The MakerDAO stablecoin, DAI, is pegged to the $1 US Dollar, not by holding US dollar reserves in a bank account equivalent to the amount of tokens in the system like the stablecoin Tether, but, rather, by holding in a smart contract collateralized assets, such as Ethereum, another cryptocurrency, and, in the future perhaps, tokenized real world assets. Holders can earn on the DAI they own. A decentralized and publicly controlled governance system manages the DAI interest rate –– that is, the cost of generating DAI––and the return on DAI.
“You can directly impact the supply and demand,” said Christensen. “For instance, if the price of DAI is below $1, then [we] need to contract the supply, we need to make DAI more scarce, and we need to make it more appealing for people to hold DAI. So, the governance process then comes to consensus around [making] it more appealing to hold DAI. That means the DAI savings rate needs to go up, and we need to make it less appealing to generate DAI, because we want to contract supply.”
In order to support the DAI price, the system also needs to increase its stability fee, which is the cost of borrowing DAI with collateral or generating DAI through the protocol. “This way it’s kind of a balancing act, where these rates keep changing as long as DAI is not trading close to $1 and then, as they change, they push it in the direction of $1.” This is how DAI has managed to stay stable and pegged to the US dollar for more than two years.
The science behind MakerDAO is based on basic microeconomics and applied in a novel way with blockchain.“What I found when I designed the MakerDAO protocol is that, on the one hand we need to draw on these basic concepts in microeconomics like supply and demand, and the fact that if you increase demand for a stablecoin, that should drive the price up. You want to increase demand for the stablecoin when the price is below $1. Similarly, if you decrease supply by making it more difficult to generate the coin or make it more expensive to borrow, that will push the price up. You can also do the opposite: if the price of the stablecoin is too high, you can actually decrease demand or you can increase supply.” Christensen argues there’s also some parallels with biochemistry.
“You can really compare it to homeostasis,” he says. “If the stablecoin deviates away from $1, there needs to be a response that then brings it back in line and then cuts off the response, so it goes back to $1 and then there’s no more change in the rates and the system.”
While many think the Maker protocol is complicated, and that there are many moving parts, Christensen argues it is an elegant mechanism that has been simplified as much as possible. “The basic mechanics of how it’s controlled and the incentives of the people running the governance, the MKR token holders, all comes together to create a system that is able to, on the one hand, be fully decentralized and fully transparent without a central authority having some sort of special access to the system, and, at the same time, provide the stability that people are used to from the regular banking system and the regular financial system.” MKR represents the utility token, governance token and recapitalization resource of the Maker system.
Heretofore, Maker users have conducted on the platform risky operations around leverage. “We’re now seeing this even greater group of people come into the system and start using the protocol, not for this very advanced use case of accessing leverage, but, rather, just as a stability hedge, if they think that their own currency has too much inflation or maybe because they [want] the low risk, but still decent yield, that the DAI savings rate and DeFi offers. This can be a very appealing financial product to have access to in addition to what they have access to locally.”
The Maker protocol is designed to ultimately be completely controlled by a decentralized governance process, by the MKR holders, and separate from the MakerDAO foundation and the original development team. “One of the things that’s really important is the decentralized governance of the protocol,” said Christensen. “That the community’s able to run it completely on its own, and that the community also has the ability to grow the system as they want to grow it.” That includes adding new stablecoins beyond the US Dollar.
“I would expect that the first one will be the euro,” said Christensen. Next comes other major world currencies, such as the Renminbi and other major Asian currencies. The goal in the long run is for every single currency to be in stablecoin format in the Maker protocol, and potentially assets beyond stablecoins, too, such as synthetic assets including stocks or commodities.
“We want to make all of these things available to everyone, instead of just [to the] very few people, relatively speaking, that today have access to the global financial system, while billions of others are left completely on the fringes,” he said.
In order to make DeFi available to everyone, Maker has long planned multi-collateral DAI, which Christensen calls the full realization of the Maker protocol. The company has been working on it for the past five years.
“Single collateral DAI [was] really more of an initial version that we decided to create so that we could start testing out what a decentralized stablecoin would look like in practice,” said Christensen. “And we could allow the ecosystem around the stablecoin to begin forming. But, now, with the launch of Multi-Collateral DAI, we actually have the full system live. That means we can start accessing the full range of features that decentralized finance makes possible. That includes [using] multiple collateral types.”
Multi-collateral DAI, according to Christensen, is Maker’s main feature, but he also points to other features as important, including the DAI savings rate. “This is the first time there is a low risk savings return available in crypto on a USD denominated stable coin,” he says. “And, in many ways, the DAI savings rate is actually what’s more exciting in the short run, because the multi-collateral feature, while it is the most important, will take a couple of months, and even years, to fully roll out and see its potential.”
