tl;dr Summary: dYdX V4 will be a standalone blockchain on Cosmos, a move prompted by a need to achieve full decentralization and higher throughput requirements.
The decentralized order-book exchange dYdX, known for trading derivatives like margin and perpetuals, recently announced that it would set up its blockchain on Cosmos.
In order to understand the network requirements for these types of trades, it’s necessary to understand what they actually are. Margin trading allows traders to take 5, 10, 25 times or more leverage on the funds they have deposited as collateral to capture more gains. This is unlike spot trading, where traders buy or sell assets at market price.
Perpetual trading, on the other hand, is like future trading without a fixed exchange date. For example, buyers and sellers agree to trade Bitcoin (BTC) at a specific price. As the cost of BTC goes up, the buyer wins, and the seller loses, but since there is no end date for this trade, the seller is not stuck with a loss and can continue with this trade by adding more collateral in an attempt to reverse their loss.
Currently, dYdX has its margin trading setup on Ethereum, where traders can use leverage up to 5x on assets like BTC and ETH paired with stablecoins (USDC & DAI). It also means that these transactions are subject to Ethereum gas fees and speed.
Perpetual trading on dYdX is set up on Starkware Layer 2 as it is a high-volume trading product and requires a fast, seamless and inexpensive network. Layer 2 dYdX offers perpetual trading for many different assets, including BTC, ETH, SOL, DOT, AAVE, LINK, and others, with up to 25x leverage.
Why the move to Cosmos?
On their blog, dYdX stated that the main requirement for V4 was “full decentralization.” They define complete decentralization as the decentralization of their least decentralized component, their order book.
dYdX has an off-chain (Layer2) order book running on a central server where all the buy and sell orders get matched and traded. The final settlement, however, happens on-chain (Layer1).
Off-chain order books enable exchanges to operate more quickly and cheaply while ensuring that trades happen at the prices consumers want.
With V4, dYdX has essentially decided to move this centralized off-chain order book server to a Proof of Stake (PoS) chain with validators.
According to their blog, a chain made with the help of Cosmos (a.k.a. appchain) will enable V4 to have each validator run an in-memory order book while still being off-chain. It means that they still get the benefits of having an off-chain trading order book—those benefits being speed and low gas fees—but with the added advantage of decentralization inherent to the validator-run PoS model.
Another change introduced with this move is that traders will no longer pay gas fees for transactions but will pay fees based on completed trades. This fee will go to the validators and stakers.
Having their own chain also means that they are no longer dependent on Ethereum, which reduces the burden on the dYdX dev team as now they can solely focus on bringing more features and products.
Their core team is contemplating using the existing DYDX token as their new layer-1 token for V4 but wants the community to weigh in on this decision.
An interesting take on this decision by Twitter user @Theeylon states that Starkware creates centralization to the degree that could make dYdX a target for the SEC. According to him, this move is more to do with achieving decentralization from a “legal” perspective. In other words, if dYdX can show “sufficient” decentralization, it no longer fits the definition of a security and can stay away from the prying eyes of the SEC.
The market reacted positively as the price of DYDX shot up by 19% after the announcement and is currently trading at $1.42, according to CoinMarketCap.
