DAI / USDS¶

Introduction¶

DAI is a decentralized stablecoin issued by the MakerDAO protocol, generated through over-collateralization of crypto assets, pegged to maintain a 1:1 value ratio with the US dollar. As the most important decentralized stablecoin in the Ethereum ecosystem, DAI operates entirely on smart contracts without relying on centralized institutions or fiat bank accounts, representing the crypto industry's exploration of decentralized financial infrastructure.

MakerDAO was founded by Rune Christensen in 2014, and officially launched on the Ethereum mainnet in December 2017. Unlike stablecoins such as USDT and USDC issued by centralized companies backed by fiat reserves, DAI is managed automatically through smart contracts. Users can mint DAI by collateralizing crypto assets like ETH and WBTC, with all operations transparent and verifiable, embodying the true spirit of decentralization.

In August 2024, MakerDAO underwent a rebrand, renaming itself Sky Protocol, and DAI was correspondingly upgraded to USDS (Sky Dollar). Despite the name change, the core mechanisms remain unchanged. DAI and USDS can be exchanged 1:1, and existing DAI holders can choose whether to upgrade. As of 2024, the market cap of DAI/USDS is approximately $5-6 billion, making it the third-largest stablecoin after USDT and USDC, and the largest decentralized stablecoin by market cap.

Core Features¶

Over-Collateralization Minting Mechanism

DAI uses an over-collateralization model where users must deposit crypto assets worth more than the amount being minted as collateral. For example, a user deposits $1,000 worth of ETH, and based on the collateralization ratio setting (typically 150%), can mint up to approximately $666 worth of DAI. This over-collateralization ensures that even if collateral prices decline, the system still has sufficient value backing all circulating DAI.

Users mint DAI by creating "Vaults" (originally called CDPs/Collateralized Debt Positions). A Vault is a smart contract that records the user's collateral and debt. Users can add collateral at any time, repay DAI to close the Vault, or withdraw some collateral. This mechanism gives users great flexibility and control.

Diversified Collateral Support

MakerDAO supports multiple crypto assets as collateral, including: - ETH (Ethereum): The primary collateral, with the largest share - WBTC (Wrapped Bitcoin): Brings Bitcoin value into Ethereum - USDC, USDP, and other centralized stablecoins: Used to stabilize DAI's peg - Liquid staking tokens: Such as stETH, rETH, etc., earning staking rewards while serving as collateral - Other ERC-20 tokens: Quality assets approved through governance voting

Each collateral type has independent risk parameters determined by MKR holders through governance voting, including collateralization ratio, stability fee rate, debt ceiling, etc. This diversification reduces single-asset risk and enhances system stability.

Stability Fee and DAI Savings Rate

Stability Fee: The annualized interest users must pay for minting DAI, similar to a borrowing rate. The Stability Fee is determined by MKR holder votes and adjusted based on market supply and demand. When DAI's price falls below $1, the fee is raised to reduce supply; conversely, it is lowered. Stability Fee income goes to the protocol treasury.
DAI Savings Rate (DSR): DAI holders can lock DAI into the DSR contract to earn interest, with the annual yield determined by governance. The DSR is used to regulate DAI demand -- raising the DSR attracts users to hold DAI, helping maintain price stability. DSR funds come from Stability Fee income.

Automated Liquidation System

When a Vault's collateralization ratio falls below the liquidation threshold (e.g., 130%), the system triggers automatic liquidation. Keepers can purchase the liquidated collateral, pay the corresponding DAI to repay the debt, and receive a liquidation discount (typically 3-13%) as incentive. This mechanism ensures the system always has sufficient collateral backing DAI.

The liquidation process is fully automated, and anyone can run liquidation bots to participate. If liquidation proceeds are insufficient to cover the debt, the protocol holds a debt auction to mint additional MKR tokens to fill the gap, creating a risk incentive for MKR holders -- they are motivated to maintain system health to avoid MKR dilution through additional issuance.

MKR Governance Token

MKR is MakerDAO's governance token, giving holders voting rights over the protocol to decide: - Adding or removing collateral types - Adjusting various risk parameters (collateralization ratio, stability fee, debt ceiling) - Modifying the DSR interest rate - Protocol upgrades and major decisions

MKR also has an economic value capture mechanism: Stability Fee income is used to buy back and burn MKR from the market, reducing supply; if the system incurs bad debt, additional MKR is minted to raise funds, with MKR holders bearing the ultimate risk.

Sky Protocol Upgrade and USDS

The 2024 Sky Protocol upgrade introduced several improvements: - USDS stablecoin: An upgraded version of DAI, exchangeable 1:1, with gradual transition - SKY token: Upgraded version of MKR (1 MKR = 24,000 SKY), enhancing liquidity and governance participation - Sky Savings Rate (SSR): Upgraded DSR, offering more flexible yield options - Sky Token Stars: Tokenized products based on US Treasury bonds, providing users with stable yields - SubDAO model: Splitting the protocol into multiple focused SubDAOs to improve governance efficiency

Core Advantages¶

True Decentralization

DAI is a fully decentralized stablecoin with all rules encoded in smart contracts, requiring no trust in any single institution. Circle can freeze USDC addresses, Tether can close accounts, but no entity can unilaterally control DAI. This decentralization gives DAI censorship resistance -- anyone can mint and use it.

