Maker, a crypto lender, is one of the pioneers of decentralized finance (DeFi). Maker uses smart contracts on the Ethereum blockchain to issue loans based on DAI, a stablecoin.
MakerDAO is a cooperative organization that maintains the Maker protocol. As one of the most valuable and widely adopted platforms in DeFi, investors and crypto users are closely watching how Maker’s governance and operating model is evolving.
Since Ethereum went live in 2015, it has hosted hundreds of decentralized applications (dApps). By far the most popular are lending, borrowing and token exchange dApps, as these services can be run without the need for intermediaries such as banks or credit bureaus. The Maker protocol was in the DeFi vanguard.
Origin and purpose of the manufacturer
In 2014, Rune Christensen created MakerDAO for the Maker ecosystem. He is a Danish entrepreneur who studied at the University of Copenhagen.
Inspired by the Ethereum Foundation, he founded the Maker Foundation in 2017. She was a coordination body for programmers and started Maker, an open-source project to push for a fully decentralized and permissionless banking system without banks.
Specifically, Maker’s mission is to create and sustain a stable on-chain digital asset pegged to the value of the dollar – the DAI stablecoin. To do this, Maker uses smart contracts that automate lending and collateralization of debt/stablecoins.
At its peak in December 2021, the MakerDAO ecosystem made up the majority of Ethereum’s TVL. Source: DeFiLlama
From that centralized beginning, the Maker Foundation gradually handed over its control to MakerDAO, the decentralized governing body for the Maker protocol. It used MKR as its governance token, granting voting rights on all aspects of Maker’s management and development.
This transition is underway and there have been a few glitches. In late 2018, the Maker Foundation established the Maker Ecosystem Growth Fund (MEGF). This fund oversees the MKR token treasury to drive adoption of the MakerDAO ecosystem. Due to disagreements over the distribution of funds, five of Christensen’s nine board members were fired.
MakerDAO’s key product is Dai stablecoin, launched in December 2017 and backed by Ethereum. In November 2019, MakerDAO updated the DAI edition to be backed by dozens of crypto assets but mostly by USDC stablecoin.
Maker’s Dai (DAI) stablecoin
For a blockchain lending service to be reliable, the collateral used for lending must be stable. Consequently, Maker’s entire lending ecosystem revolves around DAI. The Maker Protocol uses smart contracts to create Maker Vaults. These are token repositories where investors add liquidity. Therefore, Maker Vaults serve as liquidity pools to collateralize Dai stablecoin.
After liquidity is added to Maker Vaults, they mint new DAI stablecoins. The newly minted Dai stablecoin, in turn, is backed by the provided crypto asset. Typically, investors add USDC alongside Wrapped Bitcoin and Ethereum to mint new DAI.
The reason for this assignment is that both Ethereum and Bitcoin are cryptocurrencies with the largest market capitalizations. Therefore, they are the least vulnerable to wild price swings that could affect DAI’s one-to-one peg to the dollar. Conversely, USD Coin is the most commonly used centralized stablecoin as it is 100% backed by USD cash reserves or equivalent.
As a result, DAI is far from being decentralized. Nonetheless, it has the potential to do so if its collateral structure moves away from centralized stablecoins like USDC or USDT. Such a decision is in the hands of the MKR token holders.
Vendor MKR governance
To be truly decentralized, everyone involved in the protocol must be able to vote on their functions. Like shareholders of a company, MKR token holders can do this for the Maker protocol. You can use MKR tokens as voting weight to:
- Select which new crypto asset to add as DAI collateral
- Determine by how much DAI to overcollateralize each crypto asset. This reduces or increases the risk of peg instability from DAI.
- Determine the staking reward rate for DAI stablecoin
- Approve or propose new Maker upgrades
- Select or add oracle networks that feed off-chain data into on-chain smart contracts, such as: B.Chainlink.
- Choose liquidation ratios for each crypto asset backing loans. Typically, this reflects the market cap of the coin; The lower it is (below $10B), the more volatile it tends to be.
- Stability and Liquidation Fees. The first is a Dai-denominated fee for collateral retrieval, while the second is the fee (penalty) paid when Maker Vault’s assets are liquidated.
As with any other blockchain governance protocol, MKR token holders have as much voting power as they have tokens. If a maker vault is deemed too risky, it will be liquidated via automated auctions, generating new DAI.
Coinbase surprises MakerDAO with pitch to top up on USDC
The proposal could alter Christensen’s bid to reduce reliance on centralized revenue
Since MKR token holders can decide on every aspect of the maker protocol, its governance role is also its utility. When a smart voting contract is initiated, one MKR token equals one vote. Just as they would add liquidity pools to smart contracts, MKR token holders add their stake to a locked voting smart contract.
In addition to voting, MKR promotes responsible economic activity. When Maker’s credit ecosystem is overwhelmed with too much debt, MKR supply is increased as a backup. As this devalues the price of any MKR, it discourages irresponsible risk taking.
How does maker loan origination work?
Many dApps are tied to the Maker protocol to issue credit. One of them is Oasis.app. When a user desires a loan through such a dApp, the Maker protocol issues a smart contract called Collateralized Debt Position (CDP).
Let’s say a borrower wants to collateralize their CDP loan with ETH, Ethereum’s native cryptocurrency. ETH is then used to mint DAI stablecoin via Maker Vault. In other words, the ETH serves as collateral for the loan issued in the DAI.
Once the loan is repaid, the minted DAI tokens are burned, i.e. permanently removed from circulation.
Maker (MKR) tokenomics
When MakerDAO first launched in December 2017, it issued 1,005,577 MKR tokens as its maximum amount. As of September 2022, 97% of this supply is in circulation. At its peak price, MKR reached $6,339 in May 2021 and grew to a market cap of $5.98 billion during a bull run.
As previously mentioned, while MKR has a maximum supply, this can be changed at any time through a vote depending on the level of debt in the system. Because of this, the value of MKR shifts with the market winds.
For example, if the DAI stablecoin supply exceeds the necessary baseline to provide collateral for loans, the excess will be used to buy and burn MKR tokens. When this happens, the circulating MKR supply is reduced, which usually increases its price according to the economic law of supply and demand.
In addition to decentralized exchanges such as Uniswap, Maker Token is available on all major exchanges such as Binance, Coinbase, Kraken and OKX.
Disclaimer for the series:
This series article is for general guidance and information only for beginners participating in cryptocurrencies and DeFi. Nothing in this article should be construed as legal, business, investment or tax advice. Consult your advisors for all legal, business, investment and tax implications and advice. The Defiant is not liable for lost funds. Please use your best judgment and exercise due diligence before interacting with Smart Contracts.
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