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Looking back at the bear market throughout 2018 reveals a precipitous decline across the market, with many coins experiencing more than 90 percent drops. In particular, Ethereum is currently down 91 percent from its all-time-high, causing financial stress on many projects in its ecosystem.

With downward pressure and endemic volatility, stablecoins have continued to garner more support and have flooded the market. While many of these are traditional fiat-collateralized versions — such as Tether and USDC — Maker’s Dai is uniquely a crypto-collateralized stablecoin, where stability is maintained through over-collateralization of the underlying asset — ETH — through collateralized debt positions (CDPs), Maker’s governance design, and several other methods.

CDPs on Maker currently account for about 1.5 percent (~$200 million) of the total ETH in circulation, providing an intriguing insight into the growing developments of decentralized leverage.

What is Maker, Dai, and CDPs?

CDPs are managed through a CDP smart contract on Ethereum. Users can send ETH directly to the CDP and receive freshly minted Dai in return, with the amount of Dai received based on the collateralization ratio. The ETH is correspondingly locked in the CDP smart contract until the issued Dai is paid back to the contract, where the ETH will subsequently be returned to the user and the Dai is destroyed.  

If the user cannot pay back the Dai, then the CDP auctions off the ETH until the requisite number of Dai is returned to the CDP that was initially extracted.

Dai is a stablecoin which does not fluctuate in value and can be exchanged for USD, BTC, more ETH, and many other assets. Within Maker, Dai has shown an extraordinary ability to remain stable despite the massive decline in the price of its underlying asset, ETH. Maker’s MKR coin also plays a role in mitigating the collapse of the entire CDP by having MKR holders manage the governance of decisions such as decreasing the stability fee.

Additionally, MKR holders are the last resort for the liquidation of the CDP. If the underlying collateral — ETH — cannot cover the amount of Dai in circulation, then the onus is on MKR holders to create and sell MKR on the open market. This creates the incentive to properly regulate the parameters of Maker to prevent a catastrophic event from happening which would reduce the value of MKR.

What’s interesting about Maker CDP’s is that users can access decentralized leverage. Essentially, they can send ETH to the CDP, receive Dai, and use that Dai to buy more ETH on margin or numerous other cases, including repaying mortgages and taking out a loan for a car. Dai is a loan on the underlying ETH asset, so it comes with inherent risk stemming from exposure to ETH’s price movements.

However, the increasing ETH holdings in Maker CDPs is likely caused by the downward trend in market prices and people looking for a stable asset. When the underlying collateral’s value increases — particularly in an extended bull market –, instances of leveraging the CDP for cases of using Dai for loans or buying on margin seem more realistic for average users. Conversely, — as with the current bear market — leveraging Dai is more prudent as a stable value store to reduce exposure to ETH.

According to Maker, more than 5,000 CDPs have been opened, and there are nearly 80 million Dai currently in circulation. The implications of decentralized leverage are fascinating, and watching how CDPs change — should the market turn — can offer an excellent case study of how decentralized collateralization of crypto assets adapts to market conditions.

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