PYMNTS DeFi Series: What Is Algorithmic Stablecoin?

Welcome to the PYMNTS series on Decentralized Finance (DeFi).

In these articles, we’ll take a look at all the parts of DeFi that are the biggest, hottest, most rewarding, and most risky parts of the blockchain revolution. Finally, you’ll know what DeFi is, how it works, and the risks and rewards of investing in it.

See Part 1. What is DeFi?

See Part 2. What are the top DeFi platforms?

See Part 3. What is a smart contract?

See Part 4. What is Yield Agriculture and Liquidity Mining?

See Part 5. What is staking?

See Part 6. What are the top 10 uses of DeFi?

See Part 7. Unpacking DeFi and DAO

See Part 8. Very realistic risk of DeFi

See Part 9. What is the Top DeFi Blockchain?

See Part 10. What is true, what is hype, what is important

See Part 11. How to Buy NFT in 19 Easy Steps

So what is an algorithm stablecoin?

So what is stablecoin? It’s a very simple concept to understand. Take the money, put it in your bank account and create a cryptocurrency token. Offer to redeem that token for $ 1 at any time. You now have a $ 1 to $ 1 peg. The token is more or less worth less than its $ 1 so its price is stable.

Stablecoin retains its value as long as the cryptocurrency buyer is happy that the dollar actually exists and can be redeemed. Its dynamics are at the heart of US and other government issues regarding Stablecoin. If that trust is lost, a run will occur, but it will be faster, just like a run.

Very simple.

Now let’s talk about algorithmic stablecoin. This stablecoin maintains a $ 1 to $ 1 peg even if fiat cash is not supported.

It’s not just MakerDAO’s DAI stablecoin. Four of the ten largest stablecoins have a market capitalization of $ 26.6 billion and are algorithms. However, the DAI launched in 2015 was the first to occur. And it became a complete DAO, disbanding the Maker Foundation, which was the central training wheel of the DeFi project.

So how does MakerDAO do that? Pure capitalism. Algorithmically stablecoins use artificially controlled supply and demand to maintain prices. You need a partner to do this.

MakerDAO, a decentralized autonomous organization that manages projects, uses two tokens, DAI and MKR, and DeFi’s lending / borrowing platform.

Chicken or the egg first?

Depending on your point of view, MakerDAO is either a DeFi borrowing platform that uses algorithmic stablecoins or stablecoins backed by funds locked to the DeFi borrowing platform. Next is the second token, MKR. It acts as a governance token for the entire shooting match and backstops Dai’s Dolpegg.

Let’s start with the borrowing platform. With MakerDAO, crypto owners can borrow against Ethereum (ETH), Compound (COMP), and even cryptocurrencies such as Stablecoin Tether (USDT), US Dollar Coin (USDC), and Pax Dollar (PAX). I can.

The important thing is to unleash the value of crypto without actually selling it, as we believe that the price of crypto will rise in the long run. The amount of collateral is as much as 175% of the amount that can be borrowed, and that percentage depends on the volatility of the cryptocurrency used as collateral.

In exchange, Dolpegg’s Dice Table Coin (Exchange DAI) will be lent. It can be used for everything from investing in DeFi projects such as yield farming and liquidity mining to trading other cryptocurrencies. Exchange one token for another-or as a currency that can be used in crypto-lined Visa and Mastercard debit cards, or other crypto projects such as NFT-based Axie Infinity games.

reference: PYMNTS DeFi Series: What is Yield Agriculture and Liquidity Mining?

The risk is that if the value of the collateral becomes too low (easy enough in an unstable crypto market), MakerDAO’s smart contract controlled borrowing platform will clear the collateral and sell it at the bottom of the market to ensure repayment of the loan. Is to be able to do it.

Therefore, it is very similar to other DeFi lending platforms.

Tightrope walking

Dice Table Coin is where MakerDAO can be creative. For one thing, there is no die setting. Rather than being backed by fiat cash like Tops Table Coin USDT and USDC, Dai is backed by its cryptocurrency collateral. Locking the crypto collateral to MakerDAO will create a new dice table coin. When you repay a loan-and a fee-they are burned.

So how can you stabilize the price of the die? That’s where MKR, the platform’s second token, comes in.

First, MKR is a governance token that allows you to vote on how to run the MakerDAO platform. For example, setting interest rates and borrowing transaction fees, the latter can only be paid with MKR.

But it has a different role. MKR is used to stabilize Dai’s price. If Dai starts to fall below the $ 1 peg, an MKR will be created and sold to increase the value of Dai. If the die starts to heat above $ 1, the MKR will be bought back in the market, burned and knocked down.

why? Supply and demand. If the price of a die starts to fall below $ 1, the arbitrage trader borrows the die for $ 1 and then buys the die in the market for, for example, $ 0.99 and repays the die-denominated debt for less than the borrowed amount. To do. This has the effect of reducing the die supply. Go on the market and therefore raise its price.

Similarly, when Dai’s price exceeds $ 1, these traders deposit collateral, borrow Dai at the standard $ 1 price and make a profit on the open market (probably enough to cover fees). Sell ​​at, increase supply and lower prices.

If it sounds like it puts a lot of emphasis on supply and demand, then there is a backstop. If the price of the die goes up too much, the MKR tokens will be mint and sold for the die, increasing the supply. If the die falls too much, the MKR will be purchased and burned for the die, reducing the die supply.