The major component of the Maker protocol and methodology that is used with which Dai is created is known as a Vault. A Vault is formed by depositing collateral into a smart contract which then mints an amount of Dai specified by the user. The dollar value of the collateral must be greater than 150% the value of Dai (current Collateralization Ratio).
The user can complete transactions freely with their Dai. If they want to receive their initial collateral they must pay back both the Dai they withdrew as well as the interest rate on the loan (Stability Fee). If at any point, the value of the collateral goes below the collateralization ratio, then their positions get liquidated where anyone can come in and purchase the underlying collateral to repay the debt. Known as Keepers, these actors are motivated by the profit opportunity from buying the collateral below market price and then selling on the open market.
There are 3 types of auctions that occur
Surplus Auctions : They occur when loans remain overcollateralized and the payments from stability fees reach a particular amount. After that, Dai is auctioned off to Keepers for MKR which is then subsequently destroyed.
Collateral Auctions : They occur when Vaults drop below the Collateralization Ratio. The collateral in the vault is then sold until the outstanding debt is repaid plus a liquidation penalty. At that point, the auction becomes a reverse auction, where a bidder bids on accepting smaller parts of collateral for that fixed amount of Dai. Once the process ends, the remaining collateral is returned to the vault owner.
Debt Auctions: They occur in the worst-case scenario when the price of collateral drops precipitously such that it can no longer cover the entire debt paid. The system will first look towards the surplus from Stability Fees to cover the debt. If that is not sufficient, a reverse auction occurs to cover the fixed amount of Dai necessary to make the system whole. Bidders compete on willingness to accept decreasing amounts of MKR for the shortfall in Dai.
Dai Savings Rate (DSR) The DSR was developed and imposed in MCD as a way for Dai holders to earn interest on their holdings. Users are able to deposit Dai into a non-custodial smart contract and immediately begin earning interest funded by Stability Fee payments. They are also free to withdraw at any time. The DSR serves as a monetary policy tool for governance to control the outstanding supply of Dai in order to manage the $1 peg. If the peg were to drop below $1, MKR holders could vote to increase the DSR. This would incentivize Dai holders to lock more Dai up, decreasing the supply and ideally bringing the price back up.