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What is dYdX: An Order Book Decentralized Exchange (DEX)

2021-12-20 07:34:17

Launched in 2017, dYdX is a decentralized exchange (DEX) that utilizes smart contracts on the Ethereum (ETH) blockchain to provide perpetual contract trading, margin trading, spot trading, lending, and borrowing services. The platform has already released its governance token, DYDX, via an airdrop and is expected to be available on the market in September 2021.


How Is dYdX Different Compared to Other DEXs?

dYdX is a hybrid exchange, meaning that it combines centralized and decentralized components for operation. dYdX aims to offer the security and transparency of decentralized exchanges with the speed and usability of centralized ones. Its centralized features include its order book and matching engine services, while its decentralized components include smart contracts.

Unlike Uniswap (UNI) and SushiSwap (SUSHI), which are the two most popular DEXs, dYdX is not based on an automated market maker (AMM). Instead, dYdX relies on an order book model that’s commonly found on centralized exchanges. According to the development team, the platform uses an order book because it is already an established model within the cryptocurrency world that traditional market makers should be familiar with. Additionally, dYdX founder Antonio Juliano believes that order books are more efficient than AMMs. He claims that order books are less capital intensive in that they require fewer funds to achieve the same level of liquidity as AMMs.

What Does dYdX Offer?

dYdX offers decentralized finance (DeFi) services such as isolated margin trading, cross margin trading, spot trading, perpetual contract trading, and lending and borrowing services. Details of the platform’s features are as follows:

  • Margin trading: Users can borrow funds from other users to purchase more assets. There are two types of margin trading on dYdX – isolated and cross margin. In isolated margin trading, users leverage a single position. In cross margin trading, the margin is shared across all open positions in their account. So far dYdX’s margin trading supports only three assets: ETH, DAI, and USDC. The trading pairs are ETH-DAI, ETH-USDC, and DAI-USDC, and users can leverage these pairs up to 5x.
  • Spot trading: Like centralized exchanges, users can buy and sell cryptocurrency by posting market orders, limit orders, and stop orders. dYdX’s spot trading platform supports the same three pairs as margin trading.
  • Perpetual contract trading: In perpetual contract trading, users can hold long or short positions similar to futures contract trading. Generally, a user takes the long position by buying the contracts in anticipation of a future price increase. In contrast, a user takes the short position by selling the contracts in anticipation of a price drop and being able to repurchase at a lower price. However, unlike futures contracts, perpetual contracts do not have a specified expiration date. As a result, users can hold their positions indefinitely. dYdX supports the perpetual contract trading of 22 crypto assets from projects such as Ethereum (ETH), Bitcoin (BTC), and Cardano (ADA) with leverage up to 25x.
  • Lending and borrowing: Users can deposit their assets into lending pools and earn interest whenever a new block is mined. Users can also borrow funds from these pools for use on the platform’s other services.
dydx services
The services available to users on dYdX. (Source: dYdX)

dYdX’s margin trading, spot trading, and lending and borrowing services are built on Ethereum’s Layer 1 main chain. Conversely, it moved its perpetual contract trading off Ethereum Layer 1 to a Layer 2 scaling solution in February 2021. This move was done to avoid the slow transaction speeds and significant gas fees plaguing DeFi at the time. With StarkWare, dYdX built the Layer 2 protocol using ZK-Rollups to boost scalability by bundling multiple transactions together.

What Is dYdX’s Governance Token?

On August 1, 2021, dYdX announced the launch of its governance token DYDX. The total supply is 1 billion tokens which will gradually be accessible over five years. After five years, dYdX will implement a perpetual inflation rate of 2% every year to ensure that there will always be enough DYDX tokens to reward the community for their contributions.

allocation of DYDX tokens
The detailed allocation of DYDX tokens in the initial five years. (Source: dYdX)

DYDX token holders have the right to propose and vote on the Layer 2 protocol. They can determine the allocation of community treasury funds, vote for new token listings and change risk parameters. Additionally, DYDX token holders receive trading fee discounts according to the size of their holdings.

total liquid supply of DYDX tokens
The total liquid supply across the initial five years. (Source: dYdX)

Alongside the DYDX token, the platform released a liquidity staking pool where users provide liquidity by staking USDC and earning rewards in return. A safety staking pool is also in the works in which users can stake DYDX tokens to provide security to the network and earn rewards. The safety staking pool will go online when the DYDX token becomes transferable on September 8, 2021.

