Introduction

Recently, Antonio Juliano, Founder and CEO at dYdX Trading Inc., published a blog post outlining his views in connection with a topic of great interest in the crypto industry: DeFi regulations.  In that blog post, titled ‘DeFi Policy Principles: A First Principles Approach’, Antonio puts forward key principles that should inform decisions by lawmakers and industry participants alike when considering regulatory compliance in DeFi protocols.  

At a high level, these principles (the “Principles”) are organized under the following key topics:

• Customer Protection
• Disclosures
• Market Integrity
• Equality of Access
• Criminal Activity
• Innovation

To build on that principles-based framework, the dYdX Foundation has put together this post, which analyzes how the mainnet deployment of the dYdX Chain fares against the Principles. 

The dYdX Chain and the DeFi Policy Principles

Below, we lay out the dYdX Foundation’s interpretation of how the dYdX Chain mainnet could be evaluated from the perspective of each of the Principles.  Let’s dig in.  ‍

1. Customer Protection

i. Self custody

In the dYdX Chain, users (including not only traders and other users of the dYdX Chain core product -the dYdX trading platform- but also token holders, stakers, and other potential network participants) retain full custody of their crypto-assets at all times.  Whether a user wants to keep their crypto-assets in their own self-custodial wallet (be it a cold storage wallet, a ‘hot’ EOA, or a multi-sig), stake them to a validator, or deposit them (in the case of USDC tokens) as collateral to trade on the platform, the user will retain full access to, and control over, those crypto-assets at all times using their cryptographic keys or private keys.  The dYdX Chain software is compatible with several different self-custodial wallets. 

No third parties hold any positive or negative control over a user’s access to their own crypto-assets, unless the user decides to cede control over them to a specific party (e.g., a custodian or other third party). 

ii. Transparency

The entire source code of the dYdX Chain is open-source code.  Further, any accounts, transactions, proposals, or states in the dYdX Chain can be queried at any time by anyone, including, for example, via blockchain explorers like Mintscan. 

Further, there are multiple public sites maintained by different independent parties that provide a technical overview of the dYdX Chain (further to the source code itself).  These include the dYdX Foundation’s governance documentation, as well as the official technical documentation for the dYdX v4 software, for example. 

Lastly, there are multiple public dashboards maintained by independent contributors that showcase key dYdX Chain protocol data.  Examples include the dashboards and portals operated by Chaos Labs, Mintscan, Numia, Keplr, and Smart Stake Analytics, among others.  

iii. Open Source

The entire source code for the dYdX Chain is open source, including both the protocol software and the user interface code.  Any person can inspect and, subject to the applicable open-source license, deploy, fork or otherwise leverage the open-source code or any part thereof. 

iv. Sufficient Decentralization

The dYdX Chain is a fully decentralized layer-1 network; specifically, it is a standalone application-specific blockchain network based on a delegated proof of stake (dPoS) model.  This means that there are multiple categories of participants in the dYdX Chain network, including: Validators, indexer operators, full node operators, token holders (some of which are stakers and, therefore, entitled to participate in dYdX Chain governance), IBC relayers, and many more. 

While delving into the exact level of decentralization of each of the categories of participants in the dYdX Chain would probably merit its own blog post, the dYdX Chain has achieved high levels of decentralization at multiple key levels of the network’s infrastructure.  For example:

• Validators: more than 160 independent Validators are running the dYdX Chain software in a fully permissionless and disintermediated way, 60 of which form the network’s active set and are producing blocks and validating transactions. 
• Stakers: more than 15,000 network addresses are staking DYDX tokens to Validators, making for a highly distributed web of governance participants.
• Governance: the dYdX community, through dYdX Chain governance, may change any on-chain parameter and/or the source code of the dYdX Chain.

• Fees: dYdX Trading, the developer of the open source software underlying the dYdX Chain, does not earn any fees from the mainnet deployment of the dYdX Chain, whether by participating in staking or otherwise.‍

2. Disclosures

i. Documentation

As mentioned above, there exists several publicly accessible sites that provide clear, easy-to-understand documentation that describes the characteristics of the dYdX Chain and its core infrastructure components.  Users who wish to gain a better understanding of the dYdX Chain and its technical design and implementation may visit sites like https://docs.dydx.exchange/ or https://docs.dydx.community/.  These websites are publicly available and maintained respectively by dYdX Trading Inc. and the dYdX Foundation, which strive to keep all information published on them up-to-date. 

