1 Introduction
In the previous report "dYdX v4: Economic Model Improvement and Valuation Outlook" we mainly studied the update of the dYdX v4 version, discussed the v4 version features, marginal improvements compared to v3 and the reasons why dYdX left Ethereum and chose Cosmos , and concluded that Layer 1 staking, fee distribution, and the introduction of Cosmos’ native stablecoin will jointly improve the fundamentals of the DYDX token and bring continued benefits to the token.
Since our last report, dYdX has made some exciting improvements and developments. Recently, the new version has been launched on the mainnet, and the market response has been good, with strong price growth. But it is also worth noting that in December, dYdX will face a large number of initial allocation tokens being unlocked (accounting for 15% of the total tokens). How will the market react to potential selling pressure? Will the inflation caused by token release dilute the empowerment of v4? Can the positive impact of the new version continue to drive the growth of DYDX tokens? Is December the last chance to get on board? In order to further explore the development prospects of dYdX and the expected value of DYDX tokens, this article will be data-oriented and analyze from the valuation level based on the previous work. Using DCF and comparable analysis models to make reasonable predictions of dYdX's revenue and coin price, and predicting the v4 staking yield to discuss the possible impact of this selling pressure.
2. Introduction to dYdX
dYdX is a pioneer in decentralized perpetual contract exchanges, and its unique order book model brings a high-quality user experience comparable to that of centralized exchanges. Today, its market penetration rate reaches 60% of the total DEX. The new architecture and marginal innovation of v4 give dYdX stronger competitiveness. On October 24, dYdX announced the release of dYdX Chain V1.0 and open sourced its code, marking the official start of the exchange's v4 upgrade and the transition from the Ethereum Layer 2 network to an independent blockchain in the Cosmos ecosystem. Open source code is at the core of the blockchain spirit, bringing transparency to developers, enabling them to review, detect errors and improve quality. According to dYdX Trading Inc., the initial developer behind the exchange, the dYdX Chain V1.0 version and its order book have been developed and passed the final audit. The v4 upgrade will make dYdX completely decentralized and community-operated, which means that the company will no longer control the dYdX protocol and will not charge transaction fees.
On October 27, dYdX Chain was officially launched on the mainnet. dYdX Chain was officially launched on the mainnet as an independent Cosmos Layer 1 by dYdX Ops subDAO. The validator created the genesis block of dYdX Chain at 01:00 (UTC+8) on October 27. The dYdX Operations subDAO public frontend for bridging will be launched on October 30, 2023, pending official confirmation and testing. After genesis, it will be divided into two phases, Alpha and Beta. The Alpha phase will start on October 30, 2023, focusing on enhancing the stability and security of the network. The Beta phase will enable transactions but no rewards, and the transition from Alpha to Beta will be determined by factors such as governance voting.
Based on the previous report, this article will conduct a valuation analysis on dYdX in combination with the token unlocking status and v4 version features.
3. Valuation Model
Our valuation is based on discounted cash flow analysis (DCF) and comparable analysis methods, which are derived in detail in our valuation model (DYDX Valuation Model) and can be adjusted accordingly based on actual future market conditions. The following is a detailed description and explanation of the valuation method.
DYDX Supply in Valuation
Although dYdX Chain validators and stakers receive all protocol fees (i.e. only staked DYDX tokens can receive cash flow from the protocol), since freely circulating, unlocked DYDX can be freely delegated to nodes to obtain staking income, we use the total token circulation as the basis for valuation, rather than the token circulation after excluding stakes. Our valuation time point is December 31, 2023, and considering the circulation after unlocking in December, the effective token base is 446M.
Top-down
This article adopts a top-down valuation method. For each forecast year, the total volume of derivatives transactions in that year is taken as the starting point, and multiplied by the DEX penetration rate to estimate the DEX derivatives trading volume in that year. Then, the dYdX trading volume in that year is obtained by the market share of dYdX, and finally the annual protocol revenue is calculated based on the effective fee rate.
