dYdX attracts significant liquidity after releasing native markets

dYdX is a non-custodial exchange for margin trading, borrowing, and lending built on Ethereum. In May 2019, the team transitioned their product focus to a professional-focused order book exchange, providing a seamless interface for users to leverage long and short Ether. More recently, the team rolled out their own native ETH/DAI and ETH/USDC markets, which sit alongside sourced liquidity from Oasis and the 0x protocol-based Radar venues.

dYdX market share

While dYdX does not necessarily receive as much attention as other high profile Open Finance projects, its performance to date has been impressive: the exchange saw $60 million volume in Q2, $70 million in Q3, and is expected to see further growth by the end of Q4. Daily average volume sits at roughly $800,000 while the average trade size is $5,000. While volumes across Q2 and part of Q3 were largely correlated with Ether price, exchange activity has since picked up, returning to July levels despite a 20% depreciation in the value of Ether.

Source: The Block, dYdX, Coinmetrics

Within the broader context of non-custodial exchanges, often referred to as ‘decentralized exchanges’ (DEX), dYdX currently commands 3.41% market share as of October: 0x protocol-based relayers, Oasis, and Kyber continue to lead the market. However, this relatively small market share belies dYdX’s significance in the Open Finance industry: according to CoinGecko, dYdX currently sits in third place for ETH/DAI volume, with just under $800,000 traded across its platform in the past 24 hours. By comparison, Oasis and Coinbase Pro saw $1.15 million and $1.13 million respectively.   

Source: The Block, Tom Schmidt, Alex Kroeger

Native markets

The introduction of native dYdX markets came as a surprise to some cryptocurrency market structure observers, with some questioning the extent to which the project would be able to attract liquidity and compete against the pre-existing Oasis and Radar markets. Further, hosting a proprietary order book may introduce regulatory concerns. In October, dYdX CEO, Antonio Julian, told The Block that the decision to launch native markets was primarily inspired by the desire to make liquidity provider integration as easy as possible. Additionally, native markets were required in order to support margin limit orders.  

To that end, dYdX’s efforts have been incredibly successful. As the chart below illustrates, spreads on the native ETH/DAI market have fallen by 87% since the end of September. 

Meanwhile, data reviewed by The Block suggests that dYdX’s native ETH/DAI market offers the least slippage across $1,000, $25,000 and $50,000 market orders. For context, as of Oct. 31, slippage on $1,000 market orders across Radar Relay, Uniswap, Oasis, Kyber, and IDEX comes to 0.29%, 0.37%, 0.33%, 0.31%, and 0.66%, respectively. 

The success of dYdX’s native ETH/DAI market has led to the decision to discontinue support for 0x-based markets after the transition to the 0x v3 protocol. Alongside several infrastructure updates, 0x v3 introduces a new economic model for the native 0x token, ZRX: traders using the 0x protocol must pay a fee to market makers, distributed pro rata according to ZRX staked, equal to the transaction gas fee. This updated model is intended to attract more market liquidity, with the explicit user fee offset by tighter spreads. However, dYdX is confident that it can attract liquidity without burdening users with additional fees.

To date, dYdX has worked with two market making firms for its native markets, the larger of which is Wintermute Trading, a London-based cryptocurrency market making firm founded by ex-Optiver traders. Although dYdX pays Wintermute a small monthly fee for its services, Freddie Farmer, Trader and Head of DeFi at Wintermute, notes that their market making service is in itself profitable and he expects rebates to eventually be phased out over time. 

According to Farmer, Wintermute’s decision to work with dYdX, its only non-custodial exchange partner, was motivated by both the desire to provide impact in the Open Finance ecosystem and the ease of integration into dYdX’s systems. Farmer cites dYdX CEO Antonio Julian’s prior experience at Coinbase as important, noting that the margin trading exchange has, critically, not attempted to reinvent the wheel when it comes to integrations. Farmer also notes that the dYdX team has been open to feedback, adjusting their services to accommodate liquidity providers. Understandably, liquidity provision on dYdX still makes up a relatively insignificant portion of Wintermute’s total trading activity: Farmer specifically mentions risk management challenges related to settlement — is a trade settled once the order has been matched? How many confirmations on Ethereum are necessary? These risk management challenges are especially problematic when Ethereum is congested, which often coincides with peak trading demand as users seek to open or close out leveraged positions. 

Lending

dYdX’s success cannot solely be measured by trading volume. As a platform with an integrated lending protocol, dYdX has increasingly become the leading source for originations. While the following chart only shows DAI origination volumes, according to Loanscan dYdX has seen 41% of origination market share taking all assets into account versus Compound v2 and MakerDAO over the past three months and 50% over the past month. These figures are significant in that lending fees could viably serve as an alternative revenue stream once dYdX actively monetizes. 

Source: The Block, Loanscan 

dYdX’s success in the lending market vis a vis Compound, the other major Open Finance secondary lending protocol, is perhaps in part due to the construction of its interest rate formulas. As peer-to-contract lending models, borrow and supply rates move in line with utilization rates. Compound supply rates move linearly according to utilization rate while borrow rates move super-linearly: by contrast, both dYdX borrow and supply rates move super-linearly. In practice, this has led to both tighter spreads between borrow and supply rates and more attractive rates on dYdX versus Compound over the past few months.

Looking forward

For now, dYdX will continue to focus on supporting additional market makers on its native markets. Concurrently, the team will seek to launch additional functionality on their exchange, such as stop-loss orders, while also researching new products planned for Q1 2020. The team expects volume to pick up on their native exchanges as they introduce the ability to close isolated positions: currently, dYdX users can only close their isolated positions with market orders through Oasis.