What is DAI, and how does it withstand the Bear Market ?
- Intro & importance of retaining the value in our project or protocol
- Interaction & Process
- mechanism
- Examples
Tl; tr
- Great Tokenomic model comes from aligning the incentives properly, coming down to baking Demand and Supply into a protocol
- Maker DAO is substantially a loan platform with over-collateralization
- DAI adopts a soft peg ( 1 USD ) implementation with narrow fluctuation
- Anyone converting valuable assets ( ETH ) to pooled assets ( PETH ) was regarded as one of the participants of the DAI protocol, being responsible for taking care of the protocol
- Participants use governance power to affect the influential proposal and parameters
Intro & Importance of retaining the value in our project or protocol:
One of the principal and urgent problems with Crypto, at least Bitcoin, they usually experiencing high fluctuations. The main reason behind this is that the supply of Bitcoin is fixed — 19M has been mined, leaving the remaining 2M to be mined before 2140 -, so its price is directly proportional to and followed by demand.
To solve the problems, there are often 2 methods that can be taken, the first 1.) is to have a supply-function mechanism somehow detects its current economic usage, and another approach 2.) is to track specific and relatively valuable assets along with some arbitrage mechanism, making it backed by true assets.
- Supply mechanism
→ calculated and determined by mining difficulty or tx count
- Track and backed by assets
→ DAI (PETH)
While the first method is quite inaccessible for drastically changed market status, it will be more reasonable and feasible to implement the second method as it has a real implementation in the real financial world, which has been experimented with and accepted for years.
// The article is mainly focused on the single-collateral model, keeping in mind that the current DAI has upgraded to a “multi-collateral” pattern, but it didn’t affect the main logic with mild updates and join of MKR governance token, kindly take the latest reference.
Interaction & process:
— Convert assets to the required collateral type
- Convert ETH (non-ERC) to WETH (ERC standard) and then to PETH
- PETH plays a role as a recapitalization resource as all assets are collected and managed in a single pool
- Isolate the market impact of Ether price
— Creating the debt position by depositing required collateral
- Over — collateralized
— Generate position ( As a Loaner )
- Long position ( PETH + DAI )
- Short position ( DAI ) stablecoin
— Pay down the debt and borrowing fee
- denominated in DAI
- *borrowing fee paid in MKR token in multi-collateral model
— Withdraw the collateral and close the debt position
Mechanism
Target price
- Calculate the collateral-to-debt ratio of a CDP
— > impact on participants since they had the position and debt in DAI if they had other operations on the debt
— > impact on holders/ buyers on the market since they have the incentives for boosting the DAI
- Determine the value of debtor received after global settlement triggered
— > As the last-ditch for preventing massive fund pressure or hack attacks.
But how does DAI bind at a target price of $1?
TRFM
— Dynamic rate is the so-called “TRFM ( Target Rate Feedback Mechanism )”
- Having an impact on target price
- If the rate > 0, the target price is expected to increase, making holders of DAI hold; debtors buy DAI as their cost ( stability fee ) increase
- If the rate < 0, the target price is expected to decrease, making holders of DAI sell; debtors are inclined to borrow more DAI
— When TRFM engaged
- The market price is below the target price → target rate increase
- The market price is above the target price → target rate decrease
— The core concept is built on a Negative feedback loop
- Rate > 0, injure “debtor”; reward “holder”
- Rate < 0, injure “holder”; reward “debtor”
— Global settlement
- As a last resort to guarantee and promise the target price,
- Freeze minting and price to pay back both DAI holders and debtors the proportional value they are entitled to.
— The depreciated collateral value of ETH
- MakerDAO dilutes the supply of PETH to bind the exchange rate to ETH, promising ETH/ PETH always larger or equal to 1
- PETH = ( WETH balance ) / ( Total PETH supply ) WETH
Liquidation
- Executed by smart contract
- The owner receives the value of the leftover collateral minus ( debt + fee + liquidation penalty )
- PETH collateral enters into audit by selling for DAI.
- In 2 scenario
- Excessive → excessive DAI buy PETH back and burn to apprise PETH
- Shortfall → mint PETH to cover the deficit, causing PETH holders to lose value
Examples
Assumption
- Deposit: 150 USD
- PETH/ETH = 1
- ETH/ USD = 100
- Liquidation ratio = 135%
- Liquidation penalty = 105%
Process
- Buy WETH from AMM or convert ETH to WETH, acquiring 1.5 WETH ( 150/100 )
- Locked it in exchange for 1.5 PETH ( 1.5/1 )
- Deposit all PETH in exchange for 100 DAI with collateral-to-debt ratio of 150%
- At the point he has the position ( Long: 1.5ETH + 100DAI ; Short: 100DAI)
We have either choice:
- Deposit the DAI to earn the deposit fee
- Use borrowed DAI to buy more ETH, becoming a margin trader ( Long: 2.5 ETH; Short: 100DAI )
( scenario 1 )
If Eth increase 10%
- As debtor: You earn 1.5 * ( 100 * 0.1 ) = 15 USD
- As margin trader: You earn 2.5 * ( 100 * 0.1 ) = 25 USD
( scenario 2 )
If Eth decrease 10 % ( Both become liquidated )
- As debtor: You lost 1.5 ( 100 * (-0.1) ) = -15USD
- As margin trader: You lost 2.5 * ( 100 * (-0.1) ) = -25 USD
- As a debtor, when the price drop by 10%, causing the collater-to-debt ratio to fall to 135%
- After liquidation, the debt position enters into auction
- Once there is at least 105 DAI being bid on the collateral, the remaining collateral will be payback
Unquestionably, DAI is one of the most successful Defi protocols even if we were in Bear Market. Though it has lost its peg in 2018 for oracle problem along with depression of Market sentiment, it has guaranteed its status and security at the time of writing.
That’s all for the topic, hope you enjoy it !
: )
