What is Dai? (DAI)

The first decentralized, collateral-backed cryptocurrency, DAI is a crypto asset that attempts to maintain a stable 1:1 value with the U.S. dollar by locking other crypto assets in contracts.

This means that unlike other asset-backed cryptocurrencies, which may be issued by for-profit companies, DAI is the product of an open-source software called the Maker Protocol, a decentralized application running on top of the Ethereum blockchain.

As such, DAI maintains its value not by being backed by U.S. dollars custodied by a company, but by using collateralized debt denominated in ether (ETH), Ethereum’s cryptocurrency.

If you’re unfamiliar, collateralized loans provide a way for a lender to secure a loan using assets they own. Historically, these loans have a lower interest rate than unsecured loans, as they allow lenders to seize the asset and sell it in the event borrowers are unable to pay the loans.

The Maker Protocol, through smart contracts running on Ethereum, enables borrowers to lock ETH and other crypto assets, thus collateralizing it, in order to generate new DAI tokens in the form of loans.

If borrowers wish to recover the locked ETH, they will have to return the DAI to the protocol and pay a fee. In the event of liquidation, the Maker Protocol will take the collateral and sell it using an internal market-based auction mechanism.

Due to its design, the supply of DAI cannot be altered by any party in the network. Rather, it is maintained through a system of smart contracts designed to dynamically respond to changes in the market price of the assets in its contracts.

For more regular updates from on the project, you can bookmark its official Medium blog, which includes tips and tutorials on the network and its evolving technology.

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How does Dai work?

DAI is a crypto asset that is collateralized by other cryptocurrencies.

If users want to acquire DAI, they can spend ETH to purchase the dollar equivalent amount in DAI on an exchange or they can collateralize ETH and other assets using the Maker Protocol.

The latter method allows users who do not want to sell their ETH to still acquire DAI.

Collateralized Debt positions

Collateralized Debt Positions (CDPs) are the smart contracts on the Maker Protocol that users can leverage to lock their collateral assets (i.e., ETH or BAT) and generate DAI.

CDPs can be thought of as secure vaults for storing the aforementioned collateral. To account for the volatility in the crypto collateral, DAI is often over-collateralized, meaning that the deposit amount required is typically higher than the value of DAI.

For example, users must spend $200 in ETH in order to receive $100 DAI, which is meant to account for the potential decrease in the value ETH. As a result, if ETH depreciates by 25%, the $100 in DAI would still be safely collateralized by $150 in ETH.

In order to recover the stored ETH, the user has to return the DAI and pay a stability fee.