Dai simplified
Cryptocurrencies are famous for their volatility (dramatic change in prices). Bitcoin jumping from $100 to $1000 and back to $230, or Ether, the main currency of Ethereum, has seen its prices jump between $1 and $2 since its launch.
Ethereum provides a mechanism to execute smart contracts on its blockchain, this could be your will or the payment of a service provider as demonstrated by IBM and Samsung (link to demo). Holding cryptocurrency for a long period can be a great risk due to its volatility (you don’t know what value is going to have in 1 month, year, ..). Hence the need for an stable currency.
The dai is a token in the ethereum blockchain, rather like bitcoin, but whose value is pegged or kept in line to the USD (1 dai = 1 USD). Because the dai is created and stored in Ethereum, any user or contract can use it to store its value, also this way contracts can automate payments or store a reserve in a equivalent to USD.
Creating the dai
Dai cannot appear out of thin air, they need a form of collateral to back their value.
Each dai that is created needs to be backed up by an asset with at least 150% of its value. An asset could be BTC, Ether, gold, etc.
For example to create dai with BTC worth $150, the BTC will be locked and 100 dai ($100) will be created.
Why at least 150%? The value of BTC can go up and down, there is a risk that the dai will not have enough collateral to keep its value.
The value of the collateral could go down below 145% of the dai created, in this situation the issuer will need to cover it (buy 100 dai back to get back the collateral) or another entity could do it, to get a % bonus of the collateral above of the $100. This enforces the issuer to always have enough collateral, or somebody will get a percentage of their collateral.
In extreme scenarios, when nobody does cover a collateral, the system will do it automatically using its reserve funds.
Creating / issuing dai, is a simple way to get a loan.
At least 150% of collateral, prices going down, so what is the incentive?.
When you create / issue dai you are effectively getting a loan.
Imagine you have $150 of Ether tokens, and BTC price is going up. You don’t want to sell your Ether as you want to hold it as a long investment.
You can issue $100 dai using the $150 dollars as collateral and sell them straight away for $100 worth of BTC.
Time passes (minutes, days) and the price of BTC has gone up, now you have $200 worth of BTC. You can then sell your BTC to pay back the $100 dai plus interest.
Obviously there is a risk that both the value of BTC or Ether go down.
Interest can be up to 1% a day and is paid proportionally on each block, the interest is calculated based on the supply / demand, to ensure the value of the dai is always 1 dollar.
Holding dai pays a yield
What is the incentive of holding dai?
Holding dai will provide you a yield on the interest collected for issuing dai. Effectively you are lending to create the dai and get an interest.
You could hold dai by just leaving it on your wallet, or use it to finance smart contracts. For example Samsung, could be earning interest on the reserve kept to automate payment to engineers.
The combination of assets as a collateral, together with the interest and yield provides more liquidity
In the previous example, Ether was used for collateral to gain some BTC. Obviously this is not always going to be the case, but the capability of using different assets for collateral and markets allows for a diversity of lending / borrowing scenarios.
Why is this good? If we combine these many trading scenarios together with the interest and yield, it provides an incentive for a continuous trading (buy and sell volume). This way you will be able to find always a buyer or a seller for dai.