DYDX community staking improvement proposal

This proposal was authored by me, governance lead at Citadel One; a dYdX Validator.

Background

Recently the dYdX chain has passed a governance proposal supporting the deployment of a portion of the Community Pool funds via liquid staking to increase its economic security and address the centralization of dYdX’s validator set. The proposal has been successfully executed under the following conditions:

  • LSD provider: Stride
  • Amount: 20,000,000 $DYDX
  • Fees:
    • 92.5% of rewards used to auto-compound DYDX into the treasury’s staked position, growing it over time.
    • 7.5% of the rewards flow to the Stride protocol
  • Term: 12 months

The proposal to community stake with Stride has undeniably brought much-needed improvements to the dYdX chain from an economic security & network decentralization perspective. However, it could be argued that this wasn’t without trade-offs:

  • The cost incurred by the community pool is relatively high: At a price of 1.95$/ DYDX, an APR of 18.58% and a 7.5% commission, the cost to the community pool stands at ≈543,000 $USDC per year.

  • Yield dilution to $DYDX Stakers: The community pool staking 20 million $DYDX lowered the staking yield to native Stakers by approximately 14.60%: post-proposal, the voting power of the Community Pool represented roughly 14.6% of the total voting power.

Description

In this post, I’d like to propose two suggestions to the original proposal with the goal of addressing the trade-offs mentioned above:

  • Revise the fees applied by Stride
  • Redistribution of all earned $DYDX earned by the community pool back to native Stakers
  1. Revise fees applied by Stride

With the following assumptions: DYDX price: 1.95$, APR: 18.58% and Stride commission: 7.5%

The cost of liquid staking with Stride is ≈543,000 $USDC for a duration of 12 months. In exchange, Stride handles the following:

  • Validator selection and active management of delegations
  • Auto-compounding rewards

For the record: Stride has already lowered its commission by 2.5% from the standard 10% fee. However a fee of 7.5% still seems relatively high. This is because, dYdX isn’t/ won’t be making use of the features liquid staking unlocks ( liquidity, DeFi use cases…).

Unlike the reasoning in the original proposal, I do not think that a trusted third party is required to handle a fair distribution of stake. Instead, it could be done via a delegation strategy that is actively rebalanced/ monitored by a dYdX sub-DAO based on predetermined criteria that are voted on by governance. There is a chance this approach will be explored in the future once the legal and technical structures are in place. But until that happens, LSD providers present the safest way to execute community pool staking.

My argument here is that the fees charged by Stride shouldn’t be considerably higher than the cost of funding a sub-DAO to do the same work.

Therefore, I propose reducing Stride’s fees from 7.5% to 5% (half of Stride’s standard fee).

It’s also worth noting that a reduction in fees applied by Stride could serve as a powerful gesture of goodwill, reinforcing Stride’s commitment to the dYdX community’s long-term interests.

  1. Redistribute accrued rewards back to $DYDX stakers

One of the downsides of the community staking proposal is the yield dilution to $DYDX stakers by roughly 14.6%. This yield is instead used to buy-back and stake $DYDX on behalf of the community pool. This auto-compounding has the positive effect of continuously increasing the economic security of the dYdX chain as well as supporting the token price, but also the negative effect of increasingly diluting the yield of $DYDX native Stakers.

The rationale behind the loop of buy-back and stake of DYDX in the original proposal is to continuously keep increasing the economic security of the chain. There is an argument here that this could render staking less and less attractive for $DYDX holders as the yield continuously diminishes.

The community staking is a also first-time initiative for the dYdX chain and should therefore be conducted with as few trade-offs as possible.

For these reasons I’d like to put forward the idea of redistributing all fees back to $DYDX Stakers to completely offset the yield dilution.

There is more than one way to achieve this, all of which are technically challenging and would require additional development from Stride. Which is why I propose the following:

At the conclusion of the proposed term (12 months), the dYdX community passes a community spend proposal of $DYDX tokens equivalent to the surplus accumulated from staking, with the dYdX staking contract address as the recipient address.

For example: If the 20M staked $DYDX has accumulated 4M $DYDX from staking rewards, 4M $DYDX will be distributed back pro-rata to $DYDX stakers.

Note: In order to achiever this, the community isn’t required to terminate staking with Stride. If community staking continues, idle $DYDX from the community pool equal to the amount required could be used to redistribute the yield. This way, the economic security of the protocol won’t be affected.

