How does MAI work?
Getting a good understanding about how MAI works is crucial for any investor that really wants to understand Mai Finance, so in this article you will understand how MAI works.
Before getting into what is MAI, we have to understand what is a stable coin, a stable coin is a type of cryptocurrency that is designed to maintain a stable market price. Most of the stable coins are pegged (a currency where the price is designed to remain the same as a designated asset) to the US dollar, but you can find other stable coins pegged to other commodities such as gold (like EGold) or silver (SilverCoin).
However, there are 2 main categories in which all stable coins can fit, collateralized or non-collateralized. The collateralized stable coins are those that hold the assets against which their coin is pegged, meanwhile the non-collateralized make use of algorithms to control the supply of tokens in order to keep the price fixed at a predetermined level.
If you've been around in crypto for some time, you may remember the disaster of the TITAN and IRON token, but for those of you who don't, here is a quick recap. IRON Finance was a project that had 2 tokens, the IRON stable coin and the TITAN token, however the IRON stable coin wasn't fully backed with stable coins, the proportion to mint IRON was 75% USDC and 25% TITAN token. So it was basically a recipe for disaster.
In June of 2021 the TITAN token reached an ATH of $65, which caused that a bunch of investors, who invested heavily in the coin, decided to sell. This caused a problem because TITAN is priced based on supply and demand. So as the available supply of TITAN increased, the price began to decrease. This caused a huge sell pressure so the price of TITAN fell even faster, so when TITAN began to fall rapidly, IRON lost its backing and eventually its peg.
Price chart of the TITAN token
Price chart of the IRON stablecoin
People started buying the IRON stable coin to sell it for USDC and earn some quick bucks, in a huge arbitrage opportunity (this means profiting in the price variations of tokens) Long story short, it's been calculated that almost $1.75 billion were lost in this incident. Now, is there a difference between the IRON stable coin and the MAI stable coin?
MAI is a stable coin that is backed by locked collateral tokens, the minting of MAI can be done either through depositing approved collateral in vaults or through using Anchor.
When minting MAI depositing approved collateral, the CDR (Collateral to Debt Ratio) needs to be between 150%, this means that if you deposit $100 worth of collateral, the newly minted MAI can be at most worth $66.6667. We'll get to the reason behind this later in this article.
Another way to mint MAI is through the Anchor, this means that when you swap a stable coin (as of September 2021 you can mint MAI using DAI, USDC and USDT) for MAI, new MAI is minted by the treasury and the deposited stablecoin is held in the treasury as collateral. Meanwhile, when you swap back your stablecoins, the MAI that you provide will be burned.
Stablecoins that can be swaped to mint MAI
As you can see on the picture below, the price of the MAI stable coin it's almost always close to $1, this is because as the official documentation says, the MAI stable coin allows users to engage in risk-free arbitrage through Anchor when the price of MAI falls below $0.99 or rises above $1.01.
Price chart of the MAI token in the last 90 days
The peg to $1 is maintained by 2 mechanisms, via Anchor or by depositing collateral in the vaults, in this section of the article, you'll understand why
Anchor allows users to mint MAI with stable coins and redeem stable coins from MAI. Also, as you can see on the picture below, there's a 1% fee when swapping your stable coins for MAI or vice versa, there are two main reasons for these fee:
- The 1% minting fee to create MAI sets a price ceiling of $1.01.
- The 1% fee to redeem stable coins from MAI sets a price floor of $0.99
Having a price ceiling and a price floor helps MAI to not diverge from its peg too much, however as you've seen on the picture of the MAI chart, you can participate on low- risk arbitrage opportunities (meaning that you can sell your stable coins when MAI is under $1 or sell MAI when is above $1 to earn some quick bucks).
About what causes the fluctuation of the price of MAI, there could be two main reasons for this:
- If the market is in a bearish trend: people will sell their volatile assets and buy more stable coins to avoid losing value of volatile assets. This means that people want to buy MAI, increasing its price.
- If the market is in a bullish trend: people buy more volatile assets when their price is low, using their stable coins. This means that people sell their MAI, driving its price down.
In order to mint MAI using the vaults in Mai Finance, you need to deposit some collateral in there and have a CDR (Collateral to Debt Ratio) above a certain threshold, in this case is 150% (however this percentage can change in the future if the community decides so). This means that the vaults will always be over-collateralized (by 150%) to ensure that there is always collateral value to back the stable coins minted. Remember that if a vault has less than a 150% CDR it could be partially liquidated by the community, so somebody could loose some of their collateral if a liquitador pays some of their debt.
As the value of the collateral rises, more stable coins can be issued as a rise in collateral price will increase your collateral to debt ratio. Conversely, as the value of the collateral falls, fewer stable coins can be issued, this is done to prevent that the CDR falls below the 150% mark.
As you've seen throughout this article, the MAI stable coin is a type of stable coin that is over-collateralized, meaning that there will always be enough collateral to back the price of the MAI token. This should give enough relief to those investors who hesitate about investing in projects that mint stable coins. Also, keep in mind that as MAI is expanding to other blockchains, there'll be more MAI in the market, resulting in less volatily in MAI's price.
Recently, the vaults incentives have been introduced to Mai Finance, if you want to understand what that is, stay tuned because there'll be an article about this topic. This will help even more to the stability of the MAI price.
This guide is definitely not financial advice, it was made with an educational goal in mind.