3.1 Discounted Cash Flow Analysis (DCF)
dYdX generates cash flow by charging fees to users. The protocol was managed by dYdX Trading Inc. before v4, and all cash flow belonged to the company. After the v4 improvement, dYdX is controlled by dYdX Operations subDAO and is fully decentralized. dYdX officially announced that dYdX Chain will distribute all protocol fees, including USDC-denominated transaction fees and DYDX-denominated gas fees, to validators and stakers. We can assume that DYDX token holders can capture 100% of the cash flow from the development of the protocol.
Based on the above conditions, we believe that the discounted cash flow method is most suitable for the valuation of DYDX token price. Discounted cash flow method (DCF) is an absolute valuation method used to estimate the value of an asset based on its expected future cash flows. The principle is that the value of a company is calculated based on the cash flows it can generate in the future, which is equal to the result of discounting the cash flows at a discount rate that reflects its risks. Our model is based on data before September 30, 2023, with a forecast period of 5 years, and uses the terminal value to represent the future long-term cash flows under the continued operation of the protocol, and estimates the value of DYDX tokens on December 31, 2023.
3.1.1 Assumptions
Transaction Fees: Compared with various perpetual contract agreements, dYdX has a lower fee level and has certain advantages. Based on v3, v4 divides the fee into 9 levels and gives different trading rewards. By dividing the fee income in 2022 by the trading volume, we calculated the average fee rate of 0.025% as the fee rate of the protocol. As market competition becomes more and more motivated, the overall fee rate of the exchange decreases, and finally dYdX's effective fee rate decreases linearly to 0.015% (shared by buyers and sellers), which is close to the preferential fee level of Binance VIP 9, the largest centralized exchange with a monthly trading volume of US$2.5 billion.
Discount rate: Based on our assessment of current protocol developments and market risks, we set a cash flow discount rate of 29% from 2023 to 2028. When calculating the discount rate, we use the 10-year US Treasury note as the risk-free rate and BTC as the market benchmark. Beta values are obtained from a regression model of DYDX returns as a function of BTC returns. The regression analysis is based on one year of data and selects the starting time when the currency price is consistent with the current market price, that is, the data from August 1, 2022 to September 30, 2023. The Capital Asset Pricing Model (CAMP) calculates the capital cost rate to be 29.10%. Regression analysis shows that DYDX price is significantly positively correlated with BTC returns. In summary, we choose 29% as the discount rate, which is similar to the average return rate of venture capital funds of 30% and is more reasonable.
Terminal value P/E ratio: DeFi is an asset-light industry, so we choose the exit multiple method to reverse the terminal value. Referring to the P/E ratio of publicly listed traditional exchanges, we finally selected 10 times as the final exit multiple of DYDX.
Expected Trading Volume: Trading volume is directly related to the protocol’s revenue and is the core driver of DEX value. In order to predict the potential value range of DYDX under different market conditions, this report assumes three different trading volume growth scenarios.
Each forecast period starts with the annualized total derivatives trading volume since September 30, 2023, and applies the annual growth rate on this basis. According to the law of industry development, we assume that during the forecast period (2023 to 2028), the annual growth of derivatives trading volume will be faster in 2024-2025, and then gradually slow down every year, and reach negative growth in the final period. The reason is that considering the BTC production reduction next year and the expectation of the Fed's interest rate cut, the crypto world is likely to usher in a bull market in the next two years, so we give a higher growth forecast for 2024 and 2025.
To get dYdX’s volume, we assumed based on historical data that the protocol has a constant market share of 40%-60% (depending on market conditions) of total derivatives DEX volume. Here is an overview of DYDX’s expected volume in each scenario:
Baseline scenario: Derivatives volumes grow at 80% in 2024 and taper off to -5% in 2028, with total dYdX volume expected to be $2.93 trillion in 2028 as DeFi flourishes or DEX adoption increases.
