Introduction to dYdX#dydx $DYDX

dYdX is the pioneer of decentralized perpetual contract JYS, and its unique order book model provides a high-quality user experience comparable to centralized JYS. Currently, its penetration rate in the DEX market has reached 60% of the total volume.

The new architecture and marginal innovation of the v4 version make dYdX more competitive. On October 24, dYdX announced the release of dYdXChainV1.0 and open sourced its code. This marks the official start of the v4 upgrade and the transition from the Ethereum Layer 2 network to the implementation of an independent blockchain in the Cosmos ecosystem.

Open source code is core to the blockchain ethos, providing transparency to developers, allowing them to review, detect bugs, and improve code quality. According to the initial developer of dYdX Trading Inc., the dYdX Chain V1.0 version and its order book have completed development and passed the final audit. The v4 upgrade will make dYdX fully decentralized and community-operated, meaning 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. As an independent Cosmos Layer 1, dYdX Ops subDAO was officially launched on the main network. The validator created the genesis block of dYdX Chain at 01:00 on October 27 (UTC+8). The dYdX Operations subDAO public front-end for bridging will be launched on October 30, 2023, pending official confirmation and testing.

After the mainnet is launched, it will be divided into two stages: Alpha and Beta. The Alpha phase will begin on October 30, 2023, and will focus on enhancing the stability and security of the network. Trading will be launched during the beta phase, but there will be no rewards. The transition from Alpha to Beta will be determined by factors such as governance votes.

Valuation model

The valuation model is based on DCF and comparable analysis methods. These two methods are derived in detail in the valuation model (DYDX Valuation Model), and the valuation can be adjusted accordingly based on actual future market conditions. The following is a detailed description and explanation of the valuation method:

Valuation of DYDX supply

Although the validators and ZYers of dYdX Chain receive all the protocol fees, since the freely circulating, non-locked DYDX can choose to delegate it to nodes to obtain ZY benefits. Therefore, in the valuation, the total token circulation is selected as the basis, rather than the token circulation after excluding ZY. December 31, 2023 was selected as the valuation time point, taking into account the circulation after unlocking, the effective supply of tokens is 446M.

top-down approach

Using a top-down valuation method, for each forecast year, the total derivatives trading volume of that year is taken as the starting point and multiplied by the DEX penetration rate to estimate the DEX derivatives trading volume of that year. Then, the trading volume of dYdX for the year is calculated based on the market share of dYdX, and finally the income of the annual agreement is calculated based on the effective handling rate.

Discounted Cash Flow Analysis (DCF)

dYdX generates cash flow by collecting user fees to earn revenue. Prior to the v4 version, dYdX Trading Inc. was responsible for managing the protocol, and all cash flow belonged to the company. After the v4 improvement, dYdX is controlled by the dYdX Operations subDAO to achieve completely decentralized management. dYdX officially announced that dYdX Chain will distribute all protocol fees, including transaction fees denominated in USDC and gas fees denominated in DYDX, to validators and ZYers. Based on this, it can be considered that DYDX token holders can receive 100% of the cash flow.

Based on the above conditions, the discounted cash flow method is the most appropriate valuation method for the value of DYDX tokens. 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 a company's value is calculated based on the cash flows it can generate in the future, and the cash flows are discounted at a discount rate that reflects its risk. Based on the data before September 30, 2023, a 5-year forecast period is set, and the terminal value is used to represent the future long-term cash flow under the ongoing operation of the agreement, thereby estimating the value of the DYDX token on December 31, 2023. .

hypothesis

Transaction fees: Compared with other perpetual contract protocols, dYdX’s transaction fees are relatively low and have certain advantages. The v4 version divides handling fees into 9 levels based on v3 and provides different transaction rewards. By dividing the fee income in 2022 by the transaction volume, an average rate of 0.025% is calculated as the protocol’s fee rate. As market competition intensifies, JYS's overall handling rate decreases. Finally, the effective handling rate of dYdX decreases linearly to 0.015%, which is close to the preferential rate level of the largest centralized JYS VIP 9. This rate is applicable to monthly transactions. A trader with a volume of $2.5 billion.

Discount rate: Based on an assessment of current protocol developments and market risks, the cash flow discount rate from 2023 to 2028 is set at 29%. When calculating the discount rate, the 10-year US Treasury bond is used as the risk-free rate and BTC is used as the market benchmark. The beta value is obtained by building a regression model between DYDX returns and BTC returns. The regression analysis is based on one year of data, and selects the starting time when the currency price is flat with the current market price, that is, the data from August 1, 2022 to September 30, 2023. The capital asset pricing model (CAPM) calculates the capital cost rate to be 29.10%. Regression analysis shows that DYDX price has a significant positive correlation with BTC returns.

To sum up, choosing 29% as the discount rate is similar to the average return rate of venture capital funds of 30%, which is a more reasonable choice.

Based on domestic and foreign market conditions, three assumptions are made for the expected trading volume of DYDX under different trading conditions: base case, bear market case and bull market case.