How Does dYdX Work?

Like most DEXs, dYdX utilizes smart contracts for its services. Users can trade on its platform without third parties or intermediaries. Smart contracts mean that dYdX is a non-custodial exchange, so funds are 100% under user control.  With smart contracts, users can complete deposits, withdrawals, and transactions at any time without needing to wait for a match. Users only need to pay gas fees and the trading fee, which is distributed to the platform.

On dYdX, each asset has its own lending pool in which the smart contracts manage. When users deposit their assets into a particular pool, they become lenders and earn passive interest income. Borrowers can then borrow the assets from the specific pool. This interaction between the lenders and borrowers determines the supply and demand, which affects each asset’s interest rates.

When a user wishes to borrow funds from a specified asset pool, he or she will need to deposit collateral. dYdX utilizes an over-collateralization protocol to protect lenders from risky loans. Therefore, the initial collateralization ratio must be at least 125%. For example, suppose a user wishes to borrow $100 of ETH. To do so, the user would need to collateralize $125 of another supported asset. Afterwards, the user only needs to maintain a minimum collateralization ratio of at least 115% to prevent automatic liquidation.

For crypto prices on Layer 1

To upkeep cryptocurrency prices on Layer 1, dYdX relies on different price oracles. The list of price oracles on Layer 1 include:

  • ETH and BTC prices are obtained using the MakerDAO (DAI) V2 Oracle System.
  • LINK’s price is obtained via the ChainLink (LINK) oracle system.
  • dYdX uses its own price oracle system for DAI’s price.
  • The price of USDC is directly pegged to the price of USD.

For crypto prices on Layer 2

For cryptocurrency prices on Layer 2, dYdX collaborates with StarkWare and the ChainLink and Maker oracle teams to implement an oracle system compatible with Stark signatures. When prices from the oracle are verified using such signatures, the platform uses them immediately without needing to wait for the transaction to be verified. This Layer 2 solution increases the speed of price updates.

Diagram on dYdX liquidations
Diagram on dYdX liquidations (Source: CryptoMarketPool)

Who Is Behind dYdX?

In 2017, Antonio Juliano founded dYdX in San Francisco, California. He and his team have worked at Google, Bloomberg, Goldman Sachs, and ConsenSys.

dYdX has attracted quite a bit of investor interest. The company has held four funding rounds and raised $87 million in total. In December 2017, dYdX closed a $2 million equity seed round led by Andreessen Horowitz and Polychain Capital. In its most recent Series C round in June 2021, dYdX raised $65 million with Paradigm leading the investment.

What Is the Future of dYdX?

The launch of the DYDX token and liquidity mining may help increase the liquidity and Total Value Locked (TVL), a metric that users can use to compare the popularity of different DeFi protocols. This happened to Uniswap in September 2020 when it doubled its TVL within a few days after launching UNI, its governance token, and liquidity incentives.

dYdX has plenty of competitors as a lending and borrowing protocol. These include Aave (AAVE), Compound (COMP), and other similar DeFi platforms. Compared to its competitors, dYdX’s lending and borrowing interest rates are average. For example, its DAI lending interest rate is only 4.4% compared to the 5% from Aave, while its DAI borrowing interest rate is higher at 9.62% compared to Compound’s 4.27%. In any case, dYdX’s interest rates may become more competitive as more users use its lending and borrowing services.

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dYdX is a platform where users can access DeFi services such as lending, borrowing, margin trading, perpetual contract trading, and spot trading. It relies on the order book model used by centralized exchanges instead of automated market makers (AMM) used by other decentralized exchanges like Uniswap and SushiSwap. dYdX recently announced the launch of its DYDX governance token and liquidity mining. DYDX token holders receive trading fee discounts, gain the right to vote for proposals and parameter changes, and can stake the tokens to earn rewards. The launch of its token and liquidity incentives may attract users to the platform to provide liquidity, thereby boosting popularity. However, only time will tell if the token launch is successful.

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