Introduction

dYdX has long been at the forefront of decentralized finance (DeFi) as one of the primary innovators of onchain perpetual futures. As more competition moves into the space, dYdX is upgrading a variety of features to strengthen their strategic positioning within the perpetual futures market.

With the launch of dYdX Unlimited on November 19th, 2024, the protocol has brought new functionality to the platform that aims to diversify their product suite. These include permissionless trading and liquidity provisioning through Instant Market Listings, a global liquidity pool titled MegaVault, as well as a revamped affiliate program and token rewards program. 

The dYdX community has also voted to implement new tokenomics changes as well, which (1) redirect revenue to the MegaVault and the treasury subDAO, and (2) reduce trading rewards and DYDX emissions overall. These upgrades aim to enhance protocol sustainability and competitiveness by addressing inflationary pressures, stabilizing emissions, improving long-term staking rewards, and attracting more liquidity to the platform.

Since dYdX Unlimited launched, the platform has seen a surge in trading volume and appears to have a favorable valuation relative to market leaders on a trailing 30-day volume to FDV basis.

dYdX Strategic Positioning

Since the launch of dYdX Chain, the market for perpetual futures has evolved substantially. Most notably, improving base layer and oracle infrastructure has resulted in the growth of onchain perpetual futures markets. Volume share, when compared to DEXs, has grown from 20% to as high as 62% in March of 2024.

This has occurred in tandem with increasing trading volumes. Amongst the five largest perpetual futures exchanges by TVL, we are observing $35B to $50B weeks of onchain perpetual futures volume. 

This volume is supported by platforms obtaining more TVL to establish highly liquid markets for popular trading pairs.

dYdX has faced fierce competition over the last year, and has moved from pole position to 3rd and 5th place respectively for volume and TVL share compared to other top 5 protocols.

Although dYdX has lost market share compared to new competitors (some of which is expected because of airdrop/points opportunities), network KPIs still trend positively, and weekly active traders are trending upwards.

With dYdX Unlimited launching a few weeks ago, we have seen TVL and volume increase by 36% and 57% respectively.

Note that the decreased trading volume over the past few months came in tandem with the pause of the Chaos Labs’ incentive program in preparation for launching dYdX Unlimited. The surge in volume since launch on November 14th should continue due to the various improvements to the protocol as well as tokenomics.

“Unlimited” Protocol Upgrades

Instant Market Listings

Instant Market Listings aim to eliminate the traditional barriers associated with listing new trading pairs. This feature allows users to launch new markets without requiring centralized approval, extensive governance processes or exorbitant listing fees. 

This feature is enabled by backend improvements from previous software upgrades - mainly the Market Map. The Market Map expands the potential listings on dYdX chain to over 800 new assets, including Solana assets. Market mappers provide reference prices, and metadata of existing markets as well as preload and preconfigure new markets. 

If an asset has been included in the Market Map, it can be listed on dYdX. To list a market, users must deposit 10,000 USDC into MegaVault. This deposit is locked in the MegaVault for a 30-day period to ensure sufficient liquidity for active trading. Finally, once the operator confirms the safety of the listed market - usually within a day - they may supplement it with additional liquidity, at which point the market becomes live.

Instant Market Listings offers several benefits. For one, dYdX will have a competitive advantage with respect to the speed at which new markets will be available on the exchange. It also democratizes market creation, enabling a broader range of users, including niche communities, to list assets that may not be accessible on other platforms. This aligns with dYdX’s broader mission to decentralize trading. 

MegaVault: Enhancing Liquidity and Market Efficiency

Liquidity underpins the efficiency of any perpetual futures trading platform. MegaVault seeks to create a robust and scalable mechanism to supply deep liquidity across both established and long-tail markets through an automated approach to market-making.

MegaVault operates as a global liquidity pool, utilizing user deposits to market-make across multiple pairs. The feature incentivizes users to deposit liquidity as they will receive yield in return. This yield is a function of profit from MegaVault’s P&L, trading fee revenue shares, and other potential incentives voted on by the dYdX community. Importantly, users retain flexibility over their capital, with the ability to deposit and withdraw funds at any time. With that said, under extreme market conditions, users may incur slippage during withdrawal.

MegaVault architecture (Source)

Mechanically, The MegaVault is split into multiple market specific “sub-vaults” which run an automated market-making strategy for a given market. MegaVault is run by an “operator” that is elected via dYdX governance. The operator is expected to perform critical operation tasks:

1. Managing USDC allocation between sub-vaults
2. Adjusting sub-vault parameters to balance liquidity with potential returns
3. Monitoring and risk management of sub-vaults
4. Reporting and transparency on the status of the MegaVault to the governance community
5. Coordination with governance to implement changes or improvements to the vault strategy

The vault has been rebalanced two times (1, 2) to improve overall liquidity, as voted on by the community. As of November 21, 2024, Greave was voted to be the operator of MegaVault. Greave, an affiliate of Gauntlet, is an end-to-end solution provider for onchain strategy execution.

