The purpose of this document is to provide an overview of the MakerDAO platform. We sought to generate this report because throughout our research, we were unable to find an already existing centralized, consolidated, and complete resource describing in detail the up-to-date infrastructure of MakerDAO. It’s our hope that anyone can use this as a foundational resource to understand MakerDAO. For those that already have this understanding, we will be releasing a more expansive blog post that further explains the economics of the platform. So stay tuned.

MakerDAO is a decentralized autonomous organization (DAO) that exists on the Ethereum blockchain. The platform uses a self-balancing system to create a stablecoin that avoids the regulatory issues that have hindered the success of other similar projects. To generate and manage this system, MakerDAO created two tokens:

1. Maker (MKR)—a token used to govern the platform and pay stability fees
2. Dai (DAI)—a crypto-collateralized stablecoin that is targeted to the U.S. dollar

MakerDAO ensures the stability of the dai through the implementation of a decentralized governance system that is conducted via the staking of maker tokens for the period of time during which a vote occurs. Additionally, the fees needed to stabilize the dai are managed and paid through the maker token.

To create dai, users lock up ether in smart contracts called “collateralized debt positions" (CDPs) that mint dai, loan those dai to CDP creators, and hold their locked ether as collateral. In order to protect MakerDAO against declines in collateral value, the system requires users to collateralize a minimum of 150 percent of the value that they wish to borrow. Currently, the global collateralization is over 370 percent, which is significantly above the target and facilitates increased stability of the system.

The primary (and most complicated) functions of the Maker platform are targeting the dai value to that of the U.S. dollar and minimizing its volatility around that target. These goals are achieved using oracalized data streams that report the dollar price of ether and by employing complex market incentives that manage stability and risk with the help of autonomous feedback mechanisms.

MakerDAO uses a pool of ether to back dai, and refers to this pool as pooled ether (PETH). Although the platform requires users to send ether in order to create a CDP and generate dai, it has to first be converted to wrapped ether (WETH) before it is merged into the pooled ether collection.

When a user locks up ether to create a CDP, that ether is initially “wrapped" in order for it to inherit the functionality of ERC-20 tokens. This allows the wrapped ether to be traded directly for ERC-20 tokens (in this case dai). This is necessary since ether was built before the ERC-20 standard was established and, consequently, did not inherit the same functionality. When ether is converted into wrapped ether, the wrapped tokens are held in a smart contract that maintain a 1:1 peg to ether. To have your ether returned, you would send the wrapped ether back to the smart contract and complete the transaction.

Once ether has been exchanged for wrapped ether it’s used to collateralize the dai. As a result, a user’s pooled ether holdings are shown as an overall percentage of the ether pool. A user then takes out a loan in dai by creating a CDP that is collateralized by the pooled ether. When the user wants to retrieve their ether that they originally used to collateralize their CDP, an amount of dai equivalent to the debt owed must be returned to the CDP in addition to a stability fee paid in the maker token.

The MakerDAO platform is managed by a set of autonomous feedback mechanisms with the help of the following external actors within the community:

• Oracles. Used to establish the prices of assets used as collateral in CDPs. MakerDAO uses oracles to draw ETH/USD and MKR/USD price data from multiple sources to create an externally validated set of internal prices. To do so, the price data are fed into a smart contract called the Medianizer that assimilates price-feed data and then calculates the median price from those feeds. Any time the medianizer receives a price feed update, it re-calculates the median price and updates the price reported on the MakerDAO platform. Currently, MakerDAO uses 32 price feeds operated by maker holders. These price feeds all obtain data from the same sources and their addresses are publicly known.

• Keepers. Users that are incentivized to manage the risk and price stability of the system. Keepers are generally automated and serve three primary functions:

1. 1. 1. Trigger the liquidation of CDPs in the event that a collateral-to-debt ratio falls below the threshold of 150 percent.
      2. Compete to buy up liquidated CDPs for a transaction fee (a boom or bust fee of 3 percent). This helps to push the price up towards its target level.
      3. Trade dai around the target price to maintain the soft peg to the U.S. dollar. This is done by arbitraging the price on various exchanges. For example, if the price of dai is US$0.98 on a decentralized exchange, a keeper can purchase that dai to pay off the debt of a CDP and receive the collateralized pooled ether in return, turning an almost risk-free two percent profit. The effectiveness of depending on the market participants to engage in this non risk-free arbitrage is reduced by different exchanges having different logistical and technical requirements for buying and selling, which is likely at least part of the reason that the dai trades in a range around, and often below, the US$1 price target.

