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How Maker works

Explanation of Smart contract/DAP that allows you to mint the Dai token
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(gentle music) <v ->In this video, we’re going to talk about</v> the Maker Protocol and the Maker DAO. This is one of the first and one of the most successful DeFi ecosystems and it’s really important to help us understand how multiple different parts of an ecosystem fit together and how each of those different parts are incentivized, including in a decentralized way. The purpose of the Maker Protocol is actually twofold.
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First, it enables us to create a cryptocurrency backed stable coin, known as DAI. It helps to mint this type of coin and to keep it stable with various different mechanisms. And second, it enables people who have crypto assets, digital assets, such as a Ethereum and other assets within the Ethereum ecosystem to put them up as collateral and borrow against them. So it enables on one hand, a stable coin, and on the other hand, it enables us to do borrowing and lending in a decentralized way. Now there are two main tokens within the Maker ecosystem. The first is Maker. This is a governance token.
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Maker, as I mentioned is a DAO, that means there is no one single individual or entity in control of this protocol, but rather it’s governed by people who hold this Maker governance token. And that’s really important to remember, this is decentralized finance and it’s governed in a decentralized way.
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But in this video, we really want to talk about DAI. DAI is a stable coin. When we think about stable coins, we often think about them as fiat backed stable coins. So for instance, there might be one US dollar sitting in a safe that underlies each token on the market and that, that is how that stability is maintained. But DAI is a cryptocurrency backed stable coin. It’s pegged through the US dollar, so its value stays quite close to one US dollar, but underlying it, the underlying collateral is actually a whole range of different cryptocurrencies. First it was Ethereum, but now it’s expanded out. So how does this work? How does Maker work?
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Well, imagine that you have some cryptocurrency such as Ethereum, some Ether. What you can do is you can take your Ether and put it into a vault in the Maker ecosystem. You might lock up for instance, $150 worth of Ethereum into a Maker vault. What happens then, is you can then borrow against that collateral that you’ve put into your vault. You won’t be able to borrow the entire $150 worth, you have to be over collateralized, which means you might only be able to borrow $100 worth. But what’s interesting, is when you put your Ethereum into this vault and borrow against it, what you’re borrowing, is you’re borrowing this stable coin called DAI, you’re minting new DAI.
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Every time a vault is created, Ethereum goes in, DAI is minted and pulled out. Now you have taken out a loan for doing this and eventually when you take your cryptocurrency DAI and place it back into your vault, you will pay an interest rate, which is known as a stability fee and you will receive your underlying collateral back. Why would you want to do this? Well, perhaps you hold Ethereum, and you want to get some liquidity from that Ethereum, but you don’t want to sell it. What you can do is you can use the Maker protocol.
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You still hold that Ethereum sitting in your vault, but you can mint DAI and borrow DAI against it and go and use DAI in various parts around the crypto economy. Now in future steps in this course, we’ll explain a little bit further around the technicalities of how this works. So for instance, you have to be over collateralized in this ecosystem. If the value of Ethereum in your vault starts to drop below that $150 that you initially put in, you need to make some changes so that you don’t get liquidated and lose some or all of your underlying collateral. The system itself needs to stay liquid and solvent. So how does this cryptocurrency, this stable coin DAI, stay stable?
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We know that you can receive it, you can borrow it against your collateral, but how does it stay stable? There’s a whole range of different mechanisms. The most obvious one is simple arbitrage. Imagine that if on the free-market, DAI is trading at $1 50,
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anyone could go into the Maker ecosystem, open a vault, mint new DAI at a dollar, because the ecosystem remains at that dollar value and then go and sell that DAI on the free market and make an arbitrage profit from that. What’s interesting is this isn’t just this individual making a profit, what they have done in the process is they have increased the supply of DAI, by putting ETH into a vault and they have minted new DAI and they’ve increased overall supply of DAI on the market. This simple economics would teach us, would bring, DAI back to its peg of one Dollar. Conversely, imagine if DAI in a free market was trading at 50 cents. Right, it’s well under its peg.
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Those who have vaults and loans within the Maker ecosystem would be incentivized to go and buy that DAI in the free market and pay off their loans at a much cheaper rate. It’s going to be much easier for them to pay their loans. What this does is that it reduces the supply of DAI on the market, because as that DAI goes into the vaults, it’s burnt.
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There are a whole range of other mechanisms within the Maker ecosystem that help to keep DAI stable to the US dollar. As I mentioned before, Maker is a DAO. Those DAO members, those that hold the Maker token can decide for instance to shift the interest rate or the stability fee within the ecosystem. If you increase the interest rate, you’re going to have fewer individuals taking out loans. You’re going to have more individuals paying back loans, and you’re going to be able to shift the overall supply of DAI by changing those incentives.
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The Maker Protocol, and Maker DAO is a really interesting example of how a DeFi ecosystem maintains itself and achieves its objectives in a decentralized way. In future steps, we’ll go into a little bit more detail about the decisions and the risks that DeFi places and has in such protocols. These are different to centralized finance. They’re governed in different ways and there are different risks for individuals participating in it. If you’re interested in the Maker Protocol, you’re free to go and have a look at the protocol itself and the app. You’ll be able to see the collateral that’s there.
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How much is locked in vaults, how much DAI has been minted, what collateralization ratios are necessary, depending on the riskiness of those different collateral types. But in this video, we’ve given you a brief introduction to this particularly interesting protocol that’s at the heart of the DeFi ecosystem. (gentle music)

Watch Dr. Darcy Allen explain how the Maker protocol works to enable the stable coin Dai and allow for borrowing and lending.

Now it’s your turn

Visit the Maker protocol and share your findings in the comments. What is the most popular asset listed? What are the current stability fee and minimum collatoralisation ratio for the most popular asset?

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