From dYdX's latest proposal, the consensus creation of community governance and DAO

Author: Xi Angxiang, ChainCather

Last week, the governance proposal DIP 20 by dYdX DAO, aimed at reducing trading rewards by approximately 45%, was officially passed. Meanwhile, the price of the DYDX token surged by 30%.

The proposal itself is not complicated—reducing trading incentives to save funds for the treasury, with specific uses to be discussed later. However, the intentions behind it reflect a clear message from the project and its stakeholders: for the sake of long-term community interests, dYdX has chosen to appropriately forgo short-term incentives and attractive trading volume figures.

This internal "reform" of the profit distribution mechanism at dYdX concluded with 84% support and 16% opposition, and did not cause the uproar seen previously when Uni chose cross-chain bridge tools. As a leading DeFi project, dYdX has repeatedly leveraged community voting and public governance to communicate and adjust project development details and medium- to long-term plans, becoming a rare model in the industry.

This article will analyze the short- and long-term impacts of dYdX's community governance approach by referencing several important turning points in its history, and will summarize the challenges faced by decentralized communities (i.e., DAOs) in establishing consensus and profit distribution.

dYdX Governance Development Process and Important Turning Points

dYdX provides perpetual contract trading services similar to centralized exchanges like Binance, with the ultimate goal of establishing a fully decentralized derivatives exchange.

In the summer of 2017, former Coinbase engineer Antonio Juliano founded dYdX. The first two products of the protocol, Expo and Solo, were built for margin trading on Ethereum. Seeing the explosive growth of Bitmex's perpetual contract trading in 2019, dYdX decided to follow suit. The launch of derivative contracts like BTC and ETH attracted a large number of traders, and with the release of StarkNet in 2021, the usability of dYdX based on it was further improved.

Moreover, dYdX has become the most successful and highest market share on-chain derivatives platform, thanks to its early adoption of an order book model, highly competitive fee mechanisms, use of third-party price feeds, a variety of order types, and a good UI/UX interface.

However, dYdX, which once attracted a large number of traders and arbitrageurs through liquidity incentives, later became mired in a significant amount of fake trading aimed at exploiting the system. Additionally, how to further enhance scalability and design new value capture models is also a problem that dYdX needs to address.

On June 22, 2022, dYdX announced that its V4 version would be launched as a Layer 1 blockchain based on the Cosmos SDK and Tendermint, with DYDX proposed as the native token of dYdX v4.

For dYdX, retreating from Ethereum and developing an application chain based on Cosmos is naturally beneficial for the community and users. Through this approach, dYdX hopes to provide a new value capture narrative—namely, users need to use DYDX to pay for transaction fees and validator fees. Additionally, DYDX can participate in staking, run its own sequencer or verifier to capture MEV, thereby reducing transaction fees.

Before making such a choice, on January 11, 2022, dYdX Trading Inc. announced the path to complete decentralization for the dYdX protocol: dYdX V4 would be open-source, fully decentralized, and entirely entrusted to the dYdX community.

It can be said that the release of dYdX V4 on the mainnet marks a turning point in the decentralization of the dYdX protocol. Since then, the dYdX DAO has been solely and fully responsible for all aspects of the operation of the dYdX protocol. To this end, the dYdX Foundation released a potential roadmap for the dYdX DAO within the community.

In their vision, the dYdX DAO may consist of several autonomous subDAOs, each responsible for a part of the core functions of the dYdX protocol (such as finance and fund management, growth, risk management, etc.), and ultimately accountable to the dYdX community. SubDAOs need to pay timely attention to discussion requests (DRC) on the dYdX community forum, guide community discussions, promote proposal progress, and smoothly execute approved on-chain voting proposals.

dYdX Governance Experience and Underlying Logic

The path to decentralization for dYdX is certainly not a one-step process, but the core dYdX Foundation was established in June 2021 in Switzerland. As a non-profit foundation, its mission is to develop the dYdX ecosystem by supporting the community, developers, and decentralized governance.

