“The Dai Stablecoin System” is MakerDAO’s founding technical paper, authored by the MakerDAO team (with principal credit to founder Rune Christensen), first published in 2017 and substantially revised for the Multi-Collateral Dai (MCD) upgrade in November 2019. It describes how Dai is created, maintained near a $1 USD peg, and governed — without any central issuer holding reserves.

Dai is the oldest and most widely used decentralized stablecoin. At its peak, Maker had over $20 billion in total value locked and Dai was integrated into essentially every major DeFi protocol. MakerDAO is the paradigmatic example of an overcollateralized stablecoin system.

> PDF hosting: The Dai whitepaper is at makerdao.com/en/whitepaper and the MCD documentation at docs.makerdao.com.

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Publication and Context

Rune Christensen founded MakerDAO in Copenhagen in 2014, one of the earliest Ethereum DeFi projects. The original “Single-Collateral Dai” (using only ETH as collateral) launched in December 2017. Multi-Collateral Dai expanded to accept multiple collateral types in November 2019.

The system is governed by MKR token holders, who vote on:

• Which assets can serve as collateral
• Collateralization ratios per asset
• Stability fees (interest rates)
• Liquidation penalties and auction parameters

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Core Mechanism: Vaults (CDPs)

The Dai creation process uses Vaults (originally called CDPs — Collateralized Debt Positions):

1. User deposits collateral (ETH, WBTC, stETH, USDC, real-world assets, etc.) into a Vault smart contract
2. User mints Dai against that collateral, up to the collateralization ratio limit (e.g., 150% for ETH means $150 of ETH yields at most $100 of Dai)
3. The user now owns Dai (a liability of the Vault) and still economically owns the collateral (minus the debt)
4. User repays Dai + Stability Fee (the interest rate, set by governance) to unlock collateral

Example: User deposits 3 ETH worth $4,500. At 150% min collateralization, they can mint at most 3,000 Dai ($3,000). Their collateralization ratio is $4,500/$3,000 = 150%.

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Peg Maintenance: The $1 Stability Mechanisms

Dai maintains its peg through several mechanisms:

Stability Fee (interest rate):

• Raised → borrowing Dai becomes more expensive → less Dai minted → Dai price rises toward $1
• Lowered → borrowing cheaper → more Dai minted → Dai price falls toward $1

Dai Savings Rate (DSR):

• Dai holders can lock Dai in the DSR contract to earn interest
• Raising the DSR increases demand for holding Dai → Dai price rises
• Funded by the Stability Fee revenue stream

Arbitrage:

• If Dai trades above $1: users open Vaults, mint Dai, sell it on market → price falls
• If Dai trades below $1: users buy cheap Dai, close Vaults (repay debt) → Dai supply shrinks → price rises

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Liquidation System

If collateral value falls and a Vault drops below its liquidation ratio (e.g., 150% for ETH), the Vault is subject to liquidation:

1. Liquidation trigger: Anyone can call the liquidation function on an undercollateralized Vault
2. Collateral auction: The collateral is sold via a Dutch auction (in the MCD system)
3. Dai recovery: The auction raises Dai to repay the Vault’s debt
4. Liquidation penalty: An additional fee (e.g., 13% for ETH) is extracted as a penalty, discouraging under-collateralization
5. Surplus: Any excess collateral is returned to the original Vault owner

If the auction fails to raise enough Dai (collateral dropped too fast — e.g., March 12–13, 2020 “Black Thursday”), the protocol is in deficit.

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MKR Token: Backstop and Governance

MKR serves two functions:

1. Governance: Holders vote on protocol parameters
2. Backstop: If the system accumulates bad debt (undercollateralized Vaults that failed to liquidate), new MKR is minted and auctioned for Dai to recapitalize the system — diluting existing MKR holders

Conversely, when the system runs a surplus (more Stability Fee income than needed), surplus Dai is auctioned for MKR, which is burned — reducing MKR supply.

This “flop” (mint MKR to cover deficit) and “flap” (burn MKR with surplus) mechanism ties MKR value to protocol health.

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Reality Check

MakerDAO has operated since 2017 — a remarkable track record in DeFi. Key incidents:

• Black Thursday (March 12–13, 2020): ETH price crashed 50% in hours; gas congestion prevented timely liquidations; $8.3M in bad debt; Maker emergency-minted MKR to cover it
• USDC as collateral: To maintain the peg during turbulence, Maker accepted USDC (a centralized stablecoin) as the largest single collateral type — making Dai partially dependent on Circle’s compliance decisions
• Real-World Assets: Maker began accepting tokenized real-world assets (US Treasuries, mortgages) as collateral — improving yield but introducing regulatory counterparty risk
• Endgame rebranding: In 2023–2024, Rune proposed “Endgame” — splitting Maker into sub-DAOs and rebranding MKR to SKY and Dai to USDS — a controversial restructuring

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Legacy

MakerDAO created the proof-of-concept for decentralized stablecoins and governed lending. It inspired Aave, Compound, and every lending protocol that followed. The concept of overcollateralized algorithmic stablecoins is the foundation of the “DeFi” category.

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Related Terms

• Dai
• Stablecoin
• Collateralization Ratio
• Aave Whitepaper
• Compound Whitepaper

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Research

• MakerDAO Team. (2017, updated 2019). The Dai Stablecoin System. makerdao.com/whitepaper.

— Primary source. Section 2 (CDP) and Section 3 (liquidations) are the core mechanisms.

• Gudgeon, L., et al. (2020). DeFi Protocols for Loanable Funds: Interest Rates, Liquidity, and Market Efficiency. arXiv:2006.13922.

— Comparative analysis of MakerDAO with Compound and Aave; examines rate dynamics.

• Klages-Mundt, A., et al. (2020). Stablecoins 2.0: Economic Foundations and Risk-Based Models. ACM CCS 2020.

— Academic treatment of Maker’s peg mechanics and liquidation cascade risk.