Implementation

Below, are the details for how the proposed improvements could be implemented:

  1. Revise Stride fees:

If approved by dYdX governance, this will require a follow-up proposal on Stride side and will only happen if the Stride community approves it as well.

  1. Redistribution of earned $DYDX from community staking back to Stakers:

If approved by dYdX governance, this will require a follow-up community spend proposal on dYdX to execute the distribution, at the end of the term.

Next steps

At the moment, this is just a forum post to gather feedback from the community. If there is enough support, it will move to on-chain governance.

I believe that the two improvements proposed here are both beneficial to the dYdX chain but they are in no way linked. Which is why, if they make it to on-chain governance, they will each be voted on separately.

Conclusion

Ideally, the dYdX community shouldn’t rely on LSD providers to address issues such as economic security and validator set decentralization. Instead, the community should opt for a delegation strategy that recalibrates regularly based on predetermined criteria that are approved by governance. This eliminates any additional costs and incentivizes validators’ good behaviour continuously.
But until it is possible to implement such an approach, I think these suggested improvements could be beneficial for the current dYdX community staking proposal with Stride as it will:

  • Reduce the community pool’s cost.
  • Strengthen the relationship between Stride and dYdX, and potentially paves the way for longer-term staking initiatives.
  • Offsets the yield dilution incurred by native Stakers.
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There’s a couple things to keep in mind as it relates to community pool funds - as it belongs to the voting power of individual staked assets. Other tokens, most of them - have some inflationary mechanism, which is what is compounded into the LSD product and why over time each LSD is worth more. This is why many cryptos are regarded as speculative.

The are only a handful of tokens that I know of that distribute real yield. DYDX is one of them. In the instance of DYDX the USDC from the yield is used to buy DYDX creating organic buy pressure, but as you noted it would cannibalize the native yield over time. There’re many options to explore for the later concern.

However:

  1. The DYDX purchased gets auto-compounded into a linear concentrated valuation of stDYDX.

Stride | About the Ecosystem - as seen here.

  1. The community pool owns those stDYDX.

I didn’t mean to open up a can of worms with throwing my support for the buy/burn post suggesting that I disprove of the current tokenomic dynamics of Stride and DYDX. With the volume of trades in DYDX, this is one of the more compelling investments and it benefits investments in both Stride and DYDX. I bought some Stride just because of the DYDX staking proposal. I like that Stride is a consumer chain of Atom and the economic security of their product. That also means part of the 7.5% fee from DYDX would go to Atom stakers. This is kind of a goodwill gesture and VERY interesting ecosystem experiment in the Cosmos. I’m not so hot on the fee part of the proposal.

As for the redistribution of accrued rewards back to $DYDX staker’s here’s a counter proposal that achieves what I assume is the letter of your intent…

Why not? If the goal to is use community funds to create more yield for native stakers, putting the 20M odd stDYDX into yeild bearing positions and diverting that yeild to native staker’s would be a better strategy, wouldn’t it?

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Interesting start!

To chip in already (will respond more elaborate later);

  • there is already a thread started for native staking of the $DYDX where @antonio is invited to expand on the hurdles to be taken before a subDAO comes into play, but until now it has been a no-show sadly…
    Native staking of funds from the Community Pool - #3 by LeonoorsCryptoman
  • regarding the distirbution of staking rewards. I would say it is needed to find a method for a distribution which is more often. Otherwise only stakers after the 12 months are eligible, while the stakers now are diluted. Staking length matter in that perspective. Because would 1 staked $DYDX just count as 1 asset at the time of the distribution, then every coin bought the day before would get the same share as the same coin which is staked today. And that is not fair towards the current stakers. I am aware that it is much more difficult though, and random snapshots would be required to avoid mercenary capital which buys, stakes, gets the reward, unstakes and sells.
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Thanks for the feedback Leonoors. I share your concerns on the second point. A fair way to distribute the back the yield accumulated by the CP needs to be determined before proceeding. My plan was to discuss this on a separate post in case the signalling proposal is met with approval.

Here are my thoughts on a fair distribution plan:
It will be technically challenging to execute this in a way that rewards the current DYDX stakers (in the first 12 months of the community staking).
A linear distribution ( every 2 months) on a period of 12 months might be the best option for the following reasons:

  • The least complicated from a technical perspective as it only requires a Community Pool Spend prop and it doesn’t require any additional trust assumptions ( setting a multisig etc…)
  • It will attract potential long-term new stakers to joing the dYdX chain and increase the economic security of the chain.
  • The un-bonding period of 30 days and potential exposure to negative price action makes it unattractive to mercenary capital.

