WTF is a DAI stablecoin!?

Stablecoins are pretty self explanatory — They are cryptocurrency pegged to the value of a fiat currency. The idea is a result of an urge to use blockchain technology for payments without having to deal with volatile investments. Some people don’t know that there are two types of stablecoins though. The newer and less intuitive version is where DAI comes in.

DAI is a “decentralized stablecoin”

The kind of stablecoin that most people are familiar with is backed 1:1 by whatever currency it is pegged to. In order for something to be backed by cash, there has to be a central, trusted authority to manage it. Therefor, this type of stablecoin is referred to as centralized.

A huge appeal to cryptocurrency is that people are able to transact without an intermediary, so enthusiasts of the tech sometimes don’t like dealing with centralized stablecoins. Investing in a centralized stablecoin requires that you trust the company is entirely backing the coin and that they won’t make mistakes with the money.

DAI is the solution to the conflict between centralization and stability. It has the ability to be (relatively) stable without a centralized authority. This works because of software that is able to lock in collateral that is given by everyday people. That collateral then becomes the backing for DAI.

What is DAI backed by?

Even though the DAI isn’t backed by dollars, it’s collateral is valuable. MakerDAO, the company that created DAI figured that Ethereum was the best way to ensure stability without being backed by cash. Maker came to this conclusion because of faith in Ethereum’s value and the ability to transact within the Ethereum network.

By transact, I mean that tokens can be exchanged in a decentralized manner within the Ethereum network. As long as they are classified as ERC-20 tokens, they can be easily converted without an intermediary.

So, to create DAI, I would link my Ethereum wallet to Maker’s website, give them my Ethereum and they will give me DAI. This means that DAI exists only when there is Ethereum backing it. In order to get the Ethereum back, I will need to give the DAI back to maker, plus interest.

DAI is essentially a loan that Ethereum holders take out because they want to keep their Ethereum position and still have spending power that doesn’t fluctuate much.

Is it stable even if Ethereum’s price drops? 

Maker doesn’t let users give $1 worth of Ethereum for $1 worth of DAI. Borrowers must over-collateralize so that borrowers have some wiggle room if Ethereum’s price goes crazy. So instead of giving $1 worth of Ethereum, borrowers would give $1.5 in exchange for $1.

If Ethereum dropped in price and the original $1.5 suddenly became $1.25, Maker wouldn’t be out any money. If $1 of Ethereum became worth $0.75, Maker wouldn’t be able to provide a service.

Still, since the system is currently based only on the price of Ethereum, there could be a scenario where everyone becomes under-collateralized. This is why MakerDAO has plans to release a Multi-Collateral DAI coin. Their plan, sort of like Libra, is that having multiple assets backing the coin, there will be less volatility and chance for failure.

What can I do with DAI? 

Exchanging Ethereum for DAI isn’t the only way you can obtain it, it’s just the only way it can be created. On exchanges like Coinbase, you can purchase DAI for with any type of fiat or cryptocurrency that the exchange supports.

From there, you can do multiple things within the decentralized finance (DeFi) ecosystem with your DAI.

DAI is the most widely used stable coin for speculative trading. By sending your DAI from Coinbase to an Ethereum compatible wallet, you can then trade it directly through platforms like DDEX or DyDx. Trading DAI-ETH pairs maintains similar price action to a USD-ETH pair.

Services like Dharma let users earn interest on DAI. When DAI is deposited into Dharma, it is then thrown into a lending pool that works similarly to how Maker lends DAI. On Dharma, users can earn upwards of 7.4% APR by depositing DAI and can pull out any time.

If you choose to go the route of locking your Ethereum up for DAI, you can send the DAI to Coinbase in exchange for cash. You will still have to pay the value in DAI to Maker, but , of course, but sometimes Maker interest rates can cost less than a bank.

The DeFi space is growing and in the future, users might be able to take out non-collateralize loans with a decentralized credit score system. If there ever becomes a way to get direct deposits into a decentralized wallet in the form of DAI and using it for transactions became practical, it could result in people ditching their bank.

DAI isn’t foolproof

Even Maker acknowledges the potentially fatal flaws of DAI. Though it is a stablecoin, it isn’t as stable as something backed 1:1 with the U.S. dollar and has fluctuated +-5% of it’s dollar peg. This means that if you buy and sell at the worst time, you can lose 10% of your initial investment.

