Seven months back on Reddit, a query was posted asking — Why would someone choose DAI over Tether? Being new to the world of cryptocurrency, I assumed it to be some new cryptos with a new protocol. But interestingly, when I explored, they belonged to an emerging crypto asset class called Stable coins. That’s a contrasting name in Crypto world, where crypto prices fluctuate 10–20% on a single day, prefixing it with Stable is it some kind of joke?
But as they say — Its all in a name! Stable coins were birthed to provide stability to the highly volatile traditional cryptocurrency and hence, the name. Tether and DAI are also used for same purpose of reducing price volatility, but the features and the working differs a lot. Let’s dive into what our analysis says which one is better — Tether or DAI?
One of the oldest Stablecoin that was established in 2014 was named initially as RealCoin that got changed later to Tether. Tether is a crypto asset that offers individuals/organizations to send, store or receive digital token pegged to dollars, yen or euros person-to-person, instantly and in a secured manner.
Backed-up by off-chain collateral, the reason for its inception was to protect its stakeholders from cryptocurrency price volatility by preserving a one-to-one reserve ratio among the crypto token, i.e. tether and its associated fiat currency/real-world asset. It can be redeemed using the Omni layer protocol that is an “overlay network” running on top of the Bitcoin Blockchain.
The configuration of reserving fiat currency for every tether is backed up by Proof Of Reserves and the business custodian “tether Limited” that also handles the conversion of value across the network.
Once a Tether is issued, the user can transfer, store, or spend just like any other cryptocurrency. The fiat currency held in reserve is then transformed, acquiring the properties of a cryptocurrency while having its price stabilized [tethered] to the price of the fiat.
Tether tokens do not have a transaction fee, could be traded/withdrawn in exchanges, and held in a bitcoin wallet. However, Tether Limited, the custodian generates revenues by imposing a small fee on the issuance of new tokens.
Pros of Tether
· Oldest in the Lot -Any technology with its age is enhanced, and Tether has an advantage of that. It has shown the most extended stability and steady track record thereby earning trust from many traders.
· Market Cap Capture — There was a decline in market value share Q4 2018, but as per coinmarketcap it still ranks as at #4 with a market capitalization of Tether 4.12 billion USD. Tether dominates the current stable coin trading volume landscape with a 93% market share.
· Exchange Support — Tether adoption saw a boosting in exchanges that do not offer US dollar customer accounts. Just, e.g., in 2017, Poloneix Exchange became the market leader in exchange because of a rapid increase in Tether volume in mid-2017. If we compare its market capitalization from ~$7million in 2017 to ~$4.1 billion today as depicted in the graph below. The upsurge is mainly driven by traders who use Tether as a hedging and risk management tool. Crypto traders move funds into USDT to reduce the risk faced by cryptocurrency price volatility, in parallel leaving the crypto market and getting them converted into fiat currency.
Concerns/Issues of Tether
· Lack Of Transparency — As Tether reserves a 1:1 ratio of crypto token and associated fiat currency, it has been accused of maintaining a “Fractional reserve.” Lack of transparency regarding its backing has been a significant concern by the traders. Quite recently, in 2018, a third party reported that the company has $2.55 billion of U.S. dollar reserves, held at two separate institutions, to cover $2.54 billion USDT in circulation. However, such audits need to be done in real-time basis to offer transparency to the traders.
· Counterparty and credit risk — As Tether is backed up to a fiat currency, they have to rely on traditional banking systems [ in their case in Taiwan and Puerto Rica], thereby exposing its traders to counterparty and credit risk.
· Lack of clarity of Legal Rights — Tether Limited issued a statement stating — that holding tethers provides no legally enforceable rights for the holder. This raises concerns as to what exactly does Tether offers and what are its legal obligations about redemptions.
· Single Point of Failure — Many believe the tether transactions have too much dependency on Tether Limited thereby minimizing the degree of trust and lower transparency when compared to on-chain collateralized systems.
No matter what the pros and concerns say, Tether still rules the crypto market and has maintained a top-10 position in terms of value. In spite of its reputation, it is embracing regulatory mistakes like registering as a Money Service Business with the FinCEN.
Traders Take on Tether
Traders have trusted Tether on crypto exchanges, and that’s one primary reason for its market dominance. However, the issues and concerns Tether is facing offers an opportunity for other providers to jump in the game with alternative stable coins. Maybe that’s the reason it is market value share has dropped from over 90% to under 70% at present.
While Tether was off-chain fiat-backed stablecoin, DAI is on-chain collateral backed stable coin, backed by Ether cryptocurrency. DAI runs on top of the Ethereum Blockchain has been created by business entity MAKER.
