Firstly, we would like to thank the community for taking the time to read our report and give their comments. The constructive feedback is greatly appreciated.
We have identified the following concerns and we would like to address them in this post:
- Megavault 50% Revenue Share
dYdX is aiming to become the largest exchange in crypto. To achieve this, the dYdX community needs to have a long-term outlook and focus. dYdX needs to remain competitive against competitors, especially centralized exchanges. The DEX landscape is highly competitive, and rivals are constantly innovating with new products. This means dYdX needs to invest heavily in launching new initiatives like MegaVault. To drive long-term growth and increase adoption and protocol activity (which would translate into multiple other benefits, including staking yields), dYdX should focus on boosting liquidity for dYdX Chain markets, especially those new markets that the community will decide to create once permissionless markets are live with the deployment of dYdX Unlimited. As such, we recommended that 50% of protocol revenue beis directed to the MegaVault, at least initially, to ensure that MegaVault depositors are sufficiently incentivised to provide capital that can enable the vault to achieve its ultimate goal of bringing unparalleled liquidity to all dYdX markets.
dYdX MegaVault is not live yet and existing vaults are not representative of the MegaVault strategy performance. Based on the blog from dYdX Trading, an operator will be in charge of the MegaVault strategy, managing allocations to market-specific sub-vaults, adjusting parameters, monitoring and managing risk while it transitions to a more automated product. dYdX will potentially have hundreds of markets once Permissionless Market Listing is enabled with the Unlimited upgrade.
- Inflation, Staking Yield Reduction and Token Benefits
Our report refers to the inflation of the liquid circulating supply. Our reference to inflation includes DYDX token unlocks, DYDX that is transferred out of the community treasury for DAO operational expenses and growth campaigns, and DYDX distributed as trading rewards. It is important to clarify that inflation does not refer to staking rewards on the dYdX Chain in our report (given that staking rewards are denominated in USDC and derived entirely from protocol fees). The increase in circulating supply from the various initiatives listed above under inflation creates significant selling pressure for the DYDX token.
Relying too much on token emissions can dilute token holders. While stakers have earned 12.5% staking APR since November 2023, their net worth has eroded by 52% due to the token’s performance. The initiatives proposed in our report aim to increase DYDX token’s attractiveness and competitiveness by reducing circulating supply inflation, and increasing its utility, all while supporting the growth requirements of the dYdX Chain.
We acknowledge that while the APR for staking DYDX tokens may decrease soon, we believe it will remain competitive in the long term. We do not anticipate any risks to protocol security. Currently, the total value locked (TVL) on the dYdX Chain stands at $184M in USDC, with 237M DYDX tokens staked to validators. Assuming a token price of $1, the dollar value of staked DYDX still exceeds the TVL in USDC. Although changes in DYDX token price or an increase in TVL could occur, it would be extremely difficult—if not impossible—to acquire and stake enough DYDX to pose a threat to the network. Additionally, we expect the Treasury subDAO to stake approximately 40M DYDX in the near future, helping to offset any potential unstaking due to reduced APRs.
If we take into account growth incentives, the protocol is distributing more than its net revenue to stakers, which is not sustainable in the long term. This has been highlighted by Stakehouse Financial in their Treasury SubDAO proposal. Under our proposal, the protocol revenue would be rebalanced and stakers would capture a significant portion of the revenue, adjusted for growth expenses.
- Network performance and reducing the active set from 60 to 30 validators
We appreciate that validators could decide to operate at a loss with the hope that volume and revenue increase on dYdX Chain, but we think it is in the best interest of the dYdX ecosystem to reduce the active set.
The proposed reduction of the active validator set from 60 to 30 takes into account the impact on validator profitability, assuming the approval of a 50% revenue share towards MegaVault and 10% towards the Treasury subDAO. At the time of the analysis, 17 validators were unprofitable with 100% of protocol revenue directed to stakers and validators, assuming a fixed infrastructure cost of $1,000/month (which, again, we acknowledge may not be representative in all cases but, in our opinion, serves as a good proxy). With the proposed revenue share, over 34 (of 60) validators could face unprofitability, accounting for 57% of the active validators. This concern has been raised by comments suggesting that some validators have been operating at a loss since the genesis of dYdX Chain. Validator financial health is important to the chain’s security and overall success.
We do not think there are significant impacts on validator network decentralisation from reducing the active set by 50%. The top 30 validators have been delegated 86% of the total stake, with the top 4 accounting for 36%. The report notes that the Nakamoto Coefficient would remain at 4, and the HHI would increase slightly to 552 if the active set reduction is implemented. We strongly advocate for decentralization, and recommend the community adopt a delegation policy framework that encourages a more even distribution of stake, particularly supporting validators with lower delegations. Additionally, we propose reassessing the active validator set in the future, potentially increasing it once dYdX Chain achieves sufficient unincentivized volume. This should occur alongside the stabilization of DYDX price and the bootstrapping of new initiatives, which could allow for a reduction in the revenue share allocated towards them.
This proposal emphasizes the importance of maintaining a lean, agile, financially healthy validator set to ensure dYdX Chain’s security, leaving the final decision to the community.
Additionally, reducing the active validator set could improve network performance. We have not done any technical analysis, but we assume that decreasing the active set will result in less network traffic.
- Cease support for wethDYDX Bridge Smart Contract on the dYdX Chain side
Since dYdX Chain’s launch on October 26, 2023, ~226M ethDYDX, representing 22.6% of the total supply, remains unbridged. While we recognize the risks of ceasing support for the wethDYDX Bridge Smart Contract on the dYdX Chain side, after evaluating the costs and benefits, we concluded that a 6-month window following the proposal’s approval would be sufficient for ethDYDX holders to migrate to the dYdX Chain if they so choose to, providing the required time for ethDYDX token holders to migrate to the dYdX Chain.
In relation to this proposal in particular, we also strongly advocate for recurring, ample disclosures by all community members, including on the dYdX social media channels, to ensure that the public -and ethDYDX holders in particular- are sufficiently informed about this proposal and have sufficient time and information to make informed decisions.
If implemented, we believe that this proposal could significantly benefit liquidity, governance, and staking participation, promoting dYdX Chain’s growth and long-term success.
- Reducing Trading Rewards “C” constant from 0.9 to 0.5
To date, approximately 17M (~$30M) DYDX have been distributed as trading rewards on dYdX Chain and there is an opportunity to significantly reduce DYDX emissions from Trading Rewards.
"Lenses
Trading rewards were initially increased to 0.9 to stimulate activity on the dYdX Chain after its launch in Q3 2023.
Our analysis indicates that this reduction is equivalent to raising dYdX fees by 0.5 basis points. Please refer to the report for more details. Considering this alongside the impact of launch incentives, trading on dYdX is expected to remain cost-competitive compared to other exchanges (CEX and DEX). Additionally, the increase in trading fees will be more than offset by improved liquidity and reduced slippage.