ETH Collateral in dYdX

At Crypto Plaza / Dragon Stake validator, we are making this proposal for the protocol, which we believe can have a very positive impact on its development

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Derivative instruments that involve leverage are typically margined and settled in a stable currency due to risk management considerations. This practice reduces the volatility associated with these transactions, providing a more predictable environment for all parties involved.

The primary reason for this is that settling and margining in a volatile currency significantly increases the risk of trader liquidation. This is because the value of the collateral can fluctuate rapidly, potentially leading to margin calls and subsequent liquidations.

Experienced traders may be able to hedge and manage these risks effectively, even when using volatile collateral. However, many less experienced traders lack this expertise. As a result, they may be more susceptible to the risks associated with volatile collateral, which could lead to unexpected losses.

The Levana protocol serves as a notable example of this concept. It settled its leveraged derivative products directly with the same traded asset, essentially squaring the risk of reaching margin calls and liquidations. This means that the risks associated with the asset’s volatility were directly reflected in the derivative product, which could lead to increased risk for traders.

In conclusion, while more advanced traders may be able to manage these risks, it is generally more prudent to margin and settle derivative instruments in a stable currency to minimize potential risks and provide a more predictable trading environment. Therefore we don’t recommend introducing other assets to the dYdX protocol.

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yes, agree to the above. It’s been requested for a while now to introduce other coins as margin, but has never been implemented due to risk controls. What I’m thiking though is that we could perhaps ‘package’ this funding rate product in a different way. Maybe some sort of pool, which uses ETH-USD to open positions capped at 1x leverage, this way there is no liquidation risk and you contribute open interest/volume/fees for the exchange while in return earn the 17-18% funding rate. So you deposit 1 ETH for example and the protocol opens a 1 ETH short on your behalf etc. Probably a lot of work to implement this and not sure how feasible that is with our current architecture

If you want to incorporate ETH as collateral, just make sure to incorporate the liquid staked versions of it.

First, I would like to express my gratitude for your insightful comments on the proposal. You have raised excellent points, and it is true that using collateral in certain operations can indeed incur higher risks. Therefore, I would like to clarify that the proposal was about adding other assets, not replacing USDC, which is certainly more optimal in terms of risk for specific operations.

Futures markets have historically been linked with their collaterals. Some of them even continue to physically deliver the commodities (collateral) as a way to finalize settlement. In this sense, cash-settled contracts often pose higher risks for these markets, and cash settlement is a later innovation. For example, Deribit, the leading derivatives market in crypto, successfully uses crypto collateral exclusively. Recently, they have also added the option to use dollar collateral. This market, which leads in volume, has demonstrated significant resilience during extreme volatility, allowing us to confidently assert that this architecture does not present risks to the platform.

Furthermore, for many traders, the ability to use crypto collateral is optimal for developing short strategies, which partly explains this broker’s leadership. It is important for dYdX to offer a sufficiently flexible environment for professional traders, like those operating on Deribit, who manage the risks associated with these collaterals well. For some operations, these collaterals actually reduce risks significantly.

Allowing for this flexibility does not preclude less sophisticated traders from continuing to operate with dollars. Offering this capability will also provide less advanced traders with a much more competitive funding rate.

Thank you once again for your valuable feedback.

Best regards,

It is important to highlight that introducing the same collateral for multiple operations reduces liquidation risks, especially for short positions. This also mitigates the liquidation risks that dYdX might face. In this regard, my proposal aligns with the ability to create such financial products that could be packaged even for non-advanced users. I am convinced that this would position dYdX as one of the most competitive profitability products.

Since I haven’t seen this in the Roadmap, my intention was to propose a development that could be very strategic, understanding the technical and legal complexities involved.

Best regards,

Introducing liquid staking is indeed very attractive. We could even explore Liquid Restaking; however, this introduces additional risks associated with dependency on other projects. It is crucial to consider these risks and find ways to isolate them effectively. For this reason, I have not included it in the proposal.

Nevertheless, I completely agree that this possibility is highly appealing.