• Global Settlers. This can be triggered by five percent of MKR holders or by an elected group of MakerDAO representatives who can vote with their maker tokens to conduct an emergency shutdown of the entire system. These users monitor the system through emergency oracles that are capable of identifying malicious behavior within the network and its incoming data. This shutdown process is also referred to as a global settlement, and the elected group of emergency oracles are called global settlers. Global settlement could occur for a number of reasons, including:

1. 1. Upgrading the system.
   2. MakerDAO reaching its debt ceiling.
   3. Irrational market behavior.
   4. Hacks.

There are four ways to interact with a CDP:

• Creating the CDP and depositing collateral. A user must send a transactions to the MakerDAO platform in order to create, and then collateralize, a CDP.

• Generating dai from the collateralized CDP. Once the CDP has been created and collateralized, the user sends another transaction to retrieve the amount of dai they want from the CDP. When done, the CDP starts to accumulate interest against the dai taken and removes the user’s ability to access their collateral until that debt is paid.

• Paying down the debt and stability fee. Once a user is ready to retrieve their collateral, the debt and a stability fee have to be paid in advance. The stability fee builds over time and can only be paid in maker or dai. Upon receiving the required amount of dai and/or maker, the CDP ceases to exist and its collateral is returned to the creator of the CDP.

• Withdrawing collateral and closing the CDP. A user can withdraw as much of their collateral that has been paid off in both debt and stability fees. This is done by sending a transaction to MakerDAO in both maker and dai. The dai covers the outstanding debt, and the maker covers the stability fee.

To withdraw the collateral used to open a CDP, a user must first pay the debt and stability fee. This is done by sending dai to pay the debt, and maker to pay for the stability fee at an average of 7.5 percent per annum. In the event that a CDP’s collateral-to-debt ratio falls below 150 percent and is automatically liquidated, a fee of 13 percent will also be applied to the user; however, this will only happen if the value of the ether held by the CDP falls below a liquidation price. This can be avoided if the collateral-to-debt ratio of a CDP is kept well above the liquidation ratio of 150 percent.

Sample TextMakerDAO’s community, comprised of the executive team and maker holders participating in weekly calls, manages the system’s risk parameters along with the autonomous feedback mechanisms. Maker tokens are used to verify a stake in the outcome of a vote.

This section will briefly detail a few of the key factors that the governance community regularly monitors. In addition, this section serves as a basis for the discussion of the overall risk parameters that govern the CDPs:

• Stability fee. The stability fee is used to control the supply and demand of dai, while also re. Just like an interest rate, adjusting the stability fee affects the value that a user must give back when repaying their debt in full, and therefore helps to balance the supply and demand of dai. This fee is calculated continuously as follows:

[Stability Fee] = [Debt] * e ^ [Interest Rate * Time] – [Debt]

• Collateralization ratio. The collateral to debt ratio of the ether used to create a CDP vs the debt borrowed against it in dai.

[Collateralization Ratio] = [Locked PETH] * [ETH Price] * [PETH/ETH Ratio]) / [Stability Debt] * 100

• Liquidation price. The price of ether that would trigger the automatic liquidation of a CDP.

[Liquidation Price] = ([Stability Debt] * [Liquidation Ratio]) / ([Collateral] * PETH/ETH Ratio)

• Collateral left after forced liquidation. The amount of collateral redeemed by CDP owners will vary based on the fees applied, and whether liquidation was voluntary. The difference between the two is that a liquidation penalty of 13 percent is applied to forced liquidations.

