Oracle enhances value

This article is a translation of API3 engineer Erich Dylus's article "Oracle Enhanced Value," original address https://medium.com/@erich.dylus/oracle-enhanced-value-ffcc62e94cc5.

API3's innovation, the "OEV Network," can be summarized as a permissionless market between maximum extractable value ("MEV," which can be extracted from oracles as "OEV") seekers and oracle service providers for data feed update calls, which can be verified on a dedicated zk-rollup. MEV seekers first bid for exclusive rights to update qualifying data sources (such aggregated data sources are referred to as API3, decentralized APIs, or "dAPIs") within a certain number of blocks, as they anticipate being able to extract MEV from the timing of such updates. Specifically, this is because the prices shown by dAPI data providers are based on deviations between periodic dAPI updates, triggering revenue opportunities. The OEV Network requires that the winning bid amount be returned to the dApp that generates OEV in the same transaction as the update call. If the update is expected to provide value to the seeker that exceeds the gas fees + bid fees, economically rational seekers (correctly coded seekers) will bid for the update rights.

The dAPI updates conducted through the OEV Network auction are functionally identical to non-OEV Network updates with the same timestamp and do not affect periodic "heartbeat" dAPI updates; the OEV Network merely provides a mechanism for more frequent, outsourced updates. dAPIs activated by the OEV Network are freely chosen by dApps to join or exit, but successful auctions aim to allow dApps to significantly capture and retain value that would otherwise be unilaterally extracted by seekers through competitive update sorting operations.

The occurrence of OEV Network auctions means: (i) dAPI data providers are broadcasting a value that will trigger valuable state changes in dApp designs and other affected on-chain systems; and (ii) for some reason, the dAPI has not yet been updated (for example, an update based on deviation has not yet been triggered, and the next periodic "heartbeat" update is not imminent), a simple example being that a lending dApp's liquidation is based on an oracle, and the oracle has not yet provided an updated liquidation price on-chain—having the ability to refresh this price (and provide a pathway for MEV) when knowing that liquidation will correctly occur has quantifiable value to seekers.[1]

In summary, the OEV Network improves oracle operations by incentivizing seekers to bid on dAPI updates (and pay fees), which are now more accurate and "on-demand," and then requires seekers to return the extracted value to dApps, dAPI data providers, and the builders of the dAPI and OEV Network system (API3). OEV auction winners must include their payment in the same transaction as the data source update, allowing the dApp to immediately receive its retained value on its native chain. By aggregating bids in the OEV Network rather than competing on the dApp network, gas wars among seekers can be alleviated.

This represents a brand new real-time on-chain data business model, combined with the maximum value retention MEV strategy of dApps. Given the win-win situation of the OEV Network, its effects may be better described as "Oracle Enhanced Value."

Source: https://medium.com/api3/announcing-oev-network-the-zk-rollup-to-capture-all-oracle-extractable-value-b9df4168d136 The OEV Network is implemented as a ZK-rollup specialized order flow auction platform via PolygonCDK.

Programmatic Value Retention and DApp Quality Improvement

Fundamentally, the OEV Network enables third parties (MEV seekers) to update dApp-specific dAPIs in a tamper-proof manner through publicly verifiable auctions within a limited timeframe. Seekers have already extracted value from dApps and users by coordinating oracle updates with other on-chain operations; now, by choosing data sources supported by the OEV Network, dApps can ensure that value is almost entirely reclaimed by them without affecting the rules and parameters of their systems. This provides dApps with a new source of revenue while outsourcing oracle update costs to seekers. Oracles enhance the amount of value retained and captured by dApps while also increasing the revenue of first-party oracle data providers connected to such OEV Network-supported sources (by requiring the latter to earn revenue during bidding times rather than dAPI update times, a model that does not cut into dApp's MEV retention).

"Traditionally, the quality of data sources is measured by their deviation thresholds, where smaller values are better as they produce finer and thus more accurate data sources. OEV-based updates make this metric obsolete by updating precisely when needed, achieving a zero deviation threshold, thereby achieving perfect accuracy in practice. This further helps improve the financial viability of dApps by minimizing total MEV and enhancing user experience."---Yahoo Finance

This outsourced gas expenditure for more frequent oracle updates provides dApps with finer, more accurate data and returns more captured value to dApps through the auction mechanism in the process. DApps and associated development companies can directly mitigate the impact of MEV related to data sources by choosing to join the OEV Network and strategically using the proceeds (e.g., subsidizing liquidation penalties).[3]

If the OEV Network experiences downtime or there are no OEV Network opportunities, dAPI updates will continue as usual. The OEV Network does not rely on third-party oracle updates.[4]

Distinguishing OEV Network from MEV Oracle Manipulation

1) Freedom to join and exit dApps by simply changing contract address parameters.

2) Through the OEV Network, MEV seekers can only influence the timing of additional dAPI updates within a limited timeframe, without affecting the return values of the dAPI.

3) Participation is a win-win for all parties: the OEV Network (a) shifts the cost of executing dAPI functions to seekers and transfers bidding congestion on the dApp chain to the OEV Network, (b) provides finer and more accurate data (incentivizing dAPI updates), (c) allows dApps to retain value that would otherwise be lost and more appropriately compensates data providers for the value generated.

