DYDX Valuation Report Unlocking Panic and Data Truth

Unlocking the Truth DYDX Valuation Report on Panic and Data

1. Introduction

In the previous report “dYdX v4: Improvements in the Economic Model and Valuation Outlook“, we mainly studied the updates of dYdX v4 version, discussed the version features of v4, marginal improvements compared to v3, and the reason why dYdX chose Cosmos instead of Ethereum, and concluded that the introduction of Layer 1 staking, fee distribution, and native stablecoin in Cosmos will collectively improve the fundamentals of DYDX token, bringing sustained positive impact to the token.

Since our last report, dYdX has made some exciting improvements and developments. The new version has recently launched on the mainnet and has received positive market feedback, with a strong price increase. However, it’s worth noting that in December, dYdX will face a large amount of initially allocated tokens being unlocked (15% of the total supply). In the face of potential selling pressure, how will the market react? Will token release cause inflation and dilute the empowerment of v4? Can the positive impact of the new version continue to drive DYDX token growth? Is this the last opportunity to get on board before December? To further explore the future prospects of dYdX and the expected value of the DYDX token, this article will take a data-driven approach and analyze from a valuation perspective. Using DCF and comparative analysis models to reasonably predict dYdX’s revenue and token price, and discussing the potential impact of this selling pressure on v4 staking rewards.

2. Introduction to dYdX

dYdX is a pioneer in decentralized perpetual contract exchanges, and its unique order book model brings a user experience comparable to centralized exchanges. Today, its market penetration rate has reached 60% of the total DEX volume. The new architecture and marginal innovations of v4 have given dYdX stronger competitiveness. On October 24, dYdX announced the release of dYdX Chain V1.0 and open-sourced its code, marking the official start of the exchange’s v4 upgrade and the transition from the Ethereum Layer 2 network to an independent blockchain in the Cosmos ecosystem. Open-source code is at the core of the blockchain spirit, bringing transparency to developers, enabling them to review, detect errors, and improve quality. According to dYdX Trading Inc., the initial developer behind the exchange, dYdX Chain V1.0 and its order book have been developed and passed the final audit. The v4 upgrade will make dYdX fully decentralized and community-operated, which means that the company will no longer control the dYdX protocol or charge transaction fees.

On October 27, dYdX Chain was officially launched on the mainnet. dYdX Chain, as an independent Cosmos Layer 1, was officially launched on the mainnet by dYdX Ops subDAO, and validators created the genesis block of dYdX Chain on October 27, 01:00 (UTC+8). The public frontend of dYdX Operations subDAO, used for bridging, will go live on October 30, 2023, pending official confirmation and testing. After the genesis block, there will be two phases: Alpha and Beta. The Alpha phase will start on October 30, 2023, with a focus on enhancing the stability and security of the network. The Beta phase will enable trading but without rewards, and the transition from Alpha to Beta will be determined by governance voting and other factors.

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This article will analyze the valuation of dYdX based on the token unlocking situation and v4 version features, building on the previous report.

3. Valuation Model
Our valuation is based on Discounted Cash Flow (DCF) analysis and comparable analysis. These two methods are detailed in our valuation model (DYDX Valuation Model) and can be adjusted according to future market conditions. Here are the details and explanations of the valuation methods.

DYDX Supply in Valuation
Although validators and stakers of the dYdX Chain receive all the protocol fees (meaning only staked DYDX tokens can earn cash flow from the protocol), freely circulating and unlocked DYDX tokens can be delegated to nodes to earn staking rewards. Therefore, in our valuation, we consider the total token circulation rather than excluding the tokens staked. The valuation is based on the snapshot taken on December 31, 2023, considering the circulating supply after the unlocking in December. The effective token base is 446 million.

Top-down Approach
This article adopts a top-down valuation approach. For each forecasted year, we estimate the DEX derivative trading volume based on the total derivative trading volume of that year multiplied by the DEX penetration rate. Then, we calculate the dYdX trading volume for that year based on dYdX’s market share. Finally, we estimate the protocol revenue for that year based on the effective fee rate.

3.1 Discounted Cash Flow (DCF) Analysis
dYdX generates cash flow by charging users fees. Before v4, the protocol was managed by dYdX Trading Inc., and all the cash flow belonged to the company. With the improvements in v4, dYdX is now controlled by dYdX Operations subDAO, implementing fully decentralized management. According to dYdX’s official announcement, all the protocol fees, including transaction fees denominated in USDC and gas fees denominated in DYDX, will be distributed to validators and stakers. Therefore, DYDX token holders can capture 100% of the cash flow from the protocol’s development.

