Article Summary :- In this & the subsequent article, we will try to understand the novel lending platform called Maker & how the various processes that make it feasible.
Importance of Lending
Lending is the lifeblood of any economy. Unlocking capital can trigger sustainable growth levers that can supercharge entrepreneurial spirits in individuals & lead to innovation & value creation. However, this engine is currently clogged-up. Lending through traditional middlemen such as Banks have major challenges :-
Banks are still heavily reliant on brick & mortar branch based approach to lending. All the additional staff & salary cost leads to higher rate of interests.
Banks are heavily regulated & risk-averse. All the regulatory compliance cost gets added to the rate of interest charged to the end consumer.
Even to avail basic banking services, you must complete all KYC related norms.
Then to avail lending, you first must furnish countless documents that indicate your ability to pay. Somewhere the lengthy average time taken to avail a loan itself causes significant opportunity costs for entrepreneurs.
At times, you can be denied access to capital due to opaque reasons & the whole application process can be frustratingly difficult.
Though Banks & FinTechs have embraced technology & things have improved , the fundamental problems still remain.
Interest rate on savings have declined considerably over the years & inflation has been persistently high. Keeping funds in banks is akin to practically losing money each year.
In this article, we will try to explore how a decentralised lending platform such as Maker works & how it can be a massively improved way of accessing capital urgently for your needs. We will also cover the potential risks involved.
Why Maker Protocol ?
Maker was launched in 2017 & is built on top of Ethereum. Maker protocol allows users to submit “collateral crypto” assets they own & generate DAI against it. In summary, while interacting with the protocol, you as a borrower simply interact with code & no intermediary has access to your assets. In addition, you only require a crypto wallet with your assets in it. No KYC & no other lengthy processes.
Before Maker, all major cryptocurrencies such as Bitcoin as a concept of Decentralised & permissionless digital native currency had succeeded. However due to its volatile nature, it could not be used as a “Medium of Exchange” to conduct day to day transactions.
Maker with its stable “Dai” aims to solve this problem.
Though “Stablecoins” are also stable & used widely, it is not decentralised & hence might require extensive auditing of the ”centralised platform” issuing it to enforce trust.There have been quite a few controversies around stablecoins - although the use has surged dramatically.
Dai is soft pegged to the US dollar & hence is not as volatile as other traditional crypto assets. Dai is decentralised & collateral backed. Since DAI is not volatile, users can use it as medium of exchange. In addition, if an individual is not willing to sell his crypto assets, he/she can use the existing assets as collateral & generate Dai against it for use.
What crypto assets can be collateralised is managed by “Maker Governance”. Maker governance is a community which manages various aspects of Maker Protocol.Maker governance is made up of people holding “Maker” Coins. Hence, you can also buy few Maker coins from an exchange & become part of the protocol governance.
Maker is built on the Ethereum blockchain & each & every Dai transaction is visible to anyone.
MAKER Vault
It is quite simple to think of an analogy of how Maker works.
Imagine Surya, who visits a Bank with a bag of gold coins. Surya wishes to produce the gold coins as asset collateral & withdraw US dollars as capital against it.The Banker values the gold coins & determines how much US dollars it can issue to Surya as per eligibility. The Banker then opens a unique & secure vault for Surya & issues US dollars to him.
Remove the physical travel to Bank part & the need to interact with any banker.Maker enables you do avail capital securely & without any need of intermediary.
Maker Vault is essentially non-custodial smart contract i.e. simply computer code - user is in full control of its funds & any third party does not have access to the assets deposited. however, depositing assets as collateral & generating DAI creates an obligation to repay the Dai.
In order to generate DAI, you first need to open & deposit your crypto assets within Maker Vault. Whenever a new Crypto asset vault is opened & assets are deposited , new DAI is created & entered into circulation. Others can obtain Dai through exchanges or brokers or receiving a payment method.
The vault can be created & used through various interfaces such as the Oasis Portal, InstaDapp, Zerion, MyEtherWallet ( we will run through the process below in “How it works” section). Since Maker is a protocol, all these various interfaces are implementation of the same.
Collateral Assets
In the above story, Surya uses gold coins as collateral. However, gold is bulky, difficult to transport safely & requires expertise if you wish to get its real value & check authenticity. Crypto assets in comparison are trivial to carry & transact with.In addition, with the use of Oracles, they can be valued immediately in real time.
Maker protocol with its governance mechanism decides which crypto assets can be used as collateral. Any Ethereum based asset can be accepted as Collateral on Maker. While accepting an asset as collateral, Maker decentralised governance must define several parameters related to the asset. Few of the parameters are :-
Debt ceiling :- It defines the maximum limit on debt that can be created using a specific collateral asset. The maximum limit is defined is to ensure that Maker protocol is sufficiently diversified & is not dependent heavily on few assets.
Stability Fee :- It is analogous to rate on interest charged on loans. It is calculated in terms on annual percentage yield. While paying back the Dai generated, the cumulative amount you must pay in order to withdraw your collateral assets will be- Amount of Dai Generated on Day 1 + Stability Fee*
Liquidation Ratio :- The Collateral asset to Debt ratio at which your assets will be liquidated to cover the outstanding debts. High volatile assets will have very liquidation ration & vice-versa.
