dYdX’s “liveness check” debacle underscores the lack of decentralized identity solutions

Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policies before making any financial decisions.

dYdX, a popular decentralized exchange, recently asked new users to complete a “liveness check” as part of a marketing campaign offering a $25 bonus for depositing $500 or more. Because the “liveness check” involved revealing one’s identity via a webcam, the DeFi community (based on decentralization) did not go down well. dYdX promptly ended the campaign, citing “overwhelming demand”.

Why did dYdX ask new users for a “liveness” check?

dYdX recently launched a promotional campaign to onboard new users via referral links. If new users then deposit at least $500 (as USDC stablecoin) into the DEX, the integrated users will receive $25 (USDC) as a reward. So far it seems to have been a standard tariff marketing campaign.

The most unusual part came with the condition “Liveness Check”. Similar to a know-your-customer (KYC) process, dYdX required users to scan themselves via webcam so that their biometrics could be linked to their Ethereum wallet address used to access dYdX .

Apparently dYdX provided a solid justification for the “liveness check”. Because creating new Ethereum wallet addresses is a trivial matter, as is creating new dYdX accounts.

“Validation of individual users to prevent fraudulent collection of reward fees does not constitute a change in dYdX’s ideological beliefs regarding accessibility, transparency, mutability, or censorship.”

dYdX tweet

Obviously such a system could be abused. However, why couldn’t dYdX drop its DYDX governance tokens out of the air? This had happened in the past with the largest decentralized exchange, Uniswap.

In September 2020, Uniswap retroactively dropped 150 million UNI tokens at 400 UNI per address to Ethereum addresses connected to the platform at any point in time. The goal of this particular campaign was to keep customers amidst the competing SushiSwap hard fork.

Moral Hazards: CEX vs. DEX

A KYC protocol has become a standard procedure for opening accounts on almost all centralized exchanges such as B. Binance, Coinbase, Kraken, etc. The problem is that dYdX bills itself as a “leading decentralized exchange”, emphasis on decentralized. It is a long-established practice that decentralized exchanges do not require KYC.

Finally, automated financial services are decentralized without intermediaries. Users rely on the absence of any mediation for a very important reason, to avoid moral hazard. For example, the Celsius Network, a centralized lending platform, went bankrupt in large part due to reckless dealings by Celsius CEO Alex Mashinsky.

On a DEX based on voting governance, such moral hazard will either be reduced or completely neutralized depending on the degree of decentralization.

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dYdX onboarding campaign ends abruptly

Coincidentally or not, after much user backlash for implementing “Liveness Check”, dYdX decided to abruptly end the promo campaign “due to the extremely overwhelming demand for the $25 deposit bonus promotion”.

It’s unclear how long the campaign was supposed to last since it was launched with no clear deadline. At press time, dYdX has not acknowledged the backlash from users. Instead, the team doubled down and stated that “individual user verification is NOT required for new OR existing users.”

dYdX is one of the first companies to comply with tornado monetary sanctions

dYdX’s public mishap came after OFAC sanctioned Tornado Cash, an open-source financial privacy protocol, by placing it on an SDN blacklist. dYdX was one of the first to comply by blocking user accounts that had interacted with the crypto mixing platform.

Interestingly, Tether, the issuer of a fully centralized USDT stablecoin, had not suspended user accounts in this manner two weeks after the sanction. Tether claimed blockers acted prematurely because they were not specifically instructed to freeze user accounts and funds.

The response to dYdX’s biometrics collection was overwhelmingly negative. Yearn Finance’s Yield Farming Aggregator’s Adam Cochran (153.1k followers) had this to say in a lengthy thread about the move.

“Recruit and empower internal advocates who can raise their voices, represent their consumers and protect their interests – particularly around privacy.

Users are not your product, and our data is not an acceptable “compromise” for your bottom line.”

Cochran further noted that he will vote with his wallet and stop accessing dYdX. Other crypto influencers have been tougher. MakerDAO’s Chris Blec, with 40.8k followers, called the promo campaign the beginning of the end for DeFi.

You should definitely expect more of this.

When you sacrifice privacy, you get:

* Deposit bonuses, like this one
* higher APYs
* Airdrops for KYC only
* and more

This is how DeFi ends and this is how the rails are being built for a tyrannical form of open-ended financing with CBDC.

— Chris Blec (@ChrisBlec) September 1, 2022

So far, dYdX has rejected such allegations, claiming that a liveness test is not mandatory. Rather, it was merely used as an experimental exercise to deliver bonuses to the right addresses. However, with smart contract flexibility and a wide range of possible incentives and airdrops, it’s hard to see why dYdX hasn’t tried to set a new trend.

Who finances dYdX?

Founded by Antonio Juliano, dYdX is headquartered in San Francisco, California. The exchange offers both leveraged and spot trading. In addition, the platform offers liquidity pools. On the one hand, lenders add liquidity to token pairs. On the other hand, borrowers draw on these pools for credit, which gives liquidity providers interest.

At the peak of TVL in October 2021, dYdX held $1.12 billion worth of crypto assets. Credit: DeFiLlama

Thanks to its Layer 2 scalability solution, StarkWare, transactions are lightning fast and at negligible fees compared to Ethereum. According to CrunchBase, dYdX received a total of $87 million in funding over 4 rounds. Leading investors are the following:

• paradigm
• Andreessen Horowitz (a16z)
• polychain
• Three Arrows Capital (now bankrupt)
• DeFiance Capital

In addition to this seed capital, dYdX is self-funding using the DYDX governance/utility token, which went on sale in September 2021. Out of 1 billion DYDX max supply, only 7% of the tokens are in circulation.

27.73% will remain with the above investors, while 15.27% will go to founders, employees and other personnel. Half of the supply is reserved for the community. At its peak in September 2021, DYDX token hit an all-time high of $27.78 after falling -94% since then.

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About the author

Tim Fries is co-founder of The Tokenist. He has a B.Sc. in mechanical engineering from the University of Michigan and an MBA from the University of Chicago Booth School of Business. Tim was a senior associate on the investment team of RW Baird’s US private equity practice and is also a co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.

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