Those numbers make the 7.4% APR you can earn by lending DAI a bit less worth it. Even if you put DAI in a lending pool for a year, you can potentially lose money while gaining interest.

DAI has been around for less than 2 years, so using history as an example of what can happen in the future is risky. Subjectively, the coin has had success, seen growth in adoption and is yet to fail. Still, what the future holds is unknown, especially since the crypto space is most well known for it’s unpredictability.

Comparing risk on DAI lending platforms

Earning interest on crypto is in a sweet spot between profitability and ease of use. In a previous piece, I touched on some platforms that make the process of investing very simple, but exactly how risky can lending crypto assets get?

Coinbase holding risk

Coinbase is the most regulated of the options. CENTRE (Coinbase & Circle), who manages USDC, lists reserve bank partners and compliance organizations that ensure “checks and balances.” There, you can also find attestations from an accounting services firm, updated every month. 

The biggest risk of earning through Coinbase is if suddenly, everyone sold their USDC and Coinbase had backed money in contracts that they couldn’t get out of. This scenario seems very unlikely. Still, there is not much information on how the interest is calculated on Coinbase, and it would be a good idea to follow them closely incase something changes. 

DyDx lending Risk

DyDx puts borrowers in over-collateralized positions ranging from 125% to 150%. Margin traders collateral only needs to be 25% because they can’t withdraw their loan. Each borrower has a liquidation point to ensure the lender will be paid back.

If a borrower’s collateral becomes worth only 115% of their loan, it is liquidated. The other 15% goes to DyDx’s insurance fund. Everything is collateralized through Ethereum, so liquidation can occur if Eth becomes less valuable. DyDx says the insurance funds are there for times of “extreme volatility.”

So far there are no reports of the insurance fund running out of money. 

Dharma lending Risk

Lending on Dharma means that you’re adding value to the Compound protocol. Like DyDx, Compound requires 125% collateralization for both USDC and DAI. Instead of building an insurance fund through a liquidation buffer, 1/10th or 1/20th of interest paid by borrowers is set aside for “reserves.” 

Like DyDx, nobody has reported the protocol running out of reserves. 

Still, there have been times of high lending pool usage. If someone puts millions of dollars into compound, which right now contains around 150 million, they could risk not being able to pull. out. If 96% of compounds funds were being lent out, only 6 million would be able to be removed.

Multiple people being afraid that they won’t be able to pull their friends could cause a “run on the bank” scenario where everyone pulls out and causes panic. Still, the higher the usage, the more interest lenders get paid. Users have to put trust in that system of incentives.

Risk between tokens

USDC risk has been summarized in the Coinbase platform section because of how closely the two operate. DAI on the other hand has a very complex system that is tied to the volatility of Ethereum. 

To make it short, DAI has a system of checks and balances that hasn’t fallen apart yet. Still, it’s peg to the dollar is choppy. Throughout history, DAI has stayed within 5% of the dollar mark. This means that earning 5% APR could either put you at a total of 0% earnings or 10% earnings depending on the price of DAI when it is purchased and sold. 

If passed, on November 18th, “Multi-Collateral Dai” will allow users to use more than Eth for collateral. Theoretically, the feature will give DAI a wider safety net for when extreme volatility strikes the market.

Remember, it’s new technology 

Compound offers a “bug bounty” to encourage people to report issues rather than taking advantage of them. On the Dharma “risk” faq, they warn you that you are using new technology that is prone to bugs. Not all the kinks have been worked out of these systems and developers are aware. 

With that being said, all protocols have been audited to an extent by third parties. There are no records of either 0x or Compound being hacked. Keeping up with news about the protocols should help mitigate risk as it is less likely for a whole insurance fund to be taken out in one day than it is over time.


Three easy ways to earn interest on USDC and DAI

Decentralized finance (DeFi) is a field in blockchain tech that has gained traction even throughout crypto’s price bubble. A primary reason for this is how everyone can identify with the urge to lend and borrow. There are many ways to earn interest on crypto assets, but these four polished platforms are safe (not financial advice) starting points. 

