Author: Siddhearta, BanklessDAO editor, Bankless Consulting assistant Compiler: Jinse Finance, Shan Ouba

Maximum extractable value (MEV) has become an increasingly important topic in the DeFi ecosystem due to its negative impact on decentralized applications (dApps) and users. MEV can be understood as a hidden tax on dApps and users, as it increases transaction costs, reduces profitability for liquidity providers, and can negatively impact user experience.

MEV refers to the maximum profit that can be captured by MEV robots (also known as "seekers") by identifying and exploiting opportunities that arise from the ordering, inclusion or exclusion of transactions in the blockchain. Validators are the roles that process transactions and secure the blockchain. They have the power to determine the order of transactions in the blocks they validate, creating opportunities for searchers to maximize profits. By monitoring opportunities in the mempool, Seekers can execute various strategies, such as front-running transactions, exploiting arbitrage opportunities, and even prioritizing certain transactions with higher gas fees, which may delay or cancel transactions with lower gas fees. implement.

MEV based on Oracle update

A subset of MEV is related to oracle updates, which involve exploiting oracle data to gain an unfair advantage and generate profits. Oracles are an important part of DeFi as they provide real-time data to smart contracts. These data points support a variety of functions, including loan collateral, token swaps, and derivatives trading. Given the critical role of oracles in DeFi applications, they could be the target of MEV attacks.

Run first

In this case, the MEV searcher monitors the mempool for pending transactions and submits its own transaction with a higher gas fee to "jump in line" ahead of the target transaction. This allows searchers to take advantage of opportunities before the original user executes their intended transaction.

For example, if an oracle machine is about to update the price information of a certain token, the searcher can use this information asymmetry to execute transactions or adjust their collateralization ratio in the lending platform to maximize profits or minimize losses. This act of exploiting temporary price differences often leaves other users worse off than it would have been without the interference.

Arbitrage

Oracles also support communication between different blockchains. Given that assets can be traded on separate networks in the form of derivatives, oracles are used to relay price information across multiple sources of liquidity, which can result in both minor and major price differences. These differences provide arbitrage opportunities for different asset pools.

MEV Seekers can detect price differences in different markets before updating. They take advantage of this by buying assets in cheaper markets and selling them in more expensive markets.

The API3 OEV Litepaper highlights Synthetix and GMX as examples of arbitrage opportunities that negatively impact protocol performance and user experience due to lack of granularity due to deviation threshold-based rules for deciding when to update feeds. If a data source shows an outdated price compared to another market, searchers will race to trade at that price knowing they can immediately sell the asset on another market for a profit. This situation results in liquidity providers having to accept a continuous stream of unprofitable trades, leading to losses and protocol performance degradation. These issues forced Synthetix to implement the Uniswap Time-Weighted Average Price (TWAP) oracle to work with Chainlink to determine asset pricing. However, this solution is not perfect, as the TWAP oracle essentially provides outdated prices and creates a further barrier to listing additional assets.

** liquidation **

Oracle updates also provide opportunities for profitable liquidations. MEV Seekers can identify under-collateralized loans in lending platforms and quickly submit transactions to clear those loans before other users or bots. By being the first to liquidate, Seekers earn liquidation bonuses and other rewards.

These are just a few examples of the different types of MEV attacks that can be triggered by oracle updates in blockchain and DeFi ecosystems. This is a relatively constant battle, with developers continually devising solutions to enhance the security, fairness, and resilience of the web. Currently, there are two main approaches proposed to alleviate the MEV problem: MEV-Boost and Proposer-Builder Separation (PBS).

MEV-Boost is an iterative version of the original Flashbots mechanism, introducing a series of measures and roles aimed at reducing the negative impact of MEV, including Builder API, block builders, escrow mechanisms, validators, searchers, and relayers. The Builder API is a tool that allows validators and block builders to interact efficiently and prevents validators from tampering with block content in order to obtain MEV revenue. Block builders build profitable blocks using favorable trading strategies found by Seekers. These transactions are checked for validity by relayers before reaching validators, and an escrow mechanism ensures that all necessary data is available. Once validators add blocks to the Ethereum network, they are rewarded with transaction fees and MEV.