Bearish scenario: Derivatives volumes grow at 50% in 2024 and taper off to -5% in 2028, as regulatory growth slows or overall DEX usage declines as users prefer CEXs, with total dYdX volume expected to be $0.91 trillion in 2028.
Bullish scenario: Derivatives trading volume grows at 100% in 2024 and tapers off to -10% in 2028. With the successful implementation of the dYdX chain and v4, the cryptocurrency industry receives significant regulatory benefits. dYdX’s total trading volume is expected to be $6.75 trillion in 2028.
In the past 9 months, the total trading volume of the top 20 derivatives DEXs has reached about $0.49 trillion, of which dYdX accounts for $0.26 trillion. The total derivatives trading volume of the top 10 centralized exchanges is $20.49 trillion. At the time of writing, DEXs account for about 2%-3% of the total CEX trading volume.
Multiplying the expected transaction volume by the fee rate, we get the following expected revenue:
3.1.2 DCF Analysis
It should be noted that the token value in this article is based on the token circulation on December 31, and does not involve the incremental token unlocking in subsequent years. However, considering the aggressive discount rate of 29%, the dilution risk of dYdX in the current situation can be offset to a certain extent.
The following are the corresponding DCF results for the three scenarios:
Baseline Scenario: In this scenario, the DYDX token price is projected to be $4.86, with a protocol valuation of $2.170 billion on December 31, 2023.
Bear Market Scenario: In a bear market, the DYDX token price is expected to be $1.62, and the protocol valuation on December 31, 2023 is $724 million.
Bull Market: In a bull market, the DYDX token price is expected to be $10.56, and the protocol valuation on December 31, 2023 is $4.717 billion.
3.1.3 Probability-weighted scenario analysis
We assign a 25% probability to the bull and bear scenarios, respectively, and a 50% probability to the baseline scenario. The probability-weighted DCF valuation of DYDX price is calculated to be $5.48, and the valuation of the protocol is $2.445 billion. The DYDX price on September 30, 2023 is $1.96, so DYDX has a potential upside of 179.34%.
3.2 Comparable analysis
Comparable analysis is a method used to assess the value of a company or project relative to its peers. Its basic assumption is that blockchain projects of similar size and nature should theoretically have similar valuation multiples. Comparable analysis usually uses the price-to-sales ratio (P/S) and price-to-earnings ratio (P/E) to compare the valuation of the object being evaluated.
When conducting a comparability analysis, it is crucial to select a reference object that is as similar as possible to the analyzed company or project in terms of industry, business model, risk profile, and market dynamics. By ensuring comparability in these aspects, the impact of external factors on the analysis can be reduced, allowing us to focus more on the intrinsic value factors of the analyzed company or project. The four comparable projects we selected all belong to the decentralized derivatives contract trading industry, namely Synthetix, GMX, Gains Network, and Perpetual Protocol. They have similar business characteristics and risk profiles, and all four projects have been listed and traded on Binance, a leading blockchain exchange, and meet the market standards of the exchange, which will help enhance the effectiveness of the comparative analysis. Finally, by using DEX derivatives projects within the same decentralized financial market as comparable objects, the differences in market risk analysis between different industries can be resolved.
2023 Cumulative Revenue for 5 Protocols, Source: Token Terminal
Above is a comparison chart of the annual cumulative revenue of these five projects as of October 27, 2023. It can be seen from the chart that GMX has the highest project revenue and is the only one of the five that has received more than 100 million US dollars. Dydx's revenue is second, reaching 65.4 million US dollars. Perpetual Protocol has the lowest revenue of 63 million US dollars.
The following is a summary of the analysis of comparable projects:
dYdX: Since its launch in 2021, the DYDX token has faced challenges with scarce supply and lack of utility. Despite having a market share of over 50% in the DEX perpetual contract market, its token circulation ratio is much lower than its peer projects. Prior to v4, the main use of the DYDX token was governance and staking to obtain fee discounts, but the new version plans to introduce more uses, such as all fees generated by the dYdX Chain will be distributed to validators and token stakers in the future. Of course, investors may still pay attention to the impact of large-scale token unlocking in the future.