Under the baseline scenario, DYDX’s total trading volume is expected to reach $2.93 trillion by 2028. Under a bear market scenario, DYDX’s total trading volume is expected to be $0.91 trillion by 2028. Under a bull market scenario, DYDX’s total trading volume is expected to reach $6.75 trillion by 2028.

Based on historical data settings and comprehensive consideration of industry development patterns and other factors, a more reasonable estimate of the expected transaction volume under these circumstances has been made. Currently, the total trading volume of the top 20 derivatives DEX is US$0.49 trillion, of which DYDX’s share is US$0.26 trillion. The total trading volume of the top 10 centralized JYS derivatives is US$20.49 trillion.

Multiplying the expected transaction volume by the commission rate yields the following expected revenue:

DCF analysis

The following are the corresponding DCF results in the three scenarios:

Baseline Scenario: In this scenario, the DYDX token price is expected to be $4.86, with the protocol valuation on December 31, 2023 being $2.170 billion.

Bear market situation: 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 situation: In the bull market, the DYDX token price is expected to be $10.56, with the protocol valuation on December 31, 2023 being $4.717 billion.

Probability Weighted Scenario Analysis

The bull and bear markets are each given a 25% probability, and the base scenario is given a 50% probability. According to calculations, the probability-weighted discounted cash flow (DCF) valuation of the DYDX price is $5.48, valuing the agreement at $2.445 billion. Based on the DYDX price of $1.96 on September 30, 2023, there is a potential upside of DYDX of 179.34%.

Comparable analysis

Industry comparable analysis is a method used to evaluate the relative value of a company or project. This approach is based on the assumption that blockchain projects of similar size and nature should theoretically have relatively similar valuation multiples. Comparable analysis usually uses the price-to-sales ratio (P/S) and the price-to-earnings ratio (P/E) to conduct a comparative valuation of the object being evaluated.

When conducting comparability analysis, it is crucial to select a reference object that is as similar as possible to the company or project being analyzed in terms of industry, business model, risk profile and market dynamics. By ensuring the comparability of these aspects, the impact of external factors on the analysis can be reduced and more focus can be placed on the intrinsic value factors of the enterprise or project being analyzed. The four comparable projects 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 the leading blockchain JYS and comply with market standards, which will help enhance the effectiveness of comparative analysis. Finally, by using DEX derivatives projects within the same decentralized financial market as comparable objects, differences in market risk analysis between different industries can be resolved.

2023 Cumulative Revenue for 5 Protocols, Source: Token Terminal

The above is a comparison chart of the annual cumulative income of these five projects as of October 27, 2023. As can be observed from the figure, GMX’s project revenue is the highest, exceeding US$100 million, while DYDX’s revenue is second, reaching US$65.4 million. Perpetual Protocol has the lowest revenue at $63 million.

The following is a brief analysis of comparable projects:

dYdX: Since its launch in 2021, DYDX has faced challenges from scarcity of supply and lack of utility. Although the market share exceeds 50% in the DEX perpetual contract market, the circulation ratio is much lower than that of peer projects. The new version plans to introduce more uses, such as all fees generated by dYdX Chain will be distributed to validators and token ZY holders. However, investors may still need to pay attention to the impact of large-scale token unlocks in the future.

GMX: GMX is a DEX platform that supports spot and perpetual contract transactions. It adopts a global liquidity model. Users provide liquidity by purchasing and issuing liquidity tokens GLP under the ZYGMX protocol. GMX holders can ZY tokens and earn 30GMX generated by the GMX protocol. Holders can ZY tokens and earn 30GMX generated by the GMX protocol. They will also receive voting rights and participate in the governance of the GMX protocol.

SNX (Synthetix): Synthetix’s perpetual contract products are provided in a back-end form to support developers and DeFi derivatives liquidity platforms. The circulating supply and total supply of SNX tokens are almost equal. SNX uses a weekly inflation system as a reward for SNX stakers and is subject to a one-year lock-up period.

Gains Network: Gains Network uses GNS as a utility token. The holder obtains platform fees through unilateral subscription. At the same time, the platform uses its 61.23GNS as a utility token. The holder obtains platform fees through unilateral subscription. At the same time, the platform will Its 61.23GNS stakers.

Perpetual Protocol: Perpetual Protocol is a decentralized perpetual contract trading protocol built on Ethereum. It adopts a virtual AMM design, supports leverage up to 20 times, and allows the opening of short positions. Holders can transfer ZY tokens to the ZY pool and receive ZY incentives, including PERP rewards and transaction fees.

Variables considered

The Price/Earnings Ratio is a financial indicator that measures the relationship between the current token price and earnings per share of a blockchain project.

The Price/Sales Ratio is often used to evaluate the valuation of traditional companies.

The average price-to-sales ratio (Average P/S Ratio) can be used as an estimate of the balanced market multiple.

The median (Median) is not affected by extreme values ​​in the distribution sequence and has a certain degree of representativeness.

