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What is Dai and is it allowed?


Dai is the 12th most popular cryptocurrency and the 4th most popular stablecoin in the cryptocurrency space.

As a stablecoin, the value of DAI is pegged to the US dollar on a 1:1 basis, meaning 1 DAI is worth $1. Unlike most other stablecoins, DAI is completely open-source, decentralised, and is an algorithmic stablecoin based on the famous Ethereum blockchain.

While buying the DAI token on an exchange may be considered halal, people should proceed with caution when getting involved in the DAI ecosystem.

Let’s take a look at DAI and whether it is halal.

What is a stablecoin?

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A stablecoin is a cryptocurrency that is pegged to a traditional asset or currency with a stable price, such as a fiat currency or commodity. Stablecoins are meant to provide calm in the usual storm of crypto-volatility because they are pegged to these more established assets and currencies. This allows crypto investors to diversify their volatile crypto portfolios and also use cryptocurrencies as they would fiat.

There are three types of stablecoin:

  1. Crypto-backed
  2. Fiat-backed
  3. Algorithmic

Crypto-backed stablecoins over-collateralise their tokens to mitigate crypto-volatility. Fiat-backed stablecoins maintain their prices by being backed by reserves of fiat that can be exchanged for the token. Algorithmic stablecoins maintain their pegs through automated algorithms that control supply without reserves or collateral.

Stablecoins are the most potentially mainstream technologies in the crypto space and have the power to accelerate traditional finance into the crypto age. Governments and authorities are increasingly looking into stablecoin regulation, with the Bank of England looking into creating its own pound sterling stablecoin.

What is DAI?

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DAI is a decentralised, open-source ERC-20 stablecoin that is pegged to the value of the US dollar. It is produced by an open-source software called the Maker Protocol, which is a decentralised application built on the Ethereum blockchain. DAI’s value is maintained through the use of smart contracts and a system of collateralised debt positions (denominated in ETH). 

MakerDAO was founded in 2015 by CEO Rune Christensen, whilst the Maker Protocol was launched in 2017.

The goal of DAI is to provide a stable, digital currency that can be used for transactions on the Ethereum network without the need for a central authority. Because it is pegged to the dollar, its value remains stable unlike other cryptocurrencies that can be subject to large fluctuations in value.

How does DAI work technically?

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When people want to secure a loan, the lender will want to have some level of assurance that they will get their money back. This usually involves some assessment to show that the borrower is financially stable and has a good history of paying lenders back.

Another way to offer assurance to lenders is to hand over a valuable asset as a guarantee that you will pay back the money. The lender is satisfied because in the event of non-payment, they can simply seize the asset and sell it to recoup the amount the borrower owed them. Thus, the borrower secures a loan by offering an asset in return, the ‘collateral’.

Of course, from a Sharia perspective, these would involve riba and thus be impermissible. But this concept is important to understand how DAI is created.

The Maker Protocol allows users to offer their ETH as collateral to generate new DAI tokens in the form of loans. So users essentially create DAI tokens as a loan through locking their ETH.

As of November 2019, users can also offer several other cryptocurrencies as collateral such as USD Coin (USDC) and wrapped Bitcoin (wBTC).

This system of users locking in collateral means DAI is probably the most decentralised stablecoin that exists. Instead of organisations holding reserves of cash and fiat to back their stablecoin, such as USDC or BUSD, millions of users form the collateral on which DAI rests. There is no one entity that controls DAI.

Any user who then wishes to recover their ETH (or other cryptocurrency) that they offered as collateral must pay back the DAI they borrowed in full, plus a fee. Of course, just as in the case of loans in the traditional finance world, in the case of non-payment the Maker Protocol can seize the locked ETH and sell them on an internal market-based auction system.

From a Sharia perspective, it is important to note that DAI holders can often earn interest on their DAI holdings. Even popular centralised cryptocurrency exchanges like Coinbase allow holders of DAI to earn interest which they call ‘rewards’. This would of course be impermissible so potential investors in DAI should refrain from being involved in any Riba.

The DAI savings rate (DSR, which is the interest rate) is set by those who hold the MakerDAO’s native governance token: MKR. These holders of MKR are guarantors of the entire DAI system. If the system were to crash, they could liquidate their MKR tokens, thus incentivising them to maintain the DAI system.

