How Is Your Money Safe With Maker (MKR)? A Look Inside the Engine

The mechanism for Target Rate Feedback
The maker uses its Target Rate Feedback Mechanism to control the Dai-USD peg (TRFM). When the market is volatile, the Target Rate specifies the price adjustments required for Dai to achieve the Target Price of $1. For instance, if Dai is selling for less than $1, the TRFM will rise, raising the cost of producing Dai through CDPs as a result of the rise in the price of Dai. As a result of this effect, Dai holders make money, which raises the price of Dai. The price of Dai is being forced back up to its Target Price as a result of the recently increased demand for Dai.

Exogenous market supply and demand dynamics determine the TRFM and Target Rate. However, MKR voters have the power to control the TRFM's Sensitivity Parameter. When the Dai price deviates from $1, the Sensitivity Parameter controls how quickly and how much the TRFM should react. This Sensitivity Parameter makes sure there is enough response time to start a global settlement in the case of a network attack (together with the restrictions decided by MKR voters).

Modul for Peg Stability (PSM)
Users depositing collateral to permissionless vaults at an overcollateralized ratio is the main way MakerDAO generates DAI. The minting method does not, however, provide complete protection from price fluctuations across DEXs and Defi. DAI is pegged to USD by MakerDAO via a combination of open market operations (also known as the Price Stability Mechanism) and interest rate control via the Dai Savings Rate, which is currently 0.01 percent.

A Peg Stability Module (PSM) is another feature of the Maker protocol that enables users to exchange collateral directly for Dai at a fixed rate as opposed to borrowing Dai. Similar to a typical vault, but with stablecoin collateral, the PSM was created. Users who exchange stablecoins for Dai do not pay a stability charge and have a 100% liquidation ratio. Users of PSM borrow Dai rather than maintaining ownership of the asset, which is not the case with conventional vaults. Instead, they directly exchange Dai for the asset. From the standpoint of the user, the PSM is only a DEX for trading stablecoins at the most advantageous rates.

MakerDAO agrees to exchange one unit of USD for one unit of DAI at a 1:1 ratio through the Price Stability Mechanism, allowing arbitrageurs to profit if DAI rises beyond the peg. By weakening the available supply, this computational strategy seeks to tame any excessive demand for DAI. The tactic worked well at controlling the upside of DAI concerning the peg, while the downside is mostly controlled by over-collateralization.

When Dai demand exceeds Dai supply, the PSM was created to help keep the Dai peg near $1. A PSM and a conventional vault further vary in that a PSM enables Governance to receive fees on stablecoins at the time of the swap rather than over time. Another distinction is that the stablecoins that users deposit into the PSM as collateral are distributed throughout a single large liquidity pool, i.e. there are no segregated vaults. The PSM reserves are a part of this pool. In the Maker Protocol, a PSM is essentially just a stablecoin vault type, and all the restrictions that apply to vault types also apply to PSMs.

The PSM has various benefits, including:

more stability as a result of the immediate arbitrage opportunity created by the price difference between Dai and the collateral type underpinning the PSM
Fees are paid in advance.
A PSM attracts and executes substantially higher volume than vaults since it has no slippage (stablecoin to stablecoin).
The system must get real-time market pricing information from oracles for Maker to alter the Target Rate as necessary. Oracles and Global Settlers are non-native to the platform and are outsider actors. Keepers are yet another significant external player in the Maker ecosystem. Keepers are autonomous organizations that are encouraged to participate in the Maker system by lucrative chances. When Dai deviates from the forecast, Keepers can also benefit by trading Dai and arbitraging the spread.

Being an Ethereum dApp, the MakerDAO protocol is impacted by blockchain latency. With a network capacity of 25 transactions per second, Ethereum's blockchain currently has a block time of 12 seconds. Because Dai is an ERC-20 token that was created on the Ethereum blockchain and now resides there, Ethereum serves as the foundation for consensus.

Liquidations
When the loan-to-value (LTV) ratio exceeds the predetermined threshold, the process of liquidation is initiated, whereby collateral is sold to pay for the amount of Dai a user has minted from their Vault. Closing out Vaults that fall below their minimum needed Collateralization Ratio, makes sure that Dai is always backed by an adequate amount of collateral (in USD terms). The protocol automatically initiates liquidations when it sells or auctions off enough collateral.

Maker released Liquidations 2.0 in May 2021 after discovering flaws in its previous liquidation technique. Anyone may participate in the auction that makes up the liquidation, and those that place bids are known as Auction Keepers. They are outside parties who have financial incentives to automate specific Ethereum blockchain processes. Liquidation penalties revenue is used to fund surplus auctions, which sell burned MKR.

Since that time, no Dutch auction is used to manage liquidations. In a Dutch auction, the price of the collateral starts high and steadily drops until a bidder accepts it. The collateral continues to be discounted until the auction or up to a predetermined maximum if no buyer is present.