The Sky Protocol—originally known as MakerDAO—is one of the foundational pillars of decentralized finance (DeFi). Since its inception in 2015, it has evolved into a robust, community-governed ecosystem designed to maintain financial stability through decentralized mechanisms. This document provides a comprehensive overview of the core components, governance structure, and innovative features that define the protocol as of 2025.
Overview of the Sky Protocol
The Sky Protocol operates on the Ethereum blockchain and enables users to generate Dai, a decentralized stablecoin soft-pegged to the US dollar. It was the first DeFi application to achieve widespread adoption and remains a leader in on-chain financial infrastructure.
At its core, the protocol allows users to lock digital assets as collateral in non-custodial smart contracts known as Vaults to mint Dai. This system ensures that every Dai in circulation is overcollateralized and backed by real value, maintaining trustless stability without reliance on centralized entities.
Governance is decentralized and driven by holders of the MKR token, who vote on critical system parameters such as risk controls, collateral types, and emergency protocols. This model empowers a global community to manage monetary policy transparently and responsively.
👉 Discover how decentralized finance is reshaping global money systems.
Understanding Dai: The Decentralized Stablecoin
Dai is a cryptocurrency engineered to maintain a stable value relative to the US dollar. Unlike centralized stablecoins backed by fiat reserves, Dai is fully transparent, algorithmically stabilized, and collateralized by digital assets locked within the Sky Protocol.
How Dai Functions Like Money
Dai fulfills all four classical functions of money:
- Store of Value: Designed to resist depreciation during market volatility.
- Medium of Exchange: Accepted globally for payments, peer-to-peer transfers, and DeFi transactions.
- Unit of Account: Used internally across dApps for pricing goods and services.
- Standard of Deferred Payment: Enables debt settlement within the protocol via repayment of Stability Fees.
Every Dai token is backed by excess collateral—meaning the value of deposited assets exceeds the amount of Dai issued. All transactions are recorded on the Ethereum blockchain, ensuring full auditability.
Collateral Assets and Risk Management
To generate Dai, users must deposit approved collateral into a Vault. The Sky Ecosystem Governance votes on which assets are accepted, along with their corresponding Risk Parameters—customizable settings that govern safety margins and usage limits.
Accepted collateral includes Ethereum (ETH), Wrapped Bitcoin (WBTC), and tokenized real-world assets (RWAs). Each asset class has unique risk characteristics, reflected in tailored parameters such as:
- Debt Ceiling: Maximum Dai that can be generated against a specific collateral type.
- Liquidation Ratio: Minimum collateral-to-debt ratio before liquidation triggers.
- Stability Fee: Interest paid when repaying debt, funding protocol operations.
- Liquidation Penalty: A fee imposed during liquidation to discourage undercollateralization.
These mechanisms ensure systemic resilience even during extreme market conditions.
Introducing USDS: A New Generation Stablecoin
In 2024, MakerDAO rebranded to Sky Ecosystem and introduced USDS, a new dollar-pegged stablecoin built with scalability and compliance in mind.
While functionally similar to Dai—both are overcollateralized and governed by the same core system—USDS includes forward-looking design elements:
- Built with upgradeable proxy contracts (ERC1967 standard), allowing future feature additions via governance.
- Potential for a freeze function, subject to decentralized approval, aligning with regulatory frameworks for large-scale RWA integration.
- Transparent governance process for any future upgrades, including public appeals and checks-and-balances via the Sky Atlas framework.
USDS can be obtained through:
- Direct conversion from Dai via a permissionless converter contract.
- Participation in the Sky Savings Rate (SSR).
- Rewards programs like Sky Token Rewards (STR).
- Trading on major exchanges and DeFi platforms.
This dual-stablecoin strategy enables Sky to serve diverse user needs—from censorship-resistant decentralization (Dai) to compliant global scalability (USDS).
👉 Explore the next evolution of blockchain-based stablecoins.
How Sky Vaults Work
Vaults are smart contracts that allow users to lock collateral and generate Dai. They are non-custodial—users retain full control over their assets as long as they meet collateral requirements.
Step-by-Step Vault Interaction
- Create and Collateralize a Vault
Users deposit supported assets via interfaces like Oasis Borrow or community-built dashboards (e.g., Zerion, Instadapp). - Generate Dai
Once funded, users can draw Dai up to their collateral limit. The generated Dai enters circulation and becomes spendable. - Repay Debt and Stability Fee
To reclaim collateral, users must repay the borrowed Dai plus accrued Stability Fees, paid exclusively in Dai. - Withdraw Collateral
After full repayment, users can withdraw their original assets. Empty Vaults remain usable for future activity.
Each collateral type requires a separate Vault, enabling users to manage multiple positions with varying risk profiles.
Liquidation Mechanism: Protecting System Solvency
If a Vault’s value drops below its Liquidation Ratio, it becomes vulnerable to liquidation. This automated process protects the protocol by selling off collateral to repay debt.
Auction Process
- Collateral Auction
Undercollateralized assets are auctioned for Dai. Bidders compete to offer increasing amounts of Dai for fixed collateral quantities. - Reverse Collateral Auction (if applicable)
Once debt is covered, this phase begins to return excess collateral efficiently by offering decreasing amounts of asset per fixed Dai bid. - Keeper Participation
Automated bots or individuals—known as Keepers—monitor Vaults and trigger auctions when thresholds are breached. They use bidding models to optimize returns.