Based on these conditions, we believe the discounted cash flow (DCF) method is most suitable for valuing the DYDX token price. DCF is an absolute valuation method used to estimate the value of an asset based on its expected future cash flows. The principle is that a company’s value is calculated based on its future cash flows, which are discounted using a rate that reflects its risk. Our model uses data up until September 30, 2023, as the basis, with a 5-year forecast period, and represents the long-term future cash flow of the protocol using a terminal value. We estimate the value of DYDX tokens on December 31, 2023.

3.1.1 Assumption

Transaction Fees: Compared to various perpetual contract protocols, dYdX has lower transaction fees and has certain advantages. Version 4 splits the fees into 9 tiers and provides different trading rewards based on volume. By dividing the annual fee revenue by the trading volume in 2022, we calculate the average fee rate of 0.025% as the protocol’s fee rate. As market competition intensifies, exchange overall fee rates decrease, and ultimately dYdX’s effective fee rate linearly decreases to 0.015% (shared by both buyers and sellers), approaching the discounted fee rate level of Binance VIP 9, a leading centralized exchange with a monthly trading volume of $2.5 billion.

Discount Rate: Based on our evaluation of the protocol’s development and market risks, we set the discounted cash flow rate from 2023 to 2028 at 29%. For the discount rate calculation, we use a 10-year U.S. Treasury bond as the risk-free rate and BTC as the market benchmark. The beta value is derived from a regression model of DYDX returns as a function of BTC returns. Regression analysis is based on one year of data, selecting the start time that aligns with the current market price, covering the period from August 1, 2022, to September 30, 2023. The Capital Asset Pricing Model (CAPM) calculates the cost of capital at 29.10%. Regression analysis shows a significant positive correlation between DYDX price and BTC returns. Therefore, we choose 29% as the discount rate, which is similar to the average return rate of venture capital funds and is considered reasonable.

Terminal P/E Ratio: DeFi belongs to the light asset industry, so we use the exit multiple method to calculate the terminal value. Referring to the P/E ratio of publicly listed traditional exchanges, we choose a multiple of 10 as the final exit multiple for DYDX.

Projected Trading Volume: Trading volume directly relates to the protocol’s revenue and is a core driver of DEX value. To predict DYDX’s potential value range under different market conditions, this report assumes three different scenarios of trading volume growth.

Each forecast period starts with the annualized derivative total trading volume since September 30, 2023, and applies the annual growth rate. Based on industry development patterns, we assume that in the forecast period (2023 to 2028), there is rapid annual growth in derivatives trading volume from 2024 to 2025, followed by a gradual slowdown each year and negative growth in the terminal period. The reason for this assumption is the anticipation of a bull market in the crypto world in the next two years, considering the upcoming Bitcoin halving and expectations of Federal Reserve interest rate cuts. Therefore, we have higher growth expectations for 2024 and 2025.

In order to obtain the trading volume of dYdX, we set based on historical data that the protocol has a constant market share of 40%-60% in the total trading volume of derivative DEX (subject to variations depending on different market conditions). The expected trading volume for dYdX in each scenario is as follows:

• Baseline scenario: The trading volume of derivatives is expected to grow at a rate of 80% by 2024, gradually decreasing to -5% by 2028. With the booming development of DeFi or the adoption of DEX, the total trading volume for dYdX in 2028 is estimated to be 2.93 trillion USD.

• Bear market scenario: The trading volume of derivatives is expected to grow at a rate of 50% by 2024, gradually decreasing to -5% by 2028. With the slowing growth of cryptocurrencies due to regulatory sanctions or the overall decline in DEX usage, users are more inclined towards CEX. The total trading volume for dYdX in 2028 is estimated to be 0.91 trillion USD.

• Bull market scenario: The trading volume of derivatives is expected to grow at a rate of 100% by 2024, gradually decreasing to -10% by 2028. With the successful implementation of the dYdX chain and the v4 version, the cryptocurrency industry receives significant regulatory benefits. The total trading volume for dYdX in 2028 is estimated to be 6.75 trillion USD.

In the past 9 months, the total trading volume of the top 20 derivative DEXs has reached approximately 0.49 trillion USD, with dYdX holding a share of 0.26 trillion USD. The total trading volume of the top 10 centralized exchanges for derivatives is 20.49 trillion USD. At the time of writing this article, DEX accounts for approximately 2%-3% of the total trading volume in comparison to CEX.

Multiplying the expected trading volume by the fee rate, we obtain the following expected revenue:

3.1.2 DCF Analysis

It should be noted that the present value of tokens in this article is based on the token circulating supply as of December 31st and does not take into account the incremental unlock of tokens in the subsequent years. However, considering a relatively aggressive discount rate of 29%, the dilution risk of dYdX in the current situation can be partially offset.

