Want to Know the Difference Between USDL and Dai? (Here It Is!)

As the key coin fueling the MakerDAO platform, DAI is an algorithmic stablecoin that derives its peg from the basket of other digital assets. Over the past years, it has gained a reputation as a much more secure and efficient asset than fiat-backed stablecoins such as USDT and USDC.

Yet, it has some downsides as well. Read on to find out how USDL addresses these problems and what kind of solutions it offers to beat its key rival.

1. Capital efficiency

DAI requires a 150% collateral

To borrow DAI, a user has to provide 150% worth of collateral. This means that you have to lock the sum which is 1.5 times higher than the sum you get at hand.

This is not a very efficient way of using your funds. The sum that has to stay idle significantly exceeds the money you get at hand.

USDL requires only a 110% collateral

Unlike DAI, Liquid Loans requires borrowers to place only 110% collateral.

One may say that a lower collateral ratio means higher risk. As the system has fewer reserves, this may result in unexpected liquidations at any time.

Yet, there is a nice and neat solution. 

To address this question, Liquid Loans has implemented an instant liquidation mechanism that we will discuss in detail below.

2. Liquidation mechanism

MakerDAO features auction-based liquidations

To perform liquidations, MakerDAO relies on an auction-based mechanism. If the collateral in some pool drops in value and the debt becomes undercollateralized, other users can place their bids to buy out this position. 

This approach usually requires some time (usually up to a few hours) as the system needs to find the buyers for the collateral.

However, even these few hours may play a crucial role when the market is particularly volatile. In such circumstances, the price of ETH or other assets involved in the collateral may drop significantly. Thus, Maker needs an additional buffer to cover this liquidation price and, therefore, requires a higher collateral ratio.

Liquid Loans enables instant liquidations

Liquid Loans, on the contrary, implements an instant liquidation mechanism. This method makes it possible to liquidate a position as soon as the collateral value drops below a specific level. 

To determine the current price of PLS, the platform relies on the Fetch oracle. It constantly monitors the network and sends this data to the liquidators’ bots. The bots, in turn, launch the liquidating function when the price reaches a specific level. 

The whole process needs only as much time as the network does to process these transactions. On average, Ethereum requires from 30 seconds to 5 minutes for that which is much lower compared to MakerDAO. 

As a result, Liquid Loans doesn’t need such a large collateral. At the same time, the loans get liquidated just slightly below 110% since the oracle enables to finalize the process much faster.

3. Redemption function

MakerDAO has no redemption mechanism

According to MakerDAO’s white paper, DAI is soft-pegged to the US dollar. This approach is less secure than the one that hard-pegged stablecoins use.

The lack of a redemption mechanism makes such assets more vulnerable to global financial crises and can result in the assets losing their peg altogether.

This is exactly what happened to DAI in March 2023 when SVB collapse had a negative influence on the whole crypto industry.

USDL has a redemption system in place

USDL, on the contrary, is hard-pegged to USD thanks to the built-in redemption function.

It means that anyone can redeem 1 USDL worth of PLS at any time at its face value. If the USDL price drops below $1, this would simply turn into an arbitrage opportunity and give traders an incentive to buy back USDL until its price recovers.

Thus, the hard-pegging mechanism always creates an extremely strong force to automatically push the asset price should it drop below the predefined value.

4. Collateralized assets

DAI relies on fiat-backed stablecoins

DAI is a multi-collateral stablecoin which means that it is possible to use many different ERC20 tokens as collateral when taking a loan.

Up until June 2023, a fiat-backed stablecoin USDC made up a large portion of this collateral. Understanding the risks of fiat-backed stable assets, MakerDAO reduced its the ratio of this stablecoin from 50% to 8%.

Yet, it has not excluded it completely which leaves DAI vulnerable to censorship-related issues.

USDL is backed only by PLS

Liquid Loans considers these risks from the very start. By design, USDL is backed by a single on-chain asset PLS that does not depend on any custodian.

At the same time, USDL’s stability is fully governed by the code which eliminates any human interference. Therefore, the coin is 100% censorship-resistant.

5. Governance

MakerDAO relies on human governance

Users who hold the Maker (MKR) token can vote and change system parameters such as interest rates, collateralization ratio, or the budgeting structure.

Though such an approach is quite democratic, it still has some inefficiencies:

1. Users are not eager to vote

This has been a large problem for many blockchain-based decentralized systems ever since their inception. Different projects have invented numerous incentives to increase the level of participation. Yet, with MakerDAO the statistics are rather sad.

For example, in October 2023, only around 95,000 MKR holders voted in one of the polls that took place at that time. At that time, the number of tokens in circulation was equal to ~977,000. Thus, the number of active participants has not even reached the 10% mark.

2. Votes are subject to manipulation

Malicious actors may easily get a huge number of tokens via a flash loan and thus get a decisive weight in the voting mechanism. This can help them push some of their own proposals that can negatively affect the system.

LiquidLoans implements unbiased algorithms

Liquid Loans addresses these problems by creating a fully immutable system that relies on algorithms rather than on voters. 

The underlying smart contracts are not subject to any changes. At the same time, the system as a whole has no centralized owners who would be able to implement any changes in their favor.

This helps to protect the network from any attacks aimed at changing the code.

6. Staking rewards

MakerDAO offers a savings account similar to a bank

With MakerDAO’s savings account, users lock up DAI for some predefined period and earn an interest rate. The rate is defined by the community governance.

For example, in August 2023 the community voted for the savings accounts’ rate to be increased up to 8%. Such generous rewards immediately attracted more users resulting in an astonishing increase in DAI’s market capitalization.

However, the protocol didn’t experience any significant growth after that. Besides, the community at any time may vote for the decrease of the interest rate in the same way which will inevitably have a backward effect.

Liquid Loans rolls out a censorship-resistant stability pool

Liquid Loans has a stability pool which, at first glance, may look similar to DAI’s savings account. Yet, the key reasons for its creation as well as the underlying mechanics are different from MakerDAO’s development.

The stability pool was created to protect the system and help it maintain its solvency. In a nutshell, it provides the funds that help to repay debt in case a vault gets liquidated.

Whenever a liquidation occurs, the pool provides USDL needed to cover the undercollateralized loan. The collateral from the liquidated vault, in turn, gets distributed across the Stability Providers proportionate to their contribution.

As a result, the pool participants lose some part of their USDL holdings but get some part of the collateral in return. As you remember, Liquid Loans requires 110% collateral. Thus, the final gain would make up around 10%.

Closing Thoughts

Upon its release in December 2017, DAI represented a truly breakthrough solution offering the crypto market a good alternative to fiat-backed stablecoins.

Yet, over the following years, it has faced many challenges that its initial design was unable to solve.

Having launched its platform only six years later, Liquid Loans has a solid advantage as it can avoid its predecessors’ mistakes. Thus, USDL represents a truly decentralized and censorship-resistant stablecoin that keeps its rate stable regardless of any external influence.