Article by DragonStake, validator of dYdXDx https://www.mintscan.io/dydx/validators/dydxvaloper1he9yn4jhuq50vtf95ncv9rvplnqug8w9yw8dwc

In this article, we will analyze the impact that incorporating ETH as collateral would have on dYdX . We believe that adding this capability to the project could potentially increase the volume of assets deposited in the protocol by at least fivefold, in addition to improving other metrics.

Derivative protocols typically exhibit a higher number of long positions compared to short positions. There are multiple explanations for this phenomenon. The first is more behavioral, as we naturally tend to invest in assets, and derivatives are often used to gain greater exposure to these investments. Short positions are more complex investment strategies that usually require a high level of financial knowledge, in addition to identifying overvalued assets that may offer opportunities to make money when prices return to rational valuations.

This imbalance between both positions usually forces the offering of high interest rates as an additional incentive for those investors willing to take short positions. This ultimately results in these types of positions being handled by market professionals or market makers who are even capable of minimizing the risks associated with such positions.

Another important reason is that these types of positions, when taken in isolation (i.e., without another position to offset them), present asymmetric returns that result in limited gains and total losses. In other words, in these positions, our loss can be total, and unlike long positions, our gains are limited. It is true that, being leveraged positions, we can maximize profitability, but not without assuming truly excessive risks. This ultimately leads these protocols to offer high funding rates to attract investors willing to take on such risks. In Etherum around 17%

This is also a problem for investors in long positions because these high funding rates make these operations costly in terms of fees, which increase over time. Therefore, it really discourages taking long positions for extended periods and encourages using these products for shorter-term operations.

However, this problem could be mitigated if the protocol incorporated ETH as collateral. If this collateral could be used for open positions in ETH, we could then have short positions without the risk of liquidation and where the profitability would be the funding rates. At interest rates of 15%, we would see a significant amount of capital flowing into the protocol to provide capital, which would likely bring these interest rates down to levels similar to those found in other protocols where ETH is remunerated.

This value capture that dYdX could be achieving is what Ethena, a protocol that implements these strategies with centralized protocol brokers, has capitalized on. This has allowed Ethena to attract more than $3.5 billion, which is certainly much higher than the capital dYdX currently holds. By capturing just 20% of this demand, the protocol could multiply its deposited capital by five.

Not only would this be an advantage, but it would also allow for much more competitive funding rates for long investors and could enable longer-term operations, which should increase the Open Interest. All of this would result in greater liquidity for operations and also less slippage.

Introducing collateral is not without risks, particularly regarding how to offset losses and gains in USDC, but it would likely represent one of the greatest possible growth levers. Additionally, it could pave the way for introducing more collaterals, which would be especially relevant for more volatile assets where short positions are even more complex.

This is the reason that drives us to propose this development within the protocol, which we believe can have a critical impact on its growth and allow for greater profitability for platform users by providing a counterparty to long positions.