The DCF results for the three scenarios are as follows:

Baseline scenario: In this scenario, the estimated price for DYDX tokens is $4.86, and the protocol valuation on December 31, 2023 is $2.17 billion.

Bear market scenario: In a bear market, the expected price for DYDX tokens is $1.62, and the protocol valuation on December 31, 2023 is $724 million.

Bull Market Overview: During a bull market, the estimated price of DYDX token is expected to be $10.56 and the protocol valuation on December 31, 2023, is estimated to be $4.717 billion.

3.1.3 Probability-Weighted Scenario Analysis

We allocate a 25% probability to both bull and bear markets, and a 50% probability to the base scenario. After calculation, the probability-weighted DCF valuation of DYDX price is $5.48 and the protocol valuation is $2.445 billion. The DYDX price on September 30, 2023, is $1.96, indicating a potential upside of 179.34%.

3.2 Comparable Analysis

Comparable analysis is a method used to evaluate the value of a company or project relative to its peers. The fundamental assumption is that blockchain projects with similar scale and nature should have closer valuation multiples. Comparable analysis typically uses price-to-sales (P/S) and price-to-earnings (P/E) ratios to compare the valuation of the subject being evaluated.

When conducting a comparable analysis, it is crucial to select reference objects that are as similar as possible to the analyzed company or project in terms of industry, business model, risk profile, and market dynamics. By ensuring comparability in these aspects, external factors’ influence on the analysis can be reduced, allowing us to focus more on the intrinsic value factors of the analyzed enterprise or project. The four comparable projects we selected all belong to the decentralized derivative contract trading industry, including Synthetix, GMX, Gains Network, and Perpetual Protocol. They have similar business characteristics and risk profiles, and all four projects have been listed and traded on the leading blockchain exchange Binance, conforming to market standards, which will enhance the effectiveness of the comparative analysis. Lastly, by using DEX derivative projects within the same decentralized finance market as comparable objects, the analysis differences between different industries’ market risks can be resolved.

2023 Cumulative Revenue for 5 Protocols, Source: Token Terminal

The above is a comparison chart of the annual cumulative revenue of these five projects as of October 27, 2023. From the chart, it can be seen that GMX has the highest project revenue, being the only one among the five projects to exceed $100 million. DYDX has the second-highest revenue, reaching $65.40 million, while Perpetual Protocol has the lowest revenue at $63.00 million.

Below is a summary of the comparable projects:

1. dYdX: Since its launch in 2021, the DYDX token has faced challenges of scarce supply and lack of utility. Although it has a market share of over 50% in the DEX perpetual contract market, its token circulation ratio is much lower than that of peer projects. Before version 4, the main use of the DYDX token was for governance and staking to obtain fee discounts, but the new version plans to introduce more utilities, such as allocating all fees generated by dYdX Chain to validators and token stakers in the future. Of course, investors may still be concerned about the impact of future large-scale token unlocks.
2. GMX: GMX is a DEX platform that supports spot and perpetual contract trading, focusing on derivative trading. Unlike other comparable projects, GMX adopts a global liquidity mining model where users provide liquidity by purchasing and staking the liquidity tokens, GLP, issued by the GMX protocol. Holders of $GMX can stake their tokens and earn 30% of the protocol fees generated by GMX. GMX stakers can also receive $esGMX and multiplier points (MP) to further increase their earnings. Holding $GMX also grants participation in GMX protocol governance, giving them a voice in the community fund.
3. SNX (Synthetix): Synthetix’s perpetual contract products are not targeted at end-users but are provided in the form of backend products to support developers and DeFi derivative liquidity platforms. Users can interact with DeFi products that have integrated Synthetix Perps contract functionality without needing to directly use or interact with the Synthetix Perps contract itself. Currently, the trading volume of Synthetix Perps perpetual contracts is mainly generated by the spot and derivative trading platform Kwenta, which is essentially a decentralized contract product targeting trading users built on Synthetix Perps components. The circulating supply and total supply of SNX tokens are nearly equal. SNX still utilizes a weekly inflation mechanism as a reward for SNX stakers. Stakers have different SNX reward pools on Optimism and Ethereum with varying staking annual returns. SNX currently has the lowest inflation, which varies based on the collateralization ratio. However, SNX inflation rewards are subject to a one-year lock-up period, further reducing the impact on token supply. The utility of SNX tokens may change in the future though.
4. Gains Network: Gains Network revolves around the ERC20 utility token ($GNS) of its ecosystem. The purpose of $GNS is to serve as the utility token of the platform, granting ownership of the protocol through revenue generation and platform governance (to be launched). It includes earning platform fees through single-sided staking by $GNS holders and burning $GNS using platform revenue. The leverage limit within Gains Network platform is 9x, with a lower maximum opening interest rate, which may not be the ultimate choice for all traders, but it has established a solid position among novice traders. Currently, 61.23% of GNS revenue is allocated to $GNS stakers.
5. Perpetual Protocol: Perpetual Protocol is a decentralized perpetual contract trading protocol built on Ethereum. The protocol utilizes a virtual Automated Market Maker (vAMM) design that supports up to 20x leverage, allows short positions, and has lower slippage compared to other AMMs. Unlike automated market makers used for token swaps and price discovery, vAMM is only used for price discovery to handle leverage and short positions. Similar to Uniswap, traders can interact with vAMM without the need for centralized management, and its design is market-neutral and fully collateralized. PERP is the ERC-20 native token of the protocol, and Perpetual Protocol allows community members to participate in protocol governance and stake their tokens in a dedicated staking pool for a specific period. Holders receive staking incentives, including PERP rewards and trading fees.

