Uma hatches Oval MEV product for lending dapps

Oracle protocol Uma, after days of social media teasing, took the wraps off its latest innovation today: Oval, a tool to help borrow/lend protocols like Aave and Compound retain value generated through the consumption of Chainlink pricing data on Ethereum.

Dubbed Oracle Extractable Value (OEV), this value is a subset of Maximal Extractable Value (MEV), which normally is captured by third-parties, searchers, block builders and validators.

Oval aims to redistribute this value back to the application where it originated by sitting in between the app and Chainlink.

To understand Oval, you need to know the basics of the MEV “supply chain” on Ethereum. Certain blockchain transactions kick off a sequence of actions among participants involved in transaction ordering within a block. In the process, there are opportunities to capture value through extracting, auctioning and benefiting from MEV — the maximum value that can be extracted from block production in excess of the standard block reward and gas fees.

Searchers identify MEV opportunities within Ethereum transactions. They look for ways to profit from the ordering and inclusion of transactions in a block, such as through arbitrage, front-running or back-running.

Block builders then select and sequence these transactions from a pending pool. Their role is to construct a block that maximizes the potential value to be extracted.

Finally, these constructed blocks are passed on to validators. Validators are responsible for including these transactions in the Ethereum blockchain. They confirm and finalize the transactions, integrating them into the blockchain’s record permanently.

Validators typically employ automated auction mechanisms, like Flashbots — which collaborated on Oval’s design — to facilitate a more transparent and fair process for MEV extraction.

Using Flashbots, validators enable searchers to bid for their transactions to be included in the blockchain. Oval integrates with Flashbots MEV-Share, allowing searchers to bid on the right to get first crack at Chainlink price updates as well.

Newsletter

Subscribe to Blockworks Daily

This whole MEV supply chain has evolved since the Merge. It has impacted transaction ordering and network security, which has raised concerns about centralization and fairness in Ethereum’s blockchain.

Ethereum developers are well aware that the incentives currently in place could be improved, and active research on related topics like proposer-builder separation are ongoing.

Oval isn’t directed at addressing centralization fears, but it does redistribute value from the process more fairly, according to UMA’s marketing head Campbell Easton.

Aave and Compound “massively overpay to incentivize liquidators in their protocols, because those liquidators are making a risk-free profit,” Easton told Blockworks. “And all this money is accruing to validators when it should be going to Aave.”

To make that happen, the Aave DAO will need to hold a governance vote to change its source for price data from Chainlink to Oval, which wraps the data and conducts an order flow auction where searchers bid for the right to use it.

The auction winner will still get to backrun the transaction, making Oval revenue-neutral for searchers, but proceeds from the auction would be split between Aave, Uma and Chainlink, with Aave getting the lion’s share.

“MEV-share has a maximum upper tier on the amount of the builder fee that can get sent back to [Aave],” Easton explained, noting “90% of the OEV generating can be captured by Oval.”

Uma estimates that for the past three years, Aave v2 and v3 combined missed out on about $62 million in revenue as a result of having no means to capture this OEV, Easton said.

“Oval has an impressive value proposition for major protocols like Aave — update a contract address and start earning significant MEV revenue that is otherwise lost,” said Tarun Chitra, CEO of Gauntlet, which advises the Aave DAO.

Block builders and validators stand to lose revenue, but participation in this new MEV flow will be mandatory for them, once Aave makes the switch.

It’s not yet clear how much this new regime might impact Ethereum staking yield, which is derived from a combination of inflation rewards, transaction fees and MEV.

“The teams at the cutting edge of MEV research barely have modeled a lot of the stuff out,” Easton said. But, “there’s still going to be a significant amount of MEV that’s going into the MEV supply chain,” he added.

Read more: Web3 is for regular people, too

Compound would be a likely candidate to use Oval next. Robert Leshner, CEO of Superstate and founder of Compound, said in a statement he was “excited about the possibility of Oval bringing new revenue streams to DeFi protocols more generally.”

For dapp users, the process should be invisible. And that’s probably just as well, for improvement of the user experience of Web3 dapps depends on abstracting away the inner workings of these protocols.

“The hardest part of this has been figuring out how to communicate all the stuff and actually make it accessible,” Easton said.

Bell Curve hosted Uma founder Hart Lambur, Gauntlet CEO Tarun Chitra and Flashbots’ 0xQuintus to discuss Oval in depth.

Start your day with top crypto insights from David Canellis and Katherine Ross. Subscribe to the Empire newsletter.

Explore the growing intersection between crypto, macroeconomics, policy and finance with Ben Strack, Casey Wagner and Felix Jauvin. Subscribe to the Forward Guidance newsletter.

Get alpha directly in your inbox with the 0xResearch newsletter — market highlights, charts, degen trade ideas, governance updates, and more.

The Lightspeed newsletter is all things Solana, in your inbox, every day. Subscribe to daily Solana news from Jack Kubinec and Jeff Albus.