DAI is a stablecoin pegged to the US dollar through overcollateralization and on-chain stabilization mechanisms. It is one of the most popular decentralized stablecoins. This article reviews its origin, purpose, role in DeFi, peg maintenance mechanisms, advantages, and limitations.

Definitions

  • Vault – a smart contract that stores collateral and tracks DAI debt.
  • Collateral – the asset deposited in the Vault to mint DAI.
  • Collateralization Ratio (CR) – collateral value / DAI debt, in %.
  • Liquidation Threshold – the CR level at which a position is considered risky and gets liquidated.
  • Liquidation – the sale of part of the collateral to repay the debt and penalty.
  • Stability Fee – interest charged on DAI debt.
  • DSR (DAI Savings Rate) – yield rate for DAI holders.
  • sDAI – ERC-4626 wrapper token for DAI that automatically earns DSR yield.
  • PSM (Peg Stability Module) – enables near 1:1 swaps between DAI and other stablecoins to stabilize the peg.

Purpose and Goals of DAI

DAI was designed as an on-chain alternative to centralized stablecoins. It is issued against approved collateral, and all parameters are governed by smart contracts and on-chain voting.


Its goal is to provide a convenient on-chain unit of account stable relative to the dollar. DAI is used for payments, liquidity storage, and operations within DeFi protocols. The design evolves over time, but the principle remains: stability through transparent, collateral-based mechanisms.

Peg Maintenance to $1

  • Collateral and thresholds. DAI issuance is performed under collateral of approved assets in Vaults. Each type of collateral has a minimum collateralization ratio, which creates a safety margin relative to DAI debt.
  • Liquidations. If the collateralization falls below the threshold, smart contracts automatically sell the collateral to repay the debt and penalty. This mechanism quickly reduces risky positions and maintains the solvency of the system.
  • PSM (Peg Stability Module). The module allows exchanging approved stablecoins for DAI and back almost 1:1 with a low fee. When DAI is more expensive than $1, arbitrage through PSM increases supply; when cheaper — it stimulates buyback and reduces excessive supply.
  • Rates. The debt commission (stability fee) regulates DAI issuance through borrowing cost, and DSR stimulates demand for holding DAI. The balance of rates helps keep the price around $1.
  • Oracles. Collateral prices come from verified sources. Price updates are used to calculate collateralization and trigger liquidations, linking market movements to risk management.
  • Emergency shutdown. In extreme cases, there is a mechanism for protocol shutdown. DAI holders receive the right to exchange tokens for a share of underlying collateral — this sets the lower price bound.

Example of DAI Minting

Example for better understanding of the issuance process:

Given: deposited collateral 1 ETH at $3,000, minimum CR – 150%.
Issuance: 1,500 DAI → CR = 200%.
Price drops to $2,100 → CR = 140% (below threshold, liquidation risk).
Actions: repay the debt to 1,300 DAI (CR ≈ 162%) or add collateral to raise CR.
Guideline: for volatile assets keep CR 180–200% or higher.

Advantages of DAI

  • On-chain transparency and governance. Issuance under collateral, risk parameters, and rule changes are fixed in smart contracts and visible on-chain — this simplifies audit and control.
  • Stabilization mechanisms. Overcollateralization, liquidations, PSM, and rates create feedback loops that hold the price near $1 even under market volatility.
  • DSR and sDAI. The ability to earn income through DSR and use the sDAI wrapper makes DAI a convenient settlement and savings asset without locking funds.
  • Ecosystem compatibility. Supported by major lending and liquidity protocols, aggregators, and payment solutions — easier capital movement and strategy building.
  • Self-custody and accessibility. No mandatory registration with the issuer — only a wallet is required. Suitable for users and applications in jurisdictions with banking restrictions.
  • Flexible risk management. Adjustable collateralization thresholds, debt limits, and fees by collateral type allow quick system adaptation to market conditions.

Governance and Parameter Changes

  • Who governs – governance token holders vote on risk and economic parameters: collateral types, thresholds, debt limits, fees, PSM and DSR settings.
  • How decisions are made – proposals are submitted for on-chain voting; after approval, parameters are applied by contracts.
  • What is important for users – parameter values change. Before opening or modifying a position, check the values on official protocol dashboards: minimum CR, collateral debt limits, stability fee size, current DSR, and PSM configuration.

Comparison with Alternatives

Criterion DAI USDC USDT
Source of stability On-chain collateral + liquidation and PSM Issuer’s bank reserves Issuer’s bank reserves
Transparency On-chain collateral and parameters visible in network Issuer’s reports Issuer’s reports
Dependence on issuer Distributed parameter management Centralized issuer Centralized issuer
Peg mechanism Arbitrage through PSM, rates, liquidation Redemption/issuance by issuer Redemption/issuance by issuer
Main risk Under-collateralization, price data, contract risk Bank and regulatory risks

Bank and regulatory risks

DAI minimizes dependence on a banking issuer but requires attention to collateral and protocol parameters.

Current Status

DAI remains one of the most used stablecoins in the Ethereum ecosystem and compatible networks. Parameter management occurs through on-chain voting; infrastructure includes Vault, PSM, DSR/sDAI, and integrated protocols. The project develops considering requirements for collateral sustainability and industry compatibility.

FAQ

  1. Why does DAI deviate from $1 by 0.5–1%?

    Changes in supply and demand, arbitration delays, and PSM parameters. Usually short-term fluctuations.

  2. How does DAI differ from sDAI?

    DAI is a settlement stablecoin. sDAI is a wrapper token that automatically earns DSR yield. The price of sDAI increases relative to DAI through accrual.

  3. Where does DSR yield come from?

    From protocol revenues: interest from DAI loans and treasury returns directed to the savings module.

  4. What happens during liquidation?

    Part of the collateral is sold to repay debt and penalty. The remainder is returned to the Vault owner. To avoid liquidation, increase CR.

  5. If I just hold DAI in my wallet, do I risk liquidation?

    No. Liquidation applies only to Vault positions. DAI holders without Vault debt are not subject to liquidation.

  6. Do I need to open a Vault to hold DAI or sDAI?

    No. You can obtain DAI and exchange DAI↔sDAI without opening your own Vault.

  7. How to check current parameters before use?

    See official dashboards and documentation: minimum CR, debt limits, stability fee size, current DSR, and PSM settings by collateral type.

Conclusion

DAI offers an on-chain accounting unit resistant to volatility, relying on collateral and economic incentives. The model has proven effective in real market conditions. When using DAI, it is important to consider the collateral composition, current protocol parameters, and the transition to Sky/USDS.