3.2.1 Variable Consideration

Price/Earnings Ratio: The price/earnings ratio is a financial indicator used to measure the relationship between the current token price and earnings per share of a blockchain project. This ratio is commonly used to evaluate the investment value and risk level of a project. The P/E ratio may vary significantly among different industries and project types, so it is usually compared with the average of other blockchain projects or the market.

Price/Sales Ratio: The price/sales ratio is commonly used to evaluate the valuation of traditional companies based on their revenue. For DEX projects, the protocol fees (referred to as “sales revenue” in traditional companies) are a key factor in evaluating their financial performance and sustainability. By considering the relationship between market value (price) and fees generated by the protocol, the market’s assessment of the protocol’s revenue-generating ability can be understood.

Average P/S ratio: We use the commonly used market multiple approach in the crypto industry, taking the average of the price/sales ratios of five comparable projects as the market multiple. By calculating the average, we essentially consider the upper and lower bounds of comparable projects, providing a balanced estimate of the market multiple. Therefore, we choose to use the average of comparable projects as the quantitative market multiple to avoid potential biases that may arise from relying solely on the maximum or minimum value.

Median: From a statistical perspective, the median is not affected by extreme values in the distribution sequence, which improves its representativeness of the distribution sequence to some extent. Therefore, we choose the median as a reference factor for the market multiple.

Annualized Total Revenue: Evaluating the revenue generated by a blockchain project helps assess its ability to generate income and sustain operations. Revenue is a key indicator of a project’s financial health and growth potential. Assessing the revenue from protocol fees helps understand the income streams directly related to DEX trading activities and the profitability of the DEX protocol. Protocol revenue can come from various sources within the DEX protocol, including transaction fees, margin fees, liquidation fees, and funding fees. By considering protocol fee revenue as a variable, analysts can assess the diversification of income streams. This helps evaluate the protocol’s ability to withstand market fluctuations and its long-term survival.

Profit (Annualized Revenue to DYDX Holders): In the traditional stock market, the “earnings” in the P/E ratio refers to the net profit earned by a company during a specific period (usually quarterly or annually). This is an important financial indicator that investors focus on to measure a company’s profitability and financial health. However, in the blockchain space, the concept of “earnings” may not be as applicable. This is because DeFi projects do not generate profits in the traditional way and typically do not have net profits or earnings per share like traditional companies. Instead, their economic models may involve net income converted to projects or token holders, such as token transaction fees, liquidity mining rewards, and lending interest.

3.2.2 Comparable Analysis Valuation

The graph above shows the project valuation and token price based on the Price/Earnings Ratio and Price/Sales Ratio. We estimated the project’s annual revenue and net income using data from January to September 2023. dYdX’s estimated annual total revenue is $85.81 million, indicating good revenue-generating capability. Additionally, dYdX’s Price/Earnings Ratio is lower compared to the average ratio of selected decentralized derivatives protocols, suggesting undervalued potential. Lastly, based on the Price/Earnings Ratio, dYdX’s potential price is projected to be between $1.26 and $2.34.

3.3 Comprehensive Analysis

Finally, we conducted sensitivity analysis on the key variables of the DCF model and obtained the final valuation range.

Furthermore, we selected the maximum and minimum values of probability-weighted DCF valuation under different scenarios of terminal Price/Earnings Ratio and discount rate from the sensitivity analysis. Due to differences in Value Capture and tokenomics among the five comparable projects, we assigned a higher weight (40%) to the P/E valuation to improve the model’s accuracy. The P/S valuation also provides some reference, so it is given a weight of 10%. Therefore, the total weight of the comparable analysis is 50%. The remaining 50% is assigned to the weighted DCF valuation. Finally, the comprehensive analysis yields a range of $2.99-$4.12 for DYDX token price and a range of $2.993-$4.118 billion for fully diluted valuation (FDV).