MegaVault aims to improve liquidity for all trading pairs on dYdX, as well as make it possible to bootstrap liquidity on long-tail assets. In turn, it is a critical upgrade in conjunction with Instant Market Listings to support fully permissionless asset listings with immediate liquidity. It also positions dYdX to compete more effectively with competitors that offer vault products that earn yield for users by employing market-making strategies, such as Hyperliquid’s HLP vault.

dYdX MegaVault TVL and APR (Source)

MegaVault has already eclipsed $47M in TVL in a few weeks, compared to HLP’s $180M. Considering it is currently offering 58% APR versus HLP’s 43%, one could expect MegaVault’s TVL to continue to climb.

Upgrades Will Drive Liquidity 

Instant Market Listings and MegaVault in tandem were designed to attract liquidity to the platform by giving users the ability to launch and trade any asset of their choosing. Within 14 days of the release of dYdX Unlimited, the dYdX community has launched 20 new markets, increasing the number of tradable markets on dYdX to 172. 

As volumes increase, fees (and MegaVault share of revenue) also increase. The concept of a volume-liquidity flywheel is well understood with trading venues, and the mutually reinforcing relationship applies here as well:

1. As MegaVault yield increases, users will be increasingly incentivized to deposit funds.
2. As the MegaVault deposits increase, the operator will deploy more liquidity across the most popular trading pairs. These pairs will benefit from increased depth and tighter spreads.
3. High liquidity pairs that offer best execution for traders will see an increase in volume. This will generate more revenue for MegaVault, which will further increase its yield.

The MegaVault’s ability to dynamically allocate liquidity to the most popular pairs is essential to maintaining the flywheel. We are already seeing this process play out; as previously discussed, total platform volume has increased by 36% over the last 2 weeks. This mechanism scales across all trading pairs. Thus, the addition of potentially hundreds of new pairs will compound its effect.

In addition to the two key upgrades discussed, dYdX has launched an Incentive Program and an Affiliate Program on November 19th. The incentive program enables users to earn points to qualify for $1,500,000 in DYDX rewards each month, while the affiliate program enables users to earn up to $3,000 per month per referral for standard affiliates and up to $10,000 per month per referral for VIP affiliates. These programs will further align growth between community members and the dYdX protocol. 

Optimized Tokenomics: Enhancing Long-Term Sustainability

The proposed tokenomics changes by Nethermind Research aim to address several critical challenges that have hindered the protocol’s growth. The changes are strategically designed to enhance liquidity provisioning, reduce inflationary pressures, stabilize the DYDX token, and create a sustainable framework for long-term ecosystem growth. The dYdX community has voted in support of the following proposals:

Protocol Revenue Distribution:

• 50% of all protocol revenue is routed to the MegaVault.
• 10% of all protocol revenue is routed to the Treasury subDAO.
• Above an $80M level of annual protocol revenue, the Treasury subDAO could consider a buy & stake program. 

Trading Rewards:

• Reduce the Trading Rewards “C” constant from 0.90 to 0.5. 

The Bridge:

• Cease support for the wethDYDX Smart Contract (i.e., the Bridge) on the dYdX Chain side. 

This section will focus on changes that have been implemented, including revenue distribution to the MegaVault and the Treasury subDAO, the reduction in trading rewards, and the discontinuation of the bridge. Note that ending support for the wethDYDX Smart Contract on the dYdX Chain will require a separate on-chain governance proposal to disable the recognition of ethDYDX sent to the Bridge on the dYdX Chain. This proposal is expected to be initiated in June, following the conclusion of the six-month notice period. More information is available here.

Protocol Revenue Distribution

The key component of the tokenomics overhaul is the introduction of a revenue-sharing mechanism. Historically, 100% of protocol revenue has accrued to validators and stakers. This model has proved unsustainable for long-term protocol growth, though, as operational expenses must be funded by selling DYDX from the Community Treasury. Under the new model, 50% of protocol revenue is allocated to MegaVault, and 10% to the newly established dYdX Treasury SubDAO. The remaining 40% is distributed to validators and stakers. 

Liquidity is the most fundamental aspect of a perpetual futures exchange and is the reason why exchanges exhibit extreme network effects. By routing 50% of the revenue to MegaVault, the community expects the protocol to become more competitive against market leaders such as Hyperliquid. By having a central market-making vault (in this case MegaVault) optimize liquidity provisioning across the entire platform, end users will get the best execution on the most popular pairs.

The 10% revenue share with the treasury aims to provide a funding reserve for essential operations, growth initiatives, and ecosystem grants. In turn, this will reduce the need for DYDX sales to fund dYdX DAO expenditures. As the protocol generates more fees over time, the subDAO could potentially launch a “buy & stake” program, which could use excess fees to buy dYdX on the open market. If the fee generation is high enough, this could potentially make the token deflationary.

