Dai

What is Dai (DAI)?

Dai is an Ethereum-based stablecoin that is soft-pegged to the US dollar and collateralized by a mix of other cryptocurrencies using smart contract technology.

While still a cryptocurrency, a stablecoin is pegged to less volatile assets like fiat currencies. This can be done in several ways, whether by smart contracts and algorithms or a mix of assets, including cash in reserve.

Dai is overcollateralized by cryptocurrency, meaning that an amount of cryptocurrency greater than its circulating dollar value is locked away to maintain its peg.

Unlike many of the other top stablecoin projects like USDC, BUSD, and USDT, Dai is decentralized and neither operated nor developed by a single person or group.

While it was ‘flipped’ for a short while by UST (TerraUST) as the top decentralized cryptocurrency by circulating supply, UST’s subsequent collapse in the first half of 2022 saw Dai return to the top spot.

When Was Dai Launched?

Dai was launched in 2017 on the Maker Protocol, an open-source project aimed at operating a credit system that allows users to take out crypto-collateralized loans.

This type of loan enables the borrower to deposit ETH and other crypto assets into the Maker Protocol on Ethereum to lock their collateral. With this collateral secured, DAI tokens in the form of loans are generated.

Who are the Founders of Dai?

The Maker Foundation that created the Maker Protocol was founded by the Danish entrepreneur Rune Christensen in 2014. Three years later, DAI was launched on the Maker Protocol, but the Maker Foundation gave up control of the software to MakerDAO.

A DAO is a decentralized autonomous organization. As its name implies, it isn’t led or controlled by a single person or entity. DAOs are managed democratically through some sort of governance function. In MakerDAO’s case, this is via the MKR governance token.

These governance tokens function like stock in a traditional corporation. More specifically, because of the transparency and immutability of blockchain, they function like Direct Registered Shares and are immune to corporate governance malpractice.

MKR holders vote on decisions regarding the development of MakerDAO itself, the Maker Protocol, and DAI. Each individual’s voting power corresponds to the amount of MKR they hold.

How Does Dai Work?

Dai is generated when crypto assets, including Ethereum, are deposited into Maker Vaults on the Maker Protocol. Maker Protocol itself can be used via many interfaces, one of the most popular being Oasis Borrow.

Users lock in crypto assets such as ETH, LINK, UNI, YFI, and MATIC on these interfaces, then borrow Dai against these assets. The amount of DAI that can be borrowed depends on the collateral ratio, which begins at 101% but can range a lot higher depending on the asset locked.

Redemption of these locked assets, meanwhile, requires DAI to be returned to the Maker Protocol and burned, and a fee to be paid.

These mechanisms of issuance and burning of DAI are managed and publicly recorded by Ethereum smart contracts and can be viewed and traced on the blockchain.

If the value of locked assets decreases beneath the required collateralization, the Maker Protocol’s smart contracts automatically trigger a liquidation event. While this isn’t pleasant for the borrower involved, it serves as a vital mechanism in risk avoidance and keeping the protocol secure.

In contrast, traditional finance takes a different approach to the dreaded Margin Call, when the lender can decide to waive the collateral requirement for a large or favored client. Or, the borrower can simply dodge the lender’s calls!

How is the Dai Network Secured?

While the Maker Protocol is secured by its smart contracts, DAI itself is an ERC-20 token on Ethereum. That means DAI exists on the Ethereum blockchain and takes advantage of Ethereum’s Ethash algorithm and powerful network for its security.

Currently, Ethereum uses a proof-of-work consensus mechanism that involves a vast number of graphics processing units (GPUs) dedicating their computing power to solve mathematical problems. This is done to create new blocks on the Ethereum blockchain.

However, Ethereum will transition to a proof-of-stake mechanism once developers have finished testing it. This transition has been referred to as Ethereum 2.0.

What Makes Dai Unique?

Stablecoins work in different ways, but it is no accident that the top ones at the time of writing are all backed by some sort of reserve.

