Since everyone is having a meltdown about Tether, and people don’t seem to understand that decentralized stablecoins are both a thing and work, here’s a post explaining one!


While there’s numerous decentralized stablecoins, the biggest and most developed is DAI. Now don’t call me a shill, because 1) it’s a stablecoin and 2) I have never invested even a cent in its parent token (MakerDAO). But, I will nonetheless explain how DAI remains stable, and explain why it’s much better than Tether.

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**How DAI Works**

Note: If you just want to buy DAI so you can be pegged to the USD, you don’t have to worry about any of this. Just buy DAI off an exchange and you’ll be okay until the USD crashes.

DAI a masterful piece of game theory, so it will take time to digest. You can think of creating DAI as a loan from a bank; you lock up Ethereum in a smart contract, and they give you DAI accordingly. Let’s say ETH is 200$ and you lock up 1 ETH to get 100 DAI.

If you ever want to see your ETH back, you have to pay off your debt of 100 DAI (you can do this in fractions too). So, this gets us to Step 1: **If the price of DAI ever goes below 1$, you can profit by buying back DAI to pay off your decentralized debt**.

Okay, that’s nice. But what about when DAI is over 1$? This gets us to Step 2: **If DAI is trading at over 1$, you can profit by locking up ETH in the contract to buy DAI.**

Okay I see how it maintains a value of a dollar.. But what happens if Ethereum crashes? Because then I would never want to buy it back anyways. This brings us to the liquidation step; if the price of Ethereum reaches your DAI withdrawal, you get liquidated and your Ethereum is taken from you in the contract. Which brings us to step 3: **If Ethereum crashes below your threshold, your locked ETH is immediately sold back for DAI at 3% under the market value.** So don’t be too risky with how much DAI you take out!

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**Q&A**

– “This would never work in practice!”

[It has](https://coinmarketcap.com/currencies/dai/)

– “What if it suddenly fails?!?!”

MakerDAO has a voting system and is also moving towards multi-collateral for more security. You can read more [here](https://medium.com/makerdao/introduction-to-dai-2e65626e65a7)

– “How does the contract know the price of USD??”

[Oracles](https://np.reddit.com/r/MakerDAO/comments/7zitlv/why_should_we_trust_the_makerdao_oracle_system/)

– “What if Ethereum crashes?? You can’t base a stablecoin on something unstable!”

You mean like when it went from 1375$ to 200? Yeah, it’s been there. And it stayed

– “But I read an article saying it was going to fall apart in the coming months!”

Was that the one from 8 months ago?

– “I’ve thought of <fringe edgecase>”, and you didn’t address it in your post!

Good! Edge cases are the best testing methods. Unfortunately I don’t want my post to be longer than Moby Dick, so I haven’t covered anything. Post concerns below or to /r/MakerDAO, they seem to answer quite well!

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Anyways, that’s all from me. DAI has grown a lot the past several months, so idealistically I would have made this post months ago, but better late than never amirite?

Enjoy and keep your private keys safe!

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