Although the shift will reduce the staking yields by 60%, in the long-term, the goal is to balance short-term rewards with long-term network health. These changes will also diminish reliance on token emissions, thereby alleviating downward price pressure on the dYdX token and preserving capital for strategic initiatives. 

Trading Rewards

Since its migration away from Ethereum, dYdX has implemented a trading rewards program to incentivize trading activity and liquidity provision. Trading rewards are determined by a formula that scales with a constant. By reducing the trading rewards constant from 0.9 to 0.5, the platform aims to reduce rewards emissions. Since many DYDX rewards are sold in the market to offset transaction fees, the reduction in rewards should decrease the amount of sell pressure on the DYDX token. Even with this adjustment, Nethermind expects trading fees to remain competitive.

dYdX fees versus competitors (Source)

In conjunction with increased efficiency from MegaVault and trading fee rebates from the Affiliate Program, dYdX expects fees to remain competitive while simultaneously improving platform sustainability.

The Bridge

Finally, the community voted to cease support for the wethDYDX smart contract bridge after a transition window to have a clean break from the legacy token environment. With a large percentage of tokens already migrated, discontinuing the bridge aims to consolidate liquidity and governance power to dYdX chain users. Over time, unbridged tokens would be burned, helping mitigate inflationary pressures as well as optimizing community governance. More information is available here. 

Valuation Analysis

dYdX has a clear plan of attack for 2025, with the goal to trim excess operational costs to optimize for growth and competitiveness. The team brought back their founder as CEO as well as let go of 35% of their workforce with the purpose to regain the innovative edge they had as an early startup and make impactful decisions more quickly.

This parallels their approach to decrease rewards to community stakeholders and reinvest those into the MegaVault to improve liquidity provision. Although this is painful in the short term for stakeholders, if it is not done then they will continue to lose market share. In turn, these changes represent dYdX walking a fine line between doing what is necessary to incentivize community stakers and validators to stay in the short run, while creating the best trading environment possible for end users. If it is successful, then the platform will be set up for long term success.

Comparing dYdX to Hyperliquid provides insight into the protocol’s valuation. After calculating a volume-weighted average fee from the Nethermind data above, one can compare dYdX on a relative basis to Hyperliquid over the last 30 days. A trailing 30 day time period was chosen to weight the valuation for dates when dYdX Unlimited has been live.

One can see that dYdX has been doing more volume and capturing more fees on an FDV-weighted basis than Hyperliquid, indicating that dYdX could be undervalued at current prices. Considering MegaVault has a higher APY than Hyperliquid’s HLP vault, it is likely that an information asymmetry exists around dYdX’s recent upgrade and tokenomic changes.

Risks

While the proposed changes aim to offer a pathway towards more sustainable growth, they come with execution risk and may cause short-term disruptions for various stakeholders within the community. Although the upgrade has already been successful, nonetheless, investors should be aware of potential risks.

For one, the Market Mapper is a centralized entity that acts as the price oracle for long-tail assets. Although they are voted upon by governance and can be removed at any time, this introduces an attack vector for these long tail assets. The effectiveness of the feature relies heavily on the performance of the MegaVault, as well. If the MegaVault fails to attract sufficient deposits, the viability of Instant Markets Listings could be compromised. Finally, this also opens the door for low quality or underutilized markets, which could drain liquidity from more established pairs. Considering MegaVault has rapidly attracted liquidity, so long as the market remains bullish, these risks remain relatively muted.

With respect to MegaVault, it is operated by a single entity. In turn, there is a strong reliance on the operator to manage the various aspects of the vault. Due to the centralized nature of the operator, this opens up various attack vectors. For one, the operator could theoretically act maliciously, or their infrastructure could go down if proper redundancy was not built in. Both of these risks could impact customer funds. It should be noted that in future iterations of the protocol, these tasks may be automated, removing the need for an operator as well as this risk.

Finally, there are some risk considerations around the proposed tokenomics changes as well. Lowering staking yields and trading incentives could lead to validators exiting the protocol, which could cause volatility in staking participation. Similarly, if liquidity conditions do not improve rapidly, the reduction in trading rewards could cause some users to leave the platform, as they would be exposed to higher fees. It will be important to monitor the state of the protocol over the ensuing months to ensure that the community course corrects any changes that have a negative impact. As of now, the increase in volume and TVL on the protocol, as well as rising equity in MegaVault, indicate that the changes have been overwhelmingly positive.

Conclusion

dYdX has undergone a rapid transformation over the past few weeks. Although the perpetual futures market is an incredibly competitive landscape, if the current volume surge persists, dYdX appears to be undervalued relative to market leaders. The perps market is notorious for "mercenary capital” that rotates between protocols to capture airdrops and rewards. As those programs expire on other platforms, dYdX could reclaim market share as a mature platform which offers competitive execution on the most number of trading pairs.

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