Decentralized Stablecoins: How DAI Works and Its Key Risks

DAI is one of the best-known assets in the development of decentralized stablecoins. Its core mechanisms include collateral, smart contracts, liquidation, stability fees, and peg-management tools. Since MakerDAO upgraded to Sky in 2024 and introduced new assets such as USDS, DAI can no longer be understood simply as “a stablecoin fully overcollateralized by ETH.” Understanding how DAI works today requires looking at on-chain collateral, centralized stable assets, real-world assets, and governance risk together.

How Does DAI Maintain Stability Without a Centralized Issuer?

DAI’s original design centered on generating stablecoins through collateralized positions in the Maker Protocol. Users lock eligible assets into Vaults and generate DAI according to the collateral type, collateralization ratio, and other protocol risk parameters.

For volatile assets such as ETH, the system generally requires overcollateralization. If the value of the collateral falls and a position drops below the required liquidation ratio, the protocol can initiate liquidation and sell the collateral to repay the associated debt. In addition to collateral and liquidation, the DAI mechanism uses tools such as the Stability Fee, Dai Savings Rate, and Peg Stability Module to influence supply, demand, and market arbitrage. The PSM allows DAI to be exchanged with certain U.S. dollar stable assets under protocol-defined rules and has been an important mechanism for supporting the short-term price peg.

After MakerDAO Upgraded to Sky, Is DAI Still Fully Decentralized?

MakerDAO upgraded to the Sky Ecosystem in 2024 and introduced USDS as an upgraded version of DAI. By 2026, SKY had replaced MKR as the governance token of the Sky Protocol, while USDS and sUSDS had also become important assets within the new ecosystem.

This does not mean that DAI immediately disappeared, but discussions of the DAI mechanism now need to account for how the protocol has evolved beyond the original Maker era.

DAI originally emphasized overcollateralization with crypto assets. As the ecosystem expanded, however, its stability framework incorporated stablecoins, real-world assets, and other yield-generating positions. As a result, the term “decentralized stablecoin” does not mean that every asset, service, or dependency in the system is fully decentralized.

DAI reduces direct reliance on a single traditional stablecoin issuer, but some peg-management tools, collateral assets, price oracles, and governance mechanisms still involve different forms of trust. This is a more accurate description of the current architecture than saying that “DAI can never be frozen” or is “completely immune to centralized risks.”

What Are the Biggest Risks of DAI?

1. Collateral and liquidation risk. If collateral such as ETH falls sharply, many Vaults may trigger liquidation at the same time. If the blockchain is congested, market liquidity is limited, or collateral prices move too quickly, actual liquidation outcomes may be worse than expected.

2. Protocol and governance risk. Stability fees, collateral eligibility, debt ceilings, and liquidation parameters require ongoing governance decisions. Smart contract vulnerabilities, oracle failures, or governance attacks may also affect protocol operations. Sky continues to maintain security mechanisms designed to address liquidation and governance-related risks.

3. External asset risk. As centralized stable assets and real-world assets become part of the system, issuer, custodian, and regulatory events may indirectly affect DAI.

DAI’s advantage is therefore not that it “eliminates all centralized risk,” but that it redistributes the sources of stablecoin risk through an on-chain framework of smart contracts, collateral, and governance.

FAQ

• What is the main difference between DAI and USDT?
  USDT is primarily issued by a centralized company that manages reserve assets, while DAI mainly operates through protocol collateral, smart contracts, and governance. However, the DAI ecosystem may also have exposure to centralized stable assets and real-world assets.

• Does DAI always require 150% collateralization?
  No. Different Vaults and collateral assets have different liquidation ratios, so there is no universal 150% collateral requirement for every DAI position.

• How is MakerDAO different today?
  Maker upgraded to the Sky Ecosystem in 2024. USDS is positioned as the upgraded version of DAI, while SKY has become the governance token of the Sky Protocol.

• Can DAI depeg?
  Yes. Sharp declines in collateral value, insufficient liquidity, failure of peg-management tools, external stablecoin events, or governance risks could cause DAI to temporarily or persistently deviate from its target price.

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Further Readings:

Complete Guide to Stablecoins: The Differences Between USDT, USDC, and DAI

USDC vs. USDT: Which Is Safer?

The Rise and Collapse of Algorithmic Stablecoins: Lessons From UST

Yield-Bearing Stablecoins: The Next Generation of sDAI, USDe, and More

Stablecoin Regulation and Future Trends