Annualized Total Revenue can evaluate the project's ability to generate revenue and maintain operations.

In the blockchain field, the concept of profit (Annualized Revenue to DYDX Holders) may not be applicable, and various sources of income need to be considered.

Comparable analysis valuation

The above chart shows the project valuation and token price based on the Price/Sales Ratio and Price/Earnings Ratio. The project's fee income and net benefits for the full year were estimated using data from January to September 2023. It is estimated that dYdX’s annualized total revenue is US$85.81 million, indicating that the project has good profitability. Additionally, dYdX’s P/E ratio is low relative to the average of selected decentralized derivatives protocols, indicating that it may be undervalued. Based on the price-to-earnings ratio, the potential price range for dYdX is between $1.26 and $2.34.

Comprehensive analysis

Finally, a sensitivity analysis was performed on the key variables of the DCF and a final valuation range was obtained.

In the sensitivity analysis, the maximum and minimum values ​​of the probability-weighted DCF valuation under different terminal value P/E ratios and discount rates are considered. Due to differences in value capture (Value Capture) and token economic models (Tokenomics) between the five comparable projects, a 40% weight was assigned to the P/E valuation in the comprehensive valuation analysis and a 10% weight was assigned The weight of the P/S value is used to improve the accuracy of the model. The other 50% of the weight is given to the weighted DCF valuation. The comprehensive analysis results in a price range of DYDX token of $2.99-4.12, while the fully diluted valuation (FDV) range is $2.993-4.118 billion.

Because DCF gives a higher valuation, it generally raises the comprehensive valuation. The impact of the new version on the economic model is mainly reflected in the fact that the transaction fee is changed from v3's dYdX company to 100% collected by ZY nodes. The cash flow captured by the token has huge room for growth, so it should be given a higher valuation multiple. reflect its growth potential. Therefore, the valuation method using the average P/E and P/S of comparable agreements may be somewhat underestimated.

It should be noted that the valuation model and derived token prices are based on currently available data and market operations. Actual market dynamics and the operational performance of the dYdX project will ultimately determine its true market value.

Unlock discussion:

There is a clear valuation premium in the valuation analysis of dYdX, which is mainly due to the limited liquidity supply caused by ZY. DYDX, as the L1 token of the dYdX chain, is used not only to pay handling fees, but also for validators’ ZY to ensure the security of the chain. Currently, the average ZY rate across the entire Proof-of-Stake (PoS) network is 52.4%. Referring to existing PoS public chains such as BSC, Solana, etc., the long-term pledge rate is between 40% and 70%, so the pledge rate of the dYdX chain is likely to exceed 40%. This will significantly reduce the circulation of DYDX, which will cause the currency price to rise significantly while the demand for the token remains unchanged.

Calculation of pledge yield:

In December of this year, dYdX will unlock nearly 150M tokens, accounting for 15% of the total supply. The market may be concerned whether these unlocked tokens will cause significant inflation in the short term, thereby diluting the benefits of v4.

However, the market need not worry about token unlocks in December. The reason is that large amounts of token unlocking do not significantly increase the circulation of tokens. It can be noted that the unlocked tokens are the initial share distributed to the team and investors, who will likely ZY the vast majority of the tokens.

Generally speaking, the ZY rate of users of PoS public chains is low in the early stages of development. Due to risk considerations, the annualized return rate at this time is higher. With the development of the public chain, the ZY rate will gradually increase.

Currently, the average ZY rate of proof-of-stake networks on the market is approximately 52.8%, with an annualized return of 10.2%. Based on this situation, the ZY situation and annualized rate of return of the dYdX chain were estimated. According to the valuation model, dYdX’s revenue in 2023 will be 85M.

Assuming that the team and investors will ZY 80% and 50% of the unlocked tokens respectively, the annualized rate of return of ZY is estimated to be 20.27%. The ZY rate at this time is 41.2% (calculated based on the circulation quantity). The ZY rate on the dYdX chain will gradually increase every year and eventually stabilize at a level of approximately 46.68%. If the price complies with the baseline valuation scenario, the annualized rate of return after five years will rise to 44.5%, which is a relatively high rate of return.

Summarize

Through a top-down valuation analysis method, cash flow analysis (DCF) was used to make a reasonable estimate of the value of the dYdX protocol. Based on a probability-weighted approach, the protocol is valued at $2.445 billion and the price of $DYDX is expected to be $5.48, with a potential upside of 2-3 times. Finally, through a comprehensive analysis combining P/E and P/S valuation methods, it is concluded that the token price range of dYdX at the end of 2023 is US$2.99-4.12. Compared to the current DYDX token price on the market, there is still some upside potential.

Facing the possible dilution risk caused by unlocking tokens in December, since these unlocked tokens are mainly distributed to teams and investors, considering that the incentive mechanism of dYdX chain ZY is relatively strong and the annualized rate of return exceeds 20%, the unlocked tokens The token is likely to be ZY and will not cause significant selling pressure on the market.