Using crypto to borrow crypto used to be very tricky. Since most crypto assets fluctuate so wildly, the amount someone borrowed in crypto and the amount someone had to pay back could be crazy different over a short period of time. That's where MakerDAO comes in. By combining loans with a stable currency, MakerDAO wants to allow anyone to borrow money and reliably predict how much they had to pay back. In this article, we learn how the MakerDAO protocol managed to attract nearly $10B in TVL.

About MakerDAO

Started in 2015, the MakerDAO is one of the largest dApps on the Ethereum blockchain. Designed by a disparate group of contributors, including developers within the Foundation, its outside partners and other persons and entities. The project did not conduct any ICO, instead selling privately the tokens to venture capital like a16z, Paradigm, Dragonfly Capital, etc. It is the first decentralized finance application to witness significant adoption and traction since then.

MakerDAO is a protocol behind the stablecoin DAI, a cryptocurrency that maintains a soft 1:1 peg to the USD, think of 1 $DAI equal to $1. But instead of a third party claiming to have the required collateral, printing like rain as USD, what makes DAI unique is that each DAI is backed by an equivalent ETH value. At the moment, the DAI stablecoin system accepts any ERC-20 asset as collateral that has been approved by MKR token holders, who must vote on the risk levels of each ERC-20 before taking action to onboard them onto the protocol.

The Maker Protocol

MakerDAO is one the largest, most well-established dApps on the Ethereum blockchain, and it holds a considerable percentage of the total liquidity in the DeFi ecosystem, which the dominance counts for 13.5%. In fact, for those who haven’t lived on the first “DeFi summer” in June 2020, when the TVL of Ethereum in DeFi surpassed the first $1B mark, around 60% of ETH was held by the MakerDAO protocol. The MakerDAO, so far, has still proved its position, when the number of TVL is far from the top projects in the Ethereum ecosystem by 20-30%.

The Maker governance token, $MKR, was created in order to essentially support the stability of the DAI stablecoin and enable governance for the DAI credit system. This inherently means that the creation of MKR is dependent on the stability of DAI as a whole. For instance, if DAI remains stable, more MKR is burned decreasing the total supply, whereas, if DAI fluctuates too far from the one dollar peg, more MKR is minted subsequently increasing the total supply.

Since holders benefit financially from the stability of the MakerDAO system and the DAI stablecoin, holders are incentivized to act in the best interest of the MakerDAO protocol. Thus, MKR holders can vote on governance decisions and proposals such as setting higher fees and which collateral assets can be accepted as collateral by the protocol.

In the event of liquidation, there is increased market volatility and the collateral deposited no longer covers the outstanding debt, the collateral will be liquidated via an automated process. Automated market actors called Keepers, who take advantage of arbitrage opportunities bid in DAI for the collateral from a liquidated vault. This DAI is then utilised to pay back the vault’s debt, plus a liquidation fee. Keepers bid in DAI for the vault’s collateral through an auction process, and if there is enough DAI received in the auction to cover both the debt repayment and the penalty fee, the leftover collateral will be returned to the respective vault owner. Moreover, in the Maker Protocol, Keepers represent those market participants that help DAI maintain its stability and $1 target price, as they buy DAI when the market price is below the $1 level and sell it when the market price is above it.

On the other hand, if the auction fails to accumulate enough DAI to cover the vault owner’s debt, this debt then becomes ‘protocol debt’ and is covered by the Maker Buffer, a liquidity pool containing the fees denominated in DAI and paid on collateral withdrawals in addition to the proceeds from the collateral auction. If there is insufficient DAI in the Maker Buffer pool, a debt auction will be triggered and the protocol will mint MKR and sell it to bidders for DAI to recapitalise the pool and repay the outstanding debt.

Why Stablecoin DAI?

The DAI Stablecoin is the second monetary component in the MakerDAO ecosystem. It emerged as somewhat of a middle ground between the legacy financial market and the nascent digital asset one. At present, the most popular forms of stablecoins are fiat-backed ones such as USDT and USDC, which are typically collateralized by the USD but commodity-backed stablecoin do also exist.

Maker’s DAI stablecoin is a decentralized, unbiased, collateral-backed crypto asset that is softly-pegged to the USD 1:1. On the protocol, users can generate DAI by depositing collateral ERC-20 assets into Maker Vaults, creating the liquidity necessary to take out loans on the protocol. Once generated, received or bought, DAI can be deployed just like any other crypto asset, meaning that it can be sent to other users, traded and exchanged for others, used as payment for services or even held as savings through Maker’s DAI Savings Rate (DSR).

DAI Savings Rate

DSR itself is a variable rate of accrual set by Maker governance, helping balance the Maker Protocol. Funded from the Stability Fees paid by Maker Vault owners - previously referred to as Collateralized Debt Positions (CDPs), the DSR acts as another mechanism to help balance the entire system to maintain DAI’s peg to the USD.

The DSR presents no liquidity impediments. No minimum deposit is required to earn the DSR, and users can withdraw any or all their DAI at any time. DAI is simply either “in” or “out” of DSR mode. Furthermore, the DSR preserves user control. DAI holders retain total and independent control over their locked-up DAI at all times, and only a DAI holder may remove their DAI from the DSR.