On August 3, 2021, the dYdX Foundation officially announced the issuance of the governance token DYDX, allowing the dYdX community to truly govern the dYdX Layer 2 protocol through shared control of the protocol, coordinating incentives among traders, liquidity providers, and partners, and establishing a robust ecosystem around governance, rewards, and staking.

Based on years of experience and observation from dYdX v3 governance, the official has released some specific figures:

From the perspective of participation in governance, among the 30 proposals on dYdX v3, an average of 26 million DYDX (about 7.0% of the votable supply) and 412 addresses (about 1.1% of all votable wallets) participated in voting. Despite market fluctuations, the voter participation rate in governance increased quarter-on-quarter in 2022.

In terms of consensus efficiency, the average preparation time for forum discussions, off-chain voting, and creating on-chain voting throughout the proposal lifecycle was 17 days and 48 days, respectively.

To further improve the universality and efficiency of dYdX governance, the solution chosen by the dYdX community is to delegate decision-making authority for certain parameters to specialized subDAOs. Additionally, they are considering further distributing and decentralizing voting rights and proposal rights.

Overall, in the dozens of proposals over the past few years, discussions about security modules, liquidity modules, funding plans, and incentive plans have sparked widespread enthusiasm in the community due to their direct impact on dYdX's protocol revenue and ecosystem development. Most community members participating in voting have expressed their opinions from the perspective of the overall interests of the community.

The sense of mission of the dYdX DAO originally stems from its founder Antonio Juliano. He once wrote in the community about his views on the values of the dYdX community, one particularly important point being his candid discussion on what types of contributors the DAO should consider funding. Rather than compensating a large number of contributors with a small amount of money, Juliano suggested it would be better to pay a small number of talented contributors a large amount of money.

Furthermore, one significant influence in the community was the amendment released by the dYdX Foundation at the beginning of 2023 regarding the vesting schedule of the DYDX token. 30% (150 million DYDX) of the tokens were originally scheduled to unlock in early February 2023, which would have increased the circulating supply by over 100%. However, the amendment extended the token lock-up period to December 1, 2023. This move significantly consolidated the community's confidence and sense of identity regarding DYDX, which was then conveyed to a broader group of investors, with the most direct manifestation being that the price of the DYDX token surged over 25% after the announcement.

DAO Governance Challenges and Summary

So far, the governance models of DAOs are mostly simplified versions of national and corporate governance models. Most governance mechanisms in today's crypto projects are a democratic implementation based on tokens.

Mechanism designers have indeed reinforced old models with novel on-chain functionalities, such as One-Wallet-One-Vote, which resembles direct democracy, mechanisms aimed at reducing the voting power of whales, and the Proof of Participation (PoP) proposed by Vitalik Buterin and others.

These improvements cannot be said to be unimportant, as they primarily focus on increasing efficiency and mitigating or delaying the impact of malicious proposals. However, they do not answer a key question: Can the underlying governance framework incentivize positive behavior while handling complex tasks?

The vast majority of DAO governance models struggle to achieve this.

Initially, most on-chain governance systems were designed to coordinate very simple decisions: such as whitelisting collateral tokens, modifying a parameter, or activating or deactivating a relatively unimportant feature. The tasks of the DAO were clearly defined, and the role of contributors was to keep it functioning normally or make minor improvements.

However, as the user base and revenue figures increase, the scope in which DAOs can operate expands. When DAO governance involves the transfer of significant financial or other resources, the issues will be rapidly magnified. Consequently, almost every DAO faces two core challenges: excessive centralization and excessive fragility.

At least for now, DAO governance merely mimics traditional shareholder governance; in other words, we have yet to see true decentralized governance and the allure of Web3—namely, empowering more people to make creative contributions to the system.

However, it is important to acknowledge that experiments with DAOs are progressing very rapidly, evolving into forms that traditional models cannot comprehend or learn from. With the scalability, granularity, programmability, and composability of the internet and blockchain, it is expected to evolve into better models through continuous practice and innovation.

If the experiments with DAOs are destined to make mistakes, what we hope to see are effective and beneficial errors. There is no need to demand perfection from DAOs at this stage; more crypto projects like dYdX will move towards directions that are more adaptable to the market.