dYdX uses a tiered transaction fee mechanism to charge lower fees to Makers and large traders while maintaining liquidity. Compared to other exchanges, dYdX has lower transaction fees. In addition, as an incentive for early adopters of the upcoming v4 version, they will launch $DYDX token rewards, further enhancing their competitive fee structure. #dydx
The highlights of the v4 version include: (a) dYdX v4 will migrate to the Layer1 chain based on the Cosmos SDK. (b) The transaction process adopts off-chain matching and on-chain consensus. © No gas fee is required for placing/cancelling orders, and fees are only charged when completed. (d) dYdX has achieved fully decentralized governance.
Compared with v3, version v4 has made some minor improvements in token standards, governance, discount functions, trader rewards, staking, gas fees, and fee distribution, increasing the intrinsic value of the token.
Reasons for choosing Cosmos include: (a) Cosmos offers decentralization and high performance. (b) Decentralization in v4 reduces the risk of regulatory scrutiny. © USDC available on Cosmos increases dYdX liquidity. (d) Cosmos provides dYdX with better scalability and composability.
In our assessment, Layer 1 staking and fee distribution increase the utility and value capture of the token. Circle launched native USDC on Cosmos, which improved the liquidity of the token. Overall, these factors will definitely boost the fundamentals of the $DYDX token and give a positive note to potential security risks. Security is of paramount importance for dYdX. As a decentralized exchange, it needs to ensure that users' assets and transaction information are fully protected. As dYdX grows in size and influence, attackers may have more and more incentives to try to attack its system. Therefore, dYdX needs to continuously improve its security measures, including dynamic security audits, vulnerability disclosure programs, and vulnerability bounty programs.
In addition, dYdX also needs to pay close attention to compliance and regulatory requirements. As the regulatory environment of the crypto industry continues to evolve, dYdX needs to ensure that its operations comply with relevant regulations to avoid potential risks and legal issues. This includes the implementation of KYC (Know Your Customer) and AML (Anti-Money Laundering) measures, as well as cooperation and communication with regulators.
In summary, although dYdX has made significant progress in terms of functionality and applications, and the fundamentals of the token have improved, potential security risks and compliance challenges still need to be closely watched and addressed. Only through continuous efforts and innovation can dYdX maintain its leading position in the highly competitive digital currency exchange market.
Protocol Overview
dYdX is a distributed perpetual contract exchange currently hosted on the Ethereum Layer 2 blockchain built by StarkWare, relying on the security of Ethereum and using zero-knowledge proofs to speed up transactions and reduce transaction fees. dYdX adopts an order book model and performs well in 24-hour trading volume and daily active users (DAU), making it the largest and most widely used perpetual contract exchange in the market. The daily trading volume exceeds US$800 million, exceeding the combined trading volume of protocols such as Kwenta, GMX, gTrade, and Vertex.
2. Team and funding
Founded in 2017, dYdX has a team with extensive experience and technical expertise in the blockchain industry. It is worth noting that dYdX has a close relationship with the centralized exchange Coinbase. First, some of dYdX’s core team members have worked at Coinbase, including its founder Antonio Juliano, who worked as a senior engineer at Coinbase. Second, Coinbase also actively participated in dYdX’s seed round and provided liquidity support for its lending products. In addition, the current CEO of dYdX is Charles d’Haussy, who previously served as the global head of business development at ConsenSys and as the head of fintech at the Hong Kong SAR Government (Invest Hong Kong).
According to the information provided, dYdX's executive team and board members graduated from globally renowned universities and have held positions at well-known companies such as Wharton FinTech, AIG, LinkedIn, etc. This highlights that the dYdX team has extensive expertise and experience in the fields of finance and technology.
As of now, dYdX has completed four rounds of financing, raising a total of US$87 million. Its investors are strong and well-funded, including well-known industry institutions such as Paradigm, Polychain Capital, Andreessen Horowitz (A16Z), and the famous crypto market maker Wintermute.
3. History and current development of dYdX
dYdX was originally built on the Ethereum mainnet, but the outbreak of DeFi Summer caused it to encounter sky-high gas fees and congestion problems on the Ethereum network. These challenges significantly impact users’ trading experience. To solve the gas fee problem, in 2021, dYdX migrated to the more scalable Ethereum Layer 2 platform developed by StarkWare. This move effectively solves issues related to transaction speed (TPS) and gas fees.
