When I was browsing Coingecko recently, I noticed that the stablecoin USDS has jumped to the 23rd place in the market capitalization ranking. Curious, I did some research and found out that USDS is an upgraded version of DAI, and the MakerDAO protocol behind it has also been upgraded to Sky.
Let’s first take a look at MakerDAO, and then talk about upgrading Sky. This article is divided into two parts:
Previous article: MakerDAO’s product structure and principles
Next article: Sky's product structure and upgrade content
Today let’s talk about the previous article - the product structure and principles of MakerDAO.
MakerDAO was founded by Danish entrepreneur Rune Christensen in 2014. On August 27 last year, the decade-old DAO organization announced that it would change its name to SKY and prepare to migrate its business. Users can exchange DAI 1:1 for USDS and MKR 1:24000 for SKY.
MakerDAO and Aave’s over-collateralized crypto assets are different in that they lend out stablecoins such as DAI, and there is only a borrower role, no lender role, and DAI is completely generated and controlled by smart contracts.
The specific project structure is as follows:
1. Business Logic
Suppose a user has some encrypted digital assets, such as ETH. The user does not want to sell ETH, but needs cash to consume or invest in more digital assets.
1. Deposit collateral assets - Create Vault
The user initiates a transaction to the Maker Protocol through the Oasis platform, specifies the type and amount of collateral assets (such as $1,500 worth of ETH), and the system will automatically deploy the Vault smart contract. This operation establishes the initial collateral position, and when the collateral ratio reaches 151%, 1,000 DAI can be generated, at which point the user's digital wallet will display the corresponding Vault logo.
2. Generate DAI - Establish a debt relationship
The holder initiates a loan request through the Vault management interface and enters the amount of DAI to be generated (e.g. 1000 DAI). The system simultaneously creates an equivalent debt contract, which will be directly reflected in the user's wallet, and the Vault status is updated to include both the mortgage assets and the corresponding debt records.
3. Debt repayment and stability fee
When a user needs to release a debt, he must repay the principal plus the stability fee through the Vault interface (only DAI is accepted for payment). For example, if a user repays 1,000 DAI principal and the corresponding service fee, the system will execute the debt write-off and destroy the corresponding amount of DAI. After the repayment is completed, the Vault debt status will be reset to zero.
4. Redeem collateral - terminate the Vault contract
After the debt is paid off, the user can initiate a mortgage asset redemption transaction. After the system verifies that the debt is cleared, it automatically cancels the smart contract and returns the collateral (the above-mentioned deposited ETH) to the user's wallet. At the same time, the Vault logo is removed from the account, completing the full loan cycle.
When you need to get back your collateral (ETH), repay 1,000 DAI and very low interest (in DAI), get your Ether back and keep the gains (from the appreciation of Ether or the gains from investing with DAI).
Liquidation
If the price of ETH drops and the borrower’s collateral is worth less than the loan, the collateral will be liquidated. The Maker Protocol will take the collateral from the liquidated vault and sell it using a market-based auction mechanism within the protocol, and the proceeds from the auction will be used to repay the loan and fines.
auction
If the value of the user's ETH collateral drops too much to pay off the debt, the outstanding portion becomes a liability of the Maker Protocol and is repaid with DAI in the Maker Buffer, which is a fund that comes from liquidation auction proceeds and fines.
Flash Loans
In addition, MakerDAO has also introduced the flash loan business. Like Aave, users can obtain DAI without investing any money in advance and just need to repay the loan within one block. Flash loans allow users to mint up to 500 million DAI, but repay the DAI loan and pay a fee of 0.05%.
2. How does DAI maintain its value at $1?
If the collateral appreciates, it means that DAI has more sufficient collateral (higher collateral ratio, more sufficient guarantee), which will not have much impact. If the transaction price of DAI exceeds $1, Maker will use TRFM (Target Rate Feedback Mechanism) to incentivize users to create more DAI.
If the price of the collateral asset falls below a critical line, it will be liquidated and the previously pledged assets will be auctioned until the DAI borrowed from the collateral vault is repaid.
1. Loan interest thermometer
When DAI is sold at $1.1 (premium): the system automatically "subsidizes" loans and reduces the interest on generating DAI. It's like a bank saying "50% off on borrowing money now" to attract more people to borrow money to generate DAI. As more DAI becomes available on the market, the price will fall.
