Reducing the Inefficiencies of Oracle Extractable Value (OEV) with API3
Oracles are one of crypto's critical infrastructure components: they are the choreographers that synchronize the off-chain world with the blockchain’s immutable ledger.
Currently, oracles have over $40b in Total Value Secured.
Without them, there’s no way for blockchains to import secure data from the off-chain world.
If you are not familiar with oracles, feel free to refer to a previous article I wrote this summer: https://fraxcesco.substack.com/p/on-greek-mythology-and-trustless
Traditionally, this has been the realm of third-party oracle networks, serving as intermediaries that feed external data to smart contracts.
However, new solutions are coming for this market segment.
Among those, today we’ll focus on API3.
API3 is a blockchain oracle provider leading the transition from traditional third-party oracle networks to first-party oracle solutions.
API3’s products include first-party oracles, decentralized APIs, and the OEV Network, which allows dApps to recover funds typically lost to MEV and to improve protocol performance.
This short piece will dive into Oracle Extractable Value (OEV) and the products at work to reduce it and put it back in the hands of users.
Enters API3’s OEV Network.
First-Party Oracles and Decentralized APIs (dAPIs)
To understand API3 better it is important to introduce first-party oracles and dAPIs.
First-party oracles are hosted directly by the API provider. Instead, if a third-party middleman is hosting the oracle node - then it is called a third-party oracle.
First-party oracles provide several advantages to dApps:
Security: More secure because there's no middleman on the interface path.
Cost efficiency: First-party oracles are cost-efficient (no third-party costs)
Transparency: Enhanced source transparency means reputation can be gauged when utilizing real-world data in dApps.
As dApps need access to APIs, it would be optimal to interface APIs to smart contract platforms through first-party oracles to create and provide an optimal oracle architecture.
To allow dApps to use first-party oracles, API3 created their dAPIs: on-chain data feeds sourced from first-party oracles owned and operated by API providers themselves.
The dAPIs can be intended as a decentralized network that would solve the current connectivity problem via API.
Just like traditional apps use APIs, dApps can use dAPIs.
With their user-friendly interface, dAPIs abstract the complexity of technical infrastructure implementation.
All services can be accessed by dAPPs in a fully permissionless format.
What is OEV?
OEV stands for Oracle Extractable Value and is a subset of MEV extracted from any DeFi application using oracles (e.g., lending and borrowing dApps).
MEV searchers extract the OEV as a reward for the state changes created by the oracle update (oracle update, e.g., liquidation on a lending platform = fee for oracles).
Every year, OEV opportunities can be worth up to hundreds of millions of dollars.
The OEV Network
To solve the OEV problem, API3 launched the OEV network, able to capture and reduce OEV.
API3 stands at OEV, as Flashbots stands at MEV.
The OEV Network is an auction platform (or market) selling the rights to execute specific data feed updates for dAPPs to the highest bidder.
To solve the problem of funds lost to OEV, API3 hosts auctions for the right to update the oracle value.
Only the searcher who wins the auction (providing the best price) gets the right to:
• Update the oracle
• Batch update with the transaction extracting the OEV (e.g., liquidation fee)
By hosting auctions for the right to update oracle values, API3 is creating a decentralized market for oracle updates.
The winner of the auction also pays its bid to the dAPP while executing the data feed update.
API3 returns auction revenue to dApps, recovering what they would lose to MEV searchers and block producers. Instead of arbitrarily paying oracles as infrastructure utility, dApps that use the OEV network and API3’s oracles get paid to do so by recovering funds typically lost to MEV. This way, dApps would stop “leaking” OEV to third parties.
Only on AAVE, over $100m in MEV could have been recovered with OEV.
Examples of OEV Alerts:
Tangible Advantages
Once the OEV is live, protocols can recover and use funds typically lost due to MEV. Among others, this will bring down protocol fees.
On Average, liquidation fees on lending protocols are about 5-10%. By using API3 oracles, dAPPs have a chance to reduce that by as much as 99.99%, essentially saving on the entire liquidation penalty.
By creating a decentralized on-chain market for dAPPs data feed updates, API3 creates a transparent, secure, accessible, and auditable process.
Compared to other solutions:
OEV will be available on a broader range of networks from day 1, aside from the Ethereum mainnet. If your chain can get API3 data feeds, it can recapture OEV.
OEV does not require any additional layer of trust: the OEV Network is vertically integrated into the oracle, meaning no additional dependencies are created.
The OEV network allows for the continuous auctioning of real-time market data, allowing for infinitely more granular updates. No need to wait, you can have oracle updates whenever you want.
Security first: API3 is an auction host for signed data from first-party oracles. The winner of an auction will get a transaction (including all oracle signatures and the amount they won the bid with), giving them exclusive rights to update a data feed and get the respective fees.
This is a sponsored post by API3 - which has entrusted me to express my impartial analysis of their project. Infrastructural protocols are much harder to build and to gain traction.
The launch of the OEV network will be interesting to observe, as protocols will now have a chance and incentive to use API3 and immediately start to earn from auctions.
The infrastructural layer of the tech stack of crypto is in constant evolution.
This is refreshing, as MEV and OEV have significantly undermined the efficiency of blockchain operations.
API3 is working to prevent this problem and redistribute the funds extracted via OEV to the dApps and protocols where they belong.
Learn more about API3: https://bit.ly/48aJfrW
Nice reading