ii. Marketing Materials

This is a broader topic than some of the ones covered so far in this post.  As it relates to the dYdX Foundation in particular, the Foundation makes an active effort to ensure that all of its public communications and materials reflect a true, accurate, and not misleading overview of the dYdX Chain and/or its features and components, as the case may be.  To ensure this remains the case, any communications and materials made public by the dYdX Foundation go through a thorough internal review process before being published, including to ensure accuracy from a technical, product, and legal standpoint.  Moreover, the dYdX Foundation endeavors to sustain any public statements regarding the dYdX Chain with objective, tangible data and seeks to leverage on-chain metrics and analytics as much as possible.  This applies to resources and publications like the Foundation’s dYdX Chain governance documentation, our ecosystem annual and semi-annual reports, our blog posts, and many others.  We encourage other dYdX Chain ecosystem participants to follow similar practices and adhere to high standards when it comes to public statements that they make regarding the dYdX Chain. 

iii. Data Accuracy

As mentioned above, the dYdX Foundation strives to leverage dYdX Chain on-chain data as much as reasonably possible in its different activities.  Further, the Foundation seeks to collaborate with ecosystem contributors that operate or maintain public dashboards relating to the dYdX Chain to ensure they reflect clear, correct, accurate, and not misleading data and information about the protocol. 

iv. User Privacy

As in any decentralized network, multiple independent participants are providing different services and/or operating systems and infrastructure in an autonomous manner and subject to varying conditions, including with regard to user data collection and retention.  Some of these participants may provide transparency to users of their platforms or services regarding the data they collect from them (this is the case with the dYdX Foundation or the dydx.trade user interface, for example), whereas others may not provide such information – in some cases simply because they do not collect or store any type of user data.  

v. Protocol Disclosures

The dydx.trade user interface’s Terms of Use provide ample disclosures to end users interacting with the dYdX Chain via this front-end application.  Further, dYdX Trading Inc. maintains a publicly available website containing technical documentation and resources that enable an accurate and detailed understanding by end users of both the dYdX Chain protocol as a whole and the dydx.trade front-end in particular, facilitating an independent but informed and diligent use of the protocol and the user interface by anyone.  In addition to that, all users can inspect on-chain data for their (or others’) transactions or interactions with the network, either through their own infrastructure or via chain explorers like Mintscan. 

All in all, the fact that all foundational information regarding the dYdX Chain is public and open source gives an opportunity for anyone to add to the disclosures that already exist, creating a healthy and composable transparency framework. 

vi. Decentralization

Please refer to section A.iv. above for the dYdX Foundation’s global take on the current level of decentralization of the dYdX Chain.

We encourage any dYdX Chain ecosystem participants, particularly those running or operating key network infrastructure like validator nodes, RPC nodes, indexers, IBC relayers, etcetera, to be transparent about the level of decentralization of the infrastructure they operate and/or the services they provide. 

3. Market Integrity

i. Financial Soundness

The dYdX Chain makes reasonable efforts to enable third parties to have a full understanding of the status of the network.  This includes the availability of software audits (available here: https://github.com/dydxprotocol/v4-chain/tree/main/audits) and software upgrade release notes (available here: https://github.com/dydxprotocol/v4-chain/releases) for the open source software underlying the dYdX Chain, governance proposal changes and specifications (available here: https://www.mintscan.io/dydx/proposals), and semi-annual ecosystem reports published by the dYdX Foundation, among other resources. Given the dYdX Chain data is fully open-source and publicly available, users can also track metrics and protocol-level risks in real time, including via their own infrastructure.

ii. Robust to Manipulation

The dYdX Chain leverages the CometBFT state machine replication engine (a fork of Tendermint Core).  CometBFT is a robust, battle-tested consensus software used by many blockchain networks, including most of the Cosmos SDK app-chains.  However, CometBFT is not flawless and is indeed vulnerable to certain attack vectors.  Primarily, CometBFT works as long as less than 1/3 of a network’s Validators fail in arbitrary ways or behave maliciously; in other words, a group of Validators representing 1/3 or more of the dYdX Chain’s stake weight could, by intentionally colluding with each other or by inadvertent malfunctioning, halt the network, therefore preventing the creation of new blocks and the validation of new transactions.  Moreover, a group of Validators representing 2/3 or more of the dYdX Chain’s stake weight could collude to exercise discretionary control over the network.  This is why ensuring a diverse, independent validator set and a greatly distributed stake weight among Validators in the active set is crucial for network security.  Initiatives like the dYdX Foundation’s Stake Delegation Principles and Stride’s and pStake’s validator selection criteria aim to increase the strength and diversity of the dYdX Chain validator set. 

Please refer to section D.ii. below for additional thoughts on the dYdX Chain’s robustness to manipulation from the perspective of maximum extractable value (“MEV”).

iii. Code Correctness

The dYdX Chain protocol and front-end source code (i.e., the dYdX v4 software open-sourced by dYdX Trading) was tested in several internal, private, and public testnets.  A public testnet for the dYdX v4 open-source software ran for several months, and is currently live.  Ecosystem participants and, in particular, dYdX Chain governance actors (including proposers) promoting software upgrades or changes to the dYdX Chain mainnet are encouraged to test their proposal(s) (software upgrades, community spending, or parameter modifications) in a testnet environment before creating an on-chain governance proposal.  In addition to the foregoing, the dYdX v4 open-source software was audited by Informal Systems.  

iv. Cybersecurity

dYdX Trading, the core developer of the dYdX v4 open-source software, maintains a bug bounty program incentivizing independent inspection, review, and auditing of the software by third parties, rewarding parties who identify critical bugs on the software with up to $1,000,000 (with rewards for extraordinary finds being able to extend up to $5,000,000).  

