DAI is a decentralized, crypto-collateralized stablecoin developed by the MakerDAO organization. As a stablecoin, DAI is designed to maintain a stable value relative to a specific asset or a pool of assets. In DAI’s case, its value is pegged to the U.S. dollar, with each DAI token intended to be equivalent to one USD.
DAI distinguishes itself from other stablecoins by its decentralized nature. While many stablecoins are backed by reserves held by a central authority, DAI is backed by collateral assets that are locked into smart contracts on the Ethereum blockchain.
History and Development of DAI
The idea for DAI was first proposed in a whitepaper published by the MakerDAO team in 2015. MakerDAO, founded by Rune Christensen, was one of the earliest projects in the decentralized finance (DeFi) space.
The DAI stablecoin was officially launched in December 2017. Initially, DAI was a single-collateral stablecoin, which means that it was backed solely by Ether (ETH). However, in November 2019, MakerDAO upgraded the system to the Multi-Collateral DAI (MCD), which allows DAI to be backed by multiple types of assets, not just ETH.
How DAI works
MakerDAO is a peer-to-peer decentralized protocol based on the Ethereum network that facilitates borrowing, lending, and savings. The protocol allows you to borrow funds denominated in DAI. A person needs Ethereum and a MetaMask wallet to do this.
DAI is generated through a system of smart contracts on the MakerDAO platform. Users deposit collateral assets into a Vault, a type of smart contract on the Maker platform. The amount of DAI that can be generated is determined by the value of the collateral, the debt ceiling, and the collateralization ratio set by the Maker system.
DAI is based on the Ethereum blockchain, which means it can leverage the security, transparency, and interoperability of the network. DAI is backed by collateral assets, such as ether (ETH) or other cryptocurrencies, that are locked in smart contracts called vaults. These assets act as a guarantee for the value of DAI and can be liquidated if the value of the collateral falls below a certain threshold.
DAI maintains its peg to the USD by using an algorithm that adjusts the supply and demand of DAI according to market conditions. The algorithm relies on two mechanisms: the stability fee and the savings rate.
DAI is a crypto asset that attempts to
maintain a stable 1:1 value with the U.S. Dollar by locking other crypto assets in contracts.
This means that unlike other asset-backed cryptocurrencies, which may be issued by for-profit companies, DAI is the product of an open-source software called the Maker Protocol, a decentralized application running on top of the Ethereum blockchain.
As such, DAI maintains its value not by being backed by U.S. dollars custodied by a company, but by using collateralized debt denominated in ether (ETH), Ethereum’s cryptocurrency. Collateralized loans provide a way for a lender to secure a loan using assets they own. Historically, these loans have a lower interest rate than unsecured loans, as they allow lenders to seize the asset and sell it in the event borrowers are unable to pay the loans.
The Maker Protocol, through smart contracts running on Ethereum, enables borrowers to lock ETH and other crypto assets, thus collateralizing it, in order to generate new DAI tokens in the form of loans.
If borrowers wish to recover the locked ETH, they will have to return the DAI to the protocol and pay a fee. In the event of liquidation, the Maker Protocol will take the collateral and sell it using an internal market-based auction mechanism.
Due to its design, the supply of DAI cannot be altered by any party in the network. Rather, it is maintained through a system of smart contracts designed to dynamically respond to changes in the market price of the assets in its contracts.
When a user wants to retrieve their collateral, they must pay back the amount of DAI they generated plus a Stability Fee, which is essentially an interest rate. This ensures the system remains overcollateralized. If the value of the collateral falls too much, it can be automatically sold off by the system to ensure that all DAI remains backed.
The stability fee is the interest rate that users have to pay when they borrow DAI from the system by depositing collateral into vaults. The stability fee can be increased or decreased by the governance system to incentivize or disincentivize borrowing DAI.
The savings rate is the interest rate that users can earn when they deposit DAI into a special contract called the Dai Savings Rate (DSR). The savings rate can be increased or decreased by the governance system to incentivize or disincentivize holding DAI.
How DAI is Created and Destroyed
Users can create DAI by opening a vault, depositing collateral, and generating DAI up to a certain limit determined by the collateralization ratio. The collateralization ratio is the minimum percentage of collateral value that must be maintained to support the issued DAI. For example, if the collateralization ratio for ETH is 150%, then a user can generate up to 66.67 DAI for every 100 USD worth of ETH deposited in a vault.
Users can destroy DAI by repaying their debt and closing their vaults. When they do so, they have to pay back the principal amount of DAI plus the accrued stability fee. The returned DAI is automatically burned, and the collateral is unlocked for withdrawal.
Users can also create or destroy DAI by trading it on various platforms, such as exchanges, lending platforms, or decentralized applications. However, these transactions do not affect the total supply of DAI in circulation, as they only transfer ownership of existing DAI.
How DAI is Governed and Regulated
DAI is governed and regulated by MakerDAO, a decentralized autonomous organization (DAO) that consists of MKR token holders. MKR is the governance token of the Maker Protocol, which is the set of smart contracts that manage the creation and stability of DAI.
MKR holders have the power to propose and vote on changes to various parameters in the Maker Protocol, such as the types and rates of accepted collateral, the stability fee and savings rate, the debt ceiling, and the liquidation penalty. These parameters affect the supply and demand of DAI and thus its price stability.
MKR holders also have the responsibility to protect the system from risks, such as black swan events, malicious attacks, or technical failures. If the value of the collateral drops below the value of the issued DAI, resulting in undercollateralized vaults, MKR holders have to recapitalize the system by minting new MKR tokens and auctioning them for DAI. This dilutes the value of existing MKR tokens and creates an incentive for MKR holders to act prudently and rationally.
How DAI is Used and Traded
Users can use DAI for various purposes, such as trading, lending, borrowing, saving, or paying for goods and services. Since DAI is stable and compatible with other Ethereum-based tokens and applications, it can facilitate transactions that require low volatility and high interoperability.
Users can trade DAI on various platforms, such as centralized exchanges (CEXs), decentralized exchanges (DEXs), or peer-to-peer platforms. Some examples of platforms that support DAI trading are OKX, Bybit, Bitrue, Bitget, LBank, Uniswap, SushiSwap, Compound, Aave, MakerDAO Oasis, etc.
Users can also earn interest on their DAI holdings by depositing them into platforms that offer yield farming or liquidity mining opportunities. These platforms reward users with additional tokens or fees for providing liquidity or lending services to other users. Some examples of platforms that offer yield farming or liquidity mining with DAI are Yearn Finance, Curve Finance, Balancer, Harvest Finance, etc.
Our Opinion
Given that DAI is created exclusively as a result of a loan and is collateralised on a Riba-based debt, DAI is not Shariah compliant. DAI is created by depositing collateral into smart contracts on MakerDAO, and the platform then creates DAI. Borrowers of DAI must pay a stability fee, which is essentially an interest fee, or Riba. The DAI Savings Rate is also another Shariah non-compliant feature of MakerDAO.
Conclusion
Based on and subject to the foregoing information, and for the purposes of this conclusion, we realize the following elements of borrowing DAI with stability fees are in breach of Shariah* principles and rulings. Therefore, we cannot express the DAI to be in congruence with the Shariah principles and rulings.
* Your attention is drawn to the term ‘Shariah’ and ‘Shariah compliant’ and its interpretation thereof as expressed in the following linkhttps://shariyah.net/glossary/
