Why DAI is More Than Just a Stable Coin
The cryptocurrency market has both fascinated and terrified the masses as of late. The constant ups and downs are enough to make any investor lose their lunch, but the potential of a completely free monetary system is still tantalizing.
Cryptocurrency has passed the first hump, but it’s clear that something is still needed for it to survive. That thing is a stable currency that can hold its value. Something that puts crypto on par with fiat for our every day uses, but how can it be done?
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DAI the Decentralized Stable Coin
DAI is a decentralized stable coin. Anyone can create it as long as they have Ethereum, and it’s not controlled by any one entity or subject to the whims or regulatory requirements of fiat currencies, like other stable coins such as Tether. It requires no outside accounting to prove its backing, and all transactions and information are stored transparently on the blockchain.
It also does not require outside management. Thanks to smart contracts, everything is kept in check by the system itself. This includes the selling of the collateralized assets in order to maintain the peg. DAI has what is known as a “soft peg” to the US dollar. Unlike other stable coins, it is not backed by US dollars which are held in reserve. Instead, it holds Ethereum in reserve and each DAI is worth the equivalent of one US dollar in Ethereum.
The DAI token is created when a cryptocurrency holder locks up a certain amount of Ethereum inside a smart contract. They can then borrow against that equity to take out a loan for themselves, which is paid out in DAI’s stable token. This money can then be used for whatever purpose the loan taker desires, and they can be certain that its value will not fluctuate.
Can a cryptocurrency backed stable coin really work?
Many investors are uncertain about how a decentralized stable coin will fare in catastrophic events. This is a fair concern. Cryptocurrencies are not exactly known for their reliability, and if you put your life savings into Ethereum during the Cryptocurrency heyday, then you’re probably eating a lot of beans and rice right now. However, no monetary system is without its flaws and no currency, even those issued by governments, are completely safe from an economic catastrophe.
We’ve already seen some pretty hard times for cryptocurrencies as of late and DAI has managed to hold its own. The system has worked as intended thus far. Much like trading on margin, DAI has a liquidity threshold for locked equity. The user must make sure that their collateral level does not fall below this threshold or assets will be liquidated to maintain balance in the system.
Most investors don’t want to lose their Ethereum, as that would mean selling at a loss. They will either add more collateral in the form of Ethereum to balance the system or they can also pay back some of their DAI to keep this from happening. While in most cases this will be incentive enough to keep things running smoothly, there is also a system in place that will sell the project’s other token, MKR, to cover the loss if a point is ever reached where the Ethereum collateral held is not enough to cover lost equity.
What use case is there for DAI?
There’s actually a good number of potential use cases for DAI. It’s an exciting currency, and it’s likely that it will be what finally paves the way for massive retail adoption of cryptocurrencies. Here are a few ways that DAI could be useful for traders, investors, businesses and even everyday users.
Retail purchases and services
Despite being around for near a decade, Bitcoin has yet to really break into mainstream retail purchases the way people thought it would. It does have some very large supporters, like Overstock.com, but adoption is still lacking. The vendors who do accept it tend to use a third-party payment processor, like Bitpay, that automatically converts it to US dollars anyway.
This is because most retailers have razor-thin profit margins, and even small price swings could cause them to be in the red. If DAI is truly successful as a stable currency, it could inspire further adoption from merchants, and they could accept a decentralized currency confident that they would not be at a loss for those sales at the end of the business day.
There’s also the fact that DAI is an ERC20 token. This means that when Ethereum finally does move to its new Proof Of Stake system, DAI transactions will be infinitely cheaper, faster and more efficient than using a legacy currency like Bitcoin. This will relieve one of the largest pain points of doing business with cryptocurrencies, and it will also remove the many ecological concerns which surround mining, as Proof Of Stake (POS) is much more energy efficient than Proof of Work (POW).
Loans are not taxable events. Investors who lock up their Ethereum into a CDP, otherwise known as a Collateralized Debt Position, are not selling their Ethereum. They are simply taking a loan against it and using it as collateral. This means that investors have access to fast cash to use for purchases, more investments or anything else they may need without needing to pay any taxes like they would with cashing out.
This gives cryptocurrency investors the ability to use their money tax-deferred. The most obvious reason to do this is of course so that you can wait until your investment has passed the twelve-month threshold to be eligible for long-term capital gains rates before selling it. This offers significant savings over short terms capital gains rates come tax time. You could also use it as a means to push those gains into another tax year if you need some cash but you don’t want to be jumped into another tax bracket.
This could be very useful if you’ve made a significant amount of money this year, but you expect to earn less next year. Then again, in this scenario, an investor would never really have to sell at all. As long as they can continue to pay back the loan, they could just keep taking out additional loans without ever selling any of their Ethereum.
Protecting Your Upside Potential
Let’s say that you wanted to spend some of your Ethereum on something, but you were afraid that the value would keep going up. You don’t want to spend any of your Ethereum just in case that happens, but you still need access to some fast cash. You could instead take out a CDP, and then use a portion of your equity to purchase whatever you wanted with your DAI loan. If you’re right and the value of Ethereum continues to rise, then you get to keep that upside.
Your Ethereum didn’t go anywhere, but you still got to spend your cryptocurrency. You can now pay back the loan, sell your Ethereum for a larger profit if you want or continue to hold it and just take out another loan. This is not limited to products either; you’re free to do whatever you want with your DAI loan, which includes using it for another investment, which could make enough money to pay off the loan and earn a profit for yourself to grow your stack of Ethereum, further strengthening your equity position.
The future for DAI and MKR looks bright, and they have a lot more to offer cryptocurrency enthusiasts in the coming months. This includes their multi-collateral update which will allow a far greater number of Ethereum based assets to be used as collateral, including the Digix token, which is backed by a physical gram of gold. Investors should keep their eye on DAI and the Maker team because DAI is more than just a stable coin. It’s a solution to some of the biggest problems that have plagued cryptocurrencies since their inception.