DYDX

Most recent update: [June 26, 2023]

What is dYdX?  

 Built on the Ethereum network, dYdX aims to deliver key financial utilities to its userbase like perpetuals, margin and spot trading, and even lending and borrowing. It separates itself from traditional perpetuals exchanges like FTX and Bitfinex by being completely decentralized and still allowing its users to trade on leverage. According to Shrimpy Academy, there is a massive market for crypto derivatives (evidenced by the near-$50 billion derivatives trading value on Binance). dYdX may be tapping into a market that many DEXs have yet to venture into.  

Along with its namesake exchange, there also exists the DYDX token – a governance token that can be used to gain mining rewards and participate in staking pools, granting users discounts on the exchange in the process. 

The protocol was devised by Antonio Juliano, a former software engineer for Coinbase and Uber. 

How does it work exactly? 

While crypto derivatives exchanges usually rely on centralization to source lending and borrowing for margin and perpetuals trading, the usage of smart contracts on a DEX can harness the benefits of decentralized liquidity pools, collateralization, and lending across different protocols like Uniswap, Compound, and Sushi. What dYdX does is combining all the most useful DeFi technologies for a unique crypto derivatives exchange that uses crowdsourced liquidity only.  

What this means is that, in practice, when somebody deposits collateral on a leveraged trading position, they are borrowing from a decentralized pool funded entirely by other traders rather than from the exchange itself. Although this would be non-custodial (meaning there is no exchange to enforce security on the funds), it makes for faster trade execution and users only need to pay for gas fees when they either deposit or withdraw from the platform.  

On dYdX, each asset has a lending pool that borrowers and lenders interact with. Smart contracts manage the assets, allowing for instantaneous transactions that eliminate the need for waiting for a match on the other side of the trade. These smart contracts can observe the supply and demand of an asset and automatically determine its interest rate. dYdX displays two rates for a given asset: the lending rate (or supply rate) and the borrowing rate – of course, the borrowing rate will always be higher than the supply rate. 

What makes dYdX so appealing for investors is that its interface functions very similarly to other traditional exchanges. To utilize dYdX, you just need a crypto wallet like Metamask and some ETH to cover transactions fees. You can then connect your wallet to the dYdX trading app, deposit your funds, and you’re ready to start trading. 

Technological characteristics 

Interestingly, to navigate Ethereum’s ever-rising gas fees during the wait for Ethereum 2.0, dYdX offers two experiences: Layer-1 dYdX (on Ethereum) and Layer-2 dYdX (on StarkWare). Let’s take a quick look at the differences between the two platforms: 

Layer-1 

The original version of dYdX offers a highly liquid decentralized exchange for margin and spot trading, allowing leverage up to 5x on BTC and ETH. 

Borrowing to fund positions is done quickly, but investors need to collateralize appropriately: the collateralization minimum is 125%, well over the intended borrow amount. This is done on purpose to protect lenders in the event that investors have their positions liquidated.  

Although this version has the most comprehensive liquidity pools, dYdX plans to phase out margin and spot trading on Layer 1 in order to focus on perpetuals. Furthermore, because it is built directly on top of Ethereum, fees and transaction speed are directly influenced by Ethereum’s network activity.  

Layer-2 

The dYdX Layer-2 protocol is built on Starkware and utilizes the StarEx matching engine, a layer-2 scalability engine that drastically improves the non-custodial trading experience on dYdX. In essence, it acts similar to the Ethereum 2.0 upgrade where the gas costs are significantly reduced, the minimum trade sizes are reduced, and the trading fees are also reduced.  

Like the legacy version, trading on dYdX Layer-2 is similar to using a traditional, centralized exchange. It offers perpetuals for a wider range of assets, including SOL, DOT, AAVE, SUSHI, MATIC, and more. Leverage is upped to 25x on this platform – a significant jump from Layer-1. 

Due to its upgraded hardware, the Layer-2 version has additional features, like faster withdrawals using a special withdrawal liquidity provider that sends funds immediately. Furthermore, dYdX Layer-2 only accepts USDC as collateral to provide investors with a clear, stable, and widely-available quote asset.  

This is considered the future of dYdX and is the version that the team has been working on upgrading.  

For a more in-depth look at how exactly trades are executed on the dYdX trading app interface, Moralis Academy has a great deep-dive on the platform’s bells and whistles.  

