Maker: The Central Bank of Decentralized Finance — A Breakdown
MakerDAO is an open-source project on the Ethereum blockchain and a Decentralized Autonomous Organization created in 2014. The project is managed by people around the world who hold its governance token, MKR. Through a system of scientific governance involving Executive Voting and Governance Polling, MKR holders manage the Maker Protocol and the financial risks of Dai to ensure its stability, transparency, and efficiency. MKR voting weight is proportional to the amount of MKR a voter stakes in the voting contract, DSChief. In other words, the more MKR tokens locked in the contract, the greater the voter’s decision-making power.
The claim that Maker is the central bank of DeFi is not a new one. Maker, akin to central banks, is responsible for the issuance of currency, setting reserve requirements, adjusting interest rates, and ultimately acting as the lender of last resort. Maker improves upon the central bank model by decentralizing control from the few to the many, evolving the gold standard into the 21st century, and eliminating nearly all of the capital overhead required to run a traditional bank. The goal of this post is to communicate what makes Maker one of the most misunderstood, undervalued and foundational pillars of the entire DeFi ecosystem.
Let’s start by looking at some of the key definitions:
DAI
A stable, decentralized currency that does not discriminate. Dai is the primary product of the Maker ecosystem. Dai has the potential to become a true global reserve currency — that which is natively integrated into the decentralized finance ecosystem, able to provide all of the benefits of a cryptocurrency such as Bitcoin, and all while remaining perfectly price stable.
MKR
The Maker governance token. Each token represents a vote, ownership comes with various financial benefits and responsibilities. Maker token holders are the leaders of the Maker ecosystem.
Collateral
Specific property, control of which is relinquished by the owner to incentivize repayment of debts incurred. In the case of most stablecoins, collateral is denominated in USD and held in custody by a centralized entity. In the case of Dai, collateral can be any of a variety of approved cryptocurrencies held in secured smart contracts controlled by no one.
Vault
A smart contract that holds a user’s collateral. With enough collateral locked in a vault, the user is free to generate Dai. The Dai debt + any accumulated interest must then be repaid in order to enable withdrawal of the collateral.
Token Burn
“Burnt tokens” have effectively been destroyed, ultimately reducing the total supply of tokens in circulation. Interest accumulated on Maker vaults is paid back in Dai, this Dai is then automatically swapped for MKR and burned. This is the primary economic driver behind the price of MKR tokens. Burning MKR reduces the supply of tokens, putting constant upwards pressure on the price. The more Dai in circulation, the more interest is generated, the stronger the upwards pressure on MKR’s price.
Collateralization Ratio
The amount of collateral required to generate a specific amount of Dai. For example, the primary Ethereum vault has a collateralization ratio of 150%, so you’d need to deposit $150 worth of Ethereum to generate $100 of Dai.
Liquidation
The collateral in a vault is auctioned off for Dai if it falls below the collateralization ratio. This is called liquidation and helps ensure there is always enough collateral held in the system to cover the number of Dai in circulation.
Peg
The target value of Dai. Dai is “pegged” to the value of the US Dollar. In the case of Maker, this peg is arbitrary — the value of Dai can theoretically be pegged to anything.
Gold Standard
The old standard of paper money that required all bank notes to be backed by a set amount of gold. This attached tangible value to the notes, disallowing banks from endlessly printing money and providing a self-regulating and stabilizing effect on the economy. The Great Depression was the beginning of the end for the gold standard, which was officially abandoned in 1976.
Central Bank Digital Currencies (CBDCs)
Another stablecoin type that is issued by traditional central banks. These coins are coming, but will come with significant limitations. Firstly, they will fragment liquidity between many different currencies, they will also be centralized in control, infinitely inflatable, and not natively integrated into the existing DeFi ecosystem. They will cost billions of dollars to develop and will never be able to keep up with the world-wide grass-roots innovation happening in open-source cryptocurrencies.
Core Unit
A decentralized team of engineers and developers dedicated to maintaining a specific segment of the Maker protocol’s codebase. These teams are paid using income generated by the protocol, and their leadership is moderated by the MakerDAO government.
The Maker Ecosystem
When I say “Maker”, I am referring to the greater Maker ecosystem. It is important to understand the primary components of the Maker ecosystem:
The Maker Protocol
The Maker protocol is made up of the technical parts of the ecosystem — Dai, the MKR governance token, the smart contracts and the apps. This is the meat and potatoes of the ecosystem, so much so that this is what many people are referring to when they say “Maker”.
The Maker Protocol is one of the largest dapps on the Ethereum blockchain. Designed by a disparate group of contributors, including developers within the Maker Foundation, its outside partners, and other persons and entities, it is the first decentralized finance (DeFi) application to see significant adoption.
MakerDAO
MakerDAO is a Decentralized Autonomous Organization (DAO) responsible for governing over the Maker Protocol. Every Maker token holder gets a vote in how the protocol is run. Votes are primarily used to adjust variables in the protocol such as setting interest rates, collateralization ratios, and debt ceilings, as well as onboarding new collateral types and implementing new features. There is an approximate average of 5 executive votes per month. The high frequency of votes is enabled by the digital, decentralized qualities of the governance and allows for quick reactions to unforseen circumstances and improved organizational agility.
The Maker Foundation
The Maker Protocol and MakerDAO were created by the Maker Foundation, a non-profit dedicated to bootstrapping MakerDAO to fuel growth and drive the organization toward complete decentralization. Now that their goals are complete, the Maker Foundation has been completely dissolved — putting complete control of governance over the protocol into the hands of MakerDAO, who have also assumed control of the Maker Foundation treasury (84,000 MKR).
Summary
So what does it all mean? Why is Maker so exciting? How does it all come together?
Maker improves upon the existing central bank model by decentralizing control and improving efficiency. It also upgrades the gold standard to levels never before possible by enabling a huge variety of collateral types such as staked digital assets and other derivatives, as well as government backed digital currencies (USDC, and lots of CBDCs to come as they become available) and, most excitingly, real world assets (tokenized real estate, energy, gold, data storage and more).
This has been a fairly chaotic and imcomplete breakdown of what the Maker ecosystem is. Hopefully we didn’t get too lost in the weeds. I hope you learned something — More to come :)
