Why has dYdX's departure from Ethereum become a foregone conclusion?

Author: Haotian

Recently, I saw @dYdXChinese claim that its total trading volume has exceeded 120B, with 14.9% of the supply of tokens staked, and over 20M USDC allocated to stakers. In summary, after the launch of the dYdX independent chain, various data metrics have been quite good. So, how should we evaluate dYdX's "escape from Ethereum" development journey from L1 to L2 and then to an independent chain? Can the Ethereum Layer 3 application chain narrative bring dYdX back? Next, I will share my views:

1) dYdX is a typical application representative born for Trading systems, with the goal of becoming a decentralized derivatives exchange focused on order book type perpetual contracts. Because of this, in the past few years of development, dYdX has faced three core pain points:

1. It requires extremely strong technical scalability and high performance, as compared to AMM trading pool types, order books have very high demands on real-time batch matching and execution for system throughput and latency;

2. It must pursue decentralization as much as possible. During the L1 and L2 stages, in pursuit of extreme efficiency, dYdX had to adopt an off-chain centralized server to match orders. However, as a DeFi project focused on trading, competing with centralized exchanges (CEX) for market share, it must achieve transparency in key processes through smart contracts and DAO governance in the long run, and decentralize node deployment to allow community users to participate more in governance decisions. (This is also the main reason why it allocates a large portion of trading fees to validating nodes and stakers);

3. It needs to manage user retention and growth issues as effectively as possible. Compared to CEX and other exchanges, on-chain decentralized derivatives exchanges have higher barriers to entry. Therefore, product design, user interface, trading tools, and risk control functions must provide a good product experience. Compared to DEXs like Uniswap, dYdX is relatively a more closed trading system. Unlike Uniswap, which can gain significant liquidity and trading fee sharing through integration with numerous projects, dYdX can only rely on long-term user retention, especially from professional traders and market makers, to support product operation.

2) So, why does dYdX want to create an independent application chain? The answer is that neither L1 nor L2 can meet its extreme performance requirements.

Initially, dYdX developed its business on Ethereum L1 but faced competition pressure from Uniswap due to the main chain's low performance and high gas volatility, leading to the decision to migrate to L2. Upon arriving at StarkEX's layer 2 product form, it seemed to have the foundation of low gas fees and high throughput, but it still fell short of the high performance dYdX pursued. Therefore, it adopted a compromise solution of off-chain matching for trading data, utilizing Starkware's zero-knowledge proof for on-chain and off-chain finality proof, achieving a high-speed trading engine solution on L2. However, this solution still relied on off-chain services, leading to frequent criticisms of dYdX for having a "centralization problem";

Following this, with the launch of dYdX V4, dYdX built a dedicated high-performance chain based on the Cosmos SDK, with 60 active validators maintaining the consensus mechanism, including Ledger, Coinbase Cloud, etc., along with a continuously launched user staking reward distribution mechanism. With the support of the independent application chain, dYdX has been frequently refreshing various operational data metrics, such as:

1. Currently, there are 149 million DYDX (14.9% of the total) in a staked state;

2. The protocol has distributed over 20 million USDC to 18,991 stakers;

3. Community members have initiated 55 governance proposals to date;

From the data, dYdX's independent application chain is gradually realizing its original vision of becoming a super decentralized perpetual exchange. At the very least, dYdX has confirmed its ultimate application chain form, no longer needing to discuss technical stories like chain expansion and performance; in the future, it only needs to continue operating to grow user and trading volume data.

3) Since dYdX already has its own independent kingdom, from a business perspective, as a successful application, dYdX's present should be the tomorrow that many L1 and L2 applications aim to achieve.

One can't help but ask, since L1 and L2 are currently overly competitive at the infrastructure level, and there are expectations for the narrative of layer 3 super application chains, theoretically, it should be fine to develop dYdX on Ethereum's layer 3 application chain, right?

The answer may disappoint most people: it cannot.

1. dYdX focuses on decentralized derivatives trading as a trading system business, and its initial positioning was to cultivate an independent user base and data growth model, becoming a custom application chain.

Although layer 3 can customize gas tokens, consensus mechanisms, validation rules, etc., the core interoperability capabilities of layer 3 application chains and the settlement of key assets still rely on the Ethereum mainnet, which will similarly impose certain limitations on dYdX.

2. Even Uniswap does not yet have the mature conditions to build a layer 3 application chain based on Ethereum. The ecological liquidity depth of layer 2 and performance barriers on layer 1 (high gas fees) still limit their potential to create layer 3 application chains. Especially the extreme lack of users and market liquidity on layer 2 makes it difficult for application chains built on layer 2 to have a stable user base and trading depth. Moreover, dYdX has such high requirements for decentralization, order book matching performance, and trading experience.

Therefore, dYdX's departure from the Ethereum ecosystem to create an independent application chain is both a proactive escape and a helpless choice constrained by the underlying performance limitations of Ethereum. (From another perspective, although the competition in the Ethereum ecosystem has become intense, the necessity remains significant.)

This actually highlights a prominent issue with the multi-chain narrative of layer 3 applications: applications like dYdX, which have mature users and markets, may find their customization needs unmet, while some applications starting from scratch to create application chains may not receive the spillover effects of strong ecological liquidity from L1 and L2 in the short term under the layer 3 environment.

In conclusion,

dYdX's positioning and development trajectory within the crypto ecosystem are quite unique. Although it has achieved a certain level of "success," it can continue to expand and grow its business in a relatively stable manner amidst market volatility, similar to protocol companies like Uniswap and AAVE.

However, the path to success for dYdX is not something that many applications on L1 and L2 can easily replicate. In fact, Uniswap has already provided the answer: relying on the Ethereum ecosystem makes it difficult to escape; one can only continuously optimize within the stacks of L1, L2, and L3. After all, most applications lose their fundamental survival without the composable liquidity provided by the underlying public chain.