Cryptocurrencies are one of the most advanced technologies of this decade and their newest addition, stable coins, are making headlines with their even more advanced features. While stable coins are becoming a hot sector for investor money, knowing how to utilize these blockchains can be very confusing. Although, anyone can simply buy a stable coin, to fully take advantage of its protocols and earn maximum returns requires some input from investors.
The MakerDAO Whitepaper Is A Great Resource But,
It is filled with technical and financial language that can create disarray for anyone outside the industry (I had to read the whitepaper three times before it clicked). Their whitepaper is filled with valuable information. I recommend reading it in order to learn something new, but be warned it is filled with banter like this:
In order to improve the understandability of the MakerDAO Platform, I created this article to break down the different aspects of the MakerDAO Blockchain.
Explaining CDPs In An Easy To Understand Manner
One of the main components of the MakerDAO Blockchain is Collateralized Debt Position. CDP’s allow investors to lock away a fixed amount of ethereum for a given amount of DAI tokens. The investor can then trade DAI tokens for ethereum or other tokens. The investor can reclaim their locked ethereum by returning the initial amount of DAI tokens plus a small interest fee.
What’s the purpose of all these trades?
The entire process of transferring ethereum to dai tokens and back seems quite strange and unnecessary, but CDPs offer a way to make large profits in a bull market. Here’s how:
- Nathan believes ethereum is about to go on a bull run and he locks up 1.5 ethereum in exchange for DAI tokens. The price of ethereum was trading a $500, so Nathan locked up $750 worth of ethereum in total.
- In return for locking up ethereum, Nathan is given 750 DAI tokens from the systems protocol. Nathan can take this DAO and exchange it for ethereum, where he will store it and speculate its price increase.
- If the price of ethereum rises to $1000 per coin, Nathan will make an even larger profit than simply holding, because to claim his locked ether he only needs to return the initial amount of DAI tokens he was given.
- DAI is backed by USD and maintains a price of $1. Since Nathan locked up $750 worth of ethereum and bought $750 more with the DAI Tokens he was given.
- Currently, the ethereum he posses is worth $1500. Since the price of DAI remains at $1, Nathan can spend $750 and purchase the 751 (1% TX Fee) tokens required to reclaim his ethereum. This locked ethereum is worth more than it was when Nathan locked it away.
- In this scenario Nathan made a net profit of $2250, whereas investors simply holding during this time period would have netted $750.
Imagine if someone went to a pawn shop and pawned a necklace for a $100 advance from the pawn show. To get their watch back, this individual would have to pay the pawn show back $125. Let’s say this individual takes the $100 to a casino and turns it into $300. Then, they return to the pawnshop and buyback their watch, while pocketing an extra $175. The individual locked away collateral (watch) and was spotted money that they were able to use to generate more money. I wouldn’t recommend the pawn show approach, but it gives a good example of CDPs.
Now The Risks
While CDPs can lead investors to large profits, they can also lead to large risks. If market conditions are unfavorable and the price of ethereum drops past a certain pre-determined threshold, the MakerDAO system will auction off CDPs to prevent an economic meltdown within the ecosystem. This means investors can lose their entire investments by a major price drop. Make sure before you invest in a CDP that the market is expected to go on a run.