Like many of the best blockchain projects, Maker (MKR) is inherently complex and therefore requires an in-depth explanation to fully understand.
MKR is a utility token with a slight twist. To grasp this, we must first learn what a stablecoin is and how MKR’s complicit coin, Maker Dai, fits into that broad definition.
What Is a Stablecoin?
In short, a stablecoin is a cryptocurrency that has a fixed value.
In the case of Dai, Maker’s stablecoin, it is a token that is denominated in US dollars, starting at US$1 — this translates to it having a 1:1 USD soft peg (but not perpetually fixed to the USD). Until now, most stablecoins have worked similarly to an IOU. That is, the developers of the stablecoin hold exactly $1 for every coin issued. However, critics would perceive this as a flawed protocol as the coins effectively become promissory notes that are remarkably similar to fiat currency.
This results in the coin becoming more centralized and reliant upon government-controlled currencies – a result that is quite unlike most of the decentralized cryptocurrency platforms that currently lead the crypto marketplace.
Fortunately, Dai exists as a stablecoin that is not backed by any other currency, while MKR is the volatile governance token that allows it to be so.
The Importance of Stablecoins in Cryptocurrency
It may seem somewhat confusing at first but as you read on, it will become more clear how stablecoins are becoming necessary in the crypto ecosystem.
First, let’s take a comparative look using Bitcoin as an example:
As exciting as Bitcoin is at the moment (achieving record highs and mass public notoriety), it’s practically useless for its original intentions. The amount of volatility and market speculation makes it irrational to use for purchases. With people thinking that its value may once again skyrocket, they’re reluctant to spend it, lest we see another $150 million pizza.
Additionally, access to retail industries is not the only restriction caused by Bitcoin’s volatility. It’s also currently nearly impossible for financial services, such as money lending, to operate because interest rates on a loan cannot keep up with the potential growth of Bitcoin.
This is where the value of having a stablecoin, such as Maker’s Dai, becomes apparent. Integrating a stablecoin may be the missing piece of the puzzle that allows cryptocurrencies to disrupt or even overtake fiat currencies.
How Is Dai Created?
Dai is generated on demand in exchange for ether.
The process reflects transactions such as purchasing a house using a mortgage. Banks like to see that you have sufficient collateral available and in most instances, will only lend to a maximum of 80% of that value. The reason banks do this is to protect themselves from the potential costs of a depreciating asset.
Similar to these banks, Dai needs to be protected on both sides from inflation and deflation. That is why it has a fixed value. This is also why Maker requires that you contribute more than 100% of the token’s value in Ether. Quite often the amount required is 150%.
For example, if Ether is trading at $100 at the time of creating the Dai tokens, you will require 1.5 Ether or $150 to enable the creation of the Dai.
How Does Maker Work?
Maker is a decentralized autonomous organization on which the MKR token and Dai operate, and it is built on Ethereum. It is a prime example of the many spectacular products and services people are able to build using Ethereum’s smart contract platform. Essentially, it exists to reduce the price volatility of the Dai against the US Dollar.
For instance, when you create 100 Dai with your $150 worth of ether, the ether will be tied up in a collateralized debt position (CDP), which is basically just a program enabling the smart contract on Maker to set aside your “equity”.
Should you return your 100 Dai, you will be paid out with $150 worth of ether, but the Dai is destroyed as a part of this process.
The following sections cover what happens in the meantime while the price of ether fluctuates.
If Ether Increases
The price of ether increasing is no cause for concern. By already being collateralized above 100%, your position simply becomes even more collateralized. The value of Dai remains the same, but can be thought of as being stronger.
If ether continues to rise, the value of Dai increases along with it. Therefore systems must be put in place to keep this process in check. To this end, Maker incentivizes the creation of additional Dai from the same CDP, effectively diluting the Dai pool, bringing its value back to $1 and balancing out the the collateralization ratio back to 150%.
If Ether Decreases
An increasing price of the underlying security is rarely cause for concern. In those cases more of the coin can be generated, but the effect is similar to how a government that prints too much money will provoke a period of hyperinflation.
What’s much harder to manage is if the security drops in value.
Maker has a system in place for this situation that, again, leverages Ethereum smart contracts.
If the price decrease of ether is significant enough to suggest that securitization may fall below 100%, Dai would no longer be able to justify its own value of $1, thereby threatening its stability.
If the Dai gets returned, the problem is averted — although will not always be the case. More often, Maker will liquidate the security inside the CDP on the open market while the securitization is still above 100%.
The funds from this sale are used to buy back Dai until the overall ratio of all Dai in existence is sufficiently collateralized once more.
A more thorough description can be found in the Dai whitepaper.
This video also provides a quick introduction to Dai and the Maker network:
How Does the MKR Token Work?
Now that we understand the reasoning behind Dai and how it works, we can begin to understand how the MKR token fits into the picture.
Maker works as a governance token, or a utility token that also functions as a recapitalization resource for the Maker network.
MKR’s utility token aspect is based on the concept that it is the only token that can be used to pay the fees for creating a CDP to generate Dai. In fact, there are approximately 530,000 MKR in circulation and whenever they are used to pay fees, the MKR gets consumed and destroyed.
As more and more MKR is ‘burned’, its value will increase, so that less is required to perform transactions.
The governance token aspect of MKR comes by its use for voting. MKR holders get to vote on every decision proposed for the Maker network and get to make proposals as well.
Votes are regular and proposals are generally concerning risk control and safety parameters. There is also a delay between vote outcomes and implementation, to prevent bulk purchasing of MKR for malicious voting. In this sense, MKR can be thought of as shares and ownership in the Maker community.
