MakerDAO, MKR and DAI: How a Decentralized Stablecoin Works

MakerDAO is a decentralized system that issues the stablecoin DAI against collateral. This guide explains how DAI aims to stay near one dollar, what MKR does, and the risks beginners should understand.

MakerDAO, MKR and DAI at a glance

MakerDAO is a decentralized finance (DeFi) protocol running on Ethereum. Its two central tokens are:

Unlike a stablecoin issued by a central company depositing dollars in a bank, DAI is backed by users' cryptocurrency collateral and smart contracts, or code.

How DAI is issued

New DAI is created through borrowing. A user deposits an asset such as ETH as collateral in a Vault and can borrow DAI up to a proportion of its value. Repaying DAI releases the collateral, and the repaid DAI is burned, removing it from circulation.

The key concept is over-collateralization: the collateral must be worth more than the DAI borrowed.

How DAI maintains its dollar peg

• Over-collateralization: Under this model, the collateral backing issued DAI has a higher value than the DAI.
• Liquidation: If collateral value falls below the safety threshold, the system automatically sells collateral to recover the debt.
• Stability fees and the DSR: Adjusting borrowing interest and the DAI savings rate influences supply and demand.

Together, these mechanisms pull DAI toward one dollar. They do not guarantee that it always equals exactly $1; market conditions can cause deviations.

MKR's role in governance and absorbing losses

MKR holders vote on key parameters such as collateral types, collateral ratios and fees. In the system described by the original guide, losses that remain after collateral sales can be covered by issuing and selling new MKR, making MKR the asset that ultimately absorbs this risk. Conversely, system fees may be used to buy and burn MKR.

Risks to understand

Decentralization and over-collateralization do not eliminate risk.

• Collateral crashes and liquidation cascades: A sharp market decline can cause liquidations to accumulate and losses to grow.
• Smart-contract bugs: Code vulnerabilities and errors in oracle price data remain possible.
• Depegging: DAI can move away from one dollar in extreme conditions.
• Changes in collateral composition: The original guide notes that DAI uses various collateral assets, including some centralized assets. Governance decisions can change this structure.

Understand basics such as wallets and gas fees before experimenting with a small amount.

This article is for information and is not an investment recommendation. It contains no price forecast or profit guarantee. Cryptocurrency can cause loss of principal; research independently and make decisions within a level of risk you can accept.