When DAI drops to $0.9 (discount): Immediately raise the loan interest rate, just like a bank suddenly says "borrowing interest rate doubles". This scares everyone into paying back the money and destroying DAI, which reduces the amount of DAI on the market and allows the price to go back up.
2. Deposit interest seesaw
Depositing DAI can generate interest (similar to Yu'e Bao), and the interest rate is determined by voting of all MKR coin owners.
When DAI is too expensive: lowering the deposit interest rate is equivalent to telling the depositors: "Now that the interest rate is so low, it is better to sell DAI and exchange it for other things." When the supply of DAI increases, the price goes down.
When DAI is too cheap: the deposit interest rate rises sharply, just like shouting: "8% interest on depositing DAI! Hurry up and buy DAI on the market and save it!" Everyone rushes to buy DAI, causing the price to rise.
3. The ultimate fuse - emergency freeze
When encountering a hacker attack or extreme market conditions (such as ETH price halved in half an hour), the system will immediately: prohibit the creation of new loan positions, lock all asset prices, and enter "slow motion mode" to process remaining assets
It is equivalent to a financial nuclear button, which prioritizes ensuring that DAI holders can redeem their collateral at a 1:1 ratio.
3⃣ First try of RWA
MakerDAO worked on combining real-world assets and protocols in 2022 through a proposal to accept real-world assets RWA as collateral in the form of tokenized real estate, invoices, and accounts receivable.
The vaults opened by Maker that support RWA collateral already have certain lending needs. There are currently five RWA vaults:
(1) Commercial real estate development secured loan (6s Capital)
(2) Financing the purchase or construction of a primary residential asset (New Silver);
(3) ConsolFreight;
(4) Tokenizing and protecting short-term global trade receivables (Harbour Trade Credit);
(5) Yield and lending protocols for tokenized cash flow assets (Fortunafi).
4⃣ What are the roles of the project?
1. Maintainer
Developer: Responsible for the development and daily maintenance of the entire protocol code and is the entity that deploys all smart contracts.
Oracle: A price information input system used to obtain real-time information about the price of collateral assets in the vault. (See the price feed mechanism below for details)
Keepers: refers to market participants who maintain DAI at a target price of $1. They sell DAI when its market price exceeds the target price and buy it when the market price is lower than the target price. The purpose of doing so is to benefit from the long-term market price convergence to the target price. In addition, Keepers will also participate in debt auctions and collateral auctions when the Vault is liquidated, or participate in the surplus auction of the Maker protocol.
2. Governance
Participants are divided into MKR holders and the risk team. The risk team is also elected by MKR holders. Its responsibility is to support MakerDAO governance through financial risk research and drafting proposals on introducing new types of collateral and managing existing collateral. MKR holders decide whether the proposal is passed or not by voting.
3. Users
Vault owners and holders who obtain DAI through other means.
5⃣Liquidation Mechanism
🤖 Understanding Maker’s Liquidation Mechanism with Pawnshop Thinking
You pledge your inherited gold bar to a pawnshop to borrow cash, and it is agreed that if the gold bar is worth 100 yuan, you can borrow up to 60 yuan (mortgage rate 166%). If the gold bar suddenly depreciates to only 50 yuan, the pawnshop owner will immediately auction your gold bar to pay off the debt - this is the "liquidation" in the blockchain world.
👉Liquidation is divided into three steps:
1. Trigger the cordon
Each collateral (such as ETH) has a minimum collateral ratio red line (for example, ETH requires a collateral ratio of no less than 150%)
When the ETH price plummets and your collateral ratio drops to 149%, the system immediately turns red.
2. On-chain clearance sale
The network's liquidation robots (Keepers) are like hungry wolves, competing to trigger the liquidation of your positions
Your collateral (such as ETH) is thrown into the "auction house" and auctioned with DAI bidding
3. Fines + cost recovery
In addition to paying off the debt + interest, you also have to pay a liquidation penalty (e.g. 13% penalty for ETH)
The fine is divided into two parts: 3% is given to the robot as a running fee, and 10% is given to the system as a risk reserve.
🔨 High fines as a deterrent
The high penalty of 13% is like a speeding fine, which makes you afraid to operate within the mortgage rate red line.
