Will dYdX Lead The Breakthrough of DeFi Derivatives?
On the evening of September 8, dYdX airdrops the highly anticipated project token DYDX and lists it on the exchange. Once token price has stabilized on secondary market, the airdrop is valued at over $10,000 per person, which makes this airdrop the most valuable yet in DeFi.
A “Silver Spoon” Beginning
DYDX has a total supply of 1 billion. At its current price, the market values the dYdX project at over $15 billion fully diluted valuation and a market cap of over $750 million. Given dYdX is the leading platform in the DeFi derivatives space, the $15 billion valuation may be justified. But how did dYdX get here? Let’s take a quick look at its history.
As early as 2017, Antonio Juliano, the founder of dYdX, having graduated from Princeton University majoring in Computer Science, already had an impressive resume. Antonio worked as a software engineer at Coinbase, Uber, and database Mongo DB. In addition, other early team members of dYdX all came from famous companies such as Google, Coinbase, and Uber. Nevertheless, Antonio said in an interview that it was an “adventure” to be building out the dYdX project.
In addition to the founder’s insights to the potentials of distributed ledger systems, the architecture design of the dYdX system contributed to the success of dYdX. The project successfully closed a $2 million seed round in December of 2017, led by Andreessen Horowitz and Polychain, and a $10 million Series A round in October of 2018, led by A16Z Crypto and Polychain. In the following rounds, dYdX attracted many more top tier VCs including Three Arrows Capital and DeFiance Capital.
Run by a seasoned technology team and backed by well-known investment institutions, dYdX gone through a rapid development phase in 2020. Total aggregated trading volume from spot, margin, and futures trading grew a 40-fold, from $63 million in 2019 to $2.5 billion in 2020. It is worth noting that the trading volume of perpetuals continues to increase as a percentage of the total trading volume. In the last month of 2019, perpetuals account for 41% of total trading volume.
In the DeFi Summer of 2021, DeFi derivatives entered into the spotlight after the industry has gone through the building of infrastructure platforms such as spot trading, lending, and yield aggregator. Since then, how have DeFi derivatives fared?
A Neglected Long Tail Trading Market
According to data from CoinMarketCap, the current daily trading volume on dYdX is $1.25 billion, surpassed $1.14 billion on Uniswap (V3) and $0.85 billion on PancakeSwap. It is worth noting that the 7-day trading volume is also in an upward trajectory. But the performance of dYdX appears to be the only highlight in the entire DeFi derivatives space.
Among the top DEXs, dYdX is the only protocol focusing on derivatives trading. According to data from Cryptorank, on centralized exchanges the volume of perpetuals is about twice of spot trading volume. But on decentralized exchanges, the opposite is true. What is the cause of this phenomena?
Back to the “DeFi Summer,” the success of the DeFi spot trading protocol is credited to not only solving the trust issues with the underlying code, but also, most importantly, addressing the trading needs of the long tail market: the order book mechanism on centralized exchanges creates many problems to the market makers. The DEX protocols deploy AMM mechanism to solve the problems of low liquidity and high slippage of small and mid-cap tokens, thus spot trading on DEXs became extremely popular.
In contrast, DeFi derivative protocols lack interests from investors and speculators. The main reason is that the reference assets for these DeFi derivatives are mainly BTC, ETH and other large cap crypto. Centralized exchanges have been optimizing the trading experience for top cryptos for many years, and now offer the highest liquidity and most convenient way to trade. The advantages centralized exchanges have established cannot be simply removed by “decentralization.” In addition to high gas fees, DeFi derivatives as they are now do not offer any competitive advantages. This is the reason why the DeFi derivatives space is developing at a very slow pace.
DYdX Kickstarts The Derivatives Market
In response to the problems encountered in derivatives, dYdX adopts a centralized order book system, cooperates with many leading market makers, and uses smart contracts to execute transactions. This ensures high liquidity and low slippage, and offers what the traders need. In 2020, dYdX also started using a layer 2 solution based on Stark Ware to support their perpetual futures products. By using layer 2, dYdX is able to offer highly scalable and low gas to users.
According to the token incentive model of dYdX, 25% of the tokens will be awarded to trading activities. During the first trade mining cycle in August, trading volume reached $9.8 billion. As mentioned, dYdX currently uses the StarkEx trading engine, which is based on the Ethereum layer 2 project Starkware, to solve the problem of high gas fees. However, its liquidity design makes the platform closely tied to the market makers, which introduces elements of “centralization”. So far dYdX is taking the lead in DeFi derivatives by issuing tokens and offering incentives to traders and market makers, but this does not mean there is no room for other derivatives protocols.
Who Will Be The Next Rising Star In The $10 Billion Market?
Perpetual Protocol, once accounted for 80% market share of DeFi derivatives, uses a virtual automated market maker (vAMM) system. Since there is no real market maker, it by default solves the impermanent loss issues of traditional AMM. The next version of Perpetual Protocol will incorporate Uniswap V3 and launch on Arbitrum.
Another popular project is MCDEX. It uses a shared liquidity AMM to improve capital efficiency and expected profit of liquidity providers. The modified AMM allocates more trading depth around the index price to offer better pricing and lower slippage. At present, the V3 version of MCDEX is already deployed to Arbitrum.
The key to the success of the DeFi spot trading protocols is addressing the liquidity problems. But the high gas fee in Ethereum remains as an obstacle. At present, the derivatives protocols are focusing on solving the problems of liquidity and high transaction costs. While protocols are exploring different designs to solve the problems, most of them agreed that part of the solution is deploying on Ethereum Layer 2 networks.
While dYdX has temporarily taken the lead position in DeFi derivatives through trade mining incentives, there are still billions of market opportunities in this sector. DYdX has made a good start, and we expect this to create a cascading effect for other derivatives protocols. Of course, even if dYdX fails, there will be other protocols to complete this historical mission.
