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Glossary

Collateralized Debt Position (CDP)

November 21, 2023 - Around 3 mins mins to read

A Collateralized Debt Position (CDP) is a crucial component of the MakerDAO ecosystem, which operates on the Ethereum blockchain. MakerDAO is a decentralized autonomous organization that is focused on creating and maintaining a stablecoin called DAI. A stablecoin is a cryptocurrency that aims to maintain a stable value, usually pegged to a fiat currency like the US Dollar.

The concept of a CDP revolves around the idea of locking collateral in a smart contract to generate DAI, the decentralized stablecoin. This system was introduced by the MakerDAO team, and it plays a pivotal role in ensuring the stability and functionality of DAI within the decentralized finance (DeFi) space.

The primary purpose of a CDP is to enable users to access liquidity without the need to sell their assets. By locking collateral, users can generate DAI, which can be used for various purposes such as making payments, investing, or even as a hedge against market volatility. Essentially, CDPs provide an avenue for individuals to leverage their assets and access capital without relinquishing ownership.

When creating a CDP, the user needs to lock collateral that exceeds 150% of the desired DAI amount. This requirement ensures that there is always sufficient collateral to back the generated DAI. In the event that the value of the locked assets falls below the required threshold, the smart contract triggers a liquidation process to maintain the stability of the system.

During liquidation, the smart contract sells the locked assets to repay the outstanding DAI along with a 13% liquidation penalty. Additionally, the user is also liable to pay the current stability fees, which are set at a rate of 8.5% per year. These stability fees are designed to incentivize users to repay their DAI loans promptly and maintain the stability of the DAI ecosystem.

The DAI generated through the CDP process represents a decentralized loan that is backed by the value of the locked collateral. In order to regain access to the locked assets, the user must repay the DAI and stability fees. This repayment process unlocks the collateral, allowing the user to reclaim their assets.

It’s worth noting that initially, only Ether (ETH) could be used as collateral for MakerDAO’s CDPs. However, as the ecosystem evolved, support for other cryptocurrencies has been added. These include tokens such as Basic Attention Token (BAT), USD Coin (USDC), Wrapped Bitcoin (WBTC), TrueUSD (TUSD), Kyber Network Crystal (KNC), 0x (ZRX), and Decentraland (MANA). This expansion of supported collateral assets provides users with more flexibility when creating CDPs.

It’s important to mention that alongside DAI, there is also a decentralized stablecoin called Single-Collateral DAI (SAI). SAI was the original version of DAI and was solely backed by Ether as collateral. However, the MakerDAO community introduced Multi-Collateral DAI (DAI) as an upgrade, which expanded the types of assets that could be used as collateral. Currently, the majority of the circulating DAI is based on the multi-collateral model.

While MakerDAO was the first project to introduce CDPs, it is possible that other decentralized finance projects may adopt CDPs as both a term and a system in the future. The concept of leveraging assets to create stablecoins has gained popularity within the DeFi space, and CDPs have proven to be an effective method for achieving this.

In summary, a Collateralized Debt Position (CDP) is a position created by locking collateral to generate DAI, a decentralized stablecoin. CDPs allow users to access liquidity without selling their assets, while ensuring the stability of the system through collateralization requirements and liquidation mechanisms.

Author

Coincu

Glossary

Collateralized Debt Position (CDP)

A Collateralized Debt Position (CDP) is a crucial component of the MakerDAO ecosystem, which operates on the Ethereum blockchain. MakerDAO is a decentralized autonomous organization that is focused on creating and maintaining a stablecoin called DAI. A stablecoin is a cryptocurrency that aims to maintain a stable value, usually pegged to a fiat currency like the US Dollar.

The concept of a CDP revolves around the idea of locking collateral in a smart contract to generate DAI, the decentralized stablecoin. This system was introduced by the MakerDAO team, and it plays a pivotal role in ensuring the stability and functionality of DAI within the decentralized finance (DeFi) space.

The primary purpose of a CDP is to enable users to access liquidity without the need to sell their assets. By locking collateral, users can generate DAI, which can be used for various purposes such as making payments, investing, or even as a hedge against market volatility. Essentially, CDPs provide an avenue for individuals to leverage their assets and access capital without relinquishing ownership.

When creating a CDP, the user needs to lock collateral that exceeds 150% of the desired DAI amount. This requirement ensures that there is always sufficient collateral to back the generated DAI. In the event that the value of the locked assets falls below the required threshold, the smart contract triggers a liquidation process to maintain the stability of the system.

During liquidation, the smart contract sells the locked assets to repay the outstanding DAI along with a 13% liquidation penalty. Additionally, the user is also liable to pay the current stability fees, which are set at a rate of 8.5% per year. These stability fees are designed to incentivize users to repay their DAI loans promptly and maintain the stability of the DAI ecosystem.

The DAI generated through the CDP process represents a decentralized loan that is backed by the value of the locked collateral. In order to regain access to the locked assets, the user must repay the DAI and stability fees. This repayment process unlocks the collateral, allowing the user to reclaim their assets.

It’s worth noting that initially, only Ether (ETH) could be used as collateral for MakerDAO’s CDPs. However, as the ecosystem evolved, support for other cryptocurrencies has been added. These include tokens such as Basic Attention Token (BAT), USD Coin (USDC), Wrapped Bitcoin (WBTC), TrueUSD (TUSD), Kyber Network Crystal (KNC), 0x (ZRX), and Decentraland (MANA). This expansion of supported collateral assets provides users with more flexibility when creating CDPs.

It’s important to mention that alongside DAI, there is also a decentralized stablecoin called Single-Collateral DAI (SAI). SAI was the original version of DAI and was solely backed by Ether as collateral. However, the MakerDAO community introduced Multi-Collateral DAI (DAI) as an upgrade, which expanded the types of assets that could be used as collateral. Currently, the majority of the circulating DAI is based on the multi-collateral model.

While MakerDAO was the first project to introduce CDPs, it is possible that other decentralized finance projects may adopt CDPs as both a term and a system in the future. The concept of leveraging assets to create stablecoins has gained popularity within the DeFi space, and CDPs have proven to be an effective method for achieving this.

In summary, a Collateralized Debt Position (CDP) is a position created by locking collateral to generate DAI, a decentralized stablecoin. CDPs allow users to access liquidity without selling their assets, while ensuring the stability of the system through collateralization requirements and liquidation mechanisms.

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