MakerDAO is a “DAO” or a decentralized autonomous organization, which means all the members of the organization vote all all decisions about the rules for the organization. You become a member by owning the platform token, called Maker coin (MKR). Therefore it is called a governance coin. The other token associated with the MakerDao is DAI, which is a “stable coin” which means it is Pegged to the US Dollar, or always worth about a dollar. The project was started in 2015 and did not conduct an ICO, instead choosing to privately sell MKR tokens to fund development over time. Maker’s DAI stable coin launched at the start of 2018
MakerDAO is basically a credit facility that issues loans with a certain interest rate called the stability fee against a collateral called Ethereum. The loans are paid to borrowers in Dai. The MakerDao issues new Dai to find each loan. It is like a country printing currency to pay its debts. Each Dai is worth one dollar USD. The MakerDao is like a bank and charges interest in loans, but calls interest a stability fee. It is called a stability fee because it is increased or decreased to influence demand for the Dai token and thus its price, in order to keep its price at one dollar.
The holders of the MakerDAO Token Maker (MKR) influence certain aspects of the rules controlling the MakerDao. Such as: What should the be the annual borrowing fee be (stability fee)?, How much collateral should be backing each CDP? (collateralization ratio) and Shutting down the protocol in the case of a sudden drop in the price of Ether or another situation (emergency shutdown)?
The MakerDao provides loans in Dai, against assets, mainly Ethereum and in some instances Bitcoin held by Bitgo.
Bank , a business that makes money providing credit.
Credit, means credit cards and loans like those used to buy cars and homes.
Interest, the fee or money you pay the bank for borrowing money in the form of credit cards or loans.
Stability fee is the same as interest.
Default, you are in default if you don’t pay your credit card bill or loan payments for two or more months. Aldo if the value of your asset falls below a predetermined value.
Default fee: extra money you pay the bank on top of your loan balance if you default.
Liquidate: if you default on your loan used to buy your car or home the bank takes your car or house and sells it to pay off your loan.
Liquidation fee is the same as a default fee.
Debt: money you owe the bank for credit card balances or loans.
Credit Facility is another name for a bank on a blockchain like the MakerDao or DJED.
Collateralized Debt product is another name for a loan granted you in exchange for the title or ownership papers of your collateral.
Collateral, an asset like a car, home or cryptocurrency, whose ownership papers are held by a bank or credit facility when you borrow money and use the asset as security for the loan.
Agree with liquidation. If you offer an asset as security for a loan, you agree the bank or credit facility can sell your asset if you default on your loan or the value of your collateral falls below a certain dollar value.
Ownership papers: For a car it’s the title and for cryptocurrency it’s your keys.
Loans are a Debt
Loans are a Product created by a bank or a credit debt facilities.
Loans are secured or Collateralized.
In the Decentralized Finance World, Loans are called “Collateralized Loan Products“ and also called
“Collateralized Debt Products”.
Collateralized Debt Products are also called by their abbreviation “CDPs”.
Loan to Value Ratio
Traditionally, a bank doesn’t loan you 100% of the value of an asset. It loans you a percentage. If the bank loans you 50% of the assets value, the loan to value ratio is 50%.
Credit Debt Facilities don’t use a loan to value ratio, they use something called a Collateralization Ratio. It is the inverse or opposite of a loan to value ratio.
In a loan to value ratio you create a fraction with the loan value on top (numerator) and asset value on the bottom. (denominator).
In a Collateralization ratio the value of the asset is on top, and the loan is on the bottom. If the asset is worth two dollars and the loan one dollar the collateralization ratio is 2:1 or 200%.
If you don’t pay your loan, the bank sells your asset, the car or your home you pledged as security or collateral and sells it to get back the money it loaned you. This process is called repossession in America in the case of a car or foreclosure in America the case of your home. In the world of decentralized finance the bank or “credit debt facility” will also liquidate your assets if your collateralization ratio drops below a pre-agreed upon number.
Vault: the name for your account at a “credit debt facility” or Bank on the blockchain.
If you default on your collateralized debt product, the credit debt facility will sell your asset. To lessen the downward selling pressure on the value of the asset, the asset is not sold on an exchange. Instead it’s sold in an auction where people make bids and the highest bid wins.
Over capitalization of CDP: the value of your asset in the vault collateralizing your loan or CDP is above the collateralization ratio number which triggers liquidation of your assets. This is a good.
Under capitalization of CDP, this is the opposite of over capitalization, as the value of your asset means your collateralization ratio is “at or below” the number which triggers liquidation of your assets. This is bad.
Decentralized finance profit motive for CDP or collateralized debt products.
Investors take out loans on cryptocurrency they are holding long term so they can earn money from the appreciation of the cryptocurrency asset and use the loan funds to invest in another asset that generates an additional return on capitol. This means multiple streams of income from the original capitol investment and an increased return on investment.
Tokenization: the representation of a physical asset Ads digital token.
As an investor your rate of return on Ethereum is variable, for example if the price for Ethereum increased 5% in one month your ROI was 5%. If you owned $100 worth of Ethereum your 5% ROI was worth $5 USD. But what if you owned 10 times as much Ethereum? $1000 worth of Ethereum at a 5% ROI would mean $50 USD. If you had 100 times as much Ethereum your 5% ROI would be worth $500 USD. So to make more money, you need to buy more Ethereum. But with collateralization you can buy more Ethereum without having more money.
You buy and hodle one Ethereum worth $150 USD. In one month if your ROI was 5%.
150/100 =1.5 x5 = $7.5 USD
But if You deposit your $150 worth of Ethereum in the MakerDao, you can borrow 75 Dai, using your $150 worth of Ethereum as collateral. You then exchange 75 Dai for $75 USD on the exchange and buy $75 dollars worth of additional Ethereum. Now you own $225 dollars worth of Ethereum. So if in one month you get a 5% ROI on $225 USD or 225/100=2.25x5=11.25$.
So by using the MakerDao you were able to increase the amount of Ethereum your hodling from $150 to $225, a 50% increase, but without investing any additional capitol. While you pay 3.5% interest on the additional $75 worth of Ethereum you still get 1.5% ROI without increasing your capitol invested.
Are losses possible?
Certainly. But they are very similar to your possible losses HODLing Ethereum.
You buy and hodle $150 worth of Ethereum. In one month it drops 50%. Now the value of your $150 has fallen to $75. You lost 50%. If you sell now, you get $75.00.
If you take the same $150 USD investment, deposit it in the MakerDao and borrow 75$ ( 75 Dai, exchange for $75 dollars, but $75 dollars worth of Ethereum and now hodle 225$ worth of Ethereum for one month. If Ethereum falls in value 50%, your Ethereum collateral deposited in the MakerDao will be liquidated or sold for 75 dollars to pay back your loan. You are left with the $75.00 worth of Ethereum you bought using the loan. Basically the same position you would have been in, if you had just hodled your original $150 worth of Ethereum.
So technically there are losses, but in reality your ROI is zero in both scenarios.
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