Full Transparency and Verifiability

All collateral, debts, and liquidation records are publicly viewable on the Ethereum blockchain. Users can verify in real time that every DAI is backed by sufficient collateral, without relying on third-party audit reports. This level of transparency is unmatched by centralized stablecoins.

Permissionless and Globally Accessible

Anyone with crypto assets can mint DAI -- no KYC required, no bank account needed, no geographic restrictions. This provides the global unbanked population with access to stable US dollar-denominated assets.

Programmable and DeFi Integrated

As an Ethereum-native asset, DAI seamlessly integrates into various DeFi protocols. Hundreds of protocols including Aave, Compound, Uniswap, and Curve support DAI. Users can use DAI for lending, trading, liquidity mining, yield farming, and other complex financial operations.

Resistant to Single Points of Failure

DAI's diversified collateral and decentralized architecture make it immune to risks from any single bank or asset. Even if one collateral asset's price collapses, other collateral still supports the system. When USDC depegged during the SVB bank crisis in 2023, MakerDAO quickly adjusted risk parameters, and DAI maintained relative stability.

Development History¶

2014-2017: Conception and Preparation

In 2014, Rune Christensen proposed the MakerDAO concept, designing an Ethereum-based decentralized stablecoin system. From 2015-2017, multiple rounds of testing and development were conducted, funds were raised, and a community was built.

December 2017: Single-Collateral DAI (SAI) Launch

The MakerDAO mainnet officially launched with the first version of DAI (later called SAI), supporting only ETH as collateral. Early supply was small, primarily circulating among early DeFi adopters.

2018-2019: Early Growth

DAI was gradually adopted by early DeFi protocols like Compound and Uniswap, becoming an important stablecoin option. SAI supply grew from millions to tens of millions of dollars.

November 2019: Multi-Collateral DAI (MCD) Upgrade

MakerDAO launched Multi-Collateral DAI, supporting multiple assets as collateral, significantly improving system flexibility and scalability. SAI was gradually migrated to the new DAI. The DSR savings rate feature was introduced, allowing DAI holders to earn interest.

March 2020: Black Thursday

Global financial markets crashed due to the pandemic, and ETH price plummeted 50% in a single day, from approximately $200 to $80. The MakerDAO system faced severe stress, with massive Vault liquidations. Ethereum network congestion caused the liquidation mechanism to briefly fail, and the system incurred approximately $5 million in bad debt.

MakerDAO held a debt auction to mint additional MKR to raise funds and cover the shortfall. This crisis exposed system weaknesses but also proved the effectiveness of emergency mechanisms. Afterward, MakerDAO improved the liquidation system, introduced more liquid collateral types (such as USDC), and adjusted risk parameters.

2020-2021: **DeFi Summer Explosion**

The DeFi ecosystem flourished, and demand for DAI surged. DAI supply skyrocketed from approximately $100 million after Black Thursday to over $10 billion (2021 peak). DAI became the foundational stablecoin of the DeFi ecosystem, holding an important position in protocols like Uniswap, Curve, and Aave.

2022: Real World Assets (RWA) Introduction

To improve yields and stability, MakerDAO began investing in real world assets, including US Treasury bonds and corporate bonds. The proportion of RWA in protocol assets gradually increased, sparking community discussion about decentralization purity.

2023: Market Adjustment

As the DeFi market cooled and the interest rate environment changed, DAI supply retreated from its peak to the $5-6 billion range. MakerDAO continued optimizing risk parameters, introducing new collateral types, and expanding RWA investments.

August 2024: Sky Protocol Rebrand

MakerDAO officially rebranded to Sky Protocol, launching USDS and the SKY token. This upgrade aimed to simplify user experience, expand protocol scale, and improve governance efficiency. DAI holders can choose to upgrade to USDS, with 1:1 exchange available, and DAI will continue to be supported.

Use Cases¶

DeFi Lending Protocols

DAI is one of the core assets in lending protocols like Aave, Compound, and Spark. Users can: - Deposit DAI to earn deposit interest (typically 3-8% annualized) - Use DAI as collateral to borrow other assets - Borrow DAI for leveraged positions or arbitrage

Decentralized Exchanges (DEX)

DAI provides important trading pairs and liquidity on DEXs like Uniswap, Curve, and Balancer: - DAI/USDC, DAI/USDT stablecoin pairs provide low-slippage swaps - DAI/ETH, DAI/WBTC pairs provide stablecoin entry points for users - Liquidity providers earn trading fees and liquidity mining rewards

Stablecoin Value Storage

Users seeking decentralization and censorship resistance choose to hold DAI over USDC/USDT, avoiding the freezing risks of centralized stablecoins. Depositing DAI into DSR/SSR earns risk-free yield, similar to traditional bank savings but fully on-chain.

