Slow fall

Let’s take a simple numerical calculation. A user locks up 100 ETH as collateral worth $25,000 (assuming an ETH/USD price of $250). From this 100 ETH the user issues 15,000 DAI in what’s known as a CDP (collateralized debt position). The current collateralization ratio for this CDP is $25,000 / 15,000 DAI = 166.67%, which is dangerously close to the 150% minimum threshold required by the system (a 150% buffer instead of the minimum 100% is a risk parameter subject to change). Now let’s assume the ETH price drops to $200. The new collateralization ratio is 133.33%. It’s important to note that the system is still fully collateralized (and thus, global settlement would still be effective), but it is beneath the specified threshold. The Maker system can now seize the 100 ETH of collateral (which is still worth $20,000 at this time), and auction it off to the market in exchange for DAI. 15,000 DAI needs to be soaked up from the public supply to recapitalize the system (with the balance of the collateral going to the original owner). Once this DAI is raised, it is burned, after which the system is now collateralized above the 150% threshold again.