Dai (DAI)

Dai (DAI): How the Collateralized Stablecoin Works Inside the Sky Protocol

Dai is an Ethereum-based stablecoin issued through the Sky Protocol, formerly associated with MakerDAO. Its design combines collateralized borrowing, oracle-controlled risk parameters, liquidation auctions, and governance-set system controls. DAI also remains exchangeable with Sky’s newer USDS token through an official converter.

DAI’s place in the Sky system

DAI is the external ERC-20 representation of a unit recorded inside the Sky Protocol’s core accounting system. The protocol documentation distinguishes between the user-facing Dai contract and internal balances held in the core system, with DaiJoin adapters handling movement between internal accounting and the wallet-compatible token. This means DAI is not simply a standalone token contract: its issuance and redemption depend on the surrounding protocol contracts that account for collateral, debt, and system surplus.

The Ethereum DAI contract is verified on Etherscan and uses 18 decimals. Its contract includes standard transfer functions alongside permit-based approvals, allowing a user to authorize spending with a signed message rather than submitting a separate approval transaction. That feature can reduce the number of transactions required by applications, but it does not remove the need to review the spender and the signed message carefully.

Vaults create DAI against approved collateral

The core issuance model uses collateralized Vaults. Users deposit approved assets through adapter contracts, draw DAI against the collateral, and later repay the debt to recover the locked assets. The protocol is designed to be token-agnostic at its core, while adapters standardize the behavior of different collateral tokens before they enter the accounting system. Governance determines which collateral types can be used and sets parameters such as debt ceilings, collateralization requirements, fees, and liquidation penalties.

Price feeds are a necessary dependency because the system must estimate the value of collateral and determine when a Vault is no longer sufficiently collateralized. The codebase describes price feeds as a critical part of the system, while the liquidation documentation explains that auction prices begin from readings supplied through the Oracle Security Module. These dependencies mean DAI’s stability is linked not only to collateral markets, but also to oracle availability, update timing, and governance decisions about acceptable risk.

Liquidation is the main backstop for bad debt

When a Vault falls below its required collateralization level, the Dog liquidation contract can transfer the position’s collateral to the protocol and start an auction. The Clipper auction then attempts to sell that collateral for DAI, covering the Vault’s debt, stability fees, and liquidation penalty. Liquidation 2.0 uses Dutch auctions whose prices change over time and can settle purchases without requiring bidders to keep capital locked while waiting for other bids.

The system also limits how much debt can be sent to active auctions at once. Global and per-collateral limits, described as Hole and ilk.hole parameters, constrain the amount of DAI that auctions may need to raise. These controls are intended to account for available market depth, but they also create a practical dependency on auction participation and liquidity during stressed market conditions. If collateral cannot be sold efficiently, the protocol can still face bad debt even though liquidation has been triggered.

DAI and USDS now coexist

Sky’s current documentation describes a one-to-one DAI-to-USDS converter on Ethereum. Holders can convert between the two tokens without a fee, and the protocol’s token-route documentation says both tokens are linked to the same issuance source. This gives DAI holders a path into the newer USDS format without relying on an external exchange or secondary-market liquidity.

The distinction matters because new Sky products are generally documented around USDS rather than DAI. For example, the Sky Savings Rate is attached to USDS through the sUSDS savings token, while DAI remains the legacy stablecoin representation supported by the converter and existing integrations. DAI therefore continues to function as a payment, trading, and DeFi asset, but its position in the wider ecosystem should be assessed alongside the migration toward USDS-based products.

Governance controls the risk parameters

DAI does not have a separate governance token that independently controls its monetary policy. The broader Sky governance system sets protocol parameters, including collateral rules, borrowing rates, debt ceilings, rewards, and other operational settings. The governance portal describes a process in which proposals are discussed in the public forum before moving to on-chain polls and executive votes. Current governance is centered on SKY, following the transition from the earlier MKR-based structure.

This governance structure is a functional dependency for DAI users. A vote can change the cost of borrowing, the assets accepted as collateral, liquidation settings, or the treatment of protocol surplus. Governance can also introduce upgrades that require new adapters or alter compatibility with existing integrations. The protocol’s own documentation therefore treats governance concentration, upgrade execution, and parameter changes as material operating risks rather than as background administrative details.

Who uses DAI, and what to check

DAI is intended for users and applications that need a blockchain-native dollar unit without holding a direct claim on a bank account. Borrowers can use it as debt raised against collateral, while traders, lending markets, payment applications, and other DeFi contracts can use the ERC-20 token as a transferable settlement asset. Its usefulness depends on continued exchange liquidity, reliable collateral management, oracle operation, and support from the applications that integrate the token.

The main practical questions are not limited to whether DAI trades near one dollar. Users should also examine the collateral mix, governance-set parameters, converter and contract addresses, network fees, approval permissions, and the liquidity available for the intended transaction. Sky’s risk documentation warns that smart-contract defects, oracle or blockchain failures, governance attacks, liquidity constraints, regulatory changes, and stablecoin de-pegging can all produce losses. DAI’s collateralized design reduces reliance on a single issuer, but it does not eliminate system, market, or governance risk.

Key takeaways

• DAI is the wallet-facing ERC-20 representation of debt recorded in the Sky Protocol’s internal accounting system.
• New DAI is created through collateralized Vaults, with approved assets, oracle data, and governance-set risk parameters determining how much can be issued.
• Undercollateralized positions can be liquidated through Dutch auctions that sell collateral for DAI.
• DAI can be converted one-to-one with USDS through an official Ethereum converter with no conversion fee documented on the route.
• SKY governance controls key parameters affecting DAI, including collateral onboarding, borrowing costs, debt ceilings, and liquidation settings.
• DAI’s main dependencies include collateral markets, oracle infrastructure, auction liquidity, smart contracts, Ethereum, and governance execution.

Risks and open questions

• A severe collateral price decline, oracle failure, or auction-liquidity shortfall could create bad debt or weaken the peg.
• Governance can change collateral rules, fees, debt ceilings, liquidation settings, or upgrade paths, creating risks for users and integrators.
• DAI’s coexistence with USDS may create integration, liquidity, and user-experience differences across applications that support one token but not the other.
• The DAI contract’s unlimited-approval behavior can expose users to larger losses if they approve a malicious or compromised spender.
• Ethereum congestion, transaction failures, or high gas costs can interfere with time-sensitive actions such as repayment, collateral management, or liquidation avoidance.
• Regulatory changes may affect access to interfaces, DeFi services, stablecoin integrations, or particular collateral types.