Cross-Border Payments and Remittances

Although not as popular as USDT/USDC, DAI has applications in cross-border payment scenarios that value privacy and decentralization, particularly in regions with limited access to traditional financial services.

DAO and Protocol Treasuries

Many DAOs and DeFi protocols use DAI as a treasury asset due to its decentralized nature and stability. DAI is not controlled by any single company, making it suitable for long-term holding.

On-Chain Settlement and Payments

Some Web3 applications and NFT marketplaces support DAI payments, providing users with decentralized settlement options.

Risks and Challenges¶

Complexity and User Barrier

Compared to the simple model of "deposit $1, receive 1 stablecoin," DAI's over-collateralization, liquidation, and governance mechanisms are relatively complex. The barrier to understanding is high for ordinary users, limiting mass adoption. Minting DAI requires managing Vaults, monitoring collateralization ratios, and dealing with liquidation risk, which is less convenient than simply purchasing USDC.

Collateral Price Volatility Risk

DAI relies on crypto asset collateral, which has high price volatility. Extreme market movements can trigger mass liquidations or even system bad debt. Although the system was improved after Black Thursday, similar risks remain.

Low Capital Efficiency

The over-collateralization model means low capital efficiency. Users need to lock up assets worth 150%+ to mint 100% of DAI, far less efficient than the 1:1 ratio of centralized stablecoins. This limits DAI's supply expansion rate.

Governance Risk and Centralization Concerns

Despite being theoretically decentralized, MakerDAO's governance has limited actual participation, with most MKR concentrated among a few large holders. Governance proposal pass rates are low, and major decisions can potentially be controlled by a few. The introduction of RWA has also raised centralization concerns -- investing in US Treasury bonds requires relying on traditional financial institutions and custody services.

Scalability Challenges

Due to reliance on the Ethereum mainnet and crypto asset collateral, DAI's supply growth is limited by market demand for crypto assets and Ethereum Gas costs. In bear markets, users are reluctant to collateralize depreciating assets, causing DAI supply to contract.

Competition with Centralized Stablecoins

USDC and USDT far exceed DAI in liquidity, user awareness, and institutional support. Most users prefer simpler, more widely supported centralized stablecoins. DAI's market cap growth rate lags behind the overall stablecoin market.

Regulatory Uncertainty

Although DAI is decentralized, the entities and foundations operating MakerDAO may still face regulatory pressure. RWA investments create connections between the protocol and the traditional financial system, increasing regulatory risk.

Future Outlook¶

Sky Protocol Ecosystem Building

Sky Protocol's multi-DAO architecture aims to improve governance efficiency and specialization. Different SubDAOs focus on areas such as RWA, liquidity management, and protocol growth, collaboratively driving ecosystem development. The USDS brand upgrade and product innovations like Sky Token Stars may attract more users.

Deepening RWA Integration

MakerDAO/Sky will continue expanding real world asset investments, from US Treasury bonds to corporate bonds, real estate, and trade finance. RWA provides stable yields and reduces dependence on crypto market volatility, but also requires balancing decentralization with efficiency.

Layer 2 Expansion

Deploying DAI/USDS on Ethereum Layer 2 networks (such as Arbitrum, Optimism, Base) and other compatible chains reduces usage costs and improves accessibility. Cross-chain bridges and liquidity aggregation will enable DAI/USDS to circulate seamlessly in multi-chain ecosystems.

Decentralized Stablecoin Leader

As the largest decentralized stablecoin, DAI/USDS has the opportunity to solidify its position among users who value censorship resistance and privacy. As regulations tighten, some users may shift from centralized stablecoins to decentralized alternatives.

Complementing CBDCs

As countries launch Central Bank Digital Currencies (CBDCs) in the future, DAI may form a complementary relationship with CBDCs. DAI offers decentralization and programmability, while CBDCs provide government backing and legal tender status, with both serving different user needs.

Governance and Community Maturation

As Sky Protocol reforms and community education deepen, governance participation may increase. Broader MKR/SKY distribution and the SubDAO model may enhance decision-making quality and execution efficiency.

MakerDAO/Sky Protocol: The protocol for issuing and managing DAI/USDS
MKR/SKY: Governance token that determines protocol operations and risk parameters
USDS: Upgraded version of DAI, launched by Sky Protocol in 2024
Oasis: User-friendly DAI Vault management interface
DSR/SSR: DAI Savings Rate / Sky Savings Rate, providing interest income for holders
Aave, Compound, Spark: Major DAI lending protocols
*Uniswap, *Curve, Balancer: Major DAI trading and liquidity venues
Ethena: Synthetic stablecoin USDe, using a different mechanism but also a decentralized stablecoin
Liquity (LUSD): Another decentralized over-collateralized stablecoin with a more immutable design