What are the use cases of DAI?

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Stability and and avoiding volatility

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Liquidity is an important asset for any investor, and especially traders. Liquidity can be especially important during downturns to quickly exit your position.

Cryptocurrency markets are some of the most volatile markets that exist so there is a dire need for quickly converting positions into stable assets to ride out the volatility.

Without stablecoins, crypto investors would be forced to exit their crypto positions by selling their cryptocurrency and withdrawing the value into their bank accounts to convert it into the safety and stability of fiat currency. This process brings with it delays and withdrawal fees, eating into your funds.

By bringing fiat-like stability to the blockchain, DAI allows people to swap their existing crypto positions into a fiat equivalent without incurring massive withdrawal fees.

Arbitrage

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Arbitrage traders can make a profit off of buying and selling DAI coins in large quantities and selling them in short time periods. Even a drop in value of one-tenth of a cent provides opportunities for arbitrage traders. If DAI falls to $0.99 briefly, buying a large quantity and then converting it to fiat allows handsome profits if executed correctly. The 1:1 peg is naturally restored through the forces of supply and demand.

Are people using DAI right now?

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DAI initially had a daily transaction volume under $100 million, and sometimes even under $10 million. Whilst this seems like a big number, in the crypto world it is negligible.

In 2020 the daily transaction volume started to pick up into the hundreds of millions territory and even hitting the $1 billion mark in late 2020. This stayed consistent with the low billions being the new norm for DAI in 2021. 

Throughout 2022, DAI has increased in popularity with daily transaction volume hovering between $5-10 billion and sometimes reaching $15 billion.

What are the strengths and weaknesses of DAI?

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Strengths

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  • Unlike other stablecoins, DAI is truly decentralised in that no one corporation or organisation controls it. DAI is fully user-backed and the MKR protocol is held by countless users who are incentivised to keep DAI alive.
  • DAI and stablecoins like it are especially useful for traders who buy and sell cryptocurrencies regularly. When traders exit their positions, they can instantly swap to DAI to safeguard themselves against downturns in the markets, mitigate the volatility, and avoid withdrawal fees and withdrawal times.
  • Over the past few years and over massive market corrections, DAI has held steady and has kept its peg to the US dollar. This track record, in addition to being decentralised, gives users some confidence in DAI’s ability to stay afloat.

Weaknesses

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  • Whilst DAI takes the 12th spot in the crypto space and is the fourth most popular stablecoin, it faces intense competition from more established stablecoins such as USDT, USDC, and BUSD.
  • DAI does not provide price appreciation and returns since it is simply pegged to the US dollar.
  • Since DAI is pegged to the US dollar, it is completely vulnerable to inflation. With inflation now running in higher numbers in current economic conditions, this can be a problem when holding DAI for the medium to long-term.
  • Participating in the DAI ecosystem and even holding DAI can be problematic for Muslims since interest can be involved.

Is DAI a good investment?

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DAI is a stablecoin the value of which is pegged to the US dollar. It is not an investment like other cryptocurrencies and is simply like purchasing a US dollar equivalent. Because it is just like holding cash, holding DAI means you are as vulnerable to inflation as holding US dollars. There are no ‘returns’ in holding DAI.

The price of DAI sits at $1.

DAI has been able to maintain its peg to the US dollar consistently. Its lowest low was a couple of years ago to 97 cents during the market crash of 2020.

DAI is the 12th largest cryptocurrency in the world, and the 4th largest stablecoin in the world behind only Tether, USD coin and Binance USD. It has a market capitalisation of just under $6 billion and a market dominance of 0.69%.

DAI is available on all major cryptocurrency exchanges including Coinbase and Binance.

DAI provides liquidity in your crypto portfolio and crypto wallet and can be a good means for quickly getting into and out of positions instead of selling your positions, converting to fiat, and incurring withdrawal fees. Though especially for Muslims, it may be more prudent to hold the more established stablecoins which avoid the issue of interest that holders of DAI can be exposed to.

Alternatives to DAI

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Tether (USDT)

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Tether (USDT) is the largest stablecoin, taking the number 3 spot in the whole crypto space by market capitalisation. 

