The Dai Savings Rate (DSR) is a Dai deposits (DAI) interest rate. To comprehend the DSR and its risks and rewards, one must first understand Dai.
Dai, launched in January 2018, was the first stablecoin built on Ethereum. Instead of bank deposits, Dai would employ a governance mechanism to keep the US Dollar pegged. Participants could vote to increase or decrease Dai supply, depending on whether the price was too high or low. According to supply-side economics, increasing supply lowers the cost, while reducing supply raises it.
This method allowed Dai to keep its peg despite the market meltdown in January 2018 and the subsequent volatility.
Before fully grasping the Dai Savings Rate, we must first catch another Dai construct.
MakerDAO is the governance system that determines outcomes like those mentioned above (increasing or reducing the supply of Dai to maintain the one dollar peg). The DAO (decentralized autonomous organization) is supported by a second token, MKR, whose value fluctuates but is utilized to keep DAI steady.
Anyone who wants to borrow Dai from the system can issue it. To borrow (issue) Dai, a user must deposit collateral (Ether) in the system. The Stability Fee is the interest rate applied to this new Dai.
A higher Stability Fee would deter users from borrowing Dai because it would be more costly. Fewer borrowers would be more likely to pay back their loans, putting the borrowed Dai into the contract and taking it out of circulation. A lower Stability Fee would encourage users to deposit ETH and borrow (issue) Dai at a cheaper rate.
One of the most common uses of borrowed Dai is to invest it in Ether, hoping that the price of ETH will rise faster than the cost of borrowing (Stability Fee).
The Preservation of DAI-USD Peg
The MakerDAO system upgraded in November 2019. The upgrade added new ideas, including the Dai Savings Rate, which applies to all Dai put in a smart contract. MakerDAO vote determines the interest rate and pays from the Stability Fee money.
We have just seen how the Stability Fee can control Dai supply and keep the DAI-USD peg. Similarly, the Dai Savings Rate can influence Dai demand and maintain the DAI-USD peg.
With this explanation, it should be more apparent how the Stability Fee can preserve the DAI-USD peg organically.
The Maker Foundation first polls MKR token holders to determine the Dai Savings Rate. The poll asks for feedback on many risk metrics, including the DSR. It can influence an “Executive Vote” that, if MKR token holders passed, implements the modifications voted on.
To leverage one’s ETH position, users borrow Dai, pay the Stability Fee, then buy more ETH (and possibly even repeat the process). It means that the Stability Fee (and thus the DSR) can rise when confidence in future ETH price hikes grows. As ETH confidence diminishes, users are less likely to leverage their position, and the Stability Fee (together with the DSR) must fall to maintain the peg.
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