Maker: the Pioneer of Decentralised Finance
April 15, 2021
Maker (MKR) is an ERC-20 token, native to the Maker protocol, governed by the decentralised MakerDAO organisation.
If DAI is MakerDAO’s stablecoin, MKR is MakerDAO’s governance token.
DAI is a decentralised stablecoin pegged 1:1 to the dollar price, and we discussed it in this article.
As a governance token, MKR is used to vote on all DAO decisions and the operation of the Protocol.
The Maker ecosystem is one of the first projects on the decentralised finance (DeFi) scene. Maker provided one of the first smart contract lending solutions, independent of any intermediary.
In line with DeFi’s mission, the Maker project is now governed in a completely decentralised way, through a DAO, a decentralised autonomous organisation. This is evidenced by the announcement that the Maker Foundation, which was created for the sole purpose of kick-starting the project, will be dissolved in January 2022 to officially hand over governance to the DAO.
The Maker Protocol: the lending technology
The Maker protocol allows for loans in DAI in a decentralised manner, i.e. without a financial intermediary. To use this service, it is necessary to deposit cryptocurrency collateral in a Maker Vault. Maker Vaults are smart contracts dedicated to storing the collateral of DAI loans.
The first collateral was Ether (ETH), but today there are over 34 cryptocurrencies that can be used as collateral and new ones are added regularly. For example, I can deposit in Maker Vault ETH to receive a loan in DAI.
The value of the collateral must be at least 150% of the value of the DAIs to be generated.
Example: if you want to generate 100 DAIs, you need to deposit the corresponding $150 in ETH as collateral. This over-collateralisation serves to manage the risk of default and to keep the price of DAIs stable.
At this point, one may ask: who would be willing to deposit a higher value than the one being borrowed? What advantage can be gained from this exchange?
Many people use these loans because it allows them to have instant liquidity without having to sell cryptocurrencies that they find more profitable to hold at the time. Holding cryptocurrencies can also be part of a strategy to continue to take advantage of the services provided by staking, while in the case of professional traders it can be a way of maximising market positions.
MakerDAO is one of the most widely used and longest running projects in Ethereum’s DeFi ecosystem. To date it has about 2.9M ETH locked in its protocol, which is more than 2% of the total ETH supply.
The stability fee and DAI peg
Like any loan, a DAI loan involves the payment of an interest rate called Stability Fee. If the price of DAI is less than $1, the Stability Fee must be lowered in order to give the user an incentive to repay the loan.
Example: If the Stability Fee is 1%, instead of 5%, it will be easier to repay the loan because you will have to pay a lower amount.
“If the price of DAI is less than $1 the DAO needs to incentivise the repayment of the loan” because when a loan is repaid, the DAIs that Maker gets back are burnt, and as a result, the price of DAI stabilises towards $1.
Conversely, if the price of DAI is higher than $1, it is necessary to vote to raise the stability fee, so as to indirectly decrease the demand for DAI and facilitate the lowering of its value.
Example: If the stability fee is 5% instead of 1%, I will avoid taking out a DAI loan because it costs too much, so there will be less demand for DAI.
This mechanism for regulating the stability fee is similar to the measures central banks take to regulate inflation through interest rates.
The price of MKR
If DAI is a stablecoin through and through, MKR was created so that its value varies with supply and demand. Therefore, the greater the number of people involved in governance, the greater the value of MKR.
The role of the MKR token
The main role of the MKR token is to enable proper governance of the DAO.
MKR holders have the right to vote on all kinds of decisions. In particular, 1 MKR gives the right to 1 vote. In addition to decisions concerning the governance of the DAO at the management level, the most frequent and important decision to be taken at protocol level is the stability fee rate.
With DAI and MKR, MakerDAO has created a true decentralised monetary policy, which forms the basis of its financial services: a stablecoin combined with a system of loans, to which anyone can have access.