DAI.
MakerDAO is a decentralised finance platform that operates on the Ethereum blockchain.
It's a smart contract lending platform that enables users to take out loans by locking-in collateral in exchange for DAI - the platform's stablecoin that is pegged to the value of USD.
The MakerDAO platform is powered by the MKR token, which serves as both a governance token and a means to stabilise the value of DAI.
On the whole, MakerDAO is a groundbreaking project that has the potential to revolutionise the way we think about stablecoins and decentralised finance (DeFi).
Our MakerDAO guide will talk about how the team has created a stablecoin that is not subject to the volatility of traditional cryptocurrencies and thus opened up new possibilities for using blockchain technology in everyday transactions.
Introduction to MakerDAO
MakerDAO was created in 2014 by Rune Christensen, a Danish entrepreneur who saw the potential of blockchain technology to create a stablecoin that could operate without centralised control.
Since then, with a market cap that has grown to $1 billion+, MakerDAO has become one of the most significant projects in the DeFi industry.
The significance of MakerDAO lies in its ability to create a stablecoin that is pegged to the value of the US dollar, without relying on a centralised authority.
Sound familiar, Hive?
This stability is achieved through a complex system of smart contracts that respond to market conditions by adjusting the supply of DAI and the collateral requirements for loans.
As you’ll see later in this guide, the MKR token is also an essential part of the MakerDAO ecosystem.
It is used for governance, meaning that MKR holders can vote on proposals that affect the direction of the project.
Additionally, MKR is used as a backstop in case the system experiences a black swan event, meaning that MKR holders can be forced to sell their tokens to cover any losses.
How does MakerDAO work?
Consensus is at the heart of how MakerDAO works.
The platform relies on a decentralised network of participants to maintain consensus on the value of DAI, the stablecoin that MakerDAO issues.
This consensus is achieved through a complex system of smart contracts that ensure the stability of the platform.
To create DAI, users must first deposit collateral in the form of Ethereum (ETH) or other accepted tokens into a smart contract called a Collateralised Debt Position (CDP).
Once the collateral is locked in, users can then generate DAI, which they can use for transactions, trading, or simply as a store of value.
The amount of DAI that can be generated is determined by the value of the deposited collateral and the collateralisation ratio, which is set by the MakerDAO governance community.
The higher the collateralisation ratio, the more collateral is required to generate a specific amount of DAI.
This system ensures that the value of DAI is always backed by more than 100% of the deposited collateral, providing stability and security to the platform.
To maintain this stability, MakerDAO uses a mechanism called the Stability Fee.
This fee is a percentage that users must pay on their generated DAI and is used to incentivise holders of the MKR token to vote for adjustments to the collateralisation ratio.
These adjustments help to maintain the value of DAI and prevent it from deviating from the peg to the US dollar.
If the value of the collateral falls too low, the system can automatically liquidate the CDP, selling the collateral to repay the generated DAI.
This mechanism ensures that the platform always has sufficient collateral to back the generated DAI, providing a high level of security to users.
What is MKR crypto used for?
The MKR token is an essential part of the MakerDAO ecosystem, serving both as a governance token and as a backstop in case of black swan events.
MKR holders have the ability to vote on proposals that affect the direction of the project, such as adjusting the collateralisation ratio or changing the Stability Fee.
This governance structure ensures that the community has a say in the project's development and provides a mechanism for adjusting the platform to changing market conditions.
In addition to governance, MKR is used as a backstop for the system.
In the event of a significant price drop in the collateral used to generate DAI, the system will auction off MKR tokens to cover any resulting losses.
This mechanism provides an extra layer of security to the platform, ensuring that the value of DAI remains stable and backed by sufficient collateral.
MKR is also traded on various cryptocurrency exchanges, allowing users to speculate on the success and future of the MakerDAO project.
What is DAI crypto used for?
On the other hand, DAI is USD pegged stablecoin that is used as a medium of exchange, store of value and a means of hedging against market volatility.
Users can generate DAI by depositing collateral into a CDP on the MakerDAO platform.
The generated DAI can then be used for various transactions, such as buying goods and services or trading on cryptocurrency exchanges.
One of the most significant advantages of using DAI is its stability.
Unlike other cryptocurrencies, whose values can fluctuate wildly, DAI is always pegged to the US dollar.
This stability makes it an attractive option for users looking to make transactions or store value without worrying about market volatility.
DAI is also used in various decentralised finance (DeFi) applications, such as lending and borrowing platforms.
Users can borrow DAI by putting up collateral in the form of ETH or other accepted tokens and then use the borrowed DAI to do whatever they please.
DAI's stability and versatility make it an essential component of the decentralised finance ecosystem, with a wide range of use cases and applications.
MakerDAO pros and cons
MakerDAO has been one of the most popular and successful projects in the decentralised finance (DeFi) space.
But like any platform, it has its advantages and drawbacks.
Here are some of the pros and cons of using MakerDAO:
Pros of MakerDAO
- Decentralised governance: MakerDAO is governed by its community of MKR token holders, which means that the platform is decentralised and decisions are made in a transparent and democratic way.
- Stablecoin: MakerDAO's stablecoin, DAI, is pegged to the US dollar and provides stability in the volatile cryptocurrency market. This makes it a popular choice for traders and investors who want to hedge against price fluctuations.
- Collateralisation model: MakerDAO's collateralisation model allows users to deposit a variety of cryptocurrencies as collateral, which provides flexibility and reduces risk.
- Open-source platform: MakerDAO is an open-source platform, which means that its code is available for anyone to review and contribute to. This encourages innovation and collaboration in the DeFi space.
