As bitcoin hovers near its all-time high, a growing number of cryptocurrency companies are proving they can take a tiny set of resources and turn them into highly profitable enterprises very quickly.
Dydx, a four-year-old San Francisco startup that lets traders outside the U.S. buy and sell cryptocurrency-based financial products, recently processed more transaction volume than Coinbase, the most valuable crypto company in America. On September 27 and 28, Dydx recorded $18.6 billion in transactions, compared with $5.9 billion for Coinbase, according to CoinGecko. That has helped Dydx pull in $75 million in revenue so far in 2021. It expects to hit $125 million before year’s end, with $81 million in net profit, says 28-year-old founder and CEO Antonio Juliano. That would equate to a sky-high net profit margin of 65%.
Juliano grew up in Pittsburgh and went to Princeton to study computer science. Like crypto billionaire Sam Bankman-Fried, he didn’t have a burning interest in crypto before he entered the industry. He just knew he wanted to join a tech startup and later become an entrepreneur. In 2014, venture capitalist Fred Wilson visited one of Juliano’s entrepreneurship classes at Princeton and spoke about Coinbase, giving Juliano an idea for where to work after college. He graduated in 2015 and joined Coinbase as a software engineer, becoming its 100th employee. He stayed for a year, did a short stint at Uber and then started a search engine for cryptocurrency applications, which failed because his timing was too early, Juliano says.
He decided he wanted to build something on top of Ethereum, the popular cryptocurrency software that acts like a decentralized computer with applications running on top. After studying financial markets and watching Coinbase’s growth, he got the idea for Dydx. “The way most financial markets evolve is, first of all, an asset is created, then it’s traded on spot exchanges,” he says, referring to exchanges that let you directly own an asset—like Coinbase does for bitcoin.
“Then assets are traded on margin exchanges. And then, eventually, people make derivative products on top of an asset that people want to trade. So it seemed like a pretty logical next thing to build,” he says.
In late 2017, at the peak of the initial coin offering boom in crypto, he landed $2 million in seed funding from Andreessen Horowitz, Polychain Capital and Coinbase cofounders Brian Armstrong and Fred Ehrsam, among other backers. Dydx launched in 2018 and let users buy ether “on margin,” meaning they could borrow money through the Dydx platform to buy crypto, a strategy traders use to get additional leverage and maximize their profits (potential losses are magnified, too).
By 2019, Dydx was processing about $1 million a day in transactions. The next year, it pivoted to focus on “perpetual swaps,” a derivative popularized by Hong Kong crypto exchange Bitmex. Perpetuals track the price of bitcoin, but they don’t require you to own actual bitcoin. Unlike futures, the financial derivatives that have been widely used for over a century, perpetuals don’t have an expiration date. After launching them in 2020, Dydx soon grew to trade between $10 million and $30 million a day.
Two big changes brought on Dydx’s volume spike this year, according to Juliano. In April, Dydx implemented a blockchain technology called StarkWare, which dramatically speeds up cryptocurrency transactions made through Ethereum. Before this change, people trading on Ethereum-based, decentralized exchanges often had to wait 60 seconds for trades to finalize, and they had to pay Ethereum “gas” transaction fees of $50 to $100. With StarkWare, the gas fees are much lower, and Dydx pays them. “Now you make a trade, and it instantly updates like a normal website would,” Juliano says. “That’s pretty different from what most people are used to in decentralized finance.”
The second big change was that Dydx partnered with a Switzerland-based foundation to launch a Dydx cryptocurrency token, and then aggressively pursued a marketing tactic called “liquidity mining.” That’s a fancy term for offering monetary rewards for people to trade on an exchange. Dydx can offer the self-minted currency as the reward, creating a low-cost way to fund incentives. “Tokens can really throw fuel on the fire for growth with a product that already has product-market fit,” says Juliano.
The effects of these changes have been staggering. Dydx’s daily volume jumped from about $30 million in July to $450 million in August, then to $2 billion over the past month. (The spike at the end of September arose because trading awards get distributed at the end of the month, and people feel more urgency to trade when the deadline approaches.) Dydx has just 6,000 active customers who each trade hundreds of thousands of dollars a day in crypto on average.
One downside of offering the “liquidity mining” incentives to traders: It can attract “wash trading,” when a single person creates two accounts and trades with himself to collect the rewards. One day in August, Dydx noted that $1.7 billion of the cryptocurrency token compound was traded on its platform. That was about ten times more than the amount of compound that changed hands on all other crypto exchanges combined. Dydx investigated, concluded it was wash trading and didn’t pay trading rewards to the offending users.
“That prompted us to take a really active stance against wash trading,” says Juliano. “We have active monitoring programs that use both common sense and technical analytics to try to identify wash trading.” He thinks between 1% and 5% of Dydx’s volume in August was wash trading. In September, he says it dropped to 0.1% due to the new monitoring measures.
Most of Dydx’s users are in Asia and Europe—due to tighter regulatory restrictions in the U.S., Dydx blocks all U.S. residents from using its platform—and in September, China’s central bank announced that all crypto-to-crypto transactions were illegal. China has a long history of cracking down on crypto, and residents have largely found ways around the government bans. But if China finds a way to block or dampen crypto derivatives trading in the country, it would undoubtedly have a negative impact on Juliano’s business. “Dydx isn’t based in China and doesn’t market to Chinese users, so we aren’t a good source for comments on China regulation,” Juliano says.
Unlike Coinbase and other brokerages, Dydx doesn’t let people store money on its exchange, and it doesn’t have any regulatory licenses. It doesn’t perform the “know your customer” checks required of regulated financial institutions, although it uses a third-party service to help monitor users’ digital wallets for illicit funds. This bare-bones approach to regulation keeps compliance costs low and profit margins high. Juliano thinks it won’t get him into hot water with U.S. regulators. “Dydx has been in contact with the CFTC and other government regulators for a long time now,” he says. “I think we first met with them about three and a half years ago, and we’ve submitted multiple comment letters to them.” He adds, “It really comes down to the fact that we just don’t support U.S. customers.”
Dydx last raised venture capital funding in June at a $215 million valuation, according to PitchBook. It was then processing about $25 million a day, or about 1% of what it transacts today. If it raised money again, that valuation would rise steeply, but Juliano doesn’t plan to raise more venture funding since the company is so profitable. He says he’ll continue to keep head count low, likely not exceeding 50 people over the next year. “A small team with the highest quality people can out-iterate and out-ship larger teams, especially in such a new market.”
Even with a small staff, over the next three to five years, “Our highest-level goal is to become one of the biggest exchanges in crypto, period,” he says. To hit that goal, he’ll have to outpace not only Coinbase, but also FTX, which processes about $15 billion a day, and Binance, which does a whopping $90 billion.