Here’s an often overlooked statistic, according to dYdX founder Antonio Julio: Derivatives currently make up about 75% of all trading volume in the crypto market.
Deriving value from an underlying asset – rather than trading the asset itself on the spot market – allows for a wider variety of financial mechanisms, such as leveraged trading and futures. It also happens to place much higher technical demands on platforms that strive to deliver the service at the high volume and speed that customers demand.
But high volume and high speed are two desirable characteristics that rarely overlap in the same Venn diagram as blockchain technology.
On the Lightspeed podcast (Spotify/Apple), Julio explains how dYdX, the perpetual contract market, is trying to meet performance requirements by building its own custom blockchain based on Cosmos SDK technology. “It’s tailor-made for derivatives trading, tailor-made for what we do and we’re very excited about it,” he says.
Julio notes that the transition to Cosmos will take place this month, after which the platform will be “completely decentralized.”
“Right now, dYdX is hybrid-decentralized,” he says. “It’s completely non-custodial. It is completely transparent about what happens in the chain. But the most important thing that is not decentralized at the moment is the order book and the matching engine.”
Most decentralized exchanges, such as Uniswap and Curve, are automated market makers, or AMMs, Julio says. It is much easier, he continues, to operate an AMM than an order book, which requires “much more performance in terms of transactions per second, low gas rates, and so on.”
Read more: Behind the times: How LVR is a ‘fair game’ for DeFi liquidity providers
The reason order books require such high volume and speed is that thousands of programmatically placed orders can occur every second, whether they are filled or not. “No blockchain can support that,” Julio emphasizes. “StarkWare and the rest of the [layer-2s] I can’t get close to the amount of performance it takes.”
“Possibly that will change in the long term,” Julio adds, “and we’re still excited to see that happen, hopefully, but that’s not the case right now.”
Decentralization of the order book
DYdX aims to solve the speed barrier by allowing buying and selling offers to take place outside the chain. All settlements where transactions are completed are done on-chain, Julio adds, “or at least through the StarkWare combination we use.”
“The most important thing we decentralize is the order book and the matching engine,” continues Julio. “And that is actually quite a difficult problem, because these systems require a very high throughput.”
“We looked around and asked ourselves: OK, what blockchain can support on the order of well over a thousand transactions per second, ideally with very low or no gas costs.”
“The answer we came back with was neither.”
The result was building a “decentralized, but off-chain order book and matching system,” says Julio. Based on the concept of the Ethereum mempool, where transactions wait to be mined, Julio says, “What if we didn’t have to put the entire order book on-chain?”
“The validators can keep the entire status of the order book in their respective memories,” he says, promoting decentralization. “But you don’t actually have to add anything to the consensus state of the chain until a transaction occurs.”
It is a unique feature of the system, says Julio. “Only about one percent of orders placed on an order book-based exchange are filled,” so the system requires “100x the scalability for placing and canceling orders.” The small percentage of transactions that actually take place are handled on-chain, he says.
“It made this Cosmos chain that we’re building very natural,” he says, “just because you can do really custom things if you own the whole stack.”