Detailed Explanation of OEV Network Mechanism and Impact: API3 Ecosystem Expansion Tool, an Excellent Optimization Solution for Data and Extractable Value

The beginning of 2024 has already shown signs of a bull market, with the oracle sector becoming increasingly prominent. Chainlink (LINK) has once again surpassed a market capitalization of $10 billion, maintaining a stable position in the Top 15, highlighting the importance of oracles in the crypto space. Meanwhile, other oracle projects are eager to compete for a top three position.

Generally speaking, high-frequency market makers drive the development of oracles, discreetly profiting from the small bid-ask spreads between buy and sell orders, which is the primary source of profit for market makers. How to obtain timely and accurate quotes has become crucial.

After the "DeFi Summer," DeFi composability has developed significantly, and the demand for on-chain pricing has gradually exploded. Various DeFi protocols, such as decentralized exchanges and lending, need to ensure the accuracy of prices at all times. In terms of functions like liquidation and insurance, oracle solutions have even become a security issue that cannot be ignored.

The "Dark Forest" MEV has been confirmed as a new ecological model. Due to the visibility of transactions in the Mempool and the bidding rules for transaction ordering on-chain, MEV is inevitably present. Conversely, if transactions cannot avoid being extracted for MEV, then the entire network's profits cannot be fed back to the ecological products/protocols. FlashbotsGuild has profited over $650 million to date through off-chain solutions.

Burak Benligiray, co-founder of API3, proposed the concept of OEV (Oracle Extractable Value) in November 2022, which has a similar essence. According to statistics, in January 2024 alone, the Aave protocol generated $4 million in OEV revenue.

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1. Why API3 is Launching OEV Network

Typically, dApps use oracles to determine the spot prices of the assets they support. This means that changes in the data points provided by oracles will directly lead to changes in the market conditions of these dApps, usually accompanied by third-party value extraction. The direct result of these state changes may lead to several different general types of OEV: front-running, arbitrage, and liquidation.

API3 is an innovative project aimed at reforming the blockchain oracle space, allowing blockchain-based dApps to access external real-world data and services via application programming interfaces. Its core goal is to address the issues of existing third-party oracles through first-party oracles.

Currently, third-party oracles have many drawbacks, particularly in terms of security. If a central entity can switch the oracle or API used in the price aggregator or even replace the aggregator itself using a proxy mechanism, they can effectively manipulate the output of the oracle network at will. According to Messari Research, as of 2021, 38% of DeFi vulnerabilities were caused by manipulated oracle prices. For example, in 2021, the Venus Protocol accumulated over $100 million in bad debts due to price manipulation of its governance token (XVS). In November 2020, the DAI/USDC price on Coinbase Pro was manipulated, affecting over $100 million in assets on Compound.

Airnode, as API3's first-party oracle, hosts nodes within the infrastructure of API providers, eliminating intermediaries in the interface path and improving cost efficiency. Data from API providers is signed before being pushed to any chain via the first-party oracle, ensuring data transparency and flexibility. Additionally, Airnode has designed on-chain insurance services, using API3 tokens in the staking pool as collateral. When a provider's dAPI failure is confirmed through a dispute process, user losses will be covered from the staking pool.

For ordinary users, API3 also opens up staking, allowing them to earn API3 token rewards and governance voting and proposal rights in the DAO. The annualized return on token rewards fluctuates between 2.5% and 75%. When the amount staked is below 50% of the supply, it increases by 1% at the end of each cycle (7 days); conversely, it decreases by 1%. As of February 12, 2024, the annualized APR is at 20.5%. Proposals require a minimum of 0.1% of the total supply in tokens, while any amount of tokens can be used for voting.

On January 29, 2024, API3 announced the launch of the ZK-Rollup platform OEV Network, aimed at leveraging its position to capture value that would otherwise flow to third parties. OEV Network separates the request update rights and integrates them into existing oracle functions through auctions, internalizing OEV and ensuring data security and granularity, while the underlying services remain unaffected by additional interference and delays.

Extractable value must come from somewhere; in the case of OEV, it comes from liquidity providers on dApps using the data sources. dApps require a low deviation threshold to prevent losses caused by OEV, which puts continuous pressure on the operational costs of maintaining data sources. This makes it difficult for oracles and dApps to find sustainable profitability while also leaking value to more strategically significant parties.

According to the founders, API3 operates an API that announces data source updates available for bidding. Seekers (programmed bots that automatically extract MEV) regularly check these updates to see if there are any available for value extraction. When such updates occur, seekers bid with on-chain native tokens.

The auction winner will receive a meta-transaction, which is cryptographically signed by each API provider supporting the specific dAPI. Only the auction winner can use the meta-transaction by sending the bid amount that won the auction. The auction winner can then push the meta-transaction on-chain to update the dAPI and trigger any other events in the same transaction, ensuring they receive all rewards.

2. What Impact Will OEV Network Bring?

OEV Network has obvious potential to bring objective benefits to numerous participants (dApps, data providers, MEV seekers, API3 protocol). In short, API3 will extract OEV and return it to dApps.

