Chorus One is proud to introduce our new research effort, fueled by a grant from dYdX, that examines the implications of Maximum Extractable Value (MEV) within the context of dYdX v4 from a validator's perspective. This comprehensive analysis presents the first-ever exploration of mitigating negative MEV externalities in a fully decentralized, validator-driven order book. Additionally, it delves into the uncharted territory of cross-domain arbitrage involving a fully decentralized in-validator order book and other venues.
This paper, marking a significant milestone in exploring MEV dynamics, identifies factors that influence undesirable MEV extraction, and proposes concrete strategies to level the playing field in derivative trading by counteracting such behavior.
Introduction to dYdX v4
dYdX v4 signifies a transformative phase in the evolution of the dYdX protocol. It embraces a fully decentralized derivatives exchange built on a central limit order book (CLOB). Unlike previous iterations, which combined smart contracts with centralized services, v4 employs a decentralized off-chain order book and a high-performance matching engine. This architecture, powered by the CometBFT consensus and Cosmos SDK, strives to achieve scalability alongside decentralization while allowing community-driven protocol development.
This transition signifies a substantial shift, as v4 introduces the industry's first truly decentralized perpetual futures exchange. Validators will manage the order books, with meticulous steps taken to ensure fair and trustless trading through effective negative MEV mitigation.
Set against the backdrop of this pivotal upgrade, our paper serves a crucial purpose by shedding light on the complexities of mitigating bad MEV on dYdX v4, thus equipping the community with the resources needed to navigate the upcoming transition. By providing comprehensive insights, our analysis aids in anticipating the impact of MEV on the new chain and trading experience, as well as the wider Cosmos ecosystem, ultimately fostering informed decision-making.
Our analysis uncovers pivotal insights that reverberate across the ecosystem:
- Objective MEV Measurement: We emphasize the critical importance of objectively quantifying MEV on dYdX v4 for effective mitigation. We analyze the difficulties in defining an estimator that captures order book divergences from the validator's standpoint. Despite potential limitations, we propose a statistics-driven approach to address inaccuracies.
- Cross-Chain MEV Potential: Exploring the realm of cross-chain MEV within the Cosmos ecosystem, we highlight that current opportunities for cross-chain value extraction lack the compelling incentive required to drive validators towards optimizing for MEV extraction. We identify a highly optimistic scenario that hinges on substantial trade volume as a potential motivation.
- Cross-Venue MEV Opportunities: Our study underscores the allure of cross-venue MEV opportunities on dYdX v4. We argue in favor of Central Limit Order Book (CLOB) platforms like dYdX, which offer superior liquidity utilization compared to Automated Market Makers (AMMs). This dynamic incentivizes market makers to collaborate with validators, potentially leading to order book manipulation and centralization risks. Furthermore, this scenario highlights the advantageous position of actors already possessing competitive advantages on other CLOB platforms, enabling them to effectively harness MEV opportunities on dYdX v4.
- User Welfare and Centralization Risks: Our analysis delves into the potential impact of cross-venue MEV on user welfare. We explore how structural aspects of CLOBs could consolidate market makers and incentivize partnerships with large firms. This dynamic could result in centralization of validator sets, posing a risk of chain failure and additional costs for users. However, we define the condition for a scenario where ethical actions result in optimal outcomes for users, the blockchain, validators, and market makers.
Finally, our research extends beyond insights to practical solutions for mitigating validator-driven MEV risks. We propose that such MEV might manifest through partnerships between trading firms and market makers, favoring those with established advantages. We underscore the risks associated with harmful MEV, including asymmetric risk for delegators. Even in optimistic scenarios, potential revenue from partnerships may not fully offset these risks. To address this, we suggest a combination of measures including potential penalties and flexible unbonding periods for re-delegation to ethical actors, aiming to effectively manage validator-driven MEV risks.
Chorus One's MEV Strategies
At Chorus One, we leverage a sophisticated and ethical set of MEV strategies to optimize our validators' performance and continuously monitor progress. Backed by in-house experts and extensive research, we deploy various infrastructural solutions such as relay optimization, latency games, and investing in robust machines to improve our MEV performance. Learn more about Chorus One's winning MEV strategies by reading our recent blog.
For a comprehensive exploration of our research on MEV implications within dYdX v4, we invite you to read the full research paper here.
About Chorus One
Chorus One is one of the biggest institutional staking providers globally operating infrastructure for 40+ Proof-of-Stake networks including Ethereum, Cosmos, Solana, Avalanche, and Near amongst others. Since 2018, we have been at the forefront of the PoS industry and now offer easy enterprise-grade staking solutions, industry-leading research, and