Since the DCF valuation is higher, it overall increases the comprehensive valuation. The major highlight of v4’s impact on the economic model is that transaction fees are now collected 100% by staking nodes instead of the dYdX company in v3. The cash flow captured by the token has significant growth potential and should be valued with higher multiples to reflect its growth potential. Therefore, using the average P/E and P/S valuation methods of comparable protocols may result in some undervaluation.

It is important to note that the establishment and derivation of the valuation model and token price are based on the current provided data and market operations. The actual market dynamics and the operational performance of the dYdX project in the future will ultimately determine its true market value.

4. Unlocking Discussion

4.1 Valuation Premium

In dYdX’s valuation analysis, there is a clear valuation premium, mainly due to limited liquidity supply caused by staking. DYDX, as the L1 token of the dYdX chain, is used for fee payment and validator staking to ensure on-chain security. Currently, the average staking rate of the entire Proof of Stake (PoS) network is 52.4%. Referring to existing PoS public chains such as BSC and Solana, the long-term staking rates range from 40% to 70%. It is highly likely that the staking rate of the dYdX chain will exceed 40%. This will significantly reduce the circulation of DYDX tokens, and assuming token demand remains the same, the token price will increase significantly.

4.2 Staking Yield Calculation

In December this year, dYdX will unlock nearly 150 million tokens (15% of the total supply), increasing the token circulation from the original 296 million to 446 million. Concerns might arise in the market regarding whether these tokens will cause significant short-term inflation and dilute the positive effects brought by v4.

However, we believe that the token unlock in December should not cause concern in the market. This is because the large amount of unlocked tokens will not result in a substantial increase in token circulation. We can observe that the unlocked tokens this time are distributed to the team and investors’ initial shares, and they are likely to stake the majority of these tokens. Generally, in the early stages of PoS public chain development, users have a lower staking rate due to risk considerations, resulting in higher annualized returns. As the public chain evolves, the staking rate gradually increases. Currently, the average staking level on the market for Proof of Stake (PoS) networks is about 52.8%, with an on-chain yield of 10.2%. Based on this, we estimate the staking situation and APR of the dYdX chain (as shown in the graph). According to our valuation model, dYdX’s revenue in 2023 is projected to be 85 million. Assuming the team and investors stake 80% and 50% of the unlocked tokens, respectively, we can calculate an annualized staking yield of 20.27% with a staking rate of 41.2% (based on the circulating supply). The staking rate on the dYdX chain will gradually increase every year and eventually stabilize at around 46.68%. If the price meets the valuation benchmark, the annualized yield will rise to 44.5% after 5 years, indicating a high return rate. Therefore, the token still has significant upside potential in the future. In summary, we believe that there is a high probability that the team and investors will stake the tokens, and the dilution risk brought by the token unlock at the end of the year is relatively small.

5. Summary

1. This article uses a top-down valuation method, using discounted cash flow analysis (DCF) to reasonably estimate the protocol value and token price of dYdX. Through probability weighting, the protocol’s valuation is $2.445 billion, with an expected price of $5.48 for $DYDX, and a potential upside of 2-3 times. Finally, combining P/E and P/S valuation methods, a comprehensive analysis reveals that DYDX’s token price range at the end of 2023 is $2.99-4.12, which still has some potential for growth compared to the current market price of DYDX tokens.

2. Facing the potential dilution risk brought by the December unlocking of tokens, we believe that due to the strong chain staking incentives provided by dYdX, with an annualized return rate exceeding 20%, the unlocked tokens will likely be staked and will not create significant selling pressure on the market.

References

1. https://docs.dydx.community/dydx-governance/

2. https://dydx.exchange/blog/v4-rewards-and-parameters

3. https://dydx.forum/t/dydx-v3-vs-v4-new-trader-rewards-overview/881

4. https://www.washingtoncomLianGuainysearch.com/comLianGuainies/dydx-trading-inc/

5. https://help.dydx.exchange/en/articles/4798063-location-restrictions

6. https://www.binance.com/en-JP/feed/post/818240

7. https://dune.com/dydxanalytics/dydx-unified-dashboard

8. https://dune.com/impossiblefinance/derivatives-perpetual-markets

9. https://members.delphidigital.io/reports/dydx-valuation-analysis-dex-perps-comLianGuairison#synthetix-f08e

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