Explained: What is MakerDAO? How Does It Work?

MakerDAO: Maker (MKR) is a smart contract platform built on the Ethereum blockchain that attempts to address the crypto market’s volatility concerns. It serves as the foundation for a next-generation blockchain-based financial system that enables quicker and easier international payments as well as peer-to-peer transactions.

What is MakerDAO?

Launched in 2014, MakerDAO is a Decentralized Autonomous Organization (DAO) built as an open-source project on the Ethereum blockchain.

It is one of the largest decentralized applications (dApps) on the Ethereum blockchain and was the first decentralized finance (DeFi) application to earn significant adoption.

MakerDAO allows people to lend and borrow cryptocurrencies, and this process is dictated by smart contracts. In other words, MakerDAO is a cryptocurrency lending credit facility that offers loans at fixed interest rates.

Due to the extreme volatility of cryptocurrencies, MakerDAO bases lending rates and repayment amounts on the stablecoin Dai (which is created by leveraging the Maker Protocol).

In order to borrow money, a MakerDAO user must first deposit Ethereum into a Maker smart contract. This smart contract creates a Collateralized Debt Position (CDP).

How Does MakerDAO Works?

The project is managed by people across the world who hold its governance token, MKR. By using their voting power, MKR holders determine important criteria for the Maker ecosystem, such as stability fees, collateral types and rates, etc.

Holders of MKR oversee the stability, transparency, and efficiency of the Maker Protocol as well as the monetary risks associated with Dai. The amount of MKR that a voter stakes in the voting contract, DSChief, determines how much weight he has in the vote. In other words, the voting power of each voter increases with the number of MKR tokens locked in the contract.

Why are Users Borrowing DAI as Opposed to Buying It?

The main justification is that an investor would be able to access a US dollar stablecoin by borrowing DAI (as opposed to buying it) without having to sell any of their ETH. This is helpful because many yield farms and lending platforms offer greater returns for stablecoins pegged to the US dollar than they do for ETH. And at anygiven  time, DAI can be changed back into ETH.

MakerDAO provides various features, including:

1. The protocol allows ETH deposits to be locked in Maker smart contracts, and you can receive earnings in the form of newly minted Dai tokens.

2. MakerDAO provides depositors with the opportunity to earn interest on DAI held in the DAO’s bank. Dai tokens are locked in a DSR (DAI Savings Rate) contract and continue to earn Dai based on the interest rate of the DSR.

3. You can lock cryptocurrencies like ETH, WBTC, LINK, MATIC, MANA, etc. as collateral in a CDP and obtain a low-interest loan in Dai tokens.

Also Read: Explained: What are ETH Gas Fees? How Gas Fees Work on Ethereum Blockchain?