How does the Dai peg to dollar?

Question

I am interested in the Dai stable coin and have seen multiple different explanations of how the coin balances and pegs to the $1. One said it was to do with the increase or decrease in interest rates to bring the price up or down(eg. If interest goes up then demand goes down and the price falls and vice versa). The other said it was to do with supply and demand change due to people buying cheaper and selling higher for a profit(eg. when the value of dai is higher than dollar people sell for a profit, which increases supply and so the value goes down; when the value is low people buy which drives price up as supply decreases). Which of these is correct?

I apologise if this is on the wrong page.

Answer 1

It is quite complicated, but as MrClottom pointed out you can read quite a lot in the docs.

But I will try to summarize here:

First of all, DAI is created when people lock up Ether in MakerDAO. They need to lock up 150% of the value of those DAI (overcollateralization)

When demand for DAI drops, the price naturally comes down below it's peg of $1. This encourages people to buy cheaper DAI on exchanges to pay down the principle they have with MakerDAO.

If the opposite happens and the demand for DAI is high, the price naturally goes up, above it's 1$ peg. This encourages people to lock in more ETH into MakerDAO to get out more DAI. This increases the supply of DAI and naturally brings the price down.

There are many other factors at play, but this is a good overview of how the price keeps around $1.

Here is a good youtube video from Switcheo that summurize it quite well: https://www.youtube.com/watch?v=ar9yUV0W9qM