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MEV-Boost benefits the Ethereum network by preventing centralization, reducing gas fees, and enhancing user privacy. This mechanism democratizes access to MEV opportunities, reduces centralization risk, and enables individual stakers to earn MEV profits without needing to join large staking pools.

The proposer-builder separation (PBS) is part of a planned Danksharding upgrade that will see block proposals and block production managed by separate entities. MEV-Boost, as a precursor to PBS within the protocol, provides a possible appearance of PBS after implementation. PBS aims to reduce the impact of MEV on the security of the consensus layer and inspire the development of the consensus layer logic necessary to implement external block construction in Ethereum.

However, neither PBS nor MEV-Boost directly addresses the MEV opportunity presented by oracle updates. Instead, these approaches primarily focus on reducing the negative impact of MEV on the decentralization and security of the Ethereum consensus layer. To address the MEV opportunity presented by oracle updates, a different approach is required.

Learn about OEV-Share's opportunity to create sustainable and efficient dApps

MEV poses significant challenges for users and dApps, but also presents opportunities to devise new solutions that make the ecosystem more efficient. One of the opportunities to improve the efficiency of DeFi protocols is to solve the MEV problem related to oracle updates, which creates an opportunity to capture oracle extractable value (OEV).

In the API3 OEV Litepaper, API3 introduces an off-chain marketplace that allows dApps to auction meta-transactions signed by first-party oracles to update data sources. In this model, Seekers bid for the right to make oracle updates and collect transaction-related MEV. Winning bidders will be assigned to dApps and external oracle providers. This creates a more efficient system where the price feed is updated when the dApp needs it, rather than being subject to deviation thresholds. Overall, the system design can be compared to Flashbots relays, but searchers bid on oracle updates, not blockspace.

API3 is working to redesign the oracle update process to minimize the impact of MEV. By implementing novel mechanisms to protect oracle data from exploitation, they aim to ensure more secure and transparent oracle updates. This can lead to a stronger and more efficient DeFi ecosystem, which ultimately benefits users and applications.

The benefit of OEV is that the value captured by the searcher is shared with the protocol it originated from. This approach minimizes negative externalities caused by extracting MEV from dApps and helps create accurate and low-latency oracles. In cases where MEV extraction does not incentivize oracle updates, the price feed is updated based on normal deviation thresholds and heartbeat times.

Instead of fighting MEV opportunities and trying to eliminate value loss in the network, OEV-Share uses shared incentives to recapture and repurpose the value of MEV opportunities to create a more efficient and sustainable DeFi ecosystem.

#OEV benefits the entire DeFi ecosystem

One of the core challenges facing oracles is how to bring real-world data on-chain. Because cost constraints prevent data feed updates every block, oracles must strategically decide when to update, so oracle architecture plays a key role in addressing this challenge. This challenge negatively impacts the DeFi ecosystem, resulting in reduced profits and potential losses. OEV-Share presents an opportunity to turn these challenges into advantages for users, dApps, and the entire DeFi ecosystem.

By using API3's order flow auction to capture OEV, dApps can minimize the negative externalities caused by MEV withdrawals. This model allows MEV Seekers to bid for the right to update oracles, turning a problem into an opportunity. Winning bids benefits both users and dApps, and successful MEV searchers update oracles and capture associated value.

The long-tail advantage of OEV is that it creates accurate and low-latency oracles. More accurate data and value captured from order-flow auctions can be used to improve the profitability and sustainability of liquidity provision, enabling more optimized market-making protocols for applications that rely on oracles. Improvements in market making for dApp liquidity providers create a flywheel effect, attracting more liquidity to apps while lowering fees and listing more assets, thereby attracting more users and trading volume.

Oracle Extractable Value solves a key challenge in the DeFi space by increasing the efficiency of oracles and creating value for all parties involved. By minimizing the negative impact of MEV and improving data accuracy, API3 is paving the way for a more sustainable and profitable DeFi ecosystem.