Once multi-collateral DAI becomes reality, and the community and ecosystem around the protocol has grown, Maker will be ready to take the next step. “What’s going to start happening is a lot more new assets are going to be onboarded and that will include all the different Ethereum-based tokens and cross-chain assets like Bitcoin,” said Christensen. “What’s most exciting is that it will also start to include Ethereum-based tokenized real world assets that will be brought onto the Ethereum blockchain, and then used as collateral in the Maker protocol.”
It will be possible to use things like gold and real estate, as well, says Christensen. “Tokenized gold in, let’s say, a vault in Singapore, for instance, or real estate in America, where the deed is tokenized, and that token is then used as collateral, in order to get a low rate loan from a decentralized protocol, or even do things like trade finance. Small businesses [can access] the blockchain, in order to get a direct line of credit that’s based on their invoices, which are then tokenized.”
The Maker foundation is focusing on researching, experimenting with, and testing new uses of the system. “It is running trials and practice around how you deal with things like compliance and regulation around this stuff, and reconcile that we are trying to bring real world regulated assets into an, ultimately, authority-less, decentralized protocol, and how [to] reconcile those two things,” said Christensen. “It is possible. We’ve done a lot of very successful trials with different companies from all around the world that have been tokenizing various assets and then done test runs, essentially, where we simulated what it would look like to use those assets as collateral on Maker, and then calculated how much money they would save in terms of the interest rates they have to pay the banks.”
Financial assets and the financial markets will likely get tokenized over time, because of the inherent efficiency of the blockchain, Christensen believes. “That’s just the beginning, and when you go beyond that, there’s going to be a new wave of innovation that’s difficult to even predict, but that certainly is going to turn the financial system on its head and inject this value and the advantages of blockchain technology.”
Ultimately, Christensen doesn’t think that DeFI will replace the current financial system. To some extent, the financial system –– the banks, the institutions, and the governments–– will commercially adopt DeFI and embrace it, using it to improve their own efficiency, transparency, and compliance. Either way, there’s going to be a lot of disruption and creative destruction.
“It’s really going to be all based around this dynamic of, at some point, the existing system will realize that whoever moves first, and whoever actually learns how to harness this technology, and how to use it to provide better services, will get a massive advantage in the market,” he says. Tether is used today for facilitating crypto liquidity and crypto speculation, for instance. Import, export businesses are using it, too, bolstering a grassroots adoption of crypto across the world that’s not just for speculation. Yet, the DAI stable coin and the Maker protocol provide something unique, insofar as there’s no way to get a return on your Tether.
“It’s already very popular for people around the world to purchase DAI and then lend it out to other people, around the world through these decentralized finance dApps, [which] have become very developed recently,” he told me.
Christensen sees the centralized products and decentralized products as complementary. Though, over the past year, Maker, and the broader movement of decentralized finance, have captured hearts and minds. Now, DeFi combines the stability of traditional financial system and the self-sovereignty, security, and transparency of blockchain, while supporting financial globalization.
“The blockchain allows for things like leapfrogging [technological stages] in the areas where the financial systems aren’t so developed,” said Christensen. “Things like connecting the unbanked with the global capital markets, and all of these things, is just going to unlock so much and such tremendous wealth that I don’t think that the incumbent financial players, or at least not all of them, will miss this opportunity. A lot of them will jump on the bandwagon, and to some extent actually be the ones moving it forward.”
What’s Next For MakerDAO?
MakerDAO tweeted in December that the Maker Foundation had sold $27.5 million worth of MKR, its native utility token, governance token and recapitalization resource of the Maker system, to VC funds Dragonfly Capital Partners and Paradigm, with an eye towards bringing Maker to Asia.
“This is really the right time to start focusing on this region, and then really try to accelerate the growth and interest that’s already happening,” he said. “Once they are interested in something, they get really interested, and they really get behind the technology. But, they typically want to see that validation happen from the Western markets first.”
Having signed up new partners illuminates Maker’s path into China. “It can be very difficult if you’re just coming from the outside, and don’t really understand what it means when the regulatory is constantly changing,” said Christensen. “We are very well equipped to navigate [the regulation], but, ultimately, it is just a part of accessing the incredibly huge market that China is.”
Christensen has conducted prior business in China, in an industry other than blockchain. “One of the main things I learned from my time in China is that it can be very, very difficult to enter China and do sustainable business there as an outsider,” he said. “You really do need those insider connections, you really do need that local understanding and that inside view and also the recognition, and familiarity, because, in fact, that is really how markets work, and, especially, emerging markets. But, China is very unique in the sense that it makes such a massive difference.”