Prevent malicious borrowers from "betting that prices won't fall"
🤖 Liquidator Incentive System
Liquidators are essentially arbitrage hunters who use programs to monitor the entire network's mortgage warehouses
They rush to liquidate and earn a 3% penalty + they may get discounted assets (e.g. 1 dollar worth of ETH for 0.97 dollars)
💰 System self-protection
10% of the fine goes into the Maker treasury to deal with future bad debt risks
This is equivalent to letting those being liquidated bear the cost of system defense.
These liquidation ratios are all decided uniformly by the DAO organization.
6. Auction Mechanism
MakerDAO's auction system uses the Dutch Auction, replacing the previous English auction system. The new auction model is called the "Dog version".
What is a Dutch auction?
Dutch auctions, also known as "descending price auctions," are different from traditional English auctions in that the prices of the auctions are gradually reduced from high to low. At the beginning of the auction, the price is very high, and as time goes by, the price continues to decrease. If someone is willing to bid at a certain price, the auction will be completed.
Application in MakerDAO
In MakerDAO, the operation of the auction is automatically controlled by the system. The system first sets a starting price, and then determines the progress of the auction based on the changes in time and price. The auction time window and the speed of price drop are also set. If there is a liquidator willing to participate in the auction within the specified time, the auction will end immediately.
Key Parameters
During this auction process, the system will use the following parameters to control the progress and price changes of the auction:
Price buffer factor: determines the starting price of the auction item.
Price function: Set the rules for price changes, such as how much percentage the price drops every few seconds.
Maximum retracement of auction price: If the price drops by more than a certain amount (for example, the drop reaches a certain percentage), the system will reset the auction price.
Maximum auction period: Set the maximum duration of the auction. If this time is exceeded, the auction will be reset.
For example
Assuming the starting price of ETH is $240, the oracle security module quotes OSM at $200, the auction time window is 21,600 seconds, decreasing by 1% every 460.8 seconds, the initial debt of the system is 60,000 DAI, and the collateral value is 347.32 ETH, the resulting auction time price curve is as shown in the figure below.
The auction will last 21,600 seconds (about 6 hours). Every 460.8 seconds, the price will drop by 1%. If the price drops to $195, liquidator Alice bids 50,000 DAI, she can buy 256.41 ETH. If the price continues to drop until it drops to $110, another liquidator Bob bids 10,000 DAI and can buy 90.91 ETH until all debts are paid off.
If the price drops by 80% (i.e. when the price drops to $50), the auction price will be reset to avoid a situation where the system cannot repay the debt.
7⃣ MakerDAO’s Auction Classification
MakerDAO's auctions include three different types: collateral auctions, surplus auctions, and debt auctions. Among them, collateral auctions are used to liquidate debts and recover collateral through Dutch auctions.
Collateral Auction
MakerDAO's surplus pool stores the stability fees collected through the protocol and the proceeds from auctions (such as liquidation penalties). These funds will first be used to fill MakerDAO's buffer pool. If the buffer is not enough to cover the system's debt, the system will conduct a debt auction, at which time it will raise DAI funds by issuing additional MKR tokens to make up for the losses.
Debt Auction
If there is not enough DAI in the buffer to repay the debt, MakerDAO will raise DAI through a debt auction to replenish funds. Participants can bid for MKR tokens with DAI, and MKR tokens will be destroyed, thereby reducing the total supply.
Surplus Auction
If MakerDAO's buffer reaches a certain standard (for example, 250 million DAI), the excess will be used for surplus auctions. These excess DAI will be auctioned off, and bidders will pay MKR tokens to buy these DAI, and these MKR tokens will be destroyed.
8⃣Dai’s pledged sDAI to earn income
Users can pledge DAI to the DSR (DAI Saving Rate) module to earn interest.
MakerDAO will use the DAI pledged by users to buy stable financial products such as government bonds, but it can make a profit of up to 8.75%. Why is this?
The official has not given an answer, but we can speculate like this:
1. The interest on DAI loans will be paid to MakerDAO, and this part of the income may be allocated to the DSR module
2. In 2022, MakerDAO has already connected to RWA, and this part of the income may be allocated to the DSR module
3. According to the founder Rune, the income is related to the utilization rate of DAI: if the utilization rate exceeds 50%, it will fall back to the normal interest rate of about 5%.
