What is MakerDAO? (MKR)
The Beginner’s Guide
One of a number of emerging decentralized finance (DeFi) cryptocurrencies, MakerDAO is itself part of a larger system called the Maker protocol, which uses a combination of crypto assets to operate and maintain DAI without the need for any bank or government.
Specifically, the Maker Protocol requires two types of tokens to work: DAI and MKR.
DAI is created when a user locks another cryptocurrency, such as ETH, in the Maker platform to take out a loan in DAI. Users can return the DAI borrowed to claim this cryptocurrency, but they must be careful its value doesn’t fall below a certain level or it could be automatically sold.
(For more on how DAI operates, read our ‘What is DAI?’ guide.)
But while DAI is best thought of as the service provided by the Maker Protocol, MKR, is the crypto asset that governs how changes to the software that keeps DAI running are made.
In short, MKR tokens allow users to vote on proposals that affect how DAI can be used.
For example, MKR token holders can vote on which cryptocurrencies can be locked in the protocol or the price at which these assets would be sold in liquidation.
Who created MakerDAO?
The Maker Protocol was created in 2015 by a group of developers led by Rune Christensen. The group was formalized later into the Maker Foundation, a Cayman Islands company.
In 2017, the Maker team raised $12 million by selling MKR tokens to noted venture capital firm Andreessen Horowitz and others. These included the cryptocurrency fund Polychain Capital and other venture firms like 1Confirmation.
In 2018, a further $15 million worth of MKR tokens were sold to Andreessen Horowitz. The firm said at the time that it intended to participate in MakerDAO by helping to govern the DAI system.
Maker raised an additional $27.5 million in 2019 from venture firms Paradigm and Dragonfly Capital Partners for expansion to Asia.
How does MakerDAO work?
At launch, 1 million MKR tokens were created to govern the Maker protocol.
Anyone who owns these MKR tokens can cast a vote on key decisions using a process known as Executive Voting. If an Executive Vote is passed, then the code in the Maker Protocol is changed to reflect the winning proposal.
However, before an Executive Vote can be carried out, another form of voting must first take place. This is called Proposal Polling, and it’s a way for MKR holders to gauge sentiment on a proposal before committing any changes to the software.
A third type of vote can be cast by non-MKR holders using threads in the MakerDAO forum.
But while anyone may make proposals to MakerDAO, only MKR holders can vote on them. A vote is then measured by the amount of MKR tokens committed to a proposal.
For example, if 10 holders with 1,000 MKR vote for Proposal A, while 5 holders with 5,000 MKR vote for Proposal B, Proposal B wins because more MKR tokens support it.
Only the number of tokens, not the number of token holders, influences the vote’s outcome.
DAI Savings Rate
Importantly, MKR holders can decide how much DAI holders earn if they save DAI on the platform. The amount DAI holders earn for doing this is known as the DAI Savings Rate.
The DAI Savings Rate has been as high as 8.75% per annum, and as low as 0%. In fact, the current savings rate is set at zero due to a market crash in March that caused DAI to trade significantly above $1.
In the aftermath of the crash, MKR holders voted to set the DAI Savings Rate to 0% to encourage the sale of DAI, which would bring the price of DAI closer to $1.
In this case, MKR holders voted in-line with expectations.
When the price of DAI rises above $1, MKR holders are expected to vote to decrease the savings rate to reduce demand, causing the price to fall.
If the price of DAI is under a dollar, then MKR holders should vote to raise the savings rate to increase demand to hold DAI, thus causing the price to rise.
Why does MKR have value?
MKR should accrue value as use of the Maker Protocol increases, because the supply of MKR is reduced when the system is working well and increased when it is governed poorly.
If the Maker system is working as intended, it should collect fees from users who lock up cryptocurrencies in the system to generate DAI.
Once the collected fees exceed a certain amount, set by MKR holders, the Maker system holds an auction to sell the extra DAI. This extra DAI must be bought with MKR. This process is known as a Surplus Auction.
Once the auction is over, the MKR is destroyed, reducing the total supply of MKR. A reduced supply of MKR raises the token’s price.
On the other hand if things aren’t going well, and the locked coins are sold for less than their earlier value, then the Maker system needs to raise funding through a Debt Auction.
The Debt Auction sees new MKR tokens created by the system and then auctioned for DAI. This type of auction increases the total supply of MKR tokens thus reducing the price.
MKR holders are therefore motivated to ensure the Maker system runs smoothly so that it can generate more fees from users, thus reducing the supply of MKR.
If MKR holders vote unwisely, it could lead to locked coins being automatically sold at poor prices, leading to an increase in the supply of MKR tokens.
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Why use MKR?
If you want to play a role in determining key decisions on how the Maker protocol operates, then you’ll want to use MKR.
The more MKR you hold, the more you’ll be able to have a say in which cryptocurrencies are used in the protocol or which real-world assets could be used to generate DAI.
Investors may consider owning MKR should they want to gain exposure to increasing adoption of the protocol. Should the Maker protocol become widely used (and remain well run) MKR tokens could become a valuable addition to a crypto portfolio.
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