Separately, the dYdX Foundation also maintains a bug bounty program in relation to its own sites and applications. 

4. Equality of Access

i. No Advantaged Participants

In the dYdX Chain, all users are treated equitably and subject to transparent protocol-enforced terms.  The protocol does not differentiate based on subjective criteria; two users in the exact same circumstances should be able to benefit from the exact same treatment.  That said, discrepancies may exist between different types of users or between parties subject to different circumstances; for example, trading fees may differ between users, and Validators may have a more advantageous position than a ‘normal’ (i.e., non-validating) user in terms of speed of placing orders.  However, in all those cases, the basis for any differentiation is publicly and transparently disclosed and enforced autonomously and permissionlessly by the protocol (and not by any centralized actors), and any person can permissionlessly change their role or positioning in the ecosystem (e.g. by becoming a validator).   

ii. MEV

There have already been several initiatives in the dYdX Chain ecosystem directed at disincentivizing, monitoring, mitigating and/or penalizing MEV extraction on the network.  Some of these initiatives include (i) the launch of a community-funded social mitigation strategy for MEV and the creation of an MEV committee, (ii) the publication of several thought-leadership pieces and the open-sourcing of software comprising MEV-related protocol improvements by dYdX Trading (see examples here, here, here and here), and (iii) the creation of a public dashboard maintained by Skip facilitating the tracking of MEV extraction (‘orderbook discrepancy’) in the dYdX Chain. ‍

5. Criminal Activity

i. Ease of Auditability

All accounts, transactions, and states in the dYdX Chain can be audited by anyone, either in a fully permissionless manner through their own infrastructure or through publicly available blockchain explorers like Mintscan.

For the dYdX Chain in particular, there are also additional resources developed by independent ecosystem participants that seek to facilitate a deeper, more granular exploration of the network and any activity taking place on it, like, for instance, the dYdX Observatory. 

Going even another step further, anyone can permissionlessly operate their own indexer, if desired. 

ii. National Security

This is also a complex topic that likely merits its own post.  However, at a high level, the open-source software for the dYdX Chain is designed to incorporate tools to screen for and block sanctioned persons from accessing or interacting with the protocol.  For the dydx.trade front-end deployment in particular, please refer to the applicable Terms of Use for further context on this matter. 

iii. Incident Disclosures

The dYdX Chain is a relatively young protocol (mainnet was launched in October of last year) and relies on novel technological infrastructure, so the network may suffer incidents in the future – despite material efforts by different parties to prevent this.  If a major incident of a technical or other nature occurred in the dYdX Chain, any parties with knowledge of the root cause and details of the incident (including, notably, Validators) should promptly disclose the issue and any other useful information or context that they have relating to it, and collaborate in good faith to fix the incident and resolve the issue as swiftly as possible, minimizing damage to protocol users.   

Users may find the https://status.dydx.trade/ page useful in connection with incident disclosures and management in the dYdX Chain.  This page discloses any software incidents at a protocol, front-end, or indexer level; it provides transparent updates on the status of each incident through different stages, from ‘under investigation' to ‘resolved’.  It also gives regular updates on any expected or scheduled dYdX Chain maintenance.

iv. Incident Response

Should an incident occur on the network, we agree with Antonio’s views that core developers and ecosystem participants should be prepared to provide expertise and guidance to law enforcement and other interested parties, among other things.  ‍

6. Innovation

We generally agree with the views expressed by Antonio in this last section of the Principles post.  However, given that they are policymaking recommendations addressed to U.S. and other lawmakers and regulators, an analysis of the dYdX Chain from the perspective of the Principles cited in this last section of the post does not seem relevant. 

Conclusion

There are many perspectives from which one could look at a given DeFi protocol like the dYdX Chain and evaluate its features, strengths, and weaknesses. The DeFi Policy Principles outlined in Antonio’s post are just one of those frameworks.  However, we see it as a very valid framework, at least as a potential initial foundation for regulators, industry participants, and other stakeholders to base their initiatives on DeFi regulation.

In our view, and based on the information, facts and assumptions laid out in this post, the current mainnet deployment of the dYdX Chain can be said to be in a very good place from the perspective of most of the Principles.  The network, while being a young, novel, and disruptive protocol, including key technical innovations such as a fully decentralized off-chain orderbook, is very decentralized and preserves a great level of permissionlessness from almost any relevant perspective, while simultaneously providing a commendable degree of transparency through extensive public documentation and resources.