• For dApps: They can recover 90% of the value lost to MEV, improving the accuracy of data feeds without additional costs. This greatly enhances the sustainability of such dApps and directly brings potential overflow value to their users and token holders.

• For data providers and API3: The revenue from feed updates remains unchanged compared to non-OEV feeds and does not require additional resources once set up. This revenue enhances the sustainability of API3 dAPIs and other "cost" services like QRNG (Quantum Random Numbers).

• For MEV seekers: The incentives remain unchanged, with new potential to repackage and compose different strategies through the OEV network zk-rollup. Since auctions occur on the OEV network zk-rollup, the "gas wars" for bidding will incur lower costs for seekers there than on-chain costs occurring in OEV, which also protects dApps and their chains from congestion.

Additionally, API3 has made special arrangements for the portion of revenue from the OEV Network. An immutable smart contract named "API3DAORevenueIncinerator" redirects OEV revenue to purchase and burn API3 native tokens while also providing locked DEX liquidity. The code is completely immutable, and functions can be called by any address. It also has encoded slippage limits to ensure that revenue is not wasted when liquidity is initially low.

• Revenue Distribution: Revenue from API3's OEV network is sent to API3DAORevenueIncinerator in the form of USDC or ETH.

• Buy and Burn Mechanism: If the smart contract receives ETH, it will automatically buy and burn API3 tokens using Uniswap v2. If it receives USDC, half will be used to buy and burn API3 tokens, a quarter to buy API3 tokens, and a quarter to buy ETH, which will then be provided as liquidity to the API3-ETH pair and locked for a year.

• Impact on DEX Liquidity: Each buy and burn increases DEX liquidity (API3-ETH trading pair on Uniswap v2). Early liquidity providers for this pair may benefit from increased trading volume and fees.

• Reduction of Circulating Supply: The burn function and locked liquidity reduce the circulating supply of API3 tokens.

• Long-term Liquidity Removal: After one year, if liquidity is removed (which can be triggered by any address calling the corresponding function), the ETH side of the liquidity position will automatically buy API3 tokens, and all these tokens will be burned along with the API3 side. Even if liquidity is withdrawn, this mechanism ensures further buying pressure and reduces the circulating supply of API3 tokens.

By utilizing revenue to drive the value of API3 tokens, this structure can increase reliance on native token incentives rather than dependence on USDC treasury expenditures based on DAO proposals, thereby enhancing the long-term sustainability of the entire API3 project. This is expected to last for years even after API3's USDC treasury is depleted (according to current proposal rates). This aligns with the correct vision for DAO tokens (using native tokens for governance and funding), and API3 has further refined industry standards for this.

Finally, OEV provides unlimited scalability for the API3 protocol. On one hand, the revenue model decouples OEV revenue from feed expenditure costs, with winning auction seekers paying for feed update costs. On the other hand, it makes API3 easier to integrate, allowing dApp developers to achieve seamless upgrades by simply changing the contract address.

3. Financing Institutions and Team

According to RootData, API3 completed a $3 million seed round financing at a valuation of $30 million on November 12, 2020, led by Placeholder, with participation from well-known institutions such as DCG, Pantera Capital, Accomplice, CoinFund, and Hashed.

Heikki Vanttinen and Burak Benligiray are the co-founders of API3, both of whom were previously the founder and CEO and CTO of CLC Group, respectively. CLC Group is a blockchain laboratory that "develops interconnected smart contract solutions for the real world to achieve a more reliable, efficient, and secure future."

The third co-founder of API3 is Saša Milić. In addition to serving as a lecturer at the University of Toronto, teaching core courses to computer science students, she has also worked as a software engineer at Facebook and a simulation data scientist at Gauntlet.

Recently, API3 has been actively pursuing partnerships. In addition to launching the OEV Network based on Polygon zkEVM, API3 has also collaborated with Layer 2 solutions such as Metis, Linea, and Mantle. There are also many collaborative agreements in DeFi, such as Gravita Protocol, KTX.Finance, and more.

4. Conclusion

The OEV Network launched by API3 not only provides a sustainable ecosystem for all participants but also introduces a dynamic model for token value and liquidity management. OEV network revenue is not limited by API3's resources or contributor power. dApps can retain MEV value instead of letting MEV bots take everything, and data providers can earn more revenue, which is automatically used for API3 token buybacks and burns.

In terms of competitors, the OEV Network also has obvious advantages. Pyth's main market is on the Solana network, while UMA's Oval is objectively weaker in terms of functional support and incentives, relying on ChainLink and Flashbots, and only sharing 50% of OEV revenue with dApps.

"DeFi father" Andre Cronje has pointed out four stages in the development direction of oracles, and we are currently in the transition from the third stage to the fourth stage, which involves off-chain data, on-chain validators to zero-knowledge provable data. The OEV Network is likely an excellent solution to help integrate zk technology into the underlying protocols of oracles, with profound potential.