Maker also relies upon its community of MKR holders to implement policy and operates on the assumption that they will employ common sense. This is where MKR’s final aspect of being a recapitalization token comes into play.
If Maker is poorly governed, an automatic recapitalization event will be triggered, resulting in insufficient collateralization of the CDPs. In such instances, the Maker system will create additional MKR tokens to be sold, which will raise capital for additional collateralization. As a result, MKR is diluted and its value drops.
Avoiding this outcome is the incentive for MKR holders to play their part properly because if they don’t, their position in MKR will lose value.
The Maker Team
The Maker website shows that a massive team is collaborating on this project. What’s more impressive than the complicated, yet effective concept that Maker has visualized, is the level of technical expertise that was required to put this project in motion.
There isn’t a great deal known about Maker’s CEO Rune Christensen other than what has been gleaned from recent interviews. He gives off the image of a very level-headed and security-conscious executive, more than willing to take on new challenges as they present themselves.
The frontrunners of the development team consists of CTO Andy Milenius; President, Matt Richards; Chief Scientist, Nikolai Mushegian; and Head of Product, Soren Peter Nielsen. This leadership team collaborates to coordinate an interdisciplinary team of almost 40 developers, business developers and PR staff.
Quite the lineup indeed.
Another important note is that the venture capitalist firm, Andreesen Horowitz, recently bought $12 million worth of MKR. This means their organization will have some impact on the growth of this budding cryptocurrency project.
Marc Andreesen is a Silicon Valley figurehead with industry stature similar to that of tech billionaire, Peter Thiel. There are many people who follow his investment decisions and with this purchase of MKR, consumer confidence may increase in certain circles leading to increased adoption of MKR.
Use Cases for MKR and Dai
Stablecoins have a stronger argument for everyday use when compared to traditional cryptocurrencies. Their stability allows for them to be used in financial markets, like money lending, wherein the lender or institution can rely upon getting a fixed return.
Their potential for regular use in retail and commerce is also very strong due to most cryptos, like Bitcoin, having significantly higher volatility. While holders of Bitcoin will be reluctant to use their coins for transactions, due to the fear of missing any potential growth, users of stablecoins will know that their coin will still carry the same value of $1 tomorrow.
Where the argument for Dai vs other stablecoins comes into play is the fact that it is the first truly decentralized stablecoin. It is reasonably safe to assume that users who are starting to use stablecoins in these early stages of blockchain technology will be cryptocurrency enthusiasts. This is a community who believe in the original intent of cryptocurrencies being decentralized and not dependent on any other currency or security.
It’s for this reason that many users are likely to gravitate towards Dai.
As the Maker community grows in strength and Dai becomes a reasonably useful cryptocurrency, the value of Dai should, in theory, also lead to a correlated increase in the value of MKR.
Competitors and Challenges
Though the Maker and Dai combo is still in its very early days, individuals who have interest in using stablecoins may lean towards USD-backed coins.
Stablecoin systems don’t precisely “fit” into the basic philosophy of cryptocurrencies as they are effectively centralized. This means they may simply be a romantic yet risky option that most investors won’t be able to afford.
As such, it’s currently difficult to approximate how long it will take Dai to demonstrate their claimed stability and when consumers could be jumping to use it.
Global settlement describes what will happen should Maker and Dai ever collapse.
There are several events in which this could occur. If Dai becomes impossible to keep stable or becomes irreconcilably under-collateralized, global settlement will take place.
This is fundamentally when Dai becomes frozen and users are paid out the Ether in their CDPs minus transaction fees. At this point, Dai ceases to exist, though it’s quite possible that Maker might keep MKR running and introduce a new stablecoin to equalize it.
How to Purchase and Store MKR or Dai
Obtaining Dai runs more along the lines of creating it, rather than purchasing it.
To start, you will need to establish a digital wallet for Ether like the ones available for free on Blockchain.info. If you have bitcoin in your wallet, you can simply exchange it for Ether within the Blockchain.info wallet. Otherwise you will need to purchase Ether directly from Kraken or a similar exchange.
Ether can then be exchanged for Dai using Oasis.
The Road Ahead For Maker
Maker’s Dai token has only been live for a little over a month. This is following several years of effort by the Maker team to launch a practical stablecoin using the Ethereum platform.
So far, users have been able to successfully use Dai to back large purchases, like home mortgages, and they have even been able to use Dai to fund small businesses. With the adoption of Dai by the community, the development team has been seeking ways of improving its viability in the cryptocurrency economy.
The team is now assessing whether it will be worthwhile to increase the limit of Dai that can be created from $50 million up to $100 million. This decision must be made with consideration of the risks of growing the system to too large a scale before it has been proven in the marketplace.
Also on the horizon is the launch of multi-collateral Dai. Expected in the summer, multi-collateral Dai should allow the network to sustainably maintain a 1:1 value ratio between Dai and USD. How effective this will be should be more clear following its release in the summer of 2018.
Dai represents a significant step forward for stablecoins. Without stablecoins, creating a cryptocurrency platform that can compete with fiat currencies on a level playing field in volatile industries, like financial services, may be nearly impossible for cryptocurrencies.
Existing stablecoins are being rejected by supporters of cryptocurrencies due to their unpalatable centralization and dependence on fiat currencies. Dai seemingly stands as a solution to this problem.
Dai and MKR are dependent on each other to operate, yet investing in either offers unique opportunities. Dai offers stability, while MKR offers involvement and potential for profitable returns.
As the technology and methodology behind this platform continues to progress the future of stablecoins, cryptocurrency platforms are certain to bring interesting evolution to the cryptocurrency economy.