Last updated on November 17th, 2022 at 12:26 pm
The crypto space is constantly evolving, with novel features regularly developed and implemented. Volatility in the cryptocurrency market prompted the creation of a type of coin specifically immune to the market’s swinging effects.
Investors desired a coin that could serve as a store of value, withstanding market highs and lows. This is the fundamental idea behind a stablecoin. Users can currently choose from several types of stablecoins.
This article provides an overview of stablecoins as well as an in-depth analysis of the popular stablecoin known as DAI.
A stablecoin is a type of cryptocurrency designed to mimic the characteristics of fiat currency. This type of coin is pegged to the value of a fiat currency, such as the US dollar. With the volatility of the crypto space, stablecoins, as the name implies, are designed to remain stable or hold value over time. Holders of this type of token do not have to worry about volatility, regardless of the state of the crypto market.
Tether’s USDT, Circle’s USDC, and Binance’s BUSD are some popular examples of stablecoins. Stablecoins can be denominated in other fiat currencies apart from the US dollar. Though stablecoins may be pegged against a fiat currency, they are not Central Bank Digital Currencies (CBDCs).
The major difference is that stablecoins are issued by private organizations rather than the government.
Second, CBDC may or may not be based on the blockchain, as opposed to stablecoins. The central bank-issued digital currency is controlled by the country’s central bank and is typically intended to represent the underlying fiat currency.
This means that CBDC is supported by the issuing country’s government and law. The e-Naira is an example of a CBDC.
The e-Naira is a CBDC issued by the Central Bank of Nigeria in collaboration with Bitt. Inc., a Barbados-based Fintech company. This digital currency is a representation of Nigeria’s fiat currency, the Naira.
Stablecoins are used for a variety of purposes. Some people hold this type of cryptocurrency to protect themselves against price volatility in the cryptocurrency market.
Second, residents of countries with weak fiat currencies can protect their wealth by converting their fiat currencies to stablecoins.
Third, it is used for transactions because some merchants accept stablecoins as payment.
Though stablecoins are theoretically designed to be price stable and remain pegged to a fiat currency such as the US dollar, this is not always the case.
The value of a stablecoin may fluctuate slightly depending on the demand for the token. In extreme cases, the stablecoin may lose its peg to a fiat currency such as the USD, causing its value to fall.
The TerraUSD, or UST scenario, is a well-known example. UST lost its peg, falling from $1 to a few cents. UST is the algorithmic stablecoin of the older Terra chain. It lost its peg after Anchor Protocol decided to make significant modifications to the rate it offered its users in March 2022, converting the 20% standard rate to a variable rate.
With the new variable rate, it was apparent that the new return on investment (ROI) would fall below 20%. This rate modification irritated numerous holders, forcing them to leave Anchor and sell their UST and LUNA.
UST has yet to recover, and it seems like it will never return to its previous state.
What is DAI?
DAI is a collateral-backed stablecoin pegged to the US dollar to achieve a 1:1 value. DAI, like other stablecoins, was developed by a private organization known as Maker Protocol. It is a free and open-source product built on the Ethereum blockchain.
Unlike other stablecoins, which may be backed by bank-stored US dollars or short-term monetary assets, DAI is backed by collateralized debt denominated in Ether.
Smart contracts handle the DAI creation process. Usually, before a unit of DAI is minted, a user on Maker Protocol has to lock their Ether in the network as collateral and borrow DAI. This means that the minted DAI acts as the loan that the borrower collects. The borrower can utilize the DAI in any way they deem fit.
Borrowers are allowed to access their collateral, which is the locked Ether, by giving the DAI to the source—the Maker Protocol—and paying a fee. In a typical crypto lending structure, borrowers risk losing their collateral to liquidation.
Liquidation occurs when the value of the locked ETH falls below a certain threshold. This means that, depending on the cryptocurrency market volatility, the borrower may need to increase their collateral. When a user’s ETH collateral is liquidated, the Maker Protocol sells it through its market-based auction system.
What are the Differences Between DAI and Other Stablecoins?
When compared to other stablecoins, DAI exhibits some distinctions.
For starters, this stablecoin is not backed by a fiat currency such as the USD. Some stablecoin creators claim to have USD in bank accounts to back up the stablecoins they issue. In some cases, these private organizations may claim to have liquid assets to back up their stablecoins.
This is not the case with DAI, as it is backed by Ether-denominated collateralized debt.
Second, unlike other stablecoins, DAI is not collateralized against a single currency, either fiat or cryptocurrency. In the case of this stablecoin, various cryptocurrencies such as ETH, USDC, BAT, COMP, and others can be used as collateral on the Maker Protocol.
The decision to use multiple denominations for collateral is intended to improve DAI’s price stability and integrity.
Third, unlike some stablecoins issued by a single or a few organizations, this stablecoin is highly decentralized. In the case of DAI, anyone can mint it as long as they have the required collateral.
Fourth, DAI holders are allowed to earn interest. Holders of the Maker Protocol’s native token, MKR, can typically choose to act as a guarantor and set the DAI Savings Rate.
If an adverse event disrupts the mechanism’s operation, the guarantors will lose their MKR tokens.
DAI: A Brief Origin Story?
DAI is a product of the Maker Protocol, created in 2017. After a while, control of the stablecoin’s underlying architecture was transferred from the Maker Protocol to the MakerDAO.
What are the benefits of DAI?
DAI offers several benefits to its holders, which will be discussed below.
Affordable fees
Unlike traditional lending institutions, which impose draconian rules on borrowers and charge exorbitant fees, DAI is quite affordable. Users are expected to pay a minute fee to access their locked collateral when they repay their loan.
Easy access to lending facilities
DAI allows users to access crypto loans, which are relatively easy to obtain compared to traditional lending facilities from banks. Anyone can mint DAI as long as they have the necessary collateral. Users are not required to undergo any credit checks or jump through any red tape that makes the process of accessing credit facilities difficult.
Reduced Exposure to Volatility
Stablecoins are intended to reduce one’s exposure to cryptocurrency volatility. Individuals use this type of cryptocurrency to hedge their risks. DAI, as a stablecoin, provides this feature.
Income generation
DAI holders can earn money through the DAI Savings Rate system by depositing the stablecoin into the MakerDAO smart contract.
In Conclusion,
- A stablecoin is a type of cryptocurrency designed to mimic the characteristics of fiat currency.
- Tether’s USDT, Circle’s USDC, and Binance’s BUSD are some popular examples of stablecoins.
- DAI is a collateral-backed stablecoin pegged to the US dollar to achieve a 1:1 value. Like other stablecoins, DAI was created by a private organization called Maker Protocol.
- Smart contracts handle the DAI creation process.
- DAI holders can earn money through the DAI Savings Rate system by depositing the stablecoin into the MakerDAO smart contract.
Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.
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