MakerDAO, The First Central Bank on Blockchain

INTRODUCTION

Ethereum, Bitcoin, Polkadot, Algorand or Facebook’s future META are all networks, and although some are more decentralized than others, they all need network effects. To understand network effects we first need to identify and understand how a network works, but this is a topic that takes some time to learn as it is something complex and this article is not intended for that purpose.

The ecosystem in general from the beginning and especially the ecosystem of decentralized finance has been based solely on (utility) tokens issued on the Ethereum blockchain network. This trend continues to develop, but faces significant challenges in attracting liquidity from large asset owners and financial capital, given the technical limitations of the network. New and alternative networks have emerged to further develop the ecosystem.

The importance and magnitude of cryptographic networks is to understand that decentralized financial networks appeared as a result of the constant clash between applications running on blockchain, the infrastructure of technological markets and the regulation or legislative regulation of countries. Decentralized financial markets started with a strong focus on token issuance, but have always faced technological and financial barriers. These issues have shifted the focus to building much more advanced infrastructures, such as decentralized financial networks that support the issuance and trading of more sophisticated products.

CONTEXT

 As a result of the DeFi boom, demand for stable coins has skyrocketed, pushing the total supply of stable coins past the $100 billion mark. While the need for stable coins in DeFi for liquidity and volatility purposes has become apparent, the long-term sustainability of centralized stable coins is now a growing concern. Increasing regulatory uncertainty and opaque reserves have pushed many users to seek more transparent alternatives.

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In this context MakerDAO was born and with it its stable coin DAI became the most successful decentralized stable coin protocol to date, increasing its total supply by 46x in the last twelve months and generating over $63 million in net profits since the beginning of 2021.

Founded in 2015, MakerDAO is the first protocol with the power to issue money, just like a central bank does, but is this case in the form of an algorithmic stable coin under an over-collateralization executed on the Ethereum blockchain. MakerDAO was born out of necessity and recognition as volatility made cryptocurrencies inefficient as a medium of exchange. The development of the project was originally led by the Maker Foundation, but is now controlled by a DAO.

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The protocol was officially launched in 2017, initially allowing users to mint SAI using only ETH as collateral. After a successful period, Maker launched the DAI system under multiple collateral (MCD) in 2019, accepting a wider variety of ERC 20 tokens for collateral beyond ETH. MakerDAO raised $12 million through the sale of MKR tokens to Andreessen Horowitz, Polychain Capital and other crypto-focused venture capital firms.

Project Description

DAI combines the advantages of a low volatility currency with the key attributes of cryptocurrencies (permissionless, borderless, transparent, peer-to-peer, etc.). The DAI is generated, backed and held stable through collateral assets that are deposited in Vaults in the Protocol (e.g $1,000 in ETH is deposited in a vault as collateral to issue 500 DAI).  Together with the ability to adjust interest rates, ensures that the value of DAI is always equivalent to one U.S. dollar.

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When DAI is issued, the Vault owner borrows against its deposited asset, similar to any other form of secured borrowing. If the value of the Vault collateral decreases below a specified threshold, the Maker protocol could liquidate the position to pay off the outstanding DAI debt. The user will be charged a penalty for being liquidated. Under normal circumstances, a vault owner repays its original DAI loan with interest to regain control of its collateral.

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MakerDAO was faced in 2020 with one of the events that called into question the reliability of the protocol, the famous “Black Thursday” on March 12, 2020, where 5.67 million unsecured DAIs were liquidated. Since then Maker has made several improvements to its settlement system, which has proven to be extremely effective in minimizing losses. In fact on May 19, 2021, amid a 45% drop in the value of ETH, the system settled $41 million of debt through 177 auctions, generating $5.1 million in settlement fees while only two settlement losses occurred, totaling $12k. https://medium.com/@whiterabbit_hq/black-thursday-for-makerdao-8-32-million-was-liquidated-for-0-dai-36b83cac56b6

In order to create a new financial infrastructure, it is necessary to have solid foundations. A service and utility logic, but above all, to grow based on covering needs that are being met and resolved in layers. Believe it or not we are facing one of the most transcendental events of our lives, where the idea or the concept of money is going to change completely. We are already starting to relate to software, algorithms and code instead of doing it with institutions or people for the management of finances. The digital transformation we are experiencing is unprecedented, creating a new economic order and MakerDAO is its matrix.

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