Disclaimer: This post is only informative and in no case can be considered as a recommendation to buy or sell any asset. This post contains personal opinions and is not promoted by the MakerDAO Foundation

¿What is MakerDao?

It is a decentralized organization that is organized as a DAO, which is a organization where decisions are taken by its members by voting, for which they have their MKR governance token, that allows the holders of token participate in the votes that decide the next steps to be followed by.

The most prominent project is DAI token, which serves as a stable cryptocurrency, whose function is to have always a value as close as US dollar value.

What is the mechanism to get the price always attached to the dollar?

Although the procedure is complex, the system used is known by everybody, and the one that gives value to all financial assets in the markets, supply-demand law. When many people need to buy a certain asset such a house and there are few in the market, the price of houses rise, on the opposite, when there are more houses to sell than people interested on buying them, the price falls.

Ok, so far so good, but how do we apply this to the price of the DAI currency? Well if we follow the same principle, when there are many currencies in circulation, the price of DAI falls, and vice versa, when the money supply is reduced, the price goes up.

If we make the number of coins in circulation decrease, that will cause the price rising, and vice versa if we generate more coins, they will be worth less.

Therefore, the optimum would be that when the price of DAI begins to fall below the dollar, what should we do? Just eliminate DAIs of circulation, which would contract the offer and increase its value, and to make its value go down.

Controlling the supply of DAIs

Now that we are clear about how supply-demand influences price, the next question is, how do we generate or eliminate DAI from circulation?

Well, like most currencies in the world … with debt, but that’s bad, isn’t it? Is that what central banks do now and everyone criticizes, isn’t it? Yes, but here the debt is different, since there is something that supports it. To give you a loan, you have to put something in return, we call it ‘collateral’, its name among friends 😉

Let’s give an example, now DAI is the currency that pays everything in this world, and I need to buy a laptop to write this article and later you can give me a lot of applause to thank me. If I do not have money, I will ask for a loan (debt) and in return they will give me the money (DAI), this is all very nice, but as the one who gives me the loan does not trust that I will return the money, I have to leave something in exchange (collateral) in this case ETH (the currency of Ethereum on which Maker runs) and I receive the DAI (increase the supply of currency … the price falls)

Generating DAI

With this transaction we have managed to increase the number of DAIs in circulation, so immediately their price drops, if there are many loans, the price would go down too much, so we would have to eliminate DAI from circulation.

Destroying DAI

Now I want to pay back my loan, so I return the DAIs that I borrowed, plus the commission they charge to me for requesting a loan, and when I return it Maker burns these DAIs, they eliminates them from circulation, so there is less and the price goes up

Controlling supply — demand

Once we are clear how to generate more dai or eliminate these from circulation, how do I have people ask for loans or pay them back? Well, like everything in this life, with incentives.

How would it be easier for people to ask for loans? If repayment is easy, so that the interest I will charge you for the loan is low. If I lend you money at 0.1% you are more likely to ask for a loan than if I charge you a 10% commission, right?

Well, this is how the offer is regulated, and with it the price of DAI.

If the price of DAI goes down too much with respect to the dollar, let’s say each DAI is worth 0.9 dollars, I have to get the price up, that is, there is less DAI in circulation, this is achieved if people pay back their loans.

In this way, the interest will increase more and more, until the holders of DAI are encouraged to pay back the loan, since they are getting more expensive, and in the opposite case, it will be cheaper to access the credit and this It will make people incentivized to ask for more, generating more coins.

How has this mechanism worked?

The good thing about decentralized and open systems is that you can check their data, so we can see how the price of DAI has been compared to dollar, in the whole post I am referring to DAI, and now I will show the sai chart, but it is the previous token, which was migrated in November, so to check the history with more time we will consult the previous one, but the current token is DAI.

As we can see the price (green graph) has been quite close to the dollar, with some variance at some extreme point and we see that as of mid-2019 there is more volume of loans (gray graph).

If we compare it with the interest charged (stability fee) for the loans, in the following graph:

We can see that when there were more loans, the interest that had to be charged for them reached 20%, which indicates that it still does not seem like a very efficient market, where supply compensates for demand.

This way you control how many coins are in circulation and the price, to try to adjust it as much as possible to the price of the dollar, in a similar way to the issuance of traditional currencies, but in this case with a backup in another currency that gives value.

In next post, we will see how these loans and collaterals are and how much it is necessary to deposit in order to be able to withdraw DAI.