- Integration with other DeFi protocols: MakerDAO has integrated with other DeFi protocols, such as Compound and Aave, which allows users to leverage their collateral in MakerDAO to take out loans on these platforms.
Cons of MakerDAO
- Complex platform: MakerDAO can be complex and difficult to understand for new users, which may deter adoption.
- High collateralisation ratio: MakerDAO requires a high collateralisation ratio, which can be a barrier to entry for some users. This means that users need to deposit more collateral than the value of the DAI they want to borrow.
- Centralisation risk: While MakerDAO is decentralised, there is still some centralisation risk in the fact that a small group of large MKR holders can exert significant influence over the platform.
- Vulnerability to black swan events: MakerDAO's collateralisation model is designed to mitigate risk, but it is still vulnerable to black swan events that can cause significant price volatility in the cryptocurrency market.
- Liquidation risk: If the value of the collateral deposited in MakerDAO falls below a certain threshold, the collateral may be liquidated, which can result in a loss for the user.
MakerDAO offers many benefits such as decentralised governance, a stablecoin and a flexible collateralisation model.
In saying that, it also has some drawbacks such as complexity and centralisation risk.
Ultimately, whether MakerDAO is a good fit for a user's needs will depend on their individual risk tolerance and preferences.
MakerDAO comparisons
It can be difficult to make direct head-to-head comparisons between MakerDAO and other projects in the decentralised finance space.
However, MakerDAO is often compared to other stablecoin projects such as USD Coin (USDC) and Hive Backed Dollars (HBD) due to its stablecoin offering, DAI.
Additionally, other projects that focus on decentralised loans, such as Compound (COMP) and Aave (AAVE), may also be compared to MakerDAO.
They share similarities in their use of smart contracts to facilitate loans in a decentralised manner.
Let’s split these comparisons.
MakerDAO (MKR) vs Aave (AAVE)
While both MakerDAO and Aave offer decentralised lending and borrowing services, there are some key differences between the two platforms.
One of the primary differences is the type of collateral that can be used to secure a loan.
MakerDAO requires users to lock up ETH or other accepted tokens in a Collateralised Debt Position (CDP) to generate DAI, which can then be used for various purposes.
The value of the collateral must be greater than the value of the generated DAI and a liquidation penalty will be applied if the collateral value falls below a certain threshold.
This collateralisation model helps to ensure that DAI remains stable and backed by sufficient collateral.
But it also means that users are limited in terms of the assets they can use to generate DAI.
Aave, on the other hand, allows users to deposit a wide range of cryptocurrencies as collateral, including popular assets such as Bitcoin (BTC) and Ethereum (ETH) (as well as many others).
This makes it a more flexible platform for users who hold a diverse range of assets.
Another significant difference between MakerDAO and Aave is their interest rate models.
MakerDAO charges a Stability Fee, which is a variable interest rate paid by borrowers to maintain their CDPs.
This fee is set by MKR holders through the governance process and is intended to incentivise users to maintain their collateralisation ratios and ensure the stability of the DAI stablecoin.
Aave, on the other hand, uses a dynamic interest rate model that is determined by the supply and demand of assets in the protocol.
Interest rates can vary based on factors such as the liquidity of the asset, the current utilisation rate of the protocol and the user's credit risk.
This model allows for more flexibility and responsiveness in the interest rates offered, but it also means that users may experience higher rates during times of high demand.
DAI vs Hive Backed Dollars (HBD)
DAI and Hive Backed Dollars (HBD) are two stablecoins that aim to provide stability in the volatile cryptocurrency market.
While they share this common goal, there are some key differences between the two stablecoins.
One of the primary differences is the collateralisation model used by each stablecoin.
DAI is backed by a variety of cryptocurrencies that are deposited into the MakerDAO protocol, which generates DAI in return.
The value of the deposited collateral must always exceed the value of the DAI in circulation to maintain the peg to the US dollar.
HBD, on the other hand, is backed by the Hive blockchain’s ability to always convert 1 HBD into 1 USD worth of HIVE.
As long as the debt ratio is in effect, there is no risk to HBD.
In terms of usage and adoption, DAI is currently more widely used and has a larger market capitalisation than HBD.
This could be due in part to the fact that DAI has been around for longer and has had more time to gain traction in the decentralised finance (DeFi) space.
Overall, while both DAI and HBD are stablecoins that aim to provide stability in the cryptocurrency market, they differ in terms of their collateralisation models, decentralisation and adoption.
Users will ultimately choose one stablecoin over the other based on their specific needs and preferences.
Should I buy MakerDAO (MKR) crypto in 2023?
MakerDAO has been one of the most innovative and successful projects in the DeFi space and its governance token, MKR, has been a top-performing cryptocurrency in recent years.
But should you buy MKR in 2023?
If you believe in the long-term potential of decentralised finance and the growth of MakerDAO as a lending platform, then buying MKR may be a good investment.
As MakerDAO continues to evolve and innovate, its governance token is likely to increase in value over time.
However, it's important to note that investing in MKR should not be done solely for speculative purposes.
If you plan to invest in MKR, it's recommended that you do so because you actually use the MakerDAO lending platform and believe in its potential.
In addition, it's important to consider the risks involved with investing in any cryptocurrency.
The price of MKR can be volatile, and the cryptocurrency market can be unpredictable.
It's important to do your own research and invest only what you can afford to lose.
In conclusion, buying MKR in 2023 can be a good investment if you believe in the long-term potential of decentralised finance and MakerDAO as a lending platform.
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