The MakerDAO (as in 'market maker') is a smart contracts platform conforming to the Ethereum network protocol and befitting the design rationale of its underlying logic.
Maker implements a set of mechanisms (smart contracts) in a dynamic system of Collateralized Debt Positions (CDPs), autonomous feedback mechanisms and appropriately incentivized, compoetent actors that make up the Dai stability engine to generate a stablecoin token relative to the US dollar. The purple paper summarizes it so:
The Dai stablecoin system is a set of blockchain smart contracts designed to issue a collateral-backed token (called the dai) and subject its price to a decentralized stability mechanism.
As such, an alternative to the (lately quite problematic) Tether (USDT), which itself builds on top of the Bitcoin overlay network, whose rudimentary scripting functionality doesn't allow for the developing of more fine-tuned, complex solutions that adequately interface with and respond to real-world events.
MakerDAO/Dai also tries to address the issues of high volatility swings and irrationality plaguing the state of affairs in the realm of 'crypto', preventing the possibility for properly writing business logic as such (i.e., derivatives, which is a market valued in the neighborhood of 1.4 quadrillion dollars).
Dai itself, the stablecoin, is generated through so-called Collateralized Debt Positions (CDPs) wrapped in smart contracts. Currently there is support for only one type of collateral, namely Pooled Ether (PETH, or for the sake of simplification, just ETH) — the MKR token holders vote on decisions regarding the addition of new types of CDPs and are responsible for specifying their unique risk and sensitivity parameters.
In case the collateral in the system ends up being not enough to cover the amount of Dai in existence, MKR tokens are created and sold off to the open market to raise the necessary collateral thereby creating strong incentive for MKR holders to responsibly regulate the CDP parameters as ultimately it will be their money on the line should the system fail (see skin in the game).
The way Dai gets created is one deposits a certain amount of ETH as collateral which is leveraged on the Maker platform to generate Dai — essentially one stores his ETH funds locked in a CDP smart contract in order to take out a loan.
This is especially useful in situations where, for example, one must cash out some of his ETH, but believes that the price of ETH will grow — so one can lock his ETH in a CDP and get a specified amount of money in return, getting back his ETH whenever that same amount is paid back (and the ETH doesn't fall below the threshold of one's specified liquidation price).
Or, let's assume a scenario where ETH goes down and one wants to "buy the dip" but has no fiat left — so, one can lock his ETH in a CDP and take out a loan to buy more ETH with. This, as a financial instrument, is called leverage and the principle is the same as margin trading.
It's important, however, to focus in a little more detail on the components that make up the price stability mechanism and how they tie together.
The Dai target price (TP) is denominated in USD and translates to 1:1 soft peg. In case of severe market instability or irrationality, a Target Rate Feedback (TRFM) Mechanism is automatically triggered, which breaks the peg but maintains the same denomination. The Target Rate is a measure of the TP change over time, acting as incentive to either hold Dai (if TR is positive) or incentive to borrow Dai (if TR is negative).
The TRFM adjusts the TR so that it causes market forces to calibrate the market price of Dai around the target price. So, when the TRFM is engaged, both TR and TP change dynamically to balance supply and demand by adjusting incentives for generating and holding Dai. This feedback mechanism pushes the market price of Dai around the target price, thereby curbing volatility and providing real-time liquidity during demand shocks.
This is certainly one of the more complex systems that elegantly demonstrate what Ethereum is built to be capable of, and will certainly come to the spotlight of attention as margin trading platforms are introduced -- one of which is already in Alpha and could be tried out via the Kovan testnet. Meanwhile, Dai and ETH can be instantly flipped back and forth on the Bancor network and MKR/Dai parameters checked here.