GMX: GMX is a DEX platform that supports spot and perpetual contract trading, focusing on derivatives trading. Unlike other comparable projects, GMX adopts a global liquidity model where users provide liquidity by purchasing and staking GLP, the liquidity token issued by the GMX protocol. $GMX holders can stake their tokens and earn 30% of the protocol fees generated by the GMX protocol. $GMX stakers can also earn $esGMX and multiplier points (MP) to further increase their returns. Owning $GMX will also grant voting rights to participate in the governance of the GMX protocol, enabling them to have a say in the community fund.
SNX (Synthetix): Synthetix’s perpetual contract product is not intended for end users, but is provided as a backend product to support developers and DeFi derivatives liquidity platforms. Users can interact with DeFi products that have integrated Synthetix Perps contract functionality without having to directly use or interact with the Synthetix Perps contract. Currently, the trading volume of Synthetix Perps contracts is mainly generated by Kwenta, a spot and derivatives trading platform, which is actually a decentralized contract product for trading users and is built on the Synthetix Perps component. The circulating supply and total supply of SNX tokens are almost the same. SNX still uses a weekly inflation system as a reward for SNX stakers. Stakers have different SNX reward pools on Optimism and Ethereum, and have different annual returns on stakes. SNX currently has the lowest inflation, and its inflation varies according to the stake ratio. However, SNX inflation rewards are subject to a one-year lock-up period, further reducing the impact on token supply. However, the utility of SNX tokens may change in the future.
Gains Network: Gains Network revolves around the ecosystem’s ERC 20 utility token ($GNS). $GNS is designed to serve as the platform’s utility token, enabling ownership of the protocol through revenue capture and platform governance (coming soon). It includes $GNS holders earning platform fees through Single Sided Staking, as well as burning $GNS using platform revenue. With a leverage cap of 9x within the Gains Network platform and a low interest cap on opening positions, it may not be the ultimate choice for all traders, but it has established a solid position among entry-level traders. Currently, GNS distributes 61.23% of its revenue to $GNS stakers.
Perpetual Protocol: Perpetual Protocol is a decentralized perpetual contract trading protocol built on Ethereum. The protocol uses a virtual AMM (vAMM) design that supports up to 20x leverage, allows short positions, and has lower slippage than other AMMs. Unlike automated market makers, which are used for token swaps and price discovery, vAMMs are only used for price discovery to handle leverage and short positions. Similar to Uniswap, traders can trade with vAMMs without the need for a centralized authority, and their design is market neutral and fully collateralized. PERP is the ERC-20 native token of the protocol, and Perpetual Protocol allows community members to participate in protocol governance and stake their tokens in a staking pool for a specific period of time. In return, holders will receive staking incentives, which include PERP rewards and transaction fees.
3.2.1 Variable considerations
Price/Earnings Ratio: The price-to-earnings ratio is a financial indicator that can be used to measure the relationship between the current token price and earnings per share of a blockchain project. This ratio is often used to assess the investment value and risk level of a project. The P/E ratios of different industries and project types can vary greatly, so it is usually necessary to compare with blockchain projects in the same industry or the market average.
Price/Sales Ratio: Price/Sales Ratio is often used to evaluate the valuation of traditional companies based on revenue. For DEX projects, protocol fees (called "sales revenue" in traditional companies) are a key factor in evaluating their financial performance and sustainability. By using the price-to-sales ratio, which takes into account the relationship between the market value (price) and the fees generated by the protocol, we can understand how the market evaluates the revenue capacity of the protocol.
Average P/S ratio: We adopt the market multiplier method commonly used in the crypto industry and use the average of the P/S ratios of five comparable projects as the market multiplier. By calculating the average, we basically take into account the upper and lower limits of comparable projects and provide a balanced market multiplier estimate. Therefore, we choose to use the average of comparable projects as a quantitative market multiplier to avoid potential bias that may arise from relying solely on the maximum or minimum value.
