The results of the Vaults reflect what is reasonable to expect from the current liquidity provision strategy. Derivatives markets are a zero-sum game, especially when there are no external agents hedging these positions. In traditional markets, a significant portion of participants often accept losses that are offset by gains in their real-world operations to manage risk. However, in some cases, purely trading-oriented participants must bear these losses.
The current strategy implemented in the Vault ultimately channels revenue from token holders to professional market makers over the long term. It is unrealistic to expect traditional traders to be profitable, even during bull markets, because managing leveraged trading without professional expertise is highly challenging. This is evidenced by CFD broker statistics, which show that over 80% of their clients lose capital.
This means that the zero-sum game currently present in dYdX effectively results in two revenue streams for professional market makers: retail trader losses and the subsidies provided by inefficient liquidity strategies funded by the protocol’s own profits.
As expected, these strategies are not only unprofitable but also fail to offer the necessary hedging to provide counterparty liquidity for clients who win in certain situations, such as the Trump market. These strategies, while possibly offering a no-slippage price to clients, are incapable of handling large gains when they occur. In such cases, they become especially costly and insufficient for the protocol.
If, as argued, liquidity were not free, then CFD brokers, for example, would not be profitable—yet they remain one of the most lucrative businesses in existence. These brokers ensure liquidity by hedging trader positions externally in the corresponding assets, effectively diluting the platform’s risk. This hedging is typically done in aggregate rather than on an asset-by-asset basis, though it could be performed individually if necessary. In many cases, these platforms do not fully hedge their risk, assuming that traders’ PnL will be negative and opting to leave it unhedged. This approach makes liquidity provision extremely profitable, provided that the platform can manage occasional bullish market events effectively.
Generally, as can be seen in the positions the Vault generates, they are predominantly short positions, as the typical client of a decentralized derivatives exchange is a trader seeking long positions. This means dYdX’s primary need is to provide short-side counterparty liquidity. If these positions had been hedged, the losses would not have occurred, as they would have been offset by the hedge. For instance, if the Trump market had been hedged with the corresponding asset, not only would the clients’ significant gains have been mitigated, but the hedging Vault would also have earned substantial profits due to high funding rates with neutral risk.
The current Vault strategy will remain viable only as long as it is subsidized by protocol revenues and as long as its activity is kept minimal. In effect, depositors in this Vault are receiving a portion of the protocol’s profits that were previously allocated to token holders, minus the inefficiencies and losses of the liquidity strategy. This predicts that the Vault will become unattractive at a certain point, especially as its activity increases.
While it is true that this loss-generating activity contributes to higher trading volume—thereby indirectly subsidizing the protocol—this comes at the cost of extreme inefficiency. Ultimately, the additional volume will primarily benefit professional market makers, who are the true winners of this design.
It is conceivable that we could develop strategies capable of competing with professional market makers to reverse this capital flow. However, it seems unlikely that we can compete effectively in this space, especially without leveraging collateral.
The core issue lies in promoting deposits into a strategy that is fundamentally unprofitable when we could instead encourage deposits into strategies like cash-and-carry. These are demonstrably profitable for clients, as evidenced by projects like Ethena, which have achieved impressive market fit. Such strategies would provide genuine liquidity to smaller markets and prevent the kinds of issues we face, and will continue to face, in scenarios like the Trump market.
For months, we have emphasized concerns about this design, which has now become a reality. This is no longer theoretical—it’s a tangible issue that needs addressing.