Issued by Hong Kong based company Tether, it maintains its peg to the US dollar using reserves of cash, treasury bills, fiduciary deposits, and commercial paper. The USDT token has retained its stability amid the Terra collapse and the bear market, consistently trading at $1.

Tether is DAI’s biggest competitor since it is not only more established, but has a bigger market capitalisation.

USD Coin (USDC)

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Coming in at rank number 4, USD Coin is another stablecoin that has proved itself as a viable alternative to DAI. It has consistently maintained its peg to the dollar, and has a market capitalisation of $54 billion with a market dominance of just under 6%.

USDC was founded by a consortium that includes the popular exchange Coinbase. Its 1:1 value ratio of the dollar is backed by actual dollars (in the form of cash and treasury bonds), and it claims that USDC is issued by regulated financial institutions.

It saw large amounts of capital influx from investors fleeing the Terra ecosystem.

Binance USD (BUSD)

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BUSD is the sixth most popular cryptocurrency in the world and the third most popular stablecoin, behind only Tether’s USDT and Centre’s USD Coin.

BUSD is a regulated, fiat-backed stablecoin, meaning it holds its peg to the US dollar through holding reserves of actual fiat currency. The BUSD stablecoin was launched and issued in September 2019 by one of the most popular cryptocurrency exchanges in the world, Binance, in partnership with the FinTech company Paxos which specialises in blockchain technology. 

DAI faces massive competition from BUSD, especially since the latter is founded and backed by the most popular name in crypto: Binance.

Is DAI halal?

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DAI in and of itself may be deemed halal, but issues arise when being involved in the DAI ecosystem as explained above and receiving interest on DAI, which is categorically impermissible.

The essence of the debate on whether cryptocurrencies in and of themselves are halal comes down to whether they are ‘Māl’ as we have explained previously. Māl is something that can be acquired, whether it be an item or a service.

There are three stances on cryptocurrencies today:

  1. Cryptocurrency is not Māl, rather it is a speculative, non-Sharia-compliant investment.
  2. Cryptocurrency is a digital asset but not a currency.
  3. Cryptocurrency is a digital currency.

Proponents of view (1) argue that cryptocurrencies are not Sharia-compliant since they have no intrinsic value and are merely entries on a digital ledger.

Our view has always been that (1) does not seem right since cryptocurrencies have value as millions of people are willing to buy, hold, and trade them. They are just as real as fiat currency today which mostly exists in the spreadsheets of banks. Our monetary system became predominantly digital a while ago.

View (2) seems to be the most realistic view, as cryptocurrencies are a new and emerging technology that are yet to mature into fully fledged currencies used by economies at large. However, in practice, there is no real difference for casual users between (2) and (3) since they both consider trading cryptocurrencies to be permissible.

Zakat is due on DAI like any other currency. Zakat will be relatively simple to calculate since it is simply like holding US dollars. Read our Zakat on crypto guide for a good explanation.

You should be careful when it comes to trading currencies for currencies. DAI and the wider cryptocurrency ecosystem allow for forex trading on certain platforms. Forex can be a dangerous game which we advise against and which most scholars hold to be impermissible. Read our comprehensive fatwa collection on forex trading.

Locking in your cryptocurrency allows you to borrow DAI, which then must be returned with the addition of a fee. This is how DAI is created by the Maker Protocol. This is problematic as you are essentially paying a surplus value to borrow DAI and so should not be dabbled in.

Likewise, most crypto exchanges offer interest to holders of DAI in accordance with the DAI Savings Rate (DSR). This is also impermissible so investors should do their research before buying and holding DAI. Of course, various, arguably better, alternative stablecoins exist should a Muslim need to buy stablecoins.

Conclusion

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Holding the title as the most decentralised stablecoin and taking on juggernauts like Binance is a massive undertaking, and DAI is a reliable competitor.

Merging the benefits of fiat currencies with the ecosystem and technology of blockchain has brought innumerable benefits to crypto investors.

Of course, for Muslims potential problems arise when Riba is involved, which can easily be the case with DAI so investors beware.

We’ve written a whole guide on how to invest in crypto the Islamic way, check that out for a good walkthrough on how to actually begin investing.

Sources


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