Median: Statistically speaking, the median is not affected by extreme values in the distribution sequence, which to some extent improves the representativeness of the median to the distribution sequence. Therefore, we choose the median as the reference factor for the market multiplier.
Annualized Total Revenue: Analyzing the revenue generated by a blockchain project can assess its ability to generate revenue and maintain operations. Revenue is a key indicator of a project's financial health and growth potential. The assessment of protocol fee revenue helps understand the revenue streams directly related to DEX trading activities and the profitability of the DEX protocol. Protocol revenue can come from a variety of sources within the DEX protocol, including transaction fees, margin fees, liquidation fees, and funding fees. By considering protocol fee revenue as a variable, analysts can assess the diversification of revenue streams. This helps assess the protocol's ability to withstand market fluctuations and long-term viability.
Profit (Annualized Revenue to DYDX Holders): In the traditional stock market, the earnings in P/E refers to the net profit actually earned by a company in a specific period of time (usually quarterly or annually). This is an important financial indicator that investors pay attention to and is used to measure the profitability and financial health of a company. However, in the blockchain field, the concept of "earnings" may not be very applicable. This is because DeFi projects do not make profits in a traditional way. They usually do not have net profits or earnings per share like traditional companies. Instead, their economic models may involve token transaction fees, liquidity mining rewards, lending interest, etc., which are converted into net income for projects or token holders.
3.2.2 Valuation by Comparable Analysis
The above chart shows the project valuation and token price based on the Price/Earnings Ratio and Price/Sales Ratio. We estimated the project's fee income and net income for a full year using data from January to September 2023. dYdX's estimated annualized total revenue is $85.81 million, which shows that dYdX has good revenue-generating capabilities. In addition, dYdX's Price/Earnings Ratio is low relative to the average ratio of the selected decentralized derivatives protocols, and its value is likely to be underestimated. Finally, based on the Price/Earnings Ratio, the potential price of dYdX is deduced to be between $1.26 and $2.34.
3.3 Comprehensive analysis
Finally, we performed a sensitivity analysis on the key DCF variables and obtained a final valuation range.
At the same time, we select the maximum and minimum values of the probability-weighted DCF valuation under different terminal P/E ratios and discount rates from the sensitivity analysis. Due to the differences in value capture and token economics models among the five comparable projects, in the comprehensive valuation analysis, we give more weight (40%) to the P/E valuation to improve the accuracy of the model, and the P/S valuation also has a certain reference value, so it is given a 10% weight. Based on this, the total weight of the comparable analysis is 50%. The other 50% is given to the weighted DCF valuation. Finally, the comprehensive analysis results in a price range of DYDX tokens of $2.99-4.12, and a fully diluted valuation (FDV) range of $2.993-4.118 billion.
Since DCF gives a higher valuation, it generally raises the comprehensive valuation. The biggest highlight of v4's impact on the economic model is that the transaction fee is changed from being collected by the dYdX company of v3 to being 100% collected by the staking nodes. The cash flow captured by the token has huge room for growth and should be given a higher valuation multiple to reflect its growth potential. Therefore, the valuation method using the average P/E and P/S of comparable protocols will have a certain underestimation.
It is worth noting that the valuation model and the derived token price are based on the current data and market operation. The actual market dynamics and operational performance of the dYdX project in the future will ultimately determine its true market value.
4. Unlock Discussion
4.1 Valuation Premium
In the valuation analysis of dYdX, there is an obvious valuation premium, mainly due to the limited liquidity supply caused by staking. DYDX, as the L1 token of the dYdX chain, is used both for fee payment and for validator staking to ensure on-chain security. Currently, the average pledge rate of the entire Proof of Stake (PoS) network is 52.4%. With reference to the long-term pledge rate of existing PoS public chains such as BSC and Solana, it is between 40% and 70%. The pledge rate of the dYdX chain is very likely to exceed 40%. This will significantly reduce the circulation of DYDX. If the demand for the token remains unchanged, the currency price will rise significantly.