If auction proceeds fall short of obligations, the deficit is covered by the Sky Protocol Buffer, funded by Stability Fees and liquidation penalties. If insufficient, a Debt Auction mints new MKR tokens to raise Dai and restore solvency.
Real World Asset (RWA) Vaults
Sky pioneered the integration of Real World Assets (RWAs) into DeFi, bridging traditional finance with blockchain innovation.
What Are RWAs?
RWAs include off-chain assets like government bonds, real estate, or private credit, tokenized for on-chain use. These bring stability and yield diversification but require legal enforceability and custodial oversight.
RWA Vault Architecture
Each RWA Vault consists of three core components:
- RWA Urn: The vault itself, managed by governance-approved counterparties under off-chain legal agreements.
- RWA Token: A non-transferable token representing the underlying asset’s value.
- RWA Liquidation Oracle: Controlled by governance, it updates pricing and tracks liquidation status.
Additional tools like Input/Output Conduits handle complex payment flows (e.g., USDC repayments), while RWA Jars collect variable interest fees off-chain for later transfer to the protocol surplus.
RWA Liquidation Process
Unlike crypto liquidations, RWA recoveries occur off-chain and may take months:
- Soft Liquidation: Triggered when covenants are breached; allows time for resolution.
- Hard Liquidation: Initiated if recovery fails; debt is written off against the Surplus Buffer or covered via MKR minting auctions.
Despite slower resolution times, RWAs enhance capital efficiency and reduce exposure to crypto volatility.
Key External Actors in the System
The Sky Protocol relies on external participants to maintain functionality:
- Keepers: Arbitrageurs who stabilize Dai’s price and participate in auctions.
- Oracles: Provide price data through decentralized feeds protected by the Oracle Security Module (OSM), which delays updates by one hour to prevent manipulation.
- Emergency Oracles: Trusted actors who can freeze compromised feeds or initiate Emergency Shutdowns during crises.
These roles ensure accurate data flow and rapid response to threats.
The Dai Savings Rate (DSR) and Sky Savings Rate (SSR)
The Dai Savings Rate (DSR) allows any Dai holder to earn passive yield by locking tokens in a dedicated smart contract. Accessible via portals like Summer.fi, it adjusts dynamically based on market conditions:
- If Dai trades above $1, the rate decreases to reduce demand.
- If below $1, the rate increases to stimulate buying pressure.
In 2024, Sky introduced the Sky Savings Rate (SSR) for USDS, using the ERC4626 tokenized vault standard for improved composability across DeFi.
Both rates are governed by MKR holders and serve as monetary policy tools to maintain price stability.
Governance: Powering Decentralized Decision-Making
MKR token holders govern every aspect of the Sky Protocol through a structured process:
- Proposal Polling: Informal sentiment checks before formal votes.
- Executive Voting: Binding decisions on system changes (e.g., adding new collateral).
Smart contracts execute approved proposals only after passing governance checks. The Governance Security Module (GSM) can delay execution up to 24 hours to allow emergency intervention if needed.
MKR also acts as a recapitalization tool: during insolvency events, new MKR is minted in Debt Auctions to restore balance—a mechanism that incentivizes responsible governance.
Risk Mitigation Strategies
The protocol is designed to withstand multiple threat vectors:
| Threat | Mitigation |
|---|---|
| Smart contract exploits | Formal verification, third-party audits, bug bounties |
| Black swan events | Liquidation mechanisms, Debt Ceilings, Emergency Shutdown |
| Oracle attacks | OSM delay layer, Emergency Oracles |
| Market irrationality | DSR adjustments, Keeper incentives |
| User abandonment | Clear documentation, intuitive UIs |
These layered defenses ensure long-term sustainability even in unpredictable environments.
Emergency Shutdown: Last Resort Protection
When severe threats arise—such as governance attacks or systemic failure—MKR holders can trigger an Emergency Shutdown:
- All Vault activity halts; price feeds freeze.
- Users withdraw excess collateral immediately.
- Outstanding debts are settled via auctions.
- Dai holders claim residual collateral at a fixed rate tied to the $1 Target Price.
This mechanism guarantees user exit rights while preserving protocol integrity.
👉 Learn how blockchain protocols protect user funds during crises.
Frequently Asked Questions (FAQ)
Q: Can I lose money using Sky Vaults?
A: Yes—if your collateral value drops below the Liquidation Ratio before you repay your debt, your position may be liquidated with penalties. Always monitor your Vault health.
Q: Is Dai truly decentralized?
A: Yes. Dai operates without central control. Its stability comes from code-enforced overcollateralization and community-driven governance—not corporate reserves.
Q: How does USDS differ from traditional stablecoins like USDT or USDC?
A: Unlike centralized alternatives, USDS is overcollateralized and governed transparently on-chain. Future features like freeze functions require decentralized approval.
Q: Who controls RWA investments?
A: While Sky Governance approves deals, execution is delegated to trusted counterparties under legal agreements. Stars—autonomous projects within Sky—now lead RWA deployment via the Allocation System.
Q: Can I earn yield on my Dai?
A: Absolutely. Use the Dai Savings Rate (DSR) to earn yield directly within the protocol—no intermediaries required.
Q: What happens if the entire system collapses?
A: In worst-case scenarios, Emergency Shutdown allows users to claim proportional collateral based on their Dai holdings at the $1 peg—though haircuts may apply if losses exceed buffers.
Core Keywords:
Dai, Sky Protocol, MKR, Vaults, Stablecoin, RWA, USDS, Decentralized Finance