[Collateral] * [Oracle Price] * [PETH/ETH Ratio] – [Liquidation Penalty] * [Stability Debt] – [Stability Debt] = [Remaining Collateral] * [Oracle Price]

Given those definitions, we will now discuss the risk parameters themselves.

The seven risk parameters that help MakerDAO manage and deploy CDPs are:

• Debt ceiling. The maximum amount of debt that can be created by a single-collateral CDP. The debt ceiling provides an upper bound on the supply to ensure the platform does not grow too quickly and become untenable. By having a debt ceiling, MakerDAO allows for the price of dai to rise as demand grows to meet it and mitigates the damage that could be done if the value of ether that is held in CDPs takes a massive swing downwards.

• Liquidation ratio. The ratio of collateral (ether) to debt (dai) that triggers a CDP liquidation. A CDP is forced to liquidate if the collateralization ratio of the ether backing a set amount of dai falls below 150 percent. The liquidation ratio of all CDPs is monitored on a continuous basis. It is up to CDP owners to maintain a collateral to debt ratio that is greater than 150 percent and to always monitor this ratio to avoid the risk of liquidation.

• Stability fee. A fee paid in maker by every CDP owner upon return of their collateral. This fee is calculated on top of the relative debt of each CDP and is paid by the owner of each CDP. It is important to note that all maker tokens used to pay stability fees are burned.

“When a CDP is liquidated, it is immediately acquired by the system. The CDP owner receives the value of the leftover collateral minus the debt, Stability Fee and Liquidation Penalty.”
—Maker Team, The Dai Stablecoin System, December, 2017, p.9

The stability fee works with the dai savings rate to balance the supply and demand of dai. When the rate is high, it creates a disincentive to create—and consequently borrow—dai and vice versa. Therefore, the higher the stability fee, the more likely it is that supply will either decrease or increase at a slower rate. Said another way, when the dai price is trading below US$1, the Maker governance community can choose to increase the stability fee which would result in an increased incentive to close CDPs, reducing the supply of dai and moving the price towards the US$1 target.

• Liquidation penalty. Fee that is paid by owners of liquidated CDPs to cover the cost of liquidation.

• Penalty ratio. The documentation on this terminology is unclear; however, it does appear in the White Paper. Based on our research, it looks like this is another term for the liquidation penalty. Specifically, this is set at 13 percent. It refers to the proportion of dai raised above the debt owed on the CDP that is then used to buy pooled ether and burn it from the overall pooled ether supply. Maker tokens would not be burned directly as a result of the liquidation penalty in single-collateral dai.

• Boom or bust spread. Discount that incentivizes traders to purchase assets that have been seized by the MakerDAO platform in order to close a CDP that has defaulted (fallen below the liquidation ratio of 150 percent). This spread offers a three percent discount for liquidated CDPs.

• Dai savings rate. Just like a classic interest rate on a savings account, the dai savings rate rewards users for holding dai by providing a two percent annual return, essentially turning dai holdings into a savings account. The dai savings rate works with the stability fee to help adjust the supply of dai, and thus its price. In addition, like the stability fee, it is increased or decreased by the MakerDAO governance community to influence the dai price.

To maintain dai’s soft 1:1 peg to the U.S. dollar, the MakerDAO platform employs a combination of liquidation mechanisms, fees, and discounts (specifically the liquidation penalty, stability fee, and boom or bust spread). These mechanisms focus on two events:

1. The collateral-to-debt ratio decreasing due to ETH/USD volatility. When the value of ether falls below the liquidation ratio of 150 percent, liquidation is triggered by keepers that are monitoring CDPs by comparing the liquidation ratio with the actual collateral to debt ratio of the CDP. In this event, MakerDAO liquidates CDPs by selling their debt at the discounted (3 percent) the boom or bust spread, then charges the user a stability fee (3.5 percent) and liquidation penalty (13 percent). If the original owner of the liquidated CDP wants to retrieve the remaining collateral, they must first pay the stability fee in maker/dai and the 13 percent liquidation fee along with the outstanding debt in dai. Once fees are paid, the remaining ether is sent back to the user and the repaid dai is burned. To avoid liquidations, MakerDAO advises a collateral-to-debt ratio well above 150 percent and the market has agreed by providing an average collateralization ratio of over 300 percent.
2. Dai trading above or below US$1. When the market price of dai starts trading above or below the target price of US$1, the dai savings rate and stability fee are adjusted by the MakerDAO governance community. The savings rate and stability fee incentivizes users to adjust their CDP creation and termination behavior to help maintain the target price. If the market price is less than the target price, the savings rate and stability fee can be increased, and if the market price is greater than the target price, the savings rate can be decreased. These changes incentivize market participants to open CDPs or close them out, thus adjusting the supply of dai, which pushes the market price of dai back towards its target price.

