MakerDAO

4 min read

Pronunciation

[mey-ker-dow]

Analogy

MakerDAO is like a decentralized central bank run by its community. Imagine a global credit union where members can deposit various assets as collateral to borrow stable money (DAI), but instead of human bankers making decisions, smart contracts automatically manage loans and the community votes on the rules. It's as if you could walk into a automated bank, put down your gold, stocks, or other valuables, and receive newly created dollars based on their value—with the entire system maintaining the dollar's stability through algorithmic interest rates and the collective wisdom of holders who act as the board of directors.

Definition

MakerDAO is a decentralized autonomous organization and on that manages the DAI system through smart contracts and community governance. Founded in 2015 by Rune Christensen, MakerDAO pioneered algorithmic stablecoins by creating DAI—a decentralized, over-collateralized soft-pegged to the US dollar. The allows users to lock as collateral in Vaults (formerly CDPs) to generate DAI loans, while MKR holders govern the system by voting on risk parameters, collateral types, and upgrades.

Key Points Intro

MakerDAO revolutionized by creating the first decentralized system with sophisticated risk management and governance mechanisms.

Key Points

Dual-Token System: Uses DAI as the stablecoin for transactions and MKR as the governance token for voting and system recapitalization, creating aligned incentives for stability.

Over-collateralized Design: Requires users to deposit assets worth more than the DAI they borrow (typically 150%+), providing a buffer against market volatility and maintaining DAI's peg.

Decentralized Governance: MKR holders vote on critical parameters like stability fees, collateral types, debt ceilings, and emergency shutdowns through on-chain governance mechanisms.

Multi-Collateral Framework: Evolved from single-collateral (ETH only) to supporting diverse assets including stETH, WBTC, USDC, and real-world assets, increasing system resilience and scalability.

Example

When Bob wants to access liquidity without selling his ETH, he opens a Maker Vault by depositing 10 ETH (worth $20,000) as collateral. With a 150% collateralization ratio, he can generate up to 13,333 DAI. He chooses to borrow 10,000 DAI, maintaining a safer 200% ratio. Bob pays an annual stability fee (e.g., 5%) on his debt. If ETH price drops and his collateralization ratio falls below 150%, his Vault becomes eligible for liquidation—Keepers can trigger an auction to sell his collateral and repay the debt. When Bob repays his 10,000 DAI plus accrued , he retrieves his ETH. Meanwhile, MKR holders vote on whether to adjust the ETH stability fee or liquidation ratio based on market conditions.

Technical Deep Dive

MakerDAO's architecture comprises multiple interconnected smart contracts and mechanisms: Core Components: 1. Vaults (formerly CDPs): - Collateralized Debt Positions for generating DAI - Each collateral type has unique risk parameters - Users maintain ownership until liquidation - Utilizes the Vat module for core accounting 2. Price Feeds (Oracles): - with 1-hour delay - Medianizer aggregates multiple price sources - Emergency freeze during attacks - Integration with Chainlink for some assets 3. Liquidation System: - Liquidation 2.0 (introduced 2021) with Dutch auctions - Automated Keeper ecosystem for efficient liquidations - redistributed to system - Clipper contracts for collateral auctions 4. Stability Mechanisms: - Stability Fee: Interest rate on generated DAI - DAI Savings Rate (DSR): Incentivizes holding DAI - Peg Stability Module (PSM): Direct DAI-USDC swaps - Surplus Buffer and System Surplus auctions Governance Architecture: - Executive Voting: Continuous approval voting for changes - Governance Polls: Time-based sentiment signaling - Governance Security Module: 24-hour delay for changes - Delegation system for vote aggregation - Core Units: Specialized teams funded by Risk Parameters per Collateral: - Stability Fee (interest rate) - Liquidation Ratio (minimum collateralization) - (maximum DAI generation) - (fee on liquidation) - Dust Limit (minimum Vault size) DAI Monetary Policy Tools: - Target Rate Feedback Mechanism (TRFM) - deprecated - DAI Savings Rate adjustments - Stability Fee modifications - PSM and - RWA integration for yield generation Modules: - Vat: Core accounting engine - Cat/Dog: Liquidation contracts - Vow: System surplus/deficit management - Pot: DAI Savings Rate implementation - Join Adapters: Collateral onboarding - End: Emergency shutdown module Real World Assets Integration: - Legal structure through trust vehicles - asset origination and custody - representation via tokens - Examples: US Treasury bills, real estate loans - Monetalis, BlockTower credit arrangements

Security Warning

MakerDAO has critical security considerations: bugs could compromise billions in collateral, failures might trigger mass liquidations, governance attacks with accumulated MKR could modify system parameters maliciously. Black Swan events like March 2020's crypto crash can stress the system severely. Be aware of liquidation risks—monitor collateralization ratios closely during market volatility. The complexity of the system increases attack surfaces. Real-world asset integration introduces legal and counterparty risks. Flash loan attacks could manipulate governance or liquidations. Always maintain safe collateralization ratios well above minimum requirements. Understand that DAI's peg stability depends on governance decisions and market conditions. Consider using insurance protocols for large positions.

Caveat

MakerDAO faces several challenges and criticisms: governance centralization concerns as large MKR holders dominate decisions, complexity making it difficult for average users to understand risks, dependence on USDC through the PSM potentially compromising , real-world asset integration introducing traditional finance risks and regulatory exposure, the Black Thursday incident in March 2020 exposed system vulnerabilities resulting in $8.3 million in under-collateralized DAI, competition from other stablecoins offering simpler user experiences, regulatory uncertainty particularly around legislation, high costs on limiting accessibility, and the challenge of maintaining DAI's peg during extreme market conditions. The 's increasing integration with traditional finance through RWAs may conflict with original ideals. Governance participation remains low relative to total MKR supply.

Related Terms

Surplus Auction

Blockchain & Cryptocurrency Glossary

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