Busting MakerDAO Myths: Seven Misconceptions About Dai

11 November 2020

Since MakerDAO was announced in 2015, it has grown to become one of the largest and most popular decentralized finance (DeFi) projects on the Ethereum blockchain. Today, the Dai stablecoin, which can be generated on the Maker Protocol or purchased on various exchanges, is used and trusted across the globe. Yet, despite the benefits of Dai and the vast amount of educational information published by the Maker Foundation and members of the community about the project, misconceptions still exist. While some are simple misunderstandings, others are mistaken beliefs.

Below, seven of the most common Dai myths are addressed in detail.

Myth #1: Dai is an algorithmic stablecoin.

Algorithmic stablecoins, also called algo-based coins or seigniorage-style coins, are not backed by collateral. Instead, they aim to peg the price of a token to its target level using on-chain algorithms that increase or decrease supply, or buy and sell tokens, according to market conditions. 

Dai, which is soft-pegged to the US Dollar, is backed by a diversified portfolio of crypto collateral assets. When Multi-Collateral Dai was released in November 2019, it brought the Maker Protocol and Dai into a new phase, offering a more robust platform to power a stronger yet more flexible currency.  

Instead of relying on algorithms to influence supply and demand, Dai relies on Ethereum smart contracts, decentralized price feeds, and the global Maker governance community to maintain its soft peg. Dai is, therefore, best characterized as a decentralized, collateralized stablecoin.

Myth #2: Dai can be generated using centralized assets; therefore, it is not decentralized.

While it’s true that Dai can be generated using centralized tokens, such as USDC, USDT, TUSD, and PAX, those collateral assets don’t make Dai any less decentralized. To be clear, the opposite is also true: Dai generated from ETH or any other decentralized collateral asset doesn’t make the stablecoin any more decentralized.   

Dai is decentralized because there is no centralized authority with control over individual tokens (i.e., users create and have total control over their Dai) and the Maker Protocol is governed by a distributed group of MKR holders, who cast votes in the Voting Portal.  

Moreover, MakerDAO is self-governed. By approving a diversified basket of collateral assets, the Maker community helps to ensure that no one asset poses a threat to the Protocol as a whole. Additionally, a key role of Maker governance is to apply to each asset appropriate risk parameters, including a debt ceiling, a Liquidation Ratio, and a Stability Fee. The MakerDAO Risk team provides weekly analysis that permits the DAO to review developments related to collateral assets.

This community governance-led approach to diversification and risk management is what maintains Dai’s decentralization.

Myth #3: The market won’t sustain a high number stablecoins—one will ultimately prove most popular at the expense of the rest.

There are many different stablecoins, just as there are various fiat currencies. And like national currencies, some stablecoins are more widely used in specific regions of the world than others, thanks to their distinct properties.  

Stablecoins use different blockchains and take various approaches to peg their value to the US Dollar or another national currency. Some are decentralized, others are centralized. Moreover, stablecoins offer different features. For example, Dai is decentralized, transparent, and composable; therefore, it can be used in many ways by anyone, anywhere, and it can be integrated seamlessly with other decentralized applications (dapps). Centralized stablecoins, such as TUSD, may be more restrictive for issuers (e.g., forced to blacklist certain addresses) than decentralized ones, but may also provide a more rigid price peg when backed 1:1 with the USD. Additionally, some stablecoins have found adoption within particular platforms due to specific promotions, integrations, or overlap (e.g., Circle/Coinbase and USDC). All of these add to the overall network effect for stablecoins and help facilitate a liquid market between them, thereby enabling capital to flow freely through the crypto sector. 

Recognizing the benefits of stablecoin diversity, Maker governance has approved several different stablecoins as collateral types, each acting as an additional tool for generating Dai.

Myth #4: There’s no point in pegging Dai to USD, since the dollar continually loses value.

Traders in crypto and mainstream financial markets sometimes express concern about devaluation of the US Dollar. 

While the USD is subject to inflation, just like any other currency, it remains the world’s reserve currency, as its story is one of consistent strength. Dai has gained popularity in Latin America, for example, precisely because the USD is stable compared to local currencies subject to high inflation. That said, the DAO may consider creating varieties of Dai in the future.

Myth #5: If the price of Dai is not always $1, the peg is broken.

All stablecoins, including Dai, trade on the open market and experience some degree of price fluctuation around the $1 target. But what sets Dai apart from other well-known stablecoins is its design. Unlike centrally administered stablecoins, Dai is neither created by a centralized issuer or administrator nor tethered 1:1 to US dollars in a bank account. Instead, Dai is a user-generated currency backed by other digital assets on the Ethereum blockchain. Its value comes from the market mechanisms of supply and demand, influenced by different monetary parameters as set by Maker governance. The goal of the Maker community has always  been for Dai to trade at or around $1 on average. So, if anything, Dai’s soft-peg is a feature, not a bug. 

Remember, too, that the US Dollar itself is soft-pegged. Maintained by the Federal Reserve's monetary policy, the dollar is pegged to the goods and services that use it as a unit of account. Thus, when the products and services we buy get more expensive, the dollar's peg breaks to the downside, and the Fed reacts by raising interest rates to restore price stability. This approach is similar to how Maker governance reacts to Dai price fluctuations.

The Dai stablecoin is soft-pegged to the USD and, therefore, lacks the volatility of other cryptocurrencies, such as Ether and Bitcoin.

Myth #6: The Dai Peg is not affected by Stability Fee adjustments.

Maker governance helps to maintain the Dai peg by adjusting Maker Vault Stability Fees (SFs) attached to collateral types. Increasing SFs are responses to Dai trading below $1 (higher fees incentivize Vault owners to purchase Dai on the open market to pay down Dai they have generated). When Dai trades higher than $1, SFs are decreased to lower the cost of generating Dai. However, an adjustment can have a slow, incremental impact on Vault holders; therefore,the Community’s desired end result may take time to appear. 

Because the SFs associated with generating Dai are cumulative, Vault owners will take action at different times, depending on how they use the Dai they have generated. Bottom line: SF adjustments presumably influence the behavior of Vault owners, typically driving the Dai price toward its $1 peg. 

Myth #7: Dai is only used in DeFi, not for any “real-world” applications.

With the growth of the DeFi sector, the Maker Protocol has seen a sharp increase in interest and value. Dai has been integrated into many other DeFi protocols due to its composability, which enables rapid iteration of products, providing bottom-up growth. However, Dai has also value independent of its benefits within the DeFi space. It’s put to use in many ways, but primarily in the following top five areas:

  1. Inflation protection and savings
  2. DeFi products and services, and the enormous opportunities they offer
  3. Gaming
  4. Digital art
  5. E-commerce

 Learn more about Dai’s versatility.

Artist Carlos Marcial’s “Art Is the Currency of the Infinite” was put up for auction for Dai on Async in September 2020.

DeFi’s Most Popular Stablecoin

Thanks to its properties of openness, transparency, and composability, Dai has become the most widely-used decentralized stablecoin, with applications across a broad range of sectors and regions.

To stay current with Dai and Maker Protocol developments, bookmark the Maker blog and join the conversations in the MakerDAO Forum, a hub of community activity and the starting point for in-depth discussions regarding the Maker Protocol and Maker governance. 

11 November 2020