dYdX Chain: Deriving value from Complete Decentralisation

Introduction

In the words of Gottfried Leibniz, 'We live in the best possible world.” dYdX got their interesting name from his mathematics, and maybe his optimistic words also inspired them to go all out, trying to create the best possible DEX. In their endeavours, they made significant contributions to the world of Decentralised Finance - creating a first-of-its-kind crypto derivatives exchange.

dYdX filled a very particular niche in the market. Centralised exchanges offered spot trading, in which people can buy and sell currencies, decentralised exchanges did the same. On the derivative trading side of things, there was less variety, with mostly centralised exchanges offering margin trading. This is where dYdX stepped in to provide a decentralised exchange, chock full of innovation, offering a plethora of margin trading, and perpetual options. Their continuing journey saw them start out on the Ethereum L1, then move to L2 and now create their own Cosmos-based chain. We'll take you through a little journey, giving you insights and getting you up to speed!

Trading Jargon

To understand the meticulous position in which dYdX lies, we must simplify some of the words often used by investors. In the crypto trading and stock trading world, there are essentially two types of trading - spot trading and derivatives. Spot trading is on the spot, where actual tokens are bought and sold - with hopes of making a profit. Derivative trading can be of different types, but it essentially involves betting on the price movement of a token.

In derivative trading, there lies the option of margin trading, in which one can borrow money from the exchange to buy more tokens than one actually can afford. This multiplies your profit, and less fortunately - your losses. Here comes the dYdX bit - they offer perpetual trading - a more flexible way to make the bets. In perpetual trading, there is no set date for the bet to end. It's like saying, "I think Bitcoin's price will go up, and I want to bet on it, but I don't want a specific deadline." This trading is often done with margin, where you keep adding funds to keep the perpetual contract open.

The dYdX team is aware that the spot trading market is saturated, hence their eyes and innovative minds are working on crypto derivatives - such as perpetual contracts. While derivatives are something that more seasoned traders get into, dYdX offers a clean and easy-to-use UI which can help more people try their hand at it. Meanwhile, unlike most other decentralised exchanges dYdX uses the traditional order book model used by centralised exchanges instead of automated market makers (AMM).

The L2 Awakens, Sunset at L1

One of the biggest caveats of using Ethereum today is the low transaction speed of 15 TPS and high costs. This is not sustainable for the lofty goals of DeFi, Web3 and NFTs. It will be quite some time before Layer 1 goes through its iterative improvements and reaches high network speeds. The solution to this is through the very popular Rollups, especially Zero Knowledge Rollups (zk-Rollups). They achieve scalability on Ethereum by providing a way to bundle and process a large number of transactions off the Ethereum mainnet while maintaining security and decentralisation, through zero-knowledge proofs. Essentially by taking the load off Layer 1, they help Ethereum scale by 100x - as claimed by Vitalik Buterin himself.

dYdX leveraged this Layer 2 technology using StarkWare - a reputed service which develops software to improve blockchain scalability by allowing any type of computation to move off-chain. Using the zkSTARKS technology helped dYdX provide a stellar trading experience for its customers.

While Layer 1 spot trading solutions were previously provided, it was for initial traction, and as planned it was phased out in April 2021. At the same time, Layer 2 went live and opened the gates to crypto perpetual contract trading for a wide assortment of digital assets. BTC, ETH, SOL, DOT, AAVE, LINK, UNI, SUSHI, MATIC, and LTC are some of the USD-paired cryptocurrencies available for trading.

A New Hope

While major strides were made by dYdX in creating a revolutionary DEX, their quest for perfection led them to newer paths. This time, with the launch of dYdX v4 they decided to take a leap of faith and develop the software as a standalone open-source blockchain based on the Cosmos SDK and Tendermint Proof-of-stake consensus protocol.

By doing this, they reached complete decentralisation, with no reliance on any external blockchain. dYdX will therefore be a fully decentralised off-chain order book and matching engine, designed to handle significantly higher throughput than what any blockchain can currently accommodate.

This decision was taken in order to harness the radical capabilities of the cosmos chain and achieve independence. Another caveat in the current system in an L1 or L2 is the throughput is low for an orderbook and matching machine. There were considerations of moving to other trading models like AMMs or RFQ, but they decided to stick with the traditional orderbook-based approach since it has always been favoured by experienced traders and institutions - a critical market for dYdX. Having their own blockchain offers full customizability and hence freedom to implement ideas freely

Here are some more key takeaways from this major shift:

• A fully decentralised exchange improves security and makes the trading process non-custodial, making it safer for customers.
• Having their own chain enables them to eliminate gas fees for traders, helping reduce the cost of trading and unpredictability. Instead, fees are collected based on trades, akin to a centralised exchange or dYdX v3.
• This shift helps them continue to provide order-book and matching-based trading, essential to seasoned traders.
• On the launch of the dYdX chain users can bridge their tokens to the new Cosmos chain from Ethereum.
• Trading Incentives: Holders of dYdX tokens have the opportunity to earn rewards through the exchange's trading fees. These rewards are distributed in USDC, providing a transparent way to monitor performance and receive payouts.
• Much better support for perpetual trading, creating an industry-leading standard for crypto derivatives trading.

dYdX has made ~0 changes to our product in the past year (~100% of effort towards developing the dYdX chain)

And still have >50% market share in DeFi derivatives

Imagine when the product starts improving all the time. Soon with dYdX chain launch, and continuously after release

— Antonio | dYdX (@AntonioMJuliano) September 27, 2023

Conclusion

In the coming weeks, we shall see dYdX scale new heights while exploring new terrain - but with much more sovereignty. As a validator partner, we are excited to see how the new system performs and what further innovations lie in the future. A truly exponential journey from being on the Ethereum Layer 1 with radical ideas to becoming a standalone chain powering a revolutionary DEX - it is quite clear that they have stood by their vision of thinking 10x bigger.

If you hold the dydx token, you can enhance your portfolio by staking to earn rewards. Leverage Luganodes' institutional-grade infrastructure to stake your holdings and create a passive income. Staking with us ensures ease of use, support, and safety while you earn, and also contribute to the security of the COSMOS chain.

Learn how to stake dydx tokens using this guide. You can learn more about staking on our website, and feel free to contact us for any queries!

About Luganodes

Luganodes is a world-class, Swiss-operated, non-custodial blockchain infrastructure provider that has rapidly gained recognition in the industry for offering institutional-grade services. It was born out of the Lugano Plan B Program, an initiative driven by Tether and the City of Lugano. Luganodes maintains an exceptional 99.9% uptime with round-the-clock monitoring by SRE experts. With support for 45+ PoS networks, it ranks among the top validators on Polygon, Polkadot, Sui, and Tron. Luganodes prioritizes security and compliance, holding the distinction of being one of the first staking providers to adhere to all SOC 2 Type II, GDPR, and ISO 27001 standards as well as offering Chainproof insurance to institutional clients.