BUSD, for example, is regulated and has the backing of two big names in crypto, Binance and Paxos. USDC, meanwhile, is largely fiat-backed and comparatively transparent about its reserves, and USDT also claims to have strong reserves.

Algorithmic and decentralized stablecoins haven’t fared quite as well. While UST overtook DAI for a period of time, UST and the entire Luna ecosystem’s collapse in May of 2022 raised questions about stablecoin mechanisms. 

Very much unlike UST, and indeed unlike the other fiat and asset-backed stablecoins, DAI is overcollateralized.

This means that each crypto asset that can be deposited in the Maker Protocol is given a certain ratio above 100%. For every 100 DAI that a borrower wants, they must deposit a quantity of their chosen collateral asset greater than the prescribed ratio.

This overcollateralization serves as a measure of safety, especially in light of the volatility that is so prevalent in the crypto markets.

What is Dai Backed By?

DAI is backed by other crypto assets that are locked in the Maker Protocol. These crypto assets are overcollateralized, and liquidation occurs via smart contract execution.

What assets can be deposited in the Maker Vaults depends on the interface being used to access the Maker Protocol. On decentralized finance platforms like Oasis Borrow, for example, Ethereum, Wrapped Bitcoin, Chainlink, Uniswap, Polygon’s MATIC, Decentraland’s MANA, and Yearn Finance’s YFI can be used, among others.

DAI was originally called SAI when it supported collateralization by only a single cryptocurrency. Its current form took shape in November 2019, with the multi-collateral DAI.

What is the Use of Dai?

As a stablecoin, DAI is supposed to maintain a stable 1:1 peg with the US dollar by collateralizing other crypto assets via Ethereum smart contracts.

One of Dai and the Maker Protocol’s main uses is that it provides a source of credit without needing to deal with traditional financial providers.

Furthermore, while crypto assets may not be accepted as collateral by most lenders, they are the main form of collateral when borrowing DAI.

Like most stablecoins that do their job, DAI offers cryptocurrency traders a safe haven to retreat into during times of volatility. This also counts for fiat currency volatility. Citizens of nations experiencing hyperinflation can turn to DAI, as it is pegged to the US dollar, a relatively stable currency in the short term.

DAI could also be a lot easier than the US dollar to acquire in some places. That and the fact that transacting with it is fast and cheap makes it an excellent option as a medium of cross-border fund transfer.

What is DeFi?

Decentralized finance, or DeFi, is a general term for financial services on the blockchain. However, these services are generally provided by decentralized applications (dApps) built using smart contracts, rather than traditional financial services like banks.

When interacting with a dApp, the user is safe in the knowledge that the code in the dApp cannot be changed. Since dApp code is public, dApps can be vetted by anyone once they’re deployed to make sure they will perform their functions.

This means that dApp users can trust the code that they’re interacting with. In traditional finance, however, trust has to be placed in a third party, like a bank, to complete financial services transactions.

However, Wall Street and banks are losing trust at an accelerated rate. In the UK alone, 2021 saw banks being fined well over 550 million pounds by the Financial Conduct Authority.

Who Controls Dai?

Dai and the Maker Protocol which dictates its issue and burning are controlled by MakerDAO.

MakerDAO is a decentralized autonomous organization that anyone can be a part of. In order to ‘join’ MakerDAO and have a say in the direction and development of Dai, you simply need to buy the MKR token.

MKR holders can cast votes on the development of Dai and Maker Protocol in a very similar way to how stockholders are supposed to govern public listed companies.

How Much DAI Is In Circulation?

The amount of DAI in circulation is never fixed. As of June 2022, there are over 6.8 billion DAI in circulation. That said, this number changes every day based on the amount of cryptocurrency locked in the Maker Protocol by DAI borrowers.

DAI is issued by smart contract when you deposit other crypto assets into the Maker Protocol, and it is burned when you redeem those assets.

How Do You Buy DAI?

You can buy DAI on most major cryptocurrency exchanges as well as on many other online platforms including DeFi protocols.

