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A | Welcome to bankless, where we explore the frontier of Defi market structure and capital efficiency. Today on the show we're talking about Oval, a new DeFi primitive that Hartlamber from Uma is introducing to the world of DeFi's biggest lending markets. Billions of dollars have been liquidated from protocols like Aave C... |
B | Thanks, David. Thanks for having me. |
A | Heart. We had you on two years ago, I think, to talk about Bridges way back in the day. It's good to have you back, my mandarin. |
B | Yeah, good to be back. Good to see you. |
A | And reoccurring guests on the podcast. Well, I guess both are reoccurring, but Hasu's been on a few more times than you. Heart Hasu strategy lead at flashbots, as well as just ecosystem researcher and crypto economic enthusiast. Hasu, welcome back to the podcast. |
C | Hey, David, nice to meet you. Hi hart. Don't think we've met yet on a podcast, but I'm looking forward to this. |
B | I like the crypto economic enthusiast moniker. That's a good one. |
A | I think that's the right title for Hazu. I think that's the right title for most people that come on this podcast. |
C | But Hazu especially, that doesn't make it very special. David, you know. |
A | The lead crypto economic enthusiast that I know. My preferred. Okay, guys, we're gonna get into a conversation that I think bankless listeners will be familiar with. Long time bankless listeners. This is inside of the subject matter of MEV, maximally extractable value. Minor extractable value, later rebranded to maxima... |
B | Yeah, absolutely. And we can make it concrete and then maybe generalize it a little bit more, too. But today, Oracle updates, and let's talk about like, Chainlink updates. Chainlink updates drop into the public mempool on Ethereum. |
A | Chainlink price updates, price updates, correct. Price updates. |
B | Chainlink price updates get dropped in the public mempool on Ethereum, and then they get used by defi protocols. And if a chainlink price update triggers a liquidation, if that price update drops below a liquidation target on Aave or compound position, that liquidation then triggers a bunch of things, but basically col... |
A | And I believe that the amount of MeV that's captured from AaVE compound liquidations can be quite large. I think this probably happens more. This amount of mev capture is more when there's times of volatility and probably times of bull markets as well. And really just to set the stage here, we are talking about MeV. We... |
B | Yeah, totally. I mean, estimating MeV is quite difficult, but within AAVE and compound, we can have a very clear theoretical kind of bound. And the way aave and compound work is when a Chainlink update, price update comes in that causes liquidation. AAvE and compound then sell collateral at a discount. And the reason w... |
A | Hazu, I want to get your perspective on what would happen if this were left unchecked. Hart talked about some parameters about collateral ether, or maybe less liquid assets being sold at a discount. Maybe you could talk about why it's being sold at a discount and why that's important to the protocol. And then overall, ... |
C | Yeah. So, to the first part of your question, so why is it sold at a discount? I think heart actually gave a very good explanation here. So, when you want to sell, or when you want to buy a token on uniswap, and the token is quite volatile, then you don't exactly know what slippage to set. Right. And so if you set a ve... |
A | Is it just a protective mechanism that they need to sell this collateral because they must not have bad debt? |
C | Yeah. So, I mean, this is really a design choice. By the protocol itself, I would say. So if you're on uniