This article will give UX Designers an understanding of the importance of stablecoins, and show how to mint stablecoins on the highly popular DeFi protocol, MakerDAO. This is part of an overall Web3 Design Bootcamp that teaches UX Designers about Web3 concepts and design patterns so they can land a job in the rapidly merging field.
In the previous section, we swapped ETH for DAI stablecoins on Uniswap, but this is a secondary market for DAI. DAI is quite unique in how it is minted. DAI comes from a DeFi protocol called MakerDAO, where users deposit volatile assets into a Maker vault and then mint DAI stablecoins.
This is known as a collateralized-debt position (CDP), because the user borrows DAI against their collateral, and pays interest (i.e. “stability fee”) on the loan. In the picture above, users open a vault, deposit ETH into the vault, and then take out a DAI loan. The ETH is locked in the vault until users pay back the DAI loan, which is the principal amount plus whatever interest is owed.
MakerDAO requires that the collateral deposit is worth more than the stablecoin loan. This is known as “over-collateralization”, and is necessary when using volatile assets as collateral. For example, let’s say you deposit 1 ETH (worth $3000), and take out $2000-worth of DAI – this makes for a collateralization ratio of 150% (i.e. over-collateralized). If the price of ETH drops by 20% the collateral is now worth $2400, changing the collateralization ratio to 120%. The vault would still be over-collateralized, but could soon be under-collateralized if the price of ETH continues to drop. In fact, in the ETH-B vault pictured above, MakerDAO automatically liquidates the collateral to pay back the DAI loan, and closes out the vault, when the collateralization ratio drops below 130% (i.e. “min collateralization ratio”).
You may wonder what the point of this is. If these vaults need to be over-collateralized, then you’re essentially borrowing with money you already have. Aren’t loans about spending money you don’t have? We may eventually see under-collateralized crypto loans as Web3 matures. At a minimum we would need verified Web3 identities in order to track who has defaulted on their loans and assign credit scores accordingly. But still, for now, there are beneficial use-cases for crypto-collateralized stablecoins.
These stablecoin loans allow users to go long their collateral asset, while unlocking a portion of its value, in the form of DAI stablecoins, which can be used for payment throughout the rest of the Web3 ecosystem.
For example, if I’m bullish on ETH, and believe it will 2x within a year, then I want to continue holding ETH. In fact, I want to accumulate as much ETH as possible, and certainly do not want to swap my ETH for a stablecoin. Swapping ETH for a stablecoin hurts me in two ways. First, it triggers a tax event, and I will have to pay capital gains on my ETH. Second, I lose exposure to ETH’s upside potential during a bull run. Instead, borrowing DAI against my ETH with a Maker vault does not trigger a tax event, allows me to keep ownership of my ETH, while also freeing up liquidity so I can make payments in the meantime.
MakerDAO’s stablecoin, DAI, is decentralized and maintains its peg to the US dollar without reliance on reserves held by centralized entities, like USDT’s Tether and USDC’s Circle. Stable, decentralized assets are an important DeFi building block, and an open area of experimentation, which we’ll see later on.
You can think of MakerDAO as a protocol for self-loans; however, another class of lending protocols exist, like AAVE and Compound, that support peer-to-peer token lending. Lending protocols like these are foundational to DeFi because they establish lending/borrowing interest rates for a variety of tokens. Now, Web3 tokens have a time-value aspect to them, just like risk-free interest rates for fiat currencies in traditional money markets.
If you enjoy videos over reading when it comes to online learning then checkout the course on YouTube. This is part 3 of 10 in the DeFi for UX Designers Course. Also, make sure to stay tuned for future Web3 Design Courses, which will cover emerging Web3 product categories.