The DSR creates a stable store of value. It is a key component of the Maker Protocol. Users may rely on DAI earned within the DSR to try to protect their savings from inflation. Because the most amazing aspects of the DSR are that it has no counterparty credit risks and it can be implemented on the backend of any DeFi product that uses DAI. The inherent efficiency of the Maker Protocol and, by extension, the DeFi ecosystem, are what allow the DSR to provide great savings opportunities for people everywhere.

If DAI is a full-fledged stablecoin, MKR was created for its value to increase as demand increases. So the greater the number of people participating in governance, the higher the value of MKR.

MakerDAO To Real World

MakerDAO is a collateralized debt protocol that allows users to mint the decentralized stablecoin DAI against digital assets deposits. However, the DAO has recently pivoted to diversify its exposure outside of overcollateralized digital asset positions, key growing initiatives and moving to increase its integrations with companies that onboard real world assets, including real estate and financial institutions.

Bridging the gap between the real world and DeFi, MakerDAO started embracing real world assets in the form of real estate, invoices, trade receivables and recently, commercial loans. Maker’s real world assets currently make up 10% of the protocol revenue despite only representing 1% of the total value locked. In a historic first step to integrating traditional U.S. banking infrastructure with the DeFi ecosystem, MakerDAO recently approved Huntingdon Valley Bank’s collateralized lending proposal as its latest real world asset vault.

The Maker community also voted to allocate 400M DAI to short-term U.S. treasuries and 100M DAI to investment-grade corporate bonds to generate revenue for the protocol on July 4.

MakerDAO has already launched five RWA vaults, which are currently deploying 41.7M DAI combined.

Four vaults representing 27.5M DAI are the product of Maker’s partnership with Centrifuge, a Polkadot-based protocol allowing businesses operating with RWAs to access DAI-based financing.

Around 18.3M DAI worth of loans is backed by tokenized real estate via New Silver on Centrifuge, with 5.3M DAI backed by revenue-based financing assets through Fortunafi, 1.9M DAI backed by tokenized freight invoices via Consol Freight, and 1.8M backed by short-term trade receivables through Harbor.

A vault operated by the real estate financing firm 6s Capital has also deployed nearly 14.3M DAI for secured loans to commercial real estate developers throughout the United States.

The various pools earn annual returns of between 3% and 7% for MakerDAO, netting the protocol more than 1.5M DAI in revenue each year based on current utilization.

The stability fee on RWAs ranges from 3%-7%. Maker’s real world assets currently make up 10% of the protocol revenue despite only representing ~2% of the TVL

There are also early-stage proposals for vaults intended to finance the green energy projects of an Egyptian power plant, loans backed by tokenized U.S. real estate issued by the firm Robinland, and to fund Backed Finance’s creation of tokenized short-term Swiss bonds. It can be said that this is one of the very few DeFi projects that has access to Real-world assets with such a large amount of money and visions.

Tokenomics

The $MKR token launched in 2017 but the team deliberately decided not to hold any particular ICO to bootstrap their token. In fact, the tokens initially were sold via private sales to friends and family, as well as investors like a16z, Polychain Capital. The goal is to create an ownership community that is cohesive and committed to long term success and not just short term gain. Mainly, MKR is the native governance token used to vote on governance proposals and protocol updates, as well as ensure the stability of the DAI stablecoin.

MakerDAO has proven to be an incredibly solid, functional project with some widely adopted use cases across the digital asset ecosystem. The DAI stablecoin is indeed way too important for the DeFi space for it to be potentially ever neglected. Thus, due to its lending and borrowing functionalities, its collateralised assets and its use of the DAI stablecoin, the MKR token should carry on growing alongside the rest of the MakerDAO ecosystem, resulting in a general upward momentum over the medium to long-term outlook.

At the time of writing, due to the influence of “The Merge”, most of the Ethereum DeFi ecosystem has surged in token price, MKR included. However, from this point of view, the author must remind every Chainslab audience that, we are not over the bear cycle yet, any bullish attempt is short term suitable for flipper, quick profit and stand outside, use your money wisely.

Conclusion

In today’s world, financial infrastructures are starting to feel the effects of digitisation, technological advancement and, ultimately, DeFi. Decentralized Finance, in fact, is slowly but surely restructuring financial paradigms as we know them through its blockchain-enabled functionalities and decentralized applications. Over the course of the last 5 years or so, a very intriguing protocol has arisen in the DeFi space looking to merge both stablecoin generation, as asset-backed collateral, and decentralized lending and borrowing functionalities, and this protocol is no other than MakerDAO. MakerDAO is one of the largest, most well-established dApps on the Ethereum blockchain, and it holds a considerable percentage of the total liquidity in the DeFi ecosystem. With its two-token model, MKR and DAI, MakerDAO allows pretty much anyone around the globe to gain access to economic empowerment through its trustless, permissionless, DAO-like financial platform. The Maker Protocol enables network participants to lock up a variety of different assets as collateral on Maker Vaults and generate collateral-backed DAI stablecoin in return. Users can then go ahead and deploy their newly generated DAI on other DeFi protocols, engage in yield farming or staking, or even redeploy DAI to deposit more assets as collateral in Maker Vaults to leverage their positions. In the grand scheme of things, MakerDAO has come such a long way since its inception and, for the foreseeable future, it will most likely carry on developing its infrastructure, expanding its use cases and economic utilities.

Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should always do their own research.