Liquidation Penalty:- the liquidation penalty is additional fee charged on top of the outstanding debt to the user in case liquidation happens.
Collateral Auction Duration
Auction Bid Duration
Auction Step Size
Minimum Vault Debt :- The minimum amount of Dai which must be generated for opening the vault.So for an asset, if the Minimum Value debt is 8000 Dai, any transaction that attempts to generate Dai below 8000 will fail. Alternately, during payback, if your payment leaves the Debt balance in the vault below 8000 Dai but >0, the transaction will fail.
Each collateral asset requires its own unique vault. Hence a user might end up having multiple vaults depending on collateral asset being used to generate Dai.
DAI Savings rate(DSR)
Now say, instead of withdrawing the US dollars issued from Bank immediately , Surya deposits the funds in a savings account to earn interest.
Maker offers similar features.Users with Dai can deposit it as savings into a feature called DSR(Dai savings rate). Similar to your bank savings account, you will receive interest against the deposited Dai amount. The primary difference from a Bank savings account though here is that the Dai deposited resides into codes( DSR smart contract) instead with a centralised authority like Bank. Unless the code has any bug, the deposited coins are not controlled by anyone except you. Unlike Maker Vault , Dai deposited into DSR can be withdrawn at any time & it has no minimum deposit limit as such for earning interest.
DSR as a parameter serves major role in stabilising value to Dai. Similar to how central banks increase or decrease interest rates to decrease/increase money supply in the economy & control inflation, DSR is used Maker Governance to stabilise DAI’a value.
If Dai is above 1 USD, the DSR is decreased to reduce demand & reduce the value below to 1 USD.
If Dai is below 1 USD, the DSR is increased to stimulate demand & bring back the value to 1 USD.
MAKER DAO
The Maker coin is governance token i.e. user holding this token can vote on proposals. However, you need not be Maker coin holder to propose changes for Vote.
For example, you could propose revising the Liquidation ratio of a certain asset, say, BAT coin, downwards since the asset volatility has declined considerably over sometime. Your proposals will be voted by other Maker coin holders. The proposal will be either accepted or defeated. If you proposal to revise the liquidation ratio is accepted, it can take sometime for it to become effective.
How does Maker-Borrowing work?
Go to
https://makerdao.com/en/
& click on “Use Dai” Button as shown below.
You will be redirected to
https://oasis.app/
. You will need to connect to your wallet at this stage. Wallets as an article is covered here. If you are new to crypto, may be glance through it first.
Once you connect your wallet, the home screen will have below 3 primary components
“Your Vaults” will display list of Vaults you have opened. As you can imagine, for a first time user, it will be blank.
Scrolling below will display the Newly approved asset, most popular asset & the cheapest asset to deposit as collateral.
Scrolling further down will take you to the list of assets available for collateral deposit. You can see the various properties of each asset type such as Stability fee & minimum collateral ratio. You can click on “Open Vault” against a particular asset type.
If your wallet is connected , you will see another column “In my wallet'“ which displays the balance available in your wallet.
Once you click on “Open Vault” for , say against Wrapped BTC , the below window will open,
As you can see above, currently the balance is 0. The liquidation price indicates the price at which your collateral assets will be liquidated. We will cover liquidations as a process in separate article. However , as of now it is important to understand that the whole liquidation process is extremely crucial for Maker.
If you have some balance of the collateral asset, you can create DAI against it . The portal denotes the maximum amount of DAI you can generate against your asset. For example, below against wrapped BTC as collateral, i can generate upto around 32K Dai.
The reason is that the liquidation ratio of WBTC as asset is 145%. Hence, with the current price of 1 WBTC=46401 US dollars, the maximum eligible amount of Dai generation will be - (46401*100)/145= 32000
Once you withdraw Dai, you will be charged applicable Stability fee.
Once you repay all the owed Dai, you with withdraw your collateral.
How does Maker-Savings works?
Navigate to https://oasis.app/daiwallet & click on “Open Dai Wallet” or “Start Now”.
If you have balance DAI in your wallet, it will display on this page.
You can alternately also buy DAI from centralised exchanges through the page.
Click on “Start Saving” button.
You will be shown the savings rate offered. e.g. as per screens hot below it is 0.01% APY(Annual Percentage Yield).
Click on the link to create Proxy & provide permissions. Creating proxy costs transaction fees though.
Once done, you can transfer your DAI balance to DSR smart contract for earning interest.
Risks
Similar to how a physical vault can be broken into, smart contracts may have bugs which allows fraudster to pilfer your funds.There have been quite a few hacks due to smart contract bugs.
Since there is no KYC requirement, criminals could also join the platform & use withdrawn funds for illegal activities. This is the price to pay for trye decentralisation & anonymity of crypto. Eventually though, similar to internet, the goal is that the value of positive use case will be higher than negative ones.
Crypto assets are still volatile & a price crash in your collateral could trigger liquidation.
Regulatory risks.
Stats
Maker currently has over 12B+ Dollars locked as collateral.
You can navigate to the next article on Maker covering the liquidation process here.