What Is dYdX Exchange?

By Lipsa Das

Centralized exchanges offer an easy entry point to the crypto world with familiar interfaces and quick transactions. However, there’s a key tradeoff: you’re giving a third party control over your assets the minute you use a centralized exchange. While decentralized exchanges have been around for a while, their slower transaction speeds previously held them back.

Enter dYdX — a decentralized trading platform for perpetual contracts with fast and efficient transactions. It offers the simplicity and functionality of a centralized exchange while allowing you to retain full custody of your assets.

In this article, you’ll learn what dYdX is, how it differs from centralized exchanges, and how you can trade using the platform. Let’s dig in.

What Is dYdX Exchange?

dYdX is a decentralized exchange (DEX) that allows users to trade perpetual futures contracts (aka perpetual contracts) for over 35+ cryptocurrencies, including BTC, ETH, and SOL. These financial instruments are particularly appealing to experienced traders looking to take advantage of leverage trading.

It first launched on the Ethereum blockchain, but this became unsustainable, as the growing traffic on the Ethereum network caused gas fees to soar. This was particularly damaging for dYdX as it was subsidizing its users’ gas fees. For this reason, it then moved to the Ethereum layer-2 solution, Starkware, as part of its v3 iteration in 2021.

As part of its commitment to fully decentralize the platform, dYdX launched its v4 iteration on its standalone blockchain, the dYdX chain, using the Cosmos SDK. As a result, all parts of the dYdX v4 protocol are fully decentralized.

The History of dYdX

Founded in August 2017 by ex-Coinbase engineer Antonio Juliano, dYdX Decentralized Trading Platform has become one of the most successful decentralized exchanges. Its name, dYdX, is a clever play on words, as the platform allows users to trade derivatives, and dy/dx is one of the ways that the mathematical function of derivatives is expressed.

Its initial whitepaper outlined the protocols for advanced trading methods like margin trading and covered calls, a compelling niche in the crypto market. The idea quickly caught on, with it achieving a $10 million valuation before generating revenue. 

Since its launch, the protocol has undergone several evolutions, refining both its product offerings and the benefits it offers users.

dYdX on Layer 1

The first version of dYdX used Ethereum smart contracts to power spot and margin trades on the platform. These smart contracts allowed users to offer or accept loans for margin trades without middlemen, thus maintaining its trustless and self-custodial nature. This iteration of the platform allowed for up to 5x leverage trading on major cryptocurrencies like ETH and BTC.

Ultimately, Ethereum’s network congestion made this pretty slow and expensive, especially in periods of high activity. As a result, dYdX sunsetted this version of the protocol on November 1, 2021.

dYdX on Layer 2

In an attempt to make trading as seamless as its centralized counterparts, as well as to lower transaction fees, dYdX shifted its operations to the Layer 2 solution, Starkware. To clarify, Starkware uses Zero-Knowledge (ZK) rollups to enable faster transactions. This version processes trades off-chain on a central order book in batches and then finalizes those batches on-chain.

As a result of using Starkware, dYdX was able to provide its users not only with faster transaction speeds but also with lower gas and trading fees, as well as lower minimum trade sizes. Besides these benefits, dYdX v3 offers users higher leverage than the v2 product (up to 25x), as well as more cryptocurrency trading pairs and cross-margin options (which allow for higher leverage trading). Notably, v3 also marked its shift to focusing solely on perpetual trading, which quickly eclipsed margin trading as the platform’s most popular offering.

While dYdX has always been a fully non-custodial trading platform, it did have some centralized aspects on its Ethereum and Starkware versions. Fully decentralizing the platform was always a major goal, which it finally realized upon the full launch of dYdX Chain and dYdX v4 in November 2023.

dYdX Chain

In a major stride towards decentralization, dYdX v4 moved to open-source all aspects of the platform. Specifically, this meant decentralizing its order book (the list of all buy and sell orders for specific trading pairs) and matching engine (the system that matches buy and sell orders). 

dYdX was able to achieve this thanks to the launch of its fully independent blockchain, dYdX chain, on October 23rd, 2023. Notably, v4 grants users even faster transaction speeds, as the dYdX chain claims the ability to process over 2000 transactions per second (TPS) – much faster than the double-digit TPS measurements of both Ethereum and Starkware.

It’s important to note that the dYdX chain is completely independent of its parent company, as the dYdX DAO oversees its governance. For example, it is the community that will decide which new exchange pairs of cryptocurrencies will be added via on-chain governance. Similarly, the community will also be the ones to decide whether or not dYdX reintroduces spot and margin trading on the platform.

What’s more, the company no longer takes trading fees from dYdX v4, underscoring its mission to provide users with a community-driven trading experience. Instead, all the fees collected will go to the chain’s stakers and validators.

How Does dYdX Work?

As previously mentioned, both the order book and matching engine of dYdX v4 are decentralized. But how does this work?

First off, users begin by placing a buy or sell order. dYdX supports eight different order types, which are essentially just instructions to buy or sell an asset under certain conditions. Once you place an order on the exchange, a validator node stores it off-chain. 

After the order is placed, validator nodes then communicate with other nodes to find a matching trade. Remember, since it is a decentralized trading platform, users are effectively trading cryptocurrencies with one another: dYdX simply facilitates the trade. 

Let’s say that a user places an order to buy a certain amount of BTC for a certain amount of USDC. The validator nodes must find another user with a matching order to sell BTC for USDC to finalize both trades. Once the nodes identify matching trades, they add these trades to new blocks and propose them to the rest of the network.

