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<h3>dYdX Decentralized - Thoughts/Findings on dYdX Decentralization and Governance</h3>
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<h5>The following is a paper I wrote for <a href="https://dartmouthblockchain.com" target="__blank">Dartmouth Blockchain</a>. Check out our site to see more of what we do!</h5>
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<p class="para">In this paper, I will dive into dYdX and how its shift to decentralization and decentralized governance will be beneficial for the protocol as a whole, not only optically but also economically. The economics of decentralization may be difficult to institute in the short term, but they will allow for further user buy-in, both monetarily and psychologically. If dYdX is able to accomplish this full V4 decentralization with the help of their current governing delegates, it will open the protocol to an abundance of new users seeking to contribute to dYdX.
<br><br>For those unfamiliar with dYdX, the protocol was founded in 2017 by former Coinbase and Uber engineer Antonio Juliano. dYdX was created to allow margin trading, borrowing, and lending on the Ethereum blockchain. dYdX is especially unique in the way that it has no gas fees. The protocol accomplishes this seemingly unheard of feat (especially when discussing anything around Ethereum) by building on the Ethereum layer two StarkWare. This allows dYdX to have nearly instantaneous transactions and non-existent gas fees. dYdX also has an interesting model for incentive alignment: the more volume a user trades, the more the protocol rewards that user with dYdX tokens. This encourages users to trade higher volumes and increases circulation of the dYdX token, leading to more revenue for the protocol and an increase in the price of their governance token.
<br><br>Encouraging users to take initiative in a protocol coincides with the concept of decentralization in DeFi. Although decentralization is not a crypto-native or crypto-specific idea, it has been widely adopted throughout the blockchain community as a way to place ownership in the hands of the people instead of autocratic actors like states or large corporations. This philosophical ideal of the user truly owning his or her wealth has rippled through the cryptocurrency community since its inception, and it is now taking root within the greater dYdX community as shown in <a href="https://dydx.exchange/blog/v4-full-decentralization" target="__blank">this roadmap to full decentralization</a> put out by dYdX. By the end of 2022, dYdX plans to launch its V4, which includes a fully decentralized structure. To compete with centralized exchanges like FTX and Binance and differentiate from the pack, dYdX must fully lean into decentralizing the protocol and enabling community ownership. Currently, dYdX’s order book and matching model is off-chain due to technical and scaling constraints. Bringing an order book and matching system on-chain is a fascinating challenge from a technical and governance standpoint. A coinciding question is how the on-chain order book model will compete with the popular on-chain AMM model, as well as implications of liquidity availability. Having this liquidity available will prove vital to the success of dYdX decentralization.
<br><br>To realize dYdX V4, there will be a number of considerations the community will have to decide upon, an example being improvements on dYdX tokenomics. This transition will require governance participants to initiate discussions, vote on proposals, and collaborate with key stakeholders in the foundation team. Tackling this together as a community is the goal of decentralization.
<br><br>But how can researchers measure true community adoption/participation of a decentralized protocol? One metric we can scrutinize is the number of wallets holding the protocol's governance token. Shortly after their airdrop in September 2021, dYdX had about 15,000 wallets holding dYdX, their governance token. In contrast, shortly after Uniswap’s airdrop about a year earlier, Uniswap, possibly the most well-known decentralized exchange, had about 80,000 wallets holding their governance token, UNI, and about 250,000 wallets holding the token nearly a year later. This difference is significant. If dYdX is able to fully decentralize and place more of the control of the protocol into the hands of its users, these users will find ways to create innovations in months that would take the centralized team years.
<br><br>This is not to speak poorly of the team: it is obvious that they have created something incredible. This is solely to say that hundreds to thousands of people brainstorming and voting with their own tokens on how to improve the protocol will almost inevitably lead to more growth and innovation. And as Ki Chong Tran and Matt Hussey wrote in <a href="https://decrypt.co/resources/dydx-ethereum-margin-trading-platform-explained-learn" target="__blank">this case study</a> on dYdX in April of 2020, “The plan for dYdX has always been to offer increasingly advanced trading features such as options and derivatives along with their flagship margin trading features.” To continue advancing, dYdX must not hinder itself by creating an “us” and “them” in the community and instead foster full ownership of ideas and innovation for all who seek to contribute and can add value.
<br><br>Through decentralization, dYdX can allow its protocol to embrace the concepts for which it stands. It can also more easily allow for user contribution and reward those users who bring value to the protocol. Fully decentralizing is not an easy task, but if the dYdX team and voters can stay the course and “unchain” the protocol from a centralized authority, it will hopefully see the true power of a fully decentralized community. More participation = more innovation. Decentralize and the users will vote, create, and help the protocol prevail.
<br><br><a href="./essays"><p>- Charlie</a>, April 2022</p>
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