Inviting dYdX validators to participate in the discussion in order to get more feedback on the proposed improvements:
@kingnodes @Imperator.co @Ertemann @Huzmond @polkachu @Kiln.fi @Govmos @rspa @Provalidator

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Balancing the pros and cons of the proposed solution is an extensive job. We will try to address this complex topic by providing the elements we perceive from our point of view. It feels essential to stress that we are obviously unable to grasp the entirety of the levers at play.

Nevertheless, we have expressed support via our votes to the initial proposition, therefore we feel obligated to answer both our delegators and the whole dYdX community to the factors that contributed to this choice:

1. The centralization issue of the VotePower

We would like to quote one of our post in which we highlighted the problem related to a centralization of the validator set’s stake distribution:

It is important to remember that, back then, a few validators were accounting for a significant share of the votepower, doubled by the fact that they were concentrating execution in the same area, this lead to evident symptoms, among which the block misses. At that time, further decentralizing the stake was the number one priority to address this issue and many other inconveniences.

2. The limits to the Foundation delegation program

To quote from the original source provided by the dYdX foundation:

Stake Delegation Principles
If the dYdX Foundation decides to delegate all or part of its DYDX tokens to dYdX Chain validators, it will seek to do so based on the following guiding principles:

  1. Independence. The dYdX Foundation will delegate to validators that, to the best of the Foundation’s knowledge, are independent from each other and from the Foundation itself. […]
  2. Decentralization. The Foundation will strive to distribute its delegated stake across a number of independent validators. […]
  3. Proportionality. Any delegations made by the Foundation to dYdX Chain validators will be made pro-rata to the stakes of such validators at the time the delegation is made. […]
  4. Minority Delegation. The Foundation’s delegated stake weight in the dYdX Chain shall be lower than 10% of the total active stake weight of the network.
  5. No Governance Participation. If the Foundation delegates its DYDX to dYdX Chain validators, the Foundation will not actively participate in dYdX Chain governance and, therefore, will not vote in any governance proposals. Validators that receive a stake delegation from the Foundation will inherit full control and discretion over the governance power associated with any delegated DYDX tokens.
  6. Meritocracy. The Foundation will have full and absolute discretion in deciding which dYdX Chain validators it wishes to delegate to. […]
  7. No Self Delegation. The dYdX Foundation will not run a dYdX Chain validator nor any other key infrastructure component in the dYdX Chain. […]
  8. Periodic Reviews & Rebalancings. The Foundation will periodically review and reevaluate its stake delegations […].

Source: Stake Delegation Principles | dYdX Foundation

The point to pay particular attention to is the “Minority Delegation” which effectively puts a limit in the foundation’s ability to participate in the decentralization issue we mentioned previously. On december 15th 2023, the foundation announced their official candidates to receive the delegation round: Staking Delegation Announcement | dYdX Foundation. In order to obide by the previous rule, the amounts were capped. This further strained the chain to opt for other solution to further increase stake distribution.

3. The lack of Community Initiative

Despite multiple attempts, all were still not bringing actual fruitful solution to address the problem. One discussion was initiated in this forum right after the chain’s launch: Securing the chain by smoothing out voting power. But it lacked of significant community involvement and hasn’t been woken up since then. On the contrary, the centralization problem remained prominent despite the foundation delegation program.

4.The Proposal to use Stride

After months of dormant community discussion on the matter, the Reverie team decided to propose an alternate vision using Stride as a service provider to delegate a portion of the community pool funds to provide a community delegation program.

This proposed to use Stride’s ability and experience to choose and update curated set of validators with the clear target to improve the decentralization of the vote power.


Conclusions:

Following the sequence of events, we agreed to the proposed solution as it felt like an absolute necessity to deploy more capital in a targeted manner with a specific task to further distribute the vote power. This new deployment also allowed the foundation to further increase its own delegation program more recently. More recently, we saw renewed interest into a potential community delegation program. Engagement in the community is still relatively low and therefore we invite everyone to express their opinions there: Native staking of funds from the Community Pool


Thanks for reading us!
Govmos
pro-delegators-sign

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