Earning interest with USDC on Coinbase

Not all blockchain tech is decentralized, especially not Coinbase and USDC. The massive spot exchange seemed to follow the “earn interest on your coins” wave after DeFi lending had been long established. Regardless of whether or not this method is for blockchain purists, people are going to use it off the strength of Coinbase’s brand.

Coinbase is the easiest place to start earning interest. All you need to do is buy some USDC with debit card or bank account and Voilà! You are now earning 1.25% APR. It’s the least you’ll earn from platforms on this list, but probably more than your bank’s savings account will give you. 

USDC is backed 1:1 by the USD and was founded by Coinbase and Circle. The two companies created what is called the CENTRE Consortium where they look for other institutions to “help change the global financial landscape.” Coinbase is able to offer interest likely because they are earning more than 1.25% with the cash that they back USDC with. 

Earn even more on Dharma 

Dharma used to be a peer-to-peer lending service which linked a lender and borrower into a contract. Recently, they decided to scrap that whole idea and become an interface for the Compound protocol.

Now, Dharma is a gateway into contributing USDC and Dai to the Compound lending pool. The change means that users can deposit and withdraw their tokens at any time. Earning interest on Dharma is as simple as purchasing DAI or USDC from a spot exchange and sending it to your Dharma address.

Right now, USDC earns 4.66% APR while DAI earns 7.39%. As the lending pool becomes more used, APR increases for lenders. As more lenders contribute or less is borrowed, interest decreases. 

Compound is a decentralized protocol and Dharma is a centralized organization that acts as a forum for users to connect with the protocol. 

Lend to margin traders

DyDx is one of the only decentralized exchanges that lets users trade with leverage. They are able to lend money to traders by using protocols similar Compound. 

Interest rates currently don’t differentiate much from Dharma. This could change throughout time since it uses the 0x protocol and along with a proprietary one. It’s also worth noting that users can earn interest by holding Ethereum, but only a measly .06% right now. 

Earning interest on DyDx might be appealing to someone who actively trades DAI/ETH pairs on decentralized exchanges. The liquidity on their DAI/ETH pair is pooled with Maker’s own Oasis exchange, so it’s not horrible compared to other DEXs. 

DyDx requires one extra step that Dharma doesn’t have. You will need a MetaMask wallet with an Eth balance. Eth is required for gas fees when withdrawing from the wallet which usually costs 10s of cents. 

So, in order to get your DAI or USDC onto DyDx there are a couple of steps: 

  1. Buy at least $5 of eth for gas. Send that to your MetaMask wallet.
  2. Buy your DAI or USDC. Send that to your MetaMask wallet. 
  3. Deposit DAI or USDC onto the exchange with the MetaMask wallet. 

Now might be the best time to lend

These platforms are in their infancy and decentralized credit ratings aren’t in existence yet. If more people learn how to lend their crypto assets, the lending pools get bigger and interest earned will decrease. 

Trading crypto is dangerous if you don’t have the time to learn, or aren’t in the position to take risk. Lending is a good way to earn interest without converting back to FIAT.

To learn more about risk on said platforms and currencies, check out our information on that here


Coinbase adds Maker governance before important Dai vote

Coinbase announced on their blog today that Maker holders will be able to help govern products like Dai through voting on their website. In order to do so, users must hold MKR in their Coinbase Custody account.

Maker has had a respectably straightforward voting system for a while now. Compared how Ethereum is governed by dev’s judging “community consensus,” Maker at least puts a poll right on their website. 

Added right before Dai vote

Even though Multi-Collateral Dai (MCD) has been in the news as a feature that is coming soon, Maker holders still need to vote for it to come to fruition.

Maker is allowing only 3 days to vote. Polls become active on November 15th for a planned release on November 18th.

Community response to the idea of MCD has been generally positive. Maker themselves seem to be a huge proponent of MCD and releasing the option to vote on a platform like Coinbase shows their confidence in the tech. 

Do people hold Maker on Coinbase?

Right now, you can’t purchase MKR on Coinbase, so this change will fit the small niche of those who prefer to hold their tokens in a Coinbase Custody account.

Applying for an account in Coinbase Custody requires you to fill out information on your business. The feature is advertised as “institutional” so they aren’t making it any easier for the average person who uses Dai to vote on Dai.