DAI: A New Approach to Stablecoins

The rapidly increasing demand for stablecoins constitutes one of the major crypto market tendencies of the past 12 months. The total supply of USD stablecoins has reached the market level of $140 billion, implying a more than 400% annual growth. Such a demand can be largely attributed to the higher flexibility enjoyed by investors and speculators in shifting their funds among exchanges as well as borrowing against their assets.

Stablecoins refer to cryptocurrencies that have a pegged price to that of fiat money or other commodities. Most stablecoins are pegged to the US dollar as the generally used fiat paper standard. Stablecoins allow investors to determine the optimal balance between the expected returns and risks they can afford under the present market conditions.

According to the NBER analysis, stablecoins may be perceived as being a stabilizing force but only from a demand side.

DAI’s Unique Approach

While most stablecoins, including Tether, rely on fiat collateral to ensure their price stability, DAI has adopted a very different approach. DAI uses Ethereum as crypto collateral for all stablecoins issued. Moreover, considering the high degree of ETH price volatility, DAI ensures that the market value of ETH equals 150% to the amount of DAI issued to minimize the risks of inability to provide 100% coverage of DAI tokens with the US dollars. DAI’s current circulating supply equals $9.2 billion, and this stablecoin occupies 19^th place in the market by its capitalization. The total number of its holders is presented in Figure 1 below.

Overall, DAI enjoys the growing adoption among holders even despite the current correction of the overall crypto market with the high likelihood of a prolonged “crypto winter” for the following months. DAI’s approach to price stability has a number of benefits. First, it allows maintaining the close correspondence between the price stability of DAI without relying on the US dollars directly. By rationally using Ethereum and implementing smart contract algorithms, DAI’s developers can effectively minimize price fluctuations without using fiat money.

Second, DAI allows its holders to formulate more rational expectations about its potential price fluctuations and stability because its collateral of Ethereum equals 150% US dollar value is publicly known. In contrast, other stablecoins that include fiat money collateral such as Tether have a non-uniform quality of their assets, making it more difficult to formulate better-supported expectations. For instance, liquidity problems may affect the ability of other stablecoins to fulfill their functions, while such threats are not applicable to DAI. Third, the reliance on smart contracts and continuous progress in improving their effectiveness contributes to the higher stability and reliability of such solutions. The only risks faced by DAI refer to the possibility of a severe decline in Ethereum’s price. However, such a situation can also be addressed by accumulating additional reserves and temporarily reducing the amount of DAI available in the market. Overall, the presented advantages outweigh any potential risks, thus indicating a high potential for the DAI’s further capitalization growth in the following months.