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In the cryptocurrency markets, where prices change drastically in a matter of minutes, a safe haven is needed to preserve the value of your assets. That’s why stablecoins are here to save you. But stablecoins have their issues—they are centrally controlled, issued by one party, and can easily be blocked, frozen, or blacklisted. That’s when Dai comes into play, offering a decentralized approach to stability of a currency while being managed by its community.
What is Dai?
Dai is a new type of cryptocurrency known as a stablecoin. Its purpose? To maintain a stable value by being pegged to a stable asset, the US dollar. Unlike other cryptocurrencies like Bitcoin or Ethereum, its price doesn’t fluctuate by design, making it a predictable asset for a digital substitute of cash.
Dai operates on the Ethereum blockchain and isn’t like other stablecoins. USDT or USDC are centralized, which rely on a single entity to manage the reserves and save the peg. Dai is managed by a DAO, allowing for the community to make decisions.
Dai is fully collateralized by assets such as Ether and USDC. This system is collateralized debt positions, also referred to as vaults. The entire process guarantees Dai is sufficiently backed.
Why use Dai?
Since Dai is supposed to be stable, it’s not an investment. It’s digital cash for uncertain times. What is it good for, and why would you use it?
Dai is perfect, decentralized cash well-suited as a medium of exchange for various transactions in the crypto space and beyond. It can also act as a store of value if you intend to ensure the value stays at the same level. Dai, as a stablecoin, is deeply integrated with decentralized finance and used in many apps for providing liquidity, borrowing, lending, and collateralizing loans.
Dai is global and enables you to earn interest on your holdings, generating you extra passive income. Thanks to being an ERC-20 token on ETH, it’s compatible with many centralized and decentralized platforms.
How Dai works
While DAI is a stablecoin, it’s much different than, for instance, Tether. Most stablecoins are fully backed by cash reserves and their equivalents, like government-issued bonds. DAI is backed by assets approved by its DAO, which include, but are not limited to, Ether, Basic Attention Token, or USDC Coin.
To maintain a target price of $1 by being over-collateralized, meaning the value of assets that are in the treasury is more valuable than DAI issued. Dai automatically adjusts its interest rates depending on market conditions to regulate the supply of DAI available on the market.
It’s worth noting that once the value of the collateral in a vault falls below the required threshold, the position is automatically liquidated to cover the created debt.
In short, Dai is a combination of traditional stablecoins combined with some elements of algorithmic stablecoins. The entire DAO and all DAI systems act like a national bank, adjusting key components accordingly.
Dai's timeline
The entity behind Dai, called MakerDAO, was founded in 2015 with the vision of creating a better, more decentralized financial system. Dai as a protocol was introduced in 2017, which was the first phase where DAI was only backed by ETH. In 2019 multiple collaterals were finally allowed for further diversification and less reliance on one asset. The interest rate, also called DSR, which stands for Dai Savings Rate, was integrated in late 2020. DAI is focused on being integrated in more platforms and continuously improving its DAO structure and processes.
The risks of Dai
DAI is not safe from any potential exploits. At any moment it can be targeted by regulatory enforcement institutions since it's not regulated as opposed to USDC.
DAI is based on Ethereum and collateralized by other assets than cash, which can cause systemic risks. Then there’s obviously the concern of the centralization of power in the DAO, making it possible for a single entity or a small group to control every aspect of its functioning.
Why Dai matters
Dai is the way to go if you need a stable asset. Not only does it protect you from volatility, but it’s also decentralized, which makes the coins you hold truly yours. It proposes a serious alternative to more traditional stablecoins like USDT or USDC.
Let’s not forget about the failure of the algorithmic stablecoin UST, which used to be one of the largest but depegged during the fall of LUNA and its founder, Do Kwon. Billions were lost as the stablecoin plummeted to a fraction of a cent. A lesson is in here to never hold all your eggs in one basket. Diversification is always recommended, even with stablecoins.
