DAI explained.

Users lock collateral in the Sky protocol (formerly MakerDAO) and borrow DAI against it. Supply always equals outstanding loans, each backed by more value than was borrowed. The question is not whether an issuer holds the money, but whether collateral suffices and liquidations work.

Ether positions historically require 145 to 170 per cent coverage; prudent users hold far more. Below the minimum the position is auctioned, with a liquidation penalty that keeps borrowers attentive and auctions attractive to bidders.

Three levers: the stability fee borrowers pay, the savings rate holders earn, and the peg stability module allowing one-for-one swaps with USDC — fast and effective, but centralising.

In March 2023 USDC fell to about $0.88 after a US bank failure and DAI followed, because much of its backing was USDC. Backing has since broadened into short-dated Treasuries, which funds the savings rate but adds counterparty risk.

On 12 March 2020 ether nearly halved, the network congested and some auctions cleared at zero, leaving a multi-million shortfall covered by auctioning governance tokens. Auction duration, partial bids, oracle delays and an emergency shutdown were added afterwards.

It suits censorship-resistant use and decentralised applications. As a simple cash position for a European investor it is weaker: it tracks the dollar, carries contract and governance risk, and lacks a MiCA-authorised issuer, so EU trading is restricted.