It’s important to note here that when you place an order on dYdX it is not processed on-chain until it becomes a finalized trade. This mechanism also allows dYdX to have a much better throughput: it prevents excess data from taking up space on the blockchain. Crucially, this also means that users can submit and cancel orders without having to pay any gas fees. 

Of course, users still have to pay trading fees, 100% of which are used to compensate validators and stakers on the network. The fees are decided on via community governance and calculated as a percentage of the total order. To follow, users must pay these fees in USDC. For example, if you placed an order to buy $100 worth of an asset at a 0.1% trading fee, you would pay a fee of $0.10 in USDC.

What Is dYdX for?

As an advanced trading platform, dYdx offers a range of features to traders and investors. Let’s look at how features such as perpetual trading and staking have boosted its popularity.

Perpetual Trading

Perpetuals are a subset of futures contracts that essentially allow you to place a bet on the future price of an asset. However, in contrast to standard futures contracts which close on a predetermined date, perpetuals have no expiration date. Rather, the buyers (longs) and sellers (shorts) of the contract, exchange payments on an ongoing basis according to the difference between the price of the contract and the actual, real-time price of the underlying asset.

Leverage trading is particularly popular in perpetual trading. Trading with leverage means increasing your exposure size on an asset by borrowing money, otherwise called leverage. Traders use leverage to multiply their gains, though, of course, this same tactic can multiply their losses too.

Let’s understand this through an example. Say, you have $100 of capital, and you want to trade $BTC with 10x leverage. The exchange opens up a position of $1000 worth of Bitcoin (BTC), backed by your $100 capital. If the value of BTC moves up by 1%, you get a 10% return on your margin. But, if the market doesn’t move in your favor and the value of your BTC position drops close to your margin amount, the exchange can liquidate your position to repay your loan.

On a centralized exchange, there is an internal algorithm that monitors these market movements and the trader’s position through order books. On the other hand, dYdX uses open-source smart contracts to execute these trades in a transparent, trustless manner. What’s more, you can leverage decentralized liquidity pools, with capital supplied by other traders, to place position bets.

Governance 

dYdX’s native token also doubles as its governance token. Holders can participate in major protocol decisions. They can also propose and vote on protocol upgrades or changes; such as algorithm changes, managing funds, and chain upkeep. 

Governance forums drive the dYdX Governance Process using Improvement Proposals (“DIPs”) to formally approve proposals. Governance smart contracts keep track of each address’ voting power, proposal vote count, and specific timelocks. If a proposal passes a certain threshold of “yes” votes, it becomes part of the official dYdX roadmap. 

Staking

Users can stake their current crypto holdings on the exchange and earn interest in the form of native dYdX tokens. This serves as an incentive for users to deposit their funds on the platform and promote its usage.

Apart from staking, traders can also choose to provide liquidity to facilitate trades on the platform. dYdX has two main pools — liquidity pools and safety pools — where users can stake USDC coins to earn dYdX tokens and a share of the trading fees on the platform. 

NFTs

Hedgies is a free 4,200 NFT hedgehog art collection on Ethereum which rewards the exchange’s active users. Every day since February 2023, the top trader by profit and loss (PnL) on dYdX receives a Hedgies NFT. Plus dYdX also maintains weekly leaderboards and distributes Hedgies to the top ten contestants. Thus, these NFTs recognize and incentivize the top traders while simultaneously building a community of exceptional traders. 

A Hedgie acts as the main access pass to an active trading community. For example, a Hedgie unlocks exclusive Discord channels to discuss trade strategies, community events, and much more. Plus holding a Hedgie also gives you a 3% discount on dYdX’s overall trading fees.

dYdX Token: Explained

The dYdX token (ethDYDX) is an Ethereum-based multipurpose governance currency for the dYdX exchange. Launched in August 2021, ethDYDX has a total supply of 1 billion tokens. Over five years, these tokens will be accessible according to the following allocation:

• 27.7% for previous investors in dYdX Trading Inc., the company that created dYdX
• 15.3% for the founders employees, and other contributors to either dYdX Trading Inc. or the dYdX Foundation
• 7.0% for future employees and contributors of dYdX Trading Inc. or the dYdX Foundation
• 26.1% for the Community treasury
• 23.9% for rewards to traders, stakers, and liquidity providers

After the initial five years, it could become inflationary depending on what the community decides. However, the maximum rate of inflation is set to be 2% per year. Similarly, the community has full control over its 50% allocation. Indeed, governance proposals have changed the initial token allocations since its launch.

The exchange uses its native token to enable governance across the platform. Beyond its governance role, the dYdX token directly incentivizes active engagement in many aspects of the protocol, such as retroactive mining, liquidity pools, and perpetual trading. 

While holders of the token received substantial trading discounts at first, this feature was discontinued on September 29, 2023. Currently, the Ethereum-based token ethDYDX is migrating to the dYdX chain, aiming to broaden and expand its utility further.

The Future of dYdX

Judging from its continued growth and popularity, dYdX is leading the path to decentralizing crypto trading. dYdX v4 lets you maintain self-custody of your cryptocurrency while making your assets work for you in a variety of trade set-ups. 

Decentralizing the dYdX chain holds immense implications for the future of crypto trading. It directly eliminates central points of control and reduces regulatory pressure. What’s more, letting the community decide which on-chain pairs to add gives it a competitive edge. Users can collectively influence and choose new trading options, making the platform more dynamic and responsive to their needs.

And the best part? You can directly interact with self–custodial decentralized exchanges from the safety of your Ledger device. Indeed, Ledger Live’s integration with the dYdX chain allows you to manage and stake your tokens in just a few clicks.

So what are you waiting for? You can use Ledger as you join the movement towards decentralization and enjoy the peace of mind that comes with secure self-custody.