If the aforementioned price stability mechanisms of the MakerDAO platform are insufficient to prevent substantial liquidations, a global settlement is initiated by MakerDAO’s governance members. This global settlement process consists of three-steps:

1. Global settlement is voted on by MakerDAO governance community members via emergency oracles. This puts an immediate hold on the creation of CDPs and fixes the price at a value that is then used to process claims for all users.
2. Keepers process all claims at this fixed price for dai holders and CDP owners.

Dai holders and CDP owners claim their collateral at a fixed price for a corresponding amount of ether that is equal to the value of those users’ assets based on the fixed settlement price.

The maker token has a number of functions in the MakerDAO system; among them is the governance of risk and business logic. To participate in the governance process, maker holders use the governance dashboard. This entails linking their wallet address from the governance dashboard to a voting contract that pools maker and issues voting tokens. This allows users to vote on proposals by locking up their voting tokens within a proposal’s smart contract, which can be withdrawn at any time. Voting on a proprosal works in the following way.

“Voting is weighted for the amount of MKR that is voted onto a proposal. For example, if 100 users hold 600 MKR and vote for proposal A, and 50 users hold 400 MKR and vote for proposal B, then Proposal A would win with 60 percent of the vote, as Proposal B only has 40 percent of the vote.”

Thee proposed governance topics to vote on include:

1. Adding and removing price oracles
2. Adjusting the dai savings rate
3. Adjusting the stability fee
4. Adjusting the CDP debt ceiling
5. Choosing settlers for a global settlement
6. Triggering a global settlement

Safeguarding the Governance Process. Since MakerDAO’s governance is determined by community votes, security is paramount. A system like this has to be capable of protecting itself, and in the event of a malicious attack, resetting the system without destroying its ecosystem. To do so, MakerDAO is capable of stopping malicious activity from affecting the voting process. If an attacker were able to control 51 percent of the actively staked maker tokens and attempted to create a new kind of collateral or raise the debt ceiling, global settlers can force settlement across the entire system. As long as one global settler remains honest, the system can be restarted to a state that removes the attacker’s 51 percent stake, leaving only honest holders.

This concludes our presentation of the MakerDAO system and its functionality. Our goal was to provide a comprehensive overview of the platforms primary features and supporting elements in place to manage the dai stable coin. This paper was compiled using a variety of sources.

We are interested in receiving feedback, so please inform us of anything we may have misinterpreted regarding the functionality of the current MakerDAO platform. Our goal is not to misrepresent the technology in anyway, but to provide a clear overview for anyone to use as a primer for understanding MakerDAO.

1. Retrieved from mkr.tools
2. etherscan.io/address/0x729D19f657BD0614b4985Cf1D82531c67569197B
3. developer.makerdao.com/feeds
4. etherscan.io/address/0x435AD5CAE6eA3e065ce540464366b71Fba8f0c52
5. Maker Team, The Dai Stablecoin System, December, 2017, p.4
6. cdp.makerdao.com
7. Maker Team, The Dai Stablecoin System, December, 2017, p.10
8. Maker Team, The Dai Stablecoin System, December, 2017, p.7
9. vote.makerdao.com
10. etherscan.io/address/0x8e2a84d6ade1e7fffee039a35ef5f19f13057152
11. https://makerdao.com/en/faq/voting#what-is-the-proxy-contract
12. Rune Christensen, Retrieved from reddit.com/r/MakerDAO/comments/7xoe77/how_does_mkr_governance_and_voting_work

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