Dai is currently stable around $1 due to mechanisms described in the white paper, but what gives Dai its $1 value? Assets.

Which are those and how are they managed? Let’s explore.

Dai is backed by a four layer system, with MKR holders incentivised to keep the system in Layer 1.

Layer 1: ERC20 tokens to a value above the value of outstanding Dai (Ether, Gold provided by Digix and fiat)

Layer 2: Guardians (Real world legal entities using fiat reserves to cover any difference in value between outstanding Dai and backing assets)

Layer 3: MKR dilution (new MKR are printed and sold to the market)

Layer 4: Global Settlement (backing assets are sent to Dai holders)

The first layer can handle high volatility in the backing assets, but in the case of a Black Swan that causes a large enough sudden crash in them, their value would go below the value of the outstanding Dai, and this is where the next layer is entered.

The second layer is a middle layer between the entirely decentralised layers, and consists of MKR holder controlled Guardians, legal entities in jurisdictions such as Luxembourg or the Cayman Islands, that hold fiat reserves. These fiat reserves have been seeded by the Dai Foundation after it sold parts of its MKR reserves. The Guardians would use these fiat reserves to bring the value of the backing assets above the value of the outstanding Dai.

In case the Guardians’ reserves are emptied, the third layer inflates the MKR supply to raise funds to cover the difference between the value of the backing assets and the value of the outstanding Dai. This reduces the individual MKR holders value per MKR token but saves the value of Dai.

If MKR supply is inflated to infinity but there still are unbacked Dai, the system will do a Global Settlement, giving the remaining backing assets to Dai holders. This is the system’s off switch.

Note that a Global Settlement only occurs if the MKR holders’ guardian reserves are emptied and their tokens become fully diluted and worthless, something that can be avoided by good governance from these same MKR holders. This incentivises MKR holders to maintain Dai’s value above $1.