DYDX Research Report: When V4 is released in September and unlocked in December, is it worth paying attention to or avoiding it?

Original author: OUROBOROS CAPITAL

Compilation of the original text: Deep Tide TechFlow

Our bullish view on DYDX is based on the following:

1) After v4, more people buy DYDX tokens, because potential validators accumulate spot tokens to obtain transaction fees accrued by post-v4 tokens;

2) After achieving decentralization in v4, product innovation will increase significantly.

Additionally, over the longer term, we believe the following factors will drive fee growth:

i) Verifier’s ability to capture MEV;

ii) wider adoption through new features such as prediction markets and account abstraction;

iii) Panic in centralized exchanges will drive DEX growth.

introduce

DYDX v4 will be available sometime in late September. This update will fundamentally change the token economic model and further drive the product’s market fit.

Launched in 2021, DYDX made a splash in the market with its huge trading volume, even surpassing Coinbase at one point. At the time, transaction volume was primarily driven by incentives, and there was considerable laundering of transactions to gain incentives. Today, the situation is completely different. DYDX is the leading perpetual contract decentralized exchange with about 60% market share (fees often exceed incentives).

As more perpetual contracts move from off-chain to on-chain trading, we expect DYDX to continue to perform well, with higher fees, better user experience, and may even become a complete derivatives platform, including options, Prediction markets and more.

What is v4?

In short, v4 is the migration of dYdX to its own chain built with the Cosmos SDK. v4 was first announced in January 2022, with details about the dYdX chain subsequently released in June 2022.

Previously, fees were not accrued to token holders but distributed to equity holders, effectively rendering the token a useless governance token. v4 and the dYdX chain will make fees vest with token holders, which means we can think of v4 as the introduction of a fee switch for token holders.

Investment thesis 1: After v4, the annualized rate of return for DYDX currency holders is about 20%

There are multiple indications that DYDX tokens will accrue 100% of fees after v4.

Based on the current DYDX fee ($50M - annualized over the past 30 days), we estimate that validators will have a minimum staking yield of 15% from day one (assuming all circulating DYDX is staked) , but more likely closer to 20% (assuming a similar percentage of tokens staked as other high fee growth tokens such as SNX, GMX, and CVX). Furthermore, we believe this fee amount is an estimate at a time when volumes are low and expect volumes to rise when speculative demand returns. Currently, the trading volume of perpetual contract decentralized exchanges is about 30% of the historical peak (February 2022). Nevertheless, considering that the penetration rate of perpetual contract decentralized exchanges is now higher, and may further increase in the context of growing centralized exchange panic, we think it is reasonable to assume that the annualized fee is increasing. $100 million (or more) can be reached in the market.

Investment thesis 2: Decentralization will bring innovation

We believe that DYDX’s decentralization has the potential to unlock new verticals that were previously difficult to enter due to regulatory barriers, such as prediction markets, options, and synthetic products. This was also mentioned in the recent DYDX demo at Nebular Summit.

Investment thesis 3: Bullish unlocking

v4 and investor token unlocking were originally planned for early 2023, but have since been delayed. We clearly see that the timing of v4 has been synchronized with the unlocking time to ensure that the new supply is balanced with the demand brought about by the new improved token economic model.

Myth busting

This section answers what we believe are common misconceptions about DYDX.

Myth 1: There will be a massive unlock in December and tokens may be dumped

The biggest concern about the token right now is the upcoming December unlock. The December unlock will increase the token supply by 80%, and an additional 80% in a year. However, we believe the concerns here are overblown and, in reality, the team has every interest in ensuring that tokens are well-supported when unlocked, supporting our bullish view.

Of the 150 million DYDX tokens unlocked on December 1, 2023, 30% belong to employees and advisors. Weve seen precedent for this, as previous unlocks have been delayed to better time sync with the delayed v4; likely to ensure a good intersection between token supply and demand after value accrues.

It is worth noting that 70% of the employee and consultant tokens will be fully unlocked by June 1, 2024, and 90% of the tokens will be fully unlocked by June 1, 2025, which gives the token That leaves more time for holders interests to better align.

Misunderstanding 2: The trading volume of DYDX is unreal, and market makers wash the market in large quantities to obtain trading/liquidity provider rewards.

A common criticism is that market makers do a lot of trading to capture trading/liquidity provider rewards. While the dYdX tokens given to traders and liquidity providers used to be worth more than fees, this is no longer the case.

In fact, we observed a gradual decrease in trading/liquidity provider rewards while fees/volume remained stable. Additionally, the protocol has made a deliberate effort to reduce token rewards for traders and liquidity providers through several governance proposals, but this has not resulted in a reduction in trading volume.

The table below highlights the trend of DYDXs net profit margin (fees minus issuance) this year, with the latest month breaking even. We expect it to trend toward profitability again after liquidity provider rewards are reduced in DIP-24.

Misunderstanding 3: Perp DEX fees are expensive

Our comparison of DYDX’s fees with centralized exchanges shows that DYDX’s fees are already competitive and therefore not affected by fee compression. In fact, we think that fees may be considered low considering the DYDX tokens that are rewarded as exchanges/liquidity providers.

Catalyst 1: Centralized exchange losses equal decentralized exchange (DEX) gains

From the FTX incident, we know that when CEXs are surrounded by panic, perpetual DEXs tend to gain market share and token prices outperform. In the current context of heightened regulation on CEXs, this is an additional catalyst that we believe has the potential to benefit dYdX, making it a good hedge in a portfolio in a CEX panic scenario.

Catalyst 2: Validator MEV in v4

A recently explored idea is that DYDX validators would be able to earn MEV revenue on the exchange. We read Chorus Ones in-depth report on DYDX validator extraction of MEV and are convinced that validators can increase revenue by partnering with trading firms to extract MEV, further enhancing the appeal of spot buying to start a validator node.

in conclusion

We see DYDX as an opportunity to trade (short term) and invest (long term) both in the short and long term. In the short term, we expect v4 to inspire “unlock-ups” as token fees increase and validators’ need to accumulate spot. We also view it as a good core holding in a cryptocurrency portfolio over the long term due to its good fundamental market performance during cryptocurrency upcycles. In addition to new post-v4 products and perpetual DEXs potentially taking share from CEXs, it also benefits from real value accretion from speculative volume returning to cryptocurrencies.