The DYDX token 

What has made the platform so successful is its derivative token DYDX, which is primarily used to earn hefty rewards on the protocol. Before looking into how it works as a governance token, it worthy to note that it has a maximum circulating supply of 1 billion DYDX.  

For governance, holders of DYDX can take part in voting on changes to the Layer-2 protocol. Some of the things that they can vote on include: defining safety staking pool payouts in event of a loss, the risk parameters for the protocol, which tokens can be listed on the Layer-2 protocol, or even which market makers get added to the liquidity pool.  

Primarily, most of the excitement of holding DYDX comes from its reward system.  

Liquidity staking rewards 

To incentivize liquidity providers, dYdX liquidity taking pools rewards anybody that deposits USDC into the pool with DYDX. 25 million DYDX tokens are claimable for use in the program (2.5% of the total token supply).  

Once USDC is deposited, you can stake it into the pool to receive stkUSDC (staked USDC). Once it is active and part of the usable liquidity pool, your deposit will start to earn DYDX on top of a share of trading fees.  

Trading rewards 

For users that don’t want to fully commit to becoming a liquidity provider, traders that utilize the dYdX protocol can actually earn rewards just by simply trading on the exchange. The amount of rewards does depend on a few factors, however, with trading activity and volume being the main ones.  

Retroactive mining rewards 

Unsurprisingly, the protocol also finds ways to reward its users by simply existing. Retroactive mining rewards are distributed to dYdX users who trade on Layer-2 protocol as well as users who have utilized the platform for an extended period of time. 

Like trading rewards, retroactive mining rewards are determined by a user’s overall activity on the platform and the tier that they belong to.  

Discounted trading fees 

Directly correlating with the amount of DYDX tokens a user may hold in their wallet, holders can actually receive trading fee discounts. The discount is given incrementally; for example, if a user holds 100 DYDX tokens they get a 3% trading fee discount, 1000 tokens nets a 5% discount, and so forth. (Full chart on trading fee discounts on CoinMarketCap) 

Risks and Drawbacks 

However, as it is primarily built on Ethereum, users of dYdX, particulary on its Layer-1 protocol, are susceptible to sometimes considerably high gas fees, especially during periods of high transaction volume on the network. Although the Layer-2 solution mitigates this significantly, those looking for the utility of the legacy layer will need to be aware of the gas fees that may be present on their transactions. Some of the things that make it more accessible, like utilizing USDC exclusively for collateral, may alienate some users that prefer to operate with different types of currencies. 

Security 

As it is primarily built through Ethereum, DYDX benefits fully from the network’s rigorous proof-of-stake consensus algorithm. Furthermore, according to the platform’s Messari page, their security is regularly audited by blockchain security company Peckshield. They are also an entity regulated by the SEC. 

Due Diligence  

Prior to listing DYDX on the VirgoCX Platform, VirgoCX performed due diligence on DYDX and determined that DYDX is unlikely to be a security or derivative under Canadian securities legislation. VirgoCX’s analysis including reviewing publicly available information on the following:  

• The creation, governance, and location of DYDX and/or its primary development team; 
• The supply, demand, maturity and liquidity of DYDX; and 

• Legal and regulatory risks associated with DYDX.  

Statutory Rights under Securities Legislation 

VirgoCX is offering Crypto Contracts on crypto assets in reliance on a prospectus exemption contained in the exemptive relief decision Re VirgoCX Inc. dated May 30, 2022 (the Decision). Please be aware that the statutory rights in section 130.1 of the Securities Act (Ontario), and, if applicable, similar statutory rights under the securities legislation of each other province and territory in Canada, do not apply in respect of the Crypto Fact Sheet to the extent a Crypto Contract is distributed under the prospectus relief in the Decision. 

Further reading 

If you would like to learn more about dYdX and its unique platform, take a look at these resources here: 

dYdX on Messari: https://messari.io/asset/dydx/profile 

dYdX on CoinMarketCap: https://coinmarketcap.com/alexandria/article/what-is-dydx-dydx-features-tokenomics-and-price-prediction 

dYdX on Shrimpy Academy: https://academy.shrimpy.io/post/what-is-dydx-explaining-the-popular-crypto-derivatives-dex 

dYdX on Moralis Academy: https://academy.moralis.io/blog/defi-deep-dive-what-is-dydx 

dYdX on Decrypt: https://decrypt.co/resources/dydx-ethereum-margin-trading-platform-explained-learn