4) MEV seekers or participating dApps do not gain the ability to manipulate the data provided by the Airnode or the structure of the dAPI, nor can they interfere with "objective valuation methods"[5], such as the code of the smart contracts they interact with and the independent oracles they rely on.

5) The auction process and mechanism can be publicly verified on the OEV Network ZK-rollup.

MEV typically involves opportunistic reordering and manipulation of transactions at the base layer, posing risks to both dApps and users by default. MEV (including OEV) forces users and applications to take additional, often costly and undesirable measures to mitigate the adverse effects of MEV, such as potentially introducing trust relationships or increasing fees through relay mechanisms.

On the other hand, the OEV Network's handling of OEV is entirely optional for dApps seeking to integrate MEV solutions. DApps choose to join by selecting data sources activated by the OEV Network; if they later wish to exit the OEV Network, they can simply revert such addresses. DApps can freely weigh the increased various values from the OEV Network against their user preferences. It may be speculated that these preferences could be determined by the value allocation design for dApp users, LPs, or token holders, rather than by non-user stakeholders retaining value.

Debates surrounding the legitimacy of MEV seeker strategies often involve cognitive factors of market manipulation (most commonly, manipulating liquidity through "sandwich attacks" or more generally "oracle manipulation"). For the emergence of new extractable value specific to the OEV Network (e.g., involving manipulation of value for arbitrage or sandwich attacks), seekers must operate through protocol smart contracts or the OEV Network auction system (contrary to system design) or manipulate one of the applicable data sources or data providers directly to manipulate one of the first-party oracles related to the applicable dAPI. This is illegal and actionable in most jurisdictions (violating unauthorized access regulations, infringement, unfair competition, tort, conversion, market manipulation, breach of data provider terms and conditions, etc.) for seekers. Deliberately influencing data sources (through the source or transmission of data) is commonly referred to as "oracle manipulation." For example, malicious actors could manipulate oracles to create liquidation opportunities, "if the oracle can report an incorrect (low) price for the asset used as collateral if the benchmark market used to report price information can be manipulated."

The OEV Network merely outsources additional updates of dAPIs through auctions (a function call), which does not alter the algorithmic state change process resulting from such calls. Specialized order flow auctions are a permissionless market based on voluntarily disclosed data from oracle service providers; this data is computationally and substantively unaffected by the auction. Therefore, the OEV Network is neutral to the threat of oracle manipulation, as it neither facilitates opportunities for dAPI or data provider manipulation nor further prevents the possibility of such occurrences. In fact, the OEV Network is neutral to the oracle structures used by the underlying dApps and can accommodate various oracle structures. Opposing the practice of additional dAPI updates through the OEV Network is tantamount to opposing finer and more accurate pricing, thus allowing dApps to operate more precisely as designed."

Conclusion

The OEV Network proposes an extremely rare model for rescuing MEV/OEV leakage and loss, which (1) allows joining through a single parameter update, (2) is operationally identical to existing dAPI data sources but with higher granularity, (3) has a backup mechanism in case of OEV Network downtime, and (4) is designed to economically incentivize all participants.

DApps choose whether to use dAPIs supported by the OEV Network simply by changing their read contract addresses and benefit from some updates outsourced to OEV Network participants as well as from the value returned by the OEV Network system. The non-mandatory willingness of data providers to participate in the auction process with seekers, the optional choice to use dApps supported by OEV, and the system's neutral stance on MEV generation and oracle operations all meaningfully distinguish the OEV Network from other MEV relaying or capturing processes, where MEV opportunities are not voluntarily parameterized by their generators, or the value recaptured by dApps is significantly less. The value gained by dApps, data providers, and API3 would otherwise flow to seekers, and due to the outsourced execution when MEV exists, dApps can obtain higher accuracy and granularity of data at a lower cost.

Oracle Enhanced Value.

Thanks to Kevin C. and Greg P. for their feedback.

*[1] See, for example, https://eigenphi.io/mev/ethereum/liquidation/. *

[2] https://finance.yahoo.com/news/api3s-oev-oracle-enable-dapps-173200226.html

[3] Regulators and international organizations are signaling for dApp "providers" to "manage and mitigate the impact of MEV strategies used by miners/validators on the underlying blockchain chosen to operate or provide" products or services; IOSCO, Policy Recommendations for Decentralized Finance (DeFi), page 14.33, available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD744.pdf.

[4] Unlike UMA's Oval (see https://medium.com/uma-project/announcing-oval-earn-protocol-revenue-by-capturing-oracle-mev-877192c51fe2).

[5] More simply, updating unmanipulated oracle data sources does not affect the data (other than bringing it up to date), making it less likely that liquidations "merely utilize" natural market events to constitute impermissible market manipulation… as opposed to deliberately creating liquidation opportunities. This often depends on whether the manipulator "interferes with the objective assessment methods agreed upon by the parties"—for example, the code of the smart contracts they interact with and the oracles they rely on. Barczentewicz et al., "Blockchain Transaction Ordering as Market Manipulation," page 14.64, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4187752.

[6] For example, see the "Complaint," CFTC v. Eisenberg, No. 23-cv-00173 (SDNY filed January 9, 2023).

[7] Barczentewicz et al., page 17.63.