4.2 Calculation of Pledge Yield
In December this year, dYdX will unlock nearly 150M tokens (accounting for 15% of the total supply), and the token circulation will increase from the original 296M to 446M. For such a large number of tokens unlocked at one time, the market may have concerns about whether these tokens will bring about a large inflation in the short term and dilute the benefits brought by v4?
In this regard, we believe that the market does not need to worry about the token unlocking in December. The reason is that a large number of token unlocking will not bring a significant increase in token circulation. We can notice that the tokens unlocked this time are the initial shares distributed to the team and investors, and they are likely to stake most of the tokens. Generally speaking, in the early stages of the development of the PoS public chain, users have a low staking rate for risk considerations, and the corresponding annualized return is higher at this time. With the development of the public chain, the staking rate will gradually increase. At present, the average staking level of the Proof of Stake (PoS) network in the market is about 52.8%, and the yield on the chain is 10.2%. Based on this, we estimate the staking situation and APR of the dYdX chain (as shown in the figure). According to our valuation model, dYdX's revenue in 2023 is 85M. Assuming that the team and investors stake 80% and 50% of the unlocked tokens respectively, we can deduce that the annualized return on staking is 20.27%, and the staking rate is 41.2% at this time (calculated based on the circulation quantity). The staking rate on the dYdX chain gradually increases every year and eventually reaches a stable state (around 46.68%). If the price meets the valuation of the benchmark case, the annualized rate will rise to 44.5% after 5 years, which has a higher rate of return. Therefore, the token still has a large room for growth in the future. In summary, we believe that the team and investors are likely to stake the tokens, and the possibility of dilution risk caused by the token unlocking at the end of the year is relatively small.
5. Conclusion
This article adopts a top-down valuation method and uses cash flow analysis (DCF) to reasonably estimate the protocol value of dYdX. Through probability weighting, the protocol valuation is $2.445 billion, and the expected price of $DYDX is $5.48, with a potential upside of 2-3 times. Finally, combining the P/E and P/S valuation methods, a comprehensive analysis shows that the token price range of DYDX at the end of 2023 is $2.99-4.12, which still has certain upside potential compared to the current token price of DYDX in the market.
Faced with the potential dilution risk brought by the unlocking of tokens in December, we believe that since the main distribution targets of the unlocked tokens are the team and investors, the dYdX chain staking incentives are strong, and the annualized rate of return exceeds 20%, the unlocked tokens will most likely be staked and will not create a large selling pressure on the market.
References
https://docs.dydx.community/dydx-governance/
https://dydx.exchange/blog/v4-rewards-and-parameters
https://dydx.forum/t/dydx-v3-vs-v4-new-trader-rewards-overview/881
https://www.washingtoncompanysearch.com/companies/dydx-trading-inc/
https://help.dydx.exchange/en/articles/4798063-location-restrictions
https://www.binance.com/en-JP/feed/post/818240
https://dune.com/dydxanalytics/dydx-unified-dashboard
https://dune.com/impossiblefinance/derivatives-perpetual-markets
https://members.delphidigital.io/reports/dydx-valuation-analysis-dex-perps-comparison#synthetix-f08e
Disclaimer: This report is the original work of @GryphsisAcademy students @elliett 2077 , @0x CryptoAndrew, under the guidance of @CryptoScott_ETH. The authors are solely responsible for all content, which does not necessarily reflect the views of Gryphsis Academy or the organizations that commissioned the report. Editorial content and decisions are not influenced by readers. Please be aware that the authors may own cryptocurrencies mentioned in this report. This document is for informational purposes only and should not be relied upon in making investment decisions. You are strongly advised to conduct your own research and consult with a neutral financial, tax or legal advisor before making an investment decision. Remember that the past performance of any asset does not guarantee future returns.