An Ethereum wallet is all you need to connect to various online protocols that support Ethereum tokens. Alternatively, you can create an account at any major crypto exchange that operates in your area and buy DAI there.

Is It Possible to Buy DAI Instantly?

Since DAI is an ERC-20 token on Ethereum, transaction speed when purchasing DAI depends on the throughput and congestion of the Ethereum network at the time.

DAI can also be transacted using layer 2 solutions that help to scale and make Ethereum cheaper to use. At the time of writing, the Polygon and StarkNet layer 2’s have performed integration to allow the movement of DAI.

Purchasing DAI on a centralized exchange (CEX) is instantaneous, but it is important to note that assets in a CEX account are not yours. Centralized services including exchanges and lenders hold these crypto assets in their custody. In some cases, they may stop users from withdrawing assets or even funds.

How Do You Store Dai?

Self-custody of DAI, therefore, can be done using two types of wallets:

• Cold wallets. Invoking the idea of cold storage, these wallets don’t connect to the internet. Writing private keys on a piece of paper or saving them on a text file on an offline device are two very simple forms of a cold wallet.
• Hot wallets. In contrast, these do connect to the internet. While perhaps not as secure and more vulnerable to things like viruses, malware, and hacking attacks, they do tend to be more convenient to use. They can come in the form of desktop clients or browser extensions like the popular Metamask or highly-rated GameStop wallets.

Dai Energy Consumption

As an ERC-20 token on Ethereum, DAI doesn’t have its own blockchain and therefore doesn’t have much in the way of energy costs. Given that most of its ‘infrastructure’ in the way of the Maker Protocol and MakerDAO is online, Dai’s energy footprint is relatively negligible.

Ethereum in its current form as a PoW blockchain, however, does have significant energy costs. It could be suggested that a proportion of that is attributable to DAI and transactions with Maker Protocol.

As per the Digiconomist, Ethereum in its current form has an annual energy consumption of over 61 TWh. However, this is likely to reduce very dramatically following Ethereum’s shift to 2.0 and PoS.

Not only that but ETH 2.0 is also likely to dramatically reduce pressure on the global GPU market, both relaxing supply chains and reducing energy demand from the production and transportation of hardware.

Is Dai a Good Investment?

Since DAI is a stablecoin pegged to the US dollar, its value as an investment or store of value over the long term is highly questionable.

Inflation figures through the first half of 2022 have made for grim reading, and by definition, any inflation means that the dollar’s value has diminished.

In the short term or in specific situations, however, DAI can be a useful hedge. For example, while US inflation figures showed an 8.6% increase in May 2022, several countries went much higher. Sri Lanka reported 39% inflation, Argentina experienced 58%, and Turkey a whopping 73%.

This represents a significant increase in the cost of selected goods across one year and could be looked at as the amount of value lost by their fiat currency.

So across that one year in those countries, the US dollar would still count as a safe haven, and DAI, which is soft-pegged to the dollar, serves that same purpose.

Similarly, DAI can be a quick and easy exit from other more volatile cryptocurrencies in times of rapid downturns. Since it settles a lot faster than fiat currency, it allows traders a measure of agility and liquidity, letting them get back into other assets fast and ‘buy the dip.’

What are the Risks of Owning Stablecoins?

One of the main risks of any stablecoin is that it loses its peg. While many stablecoins deviate temporarily from their peg and create arbitrage opportunities for traders, not regaining the peg is a real risk.

The previously mentioned collapse of TerraLuna and its stablecoin TerraUSD has created a lot of awareness in the stablecoin space. While DAI’s overcollateralization is a significant advantage, its backing remains via crypto assets that carry inherent risk and high volatility.

Moreover, Dai and indeed all other stablecoins share the risks of the currency to which they are being pegged. A sudden collapse of the US dollar for whatever reason would see a dollar stablecoin retain its peg but lose significant value compared to anything else.

This is true for inflation and long-term currency devaluation as well. Monetary policy decisions by central bankers have historically meant that cash loses value in the long run. For this reason, investment assets tend to be judged by their quality as stores of value.