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What is a CDP?

What is a CDP?

CDP stands for Collateralized Debt Position. In laymen’s terms, it’s when you put up assets as collateral in order to take out a loan or debt against said collateral. When you’re talking about Ethereum, a CDP specifically refers to a position or loan taken out in DAI through the MakerDAO smart contract which is backed by ETH.

When you open a MakerDAO CDP, you lock in ether (ETH) as collateral. And then, you’re able to mint up to 2/3 of the US dollar value of your ether in DAI, a stablecoin pegged to the US dollar. In other words, your CDP must have at least 150% more collateral value than your total debt in DAI.

CDP holders pay an annual interest rate on their debts called the stability fee for the opportunity to mint new DAI. And when the debt is repaid, the DAI is burned along with the stability fee owed in Maker’s token MKR. The stability fee deters users from over-inflating the total supply of DAI.

For every 1 DAI, there is at least $1.50 worth of Ether (ETH) locked into a Maker CDP as collateral. And if your collateral value falls, you must lock in more ETH, pay back some of your debt, or risk having their CDP liquidated. When a CDP is liquidated, the ETH held as collateral is automatically sold to pay back the debts in addition to a penalty fee for failing to keep your collateral ratio above 150%.

MakerDAO’s CDP Portal

How do I open a CDP?

It’s quick and easy to open a CDP. Just head on over to MakerDAO’s Portal, send a few transactions… and then BAM! You’re the proud owner of a CDP.

First, connect your wallet and the menu will guide you through sending the transaction to open your CDP. Once you’ve opened your CDP, you’ll need to add some ETH to your CDP with the ‘Deposit’ button. Next, click the ‘Generate’ button to mint your desired amount of DAI.

And when you want to pay your debt back, return to this portal and use the ‘Pay Back’ button. Don’t worry if you don’t have MKR for the stability fee because you can also pay it back with DAI. Now, you have the option to withdraw your collateral. Also, you can either close your CDP entirely or leave it open for later borrowing, it’s your choice.

Remember to keep in mind that you will owe interest on any DAI you borrow. Additionally, you won’t be able to access any ether you lock up in your CDP until your debt is paid. And if the price of ETH begins to fall, you may become at risk of liquidation if you don’t take action. We recommend you do not borrow the maximum amount possible and instead consider borrowing a smaller amount to reduce your risk of liquidation.

Why open a CDP?

The easy answer is: to have access to DAI. While the price of ETH may fluctuate, you can count on DAI to hover around $1. So there’s a natural demand for DAI in payments, commerce, games, lending, and many many more use cases. DAI has also become the de facto stablecoin for decentralized exchanges.

The more complicated answer is that there are a number of reasons you might want to borrow against your ETH. Maybe you want the DAI to pay off other bills in your life but you don’t want to sell your ETH. Or, maybe you want to mint DAI to leverage yourself by purchasing other investments. There are numerous reasons you might want liquidity while still being exposed to the price of ETH.

If you still need a little help wrapping your head around the concept of a CDP, come find us on Discord or Twitter @DefiPulse.

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