According to recent information from Dune Analytics, which takes data directly from the blockchain transaction logs, the blockchain-based token, DAI, created by MakerDAO, monthly transaction volume reached $2.5 billion in November 2019 and over $1 billion in December 2019. Since then 2020 has been a amazing year, with over 2 billion USD tied up in smart contracts on the MakerDao.
Who is the MakerDao?
MakerDAO is a decentralized autonomous organization based platform that contains the maker coin (MKR) which acts as a governance coin, and the DAI which is a stable digital currency. The project was started in 2015 and did not conduct an ICO, instead choosing to privately sell MKR tokens to fund development over time. Maker’s DAI stable coin launched at the start of 2018
What is the MakerDao?
MakerDAO is basically a credit facility that issues loans with a certain interest rate called the stability fee against a collateral called Ethereum. The loans are paid to borrowers in Dai. Each Dai is worth one dollar USD. The stability fee or interest rate is raised to reduce selling pressure on the Dai and help keep it pegged to the dollar and vice versa. The DAI stability fee or interest rates for borrowers was 1%, but later the stability fee increased from 1% to 3.5%.
Who Controls the System?
The holders of the MakerDAO Token MKR token influence certain aspects of the protocol such as: What should the be the annual borrowing fee be (stability fee)?, How much collateral should be backing each CDP? (collateralization ratio) and Shutting down the protocol in the case of a sudden drop in the price of Ether or another situation (emergency shutdown)?
What does the MakerDao do and why are there so many transactions? The MakerDao provides loans in Dai, against assets, mainly Ethereum and in some instances Bitcoin held by Bitgo.
For Example
If you deposit one Ethereum worth $150 USD in the MakerDao you can ask for a 50 Dai loan and 50 Dai is worth 50 dollars USD. Your asset, the Ethereum, is held as collateral and you get it back when you repay the loan. This process of depositing your Ethereum as collateral and getting a loan is known as collateralization.
The ratio of collateral to loan is $150/$50 or 3:1. This is called your collateralization ratio. The minimum ratio is 1.5. If the price of Ethereum falls, your ratio will fall. Once the dollar value ration of your Ethereum collateral gets to 1.5 your Ethereum collateral will be liquidated or sold to pay back your loan.
Why Collateralize your Ethereum
As an investor your rate of return on Ethereum is variable, for example if the price for Ethereum increased 5% in one month your ROI was 5%.
If you owned $100 worth of Ethereum your 5% ROI was worth $5 USD.
But what if you owned 10 times as much Ethereum? $1000 worth of Ethereum at a 5% ROI would mean $50 USD.
If you had 100 times as much Ethereum your 5% ROI would be worth $500 USD.
So to make more money, you need to buy more Ethereum. But with collateralization you can buy more Ethereum without having more money.
For Example.
You buy and hodle one Ethereum worth $150 USD. In one month if your ROI was 5%.
150/100 =1.5 x5 = $7.5 USD
But if You deposit your $150 worth of Ethereum in the MakerDao, you can borrow 75 Dai, using your $150 worth of Ethereum as collateral. You then exchange 75 Dai for $75 USD on the exchange and buy $75 dollars worth of additional Ethereum. Now you own $225 dollars worth of Ethereum. So if in one month you get a 5% ROI on $225 USD or 225/100=2.25x5=11.25$.
So by using the MakerDao you were able to increase the amount of Ethereum your hodling from $150 to $225, a 50% increase, but without investing any additional capitol. While you pay 3.5% interest on the additional $75 worth of Ethereum you still get 1.5% ROI without increasing your capitol invested.
Discussion
You didn’t use any additional capitol to increase your ROI, you used a “Credit Facility”, which is called MakerDao. This allowed you to earn money from the appreciation of your asset and to borrow against your asset to buy more asset and earn more money. That’s why this is popular and that’s why the MakerDao has increasing volumes as more people collateralize their assets to make more money.
In some ways, this is a win-win situation as the MakerDao gains 3.5% stabilization fee and the borrower gains addition ROI.
But there’s more.
Bitgo is currently offering a service which allows people to Tokenize their Bitcoin and get Ethereum. Then those Bitcoin owners can deposit their “Ethereum loans” at the MakerDao and borrow against it. Then they can earn off the appreciation of Ethereum and the appreciation of their Bitcoin.
And even more
You can also deposit the Ethereum you bought with your MakerDao loan in the MakerDao to increase both the amount deposited and the amount you can borrow. So if you deposited $300 worth of Ethereum and borrowed $100 in Dai, which you changed to dollars and bought Ethereum. You could deposit this additional $100 worth of Ethereum in the MakerDao for a total of $400 dollars worth of Ethereum in your account. Now you could borrow an additional $100 to bring your total borrowing to $200 and use this second $100 loan to buy $100 worth of Ethereum and deposit this also, for a total of $500 of Ethereum deposited and $200 borrowed.
Now your $300 worth of Ethereum has grown to $500 worth of Ethereum using the MskerDao credit facility and your collateralization ration is 500/200 or 2.5, well above the 1.5 liquidation market and requiring a 40% drop in the Ethereum Price
Are losses possible?
Certainly. But they are very similar to your possible losses HODLing Ethereum.
Example
You buy and hodle $150 worth of Ethereum. In one month it drops 50%. Now the value of your $150 has fallen to $75. You lost 50%. If you sell now, you get $75.00.
If you take the same $150 USD investment, deposit it in the MakerDao and borrow 75$ ( 75 Dai, exchange for $75 dollars, but $75 dollars worth of Ethereum and now hodle 225$ worth of Ethereum for one month. If Ethereum falls in value 50%, your Ethereum collateral deposited in the MakerDao will be liquidated or sold for 75 dollars to pay back your loan. You are left with the $75.00 worth of Ethereum you bought using the loan. Basically the same position you would have been in, if you had just hodled your original $150 worth of Ethereum.
So technically there are losses, but in reality your ROI is zero in both scenarios.
Decentralized Finance
The MakerDao doesn’t care about your race, religion, sex or country of origin. There are no financial qualifications other then having Ethereum. This is permission-less, as in you don’t need anyone’s permission to do this. It is also trust-less by design as the smart contract locks up your Ethereum when you enter the agreement and releases your Ethereum when you repay the loan.
This is the future, and because we have a stable coin here, we could do this here.
✍️written by Shortsegments.
