Analysis and Proposals on dYdX Chain and DYDX Tokenomics

Hey everyone, I’m Vishal, one of the cofounders of Stride Labs, and a longtime holder of DYDX. I wanted to weigh in with my thoughts here. To start, thank you to Nethermind for spending the time to develop this proposal, and thank you to the many community members who contributed to the discussion.

To share my high-level thoughts, I’m strongly in-favor of this proposal. dYdX has been a market leader in decentralized perps since they were invented, and has repeatedly prioritized the long-term health of the protocol. The migration to the v4 chain is great example of this - dYdX made the push to become the most fully decentralized perps protocol, optimizing for long-term growth over short-term revenue. Now, the decentralized perp market has become increasingly competitive, particularly with the recent growth of Hyperliquid. I believe the changes described in this proposal will meaningfully improve the fundamentals of dYdX and ensure it remains competitive.

One thing I’ll note: I’m very aware that this proposal will short-term reduce rewards for DYDX stakers and validators. The Stride Protocol currently stakes ~10% of all DYDX tokens, and its short-term revenue will decrease if this proposal passes. I don’t view this as a negative. Ultimately, stakers, validators, and tokenholders should care about the long-term growth of dYdX. Getting 100% of a medium amount of revenue is worse than getting 40% of a much larger amount of revenue. Perps are potentially the most competitive sector in crypto, and it’s vital that dYdX invest in increasing volumes.

Addressing each part of the proposal:

Protocol Revenue Distribution

It’s becoming increasingly clear that long-tail assets can drive significant amounts of volume and fees to trading venues. To cite a very recent example: GOAT has incredibly high volume - more than 2x blue-chip tokens like UNI. Having reasonable liquidity for long-tail assets will also attract new users. Traders like to be able to trade the full gambit of tokens they’re interested in, and every time a trader needs to switch applications, dYdX potentially loses their long-term volume.

To this, the MegaVault can help ensure dYdX has ample liquidity for long-tail assets. Carl highlights the early effectiveness of this vault here. ~$1.5m of capital has facilititated $100m+ in volume. It seems incredibly useful to direct large amounts of revenue to this vault to drive trading volumes, and additionally have that TVL be owned by the protocol. In my opinion, dYdX needs to aim to be the most liquid venue for all assets, and I don’t see a path to doing that for long-tail assets other than having a heavily capitalized MegaVault.

I would be very open to re-evaulating sending revenue to this vault based on traction (e.g. it’s possible that the vault becomes extremely capitalized from outside capital), but based on the data so far, it seems like very high ROI.

I want to emphasize one point here: the benefit of the MegaVault isn’t only that it drives volumes, but also that it becomes a user-acquisition tool. Particularly in the most recent trading meta, users are increasingly drawn to the long-tail of memecoins.

Reduction of the Validator Set

I can’t directly speak to the profitability of validators, and whether or not validators want to run unprofitably on networks. However, I can speak to the importance of having a highly performant chain.

Traders, particularly quantiative traders, have a ~limitless appetite for transaction throughput. On venues where they are offered the chance, traders will spend millions to optimize throughput on the order of nanoseconds (e.g. NYSE). dYdX contributors and validators have done a truly spectacular job at optimizing the dYdX chain - block times are down to ~1.1s running a fully decentralized network. This is done through many technical optimizations on the chain-level, as well as social coordination among validators to optimize the geographic placement of their nodes.

However, the reality is that other decentralized perp markets, like Hyperliquid, operate in a pseudo-centralized manner with few nodes that are tightly colocated. This allows them to give extremely strong guarantees to traders around trade execution, which drives much more liquidity and volume to the venue.

I’ve heard from multiple liquidity providers that dYdX performance is still below other markets. Unfortunately, dYdX is still compared to fully centralized venues like Binance, Coinbase, etc, as well as psuedo-centralized venues like Hyperliquid. Having even 1-5% of transactions fail or not get processed in time is enough to convince HFT firms to stop supporting dYdX.

I view this as a critical issue for dYdX, and should be the protocol’s top goal. Market makers offboarding from dYdX would be catastrophic.

The long-term viability of dYdX is fully dependent on attracting the most competitive and efficient liquidity providers. I fully believe that reducing the validator set can only improve the performance of the chain.

As other contributors have mentioned, validators already mostly colocate their nodes, and we would achieve large gains by improving the technical setup of a few underperforming validators. I fully agree with this, and I believe any delegations done by the dYdX protocol or the Treasury SubDAO should only delegate to highly performant validators. I don’t disagree with this view at all, and also view the underperformance of large validators as a critical issue.

However, it’s certainly true that fewer validators will lead to faster blocks. Fewer validators means less gossipping on the p2p layer, and fewer nodes needed to reach 2/3 consensus. Even in a world where all validators are located in the same room, fewer nodes will still directly lead to faster blocks.

Carl highlights some empirical data about this here - it is a fact that the current dYdX network has performance issues. We need to increase the tx throughput of the network, or we risk losing meaningful liquidity.

I am aware that this reduction would be painful, but I do strongly believe it’s necessary for the long-term competitiveness of dYdX. I believe that one of dYdX’s core goals should be optimizing tx throughput for liquidity providers, otherwise all validators will be negatively affected in the long-term.

Trading Rewards

Given the increase of liquidity to the MegaVault, it seems reasonable to decrease the rewards given to traders. This will also mitigate some of the selling pressure on the dYdX token. Based on the analysis done by Nethermind, it seems like dYdX is over-compensating traders, and there is room to decrease trading rewards.

I would caveat this by saying that dYdX governance should be nimble with the adjusting trading rewards. Based on the trading environment and the empirical results of the change, this value should be changed again in the future.

The Bridge

At this point, DYDX holders have had ~1 year to bridge their tokens. It seems reasonable to give holders another 6 months to bridge or they risk losing their tokens. Ultimately, it is difficult for market makers to support liquidity on two separate tokens on separate networks, and I suspect liquidity for DYDX would be improved by fully consolidating to the v4 token.

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