Ethereum blockchain is all about smart contracts, and DAI uses these smart contracts to stabilizes the DAI exchange rate via Collateralized Debt Positions (CDPs) and autonomous feedback mechanisms.
So a user or market traders deposits ETH into the Collateralized Debt Positions (CDPs) via smart contracts, based on the value of the deposited asset DAI is issued. The ETH is held into CDP until the debt [includes interest as well] is paid in full.
How DAI works to stabilize price volatility — CDP’s and Autonomous feedback Mechanism?
In case the value of the collateral is dropping, the DAI system can liquidate CDP’s by auctioning the underlying collateral held by the smart contracts.
The DAI system has a governance token called as MakerDAO[MKR]. Individuals who have the ownership of MKR have governance rights to decide what type of collateral could be held in CDP’s. When traders close their debts, they need to pay a governance/stability fee in the form of MKR that is burned by the DAI system. This helps in reducing the supply of MKR as a direct financial incentive for supporting the DAI ecosystem and holding MKR.
The Autonomous feedback mechanism also helps in stabilizing the Dai price with the following parameters –
1. Target Price — It offers two functions
a. Calculation of collaterals to debt ratios of CDP’s
b. In the case of the global settlement, determining the value of asset deposited into CDP’s
2. Target Rate Feedback Mechanism — One of the crucial processes to maintain DAI market price. When the market is severely unstable, the TRFM gets activated. So what it does is say when the supply is high vs the demand, the prices will see a dip. Now to guard against the volatility, demand has to be increased and reduce the supply. TRFM would increase the Target Rate that leads to an increase in Target price, making DAI more expensive to mint because you are getting less collateral when comparing to the last Target price increase. On the other hand, when demand is high and supply is low, the target rate is dropped leading to a decrease in Target Price. This makes DAI cheaper to mint, and traders create more supply.
3. Sensitivity Parameter — Another parameter that belongs to Maker token holders, as they can set the parameter to stabilize the coin. The sensitivity parameter regulates the magnitude of the Target Rate change in retort to deviations of the DAI market price away from the target price.
4. Global Settlement — This parameter is used in cases like hacking, security breaches, or long term market instability or system upgrades. It is like an emergency window in case of fire exit, to ensure CDP owners and Dao holders to have a claim on the correct value of their holdings.
Pros of DAI
· First Decentralized Stablecoin — First in its category of decentralized, on-chain collateral backed stable coin Dai is in a strong position. The code is also open-source and auditable when compared to other stablecoin projects.
· Governance Decentralized — With its unique design of governance with MKR holders, offering transparency and promoting decentralized governance.
· Framework expansion to other crypto assets — The framework adopted by Dai system is not dependent on any specific asset; based on CDP’s and autonomous mechanism it can be expanded to any other crypto assets without the change in the prototype. This adds an extra advantage for actors to invest and trade.
· Backed up by Stable and skilled development Team — Maker is regarded as a highly-skilled smart contract developer team to roll-out smooth launches at relatively stable pricing. Also, with its open-source platform, it could be easily integrated/build with third parties to expand the advantages of Dai system.
Concerns/Issues of DAI
· Backed-up by one collateral — Currently, only ETH is available to back up DAI. Relying on ETH means all Dai is vulnerable to significant dips in a sole crypto asset’s price, which could lead to a single point of failure risk.
· Complex model — Dai system is a bit complicated when compared to other stablecoins in the market. As for actors working and technical knowledge is of importance, complexity may lead users to misunderstand the Dai system that could also lead to losses.
· More resources needed to produce 1Dai — As per stats to generate 1 Dai, a minimum of $1.50 is required that means an excess capital; while this may be helpful in scenarios during a downturn it is not an efficient way of capital utilization.
· Constraint to Scale — There is an upper limit applied to the supply of Dai, capped by the total amount of collateral, users are willing to put into CDP’s. This limit [i.e. unknown] may lead to the inability to scale when compared to other stablecoins.
Traders Take on DAI
Dai backed by ETH is a decentralized stablecoin does not have counterparty and credit risk when compared to the centralized stablecoins like Tether. Since its launch in Dec’2017, Dai has managed to stay relative to its USD soft-peg. Another boost with its launch of multi-collateral CDP’s will assist in expanding the reach of the coin and allow Dai circulating supply to increase further.
Quick Comparison of Tether and DAI
While both stablecoin serve the same purpose, they differ a lot in the way they work and other parameters like trusted/trustless, automation, etc. Tether has the advantage of being the oldest, while DAI has an advantage of open-source, trusted and decentralized. Tether has counterparty and credit risk, but DAI has an issue with its complex design. So you need to evaluate which one suits your needs, if you are looking for something to shop on Dapps, DAI would be helpful, but Tether can be used in more comprehensive exchanges for trading.