Following the migration, dYdX’s trading volume increased significantly, with total trading volume on dYdX v3 reaching approximately $1 trillion, firmly establishing its position as the market-leading perpetual contract decentralized exchange.
4. Improvement in business segments and transaction costs
dYdX offers a comprehensive range of features, including lending, leveraged trading, and perpetual contracts. Margin trading has an integrated lending function, and the funds deposited by users automatically form a fund pool. If there is insufficient funds during the transaction, the platform will automatically lend money on behalf of the user and pay interest on the user's behalf. dYdX increases liquidity by charging Maker lower fees. The larger the monthly trading volume, the lower the fee. This mechanism is more friendly to institutions and professional traders. As shown, dYdX’s lower trading fees give it a significant advantage among major cryptocurrency trading platforms.
Trading fees on dYdX vary based on the volume tier over a 30-day period. In dYdX v3, there are six tiers, with higher tiers corresponding to greater volume. This structure allows Maker and Taker fees to decrease as volume increases. Notably, Maker fees drop to zero when volume over a 30-day period exceeds or equals $50 million.
According to the official plan, in the first 120 days after the launch of v4, Maker will incur order fees unless the 30-day trading volume reaches or exceeds $25 million, at which point the Maker fee will be waived. In addition, when the 30-day trading volume reaches $125 million and exceeds 0.5% of the market share, Maker will again be eligible for trading rewards. It should be noted that this is only the current situation, and the fee tiers may be adjusted by the governance community based on actual conditions.
At the same time, according to the latest proposal passed as of October 2, the community will distribute $20 million worth of DYDX tokens to early adopters of v4 within 6 months to incentivize users to transition to v4 and migrate seamlessly to the dYdX chain. It is expected that this measure will effectively promote the adoption of v4 and support its early growth. It also enhances the fee advantage of dYdX.
5. dYdX v4 Token Economics
5.1 Token Allocation and Lockup Schedule
A total of 1 billion DYDX has been issued, which will be released gradually over five years starting on August 3, 2021. Since the launch of DYDX, there have been several governance proposals (DIP 14, DIP 16, DIP 17, DIP 24) that have led to changes to the initial allocation. The current allocation includes:
50.0% (500,000,000 DYDX) is allocated to the community, 14.5% (144,693,506 DYDX) is allocated based on the trading reward formula, 5.0% (50,309,197 DYDX) is allocated to past users who have completed specific trading milestones on the dYdX Layer 2 Protocol (retroactive mining rewards), 5.2% (52,458,925 DYDX) is based on the market maker reward formula, 24.2% (241,735,862 DYDX) is allocated to the community treasure and the reward treasure, 0.6% (5,753,430 DYDX) is allocated to users who pledge USDC to the market making pool, and 0.5% (5,049,079 DYDX) is allocated to users who pledge DYDX to the security staking pool.
The other 50.0% (500,000,000 DYDX) is mainly used for distribution to investors and employees.
Governance may adopt a sustained inflation rate of up to 2% per year for five years after launch to increase the supply of DYDX, thereby ensuring the resources needed to sustain the development and expansion of the protocol. Any inflationary measures will need to be approved via a governance proposal and will be subject to a maximum annual limit of 2%.
5.2 Token Utility and Value Capture
In the v3 version, the three main uses of the $DYDX token are governance, fee discounts, and staking. It is worth noting that the security staking module was deactivated in a proposal in October 2022.
In contrast, v4 introduces the new feature of validator staking. With v4, dYdX is fully decentralized and governed entirely by token holders. This enables $DYDX token holders to define the functionality of the token, add or remove markets, and modify the parameters of dYdX v4. Building on the success of perpetual contracts, dYdX can also enter the spot market and develop into a versatile DeFi application with high user retention.
6. Marginal improvements in dYdX v4
6.1 Main features of the new version
dYdX’s new version v4 will be released on the mainnet in Q4 2023. Here are the main features of this new version:
1) Layer 2 → replaces Layer 1
dYdX v4 no longer relies on the Ethereum mainnet, but instead runs within the Cosmos ecosystem, utilizing the Cosmos SDK and CometBFT POS mechanism.
v4 uses a proof-of-stake consensus mechanism supported by two types of nodes: validators and full nodes. Validators are responsible for storing orders, processing transactions, and generating new blocks through the consensus process, while full nodes do not participate in the consensus mechanism but handle transaction propagation and block processing.
2) Order mechanism update
When placing an order on v4, the following process will be followed: the user initiates a transaction on the front end → the transaction is sent to the validator → the order is matched and a new block is created → consensus process: 2/3 of the validators confirm through voting → data is updated and returned to the front end through the indexer.
3) No transaction gas fee
In dYdX v4, each validator maintains an off-chain order book. User order submissions and cancellations are propagated off-chain through the network. Only when orders are matched in real time are the trade results submitted to the blockchain. This means that user order submissions and cancellations are considered off-chain operations and do not require transaction gas fees. The protocol only charges transaction fees when orders are completed on-chain.
4) Completely decentralized governance
Under the approved DIP 18-Operations SubDAO proposal, the dYdX DAO will be fully authorized to the protocol, transferring control away from dYdX Trading Inc. This means that the operations of dYdX will be fully decentralized, with the community playing a key role in facilitating the transition by establishing an operations sub-DAO to ensure a seamless transition of the operating framework.
6.2 Comparison between v3 and v4
Based on the recommendations of the v4 incentive plan and the v4 adoption and token migration plan, we have identified six areas where v4 has marginal improvements over v3 token usage, namely token standards, governance, discounts, staking, gas fee payments, and fee distribution. Please refer to the table below for a detailed comparison:
6.3 Why choose Cosmos
1) Decentralization and high performance
The order book and matching engine implementation mechanisms in dYdX place extremely high demands on throughput. Currently, the Ethereum network faces scalability issues, and the security, speed, and scalability of the Cosmos Network can help dYdX meet these challenges. This in turn provides traders with faster transaction speeds, lower fees, and a fully decentralized trading experience.
2) Regulatory flexibility
According to the latest ruling of the U.S. Commodity Futures Trading Commission (CFTC) in September, the three DeFi protocols Opyn, Inc., ZeroEx, Inc., and Deridex, Inc. were all accused of illegally providing digital asset derivatives transactions and faced hundreds of thousands of dollars in fines. Compared with the SEC, the CFTC enforces stricter regulation on cryptocurrencies. In view of this trend, the CFTC may expand its regulatory scope to more decentralized perpetual contract trading platforms based on smart contracts and require them to implement Know Your Customer (KYC) procedures. It is worth noting that the three accused protocols are entities registered in California. Similarly, dYdX Trading, Inc., which is registered as a single entity in the United States, faces the same situation. In v3, dYdX Trading, Inc. controls the protocol and enjoys all fee income, making it vulnerable to regulatory scrutiny due to its centralized management method. Although dYdX has been extremely cautious about regulatory issues in the United States and does not provide services to U.S. residents, it is clear that in the face of increasingly stringent regulatory trends, it is a wise move to transition to full decentralization. In v4, dYdX will be fully decentralized, with dYdX Trading, Inc. (the platform operator) no longer running any centralized components. dYdX will be managed and controlled by the community in a fully decentralized manner. With full decentralization, regulators will no longer classify dYdX as a "centralized exchange," allowing dYdX to expand its market and reach more users.
3) Cosmos launches USDC
As a new Layer 1, the dYdX chain has its own set of validators and requires users to connect through a cross-chain bridge. As Ethereum co-founder Vitalik Buterin pointed out, the security of cryptocurrency assets depends not only on the original network, but also on the other chains that the assets pass through when they are packaged, locked, and transferred through cross-chain bridges. Cross-chain bridge hacks are common, posing a major threat to the flow of large amounts of funds, and the inability to deal with the risks of cross-chain bridges will be fatal to dYdX, especially considering its large user base. Circle recently launched native USDC on Cosmos, which helps improve the liquidity of dYdX and reduce the need and associated risks of cross-chain asset transfers. This is one of the reasons why dYdX chose Cosmos.
4) Scalability and composability
dYdX transactions are recorded on the blockchain in discrete “blocks”. Each block can only hold a limited amount of data and is processed periodically. As the blockchain attracts more users, the limited block space becomes more sought after, causing gas fees to increase. To address this, dYdX v4, powered by Cosmos, introduces the concept of Lisks.
Unlike most Rollups, Lisks are self-contained blockchains tuned for a specific purpose. Lisk builders are free to customize every aspect, from the underlying protocol to the user interface. Lisks have their own unique consensus protocol and are extensively customizable. This opens up entirely novel functionalities for new features and delivers transaction speed while enhancing decentralization and scalability. While dYdX v3 is on Starknet (L2 solution), v4 will spur a move to Lisks. For dYdX, the Lisk model offers a superior combination of decentralization, scalability, composability, and transaction speed compared to current Rollup solutions.
7. Outlook of dYdX v4:
Currently, for dYdX v3, all trading revenue goes to dYdX Trading, Inc. The relatively small wealth effect of the $DYDX token, outside of being used for governance and staking to receive fee discounts and platform rewards, has been a significant barrier to price appreciation. This shortcoming is expected to improve in dYdX v4, as there will no longer be a centralized entity receiving fee revenue. In addition, the dYdX community has passed a proposal to utilize the $DYDX token for staking and securing the dYdX chain, providing more substantial utility and purpose.
1) Layer 1 staking increases the demand for holding $dYdX tokens
The Security Staking Module (SSM) is a protection mechanism of the dYdX protocol to deal with fund shortage situations, such as smart contract risks. In the past, funding providers (stakeholders) were rewarded from the genesis supply for taking on these risks. In v3, staking $DYDX tokens to the security module was a utility feature of the token, but this did not significantly drive demand for purchasing dYdX tokens. In the event of a shortage of funds in the protocol, the value of the funds pledged by the pledger may be at risk of being reduced. Therefore, the effectiveness of the SSM mechanism is questionable, as smart contract risks may cause the token price to fall and the value of the security module reserve to be significantly reduced. Therefore, on November 28, 2022, the community passed the DIP17 proposal and closed the security staking module.
According to the official announcement, after the release of the dYdX v4 mainnet, the dYdX Chain will become a proof-of-stake blockchain network. At this stage, v4 will require an L1 protocol token for validators to stake to ensure the security of the network and delegate its management to the stakers of this L1 token. Currently, the dYdX community has chosen $DYDX as the L1 token for the dYdX chain. Since dYdX adopts the PoS (Proof of Stake) mechanism, L1 tokens are used for validator staking. Anyone who stakes a certain amount of tokens has the opportunity to become a validator and ensure the security of the chain. Although we are not sure about the exact number of $DYDX tokens required for validator staking, the number of available nodes, or the specific details of the delegation mechanism, it is foreseeable that this new staking model in v4 will replace the previous SSM staking model of v3, increase the demand for $DYDX tokens, and potentially drive its price up.
2) Fee distribution strengthens the token base
According to the initial conception of the official document, after each transaction, a portion of the transaction fee will be automatically returned to the user as a transaction reward through the smart contract. After each transaction, a portion of the commission will be sent directly from the smart contract to the user as a transaction reward. The maximum transaction reward for each transaction will not exceed the processing fee of the transaction. Since the transaction reward is limited to the net transaction fee generated by the block protocol, and the distributed transaction rewards may be based on each block, the protocol can incentivize trading activities without exceeding its budget, thereby saving a lot of money and reducing token inflation.
According to the plan, v4 will not charge GAS fees, only transaction fees. The $DYDX token will most likely be used to pay for these transaction fees. This significantly expands the token’s practical uses and increases its intrinsic demand. Additionally, the allocation of transaction fees is entirely determined by the community. If the community approves the proposal, more of the platform’s revenue will flow to $DYDX token holders. This allows the $DYDX token to capture more value from the development of the protocol.
3) Introducing native stablecoins to enhance asset security
Circle recently announced that Cosmos will support native USDC. The introduction of a native stablecoin on the chain not only improves the liquidity of $DYDX tokens, but also reduces the need and associated risks of cross-chain asset transfers, ensuring the security of dYdX chain assets.
From an objective and rational standpoint, we believe that dYdX v4 will empower the $DYDX token and bring a range of benefits. However, it is necessary to acknowledge that the decision to create a new chain instead of building on Ethereum also brings potential risks related to security:
L2 Rollup is still superior to Cosmos because it relies on the superior security of Ethereum without incurring the high cost of maintaining its own security. If users have confidence in the underlying Ethereum blockchain, they are likely to have confidence in the security of dYdX transactions on L2. However, in v4, users need to trust a new set of validators on the dYdX chain. In addition, staking requires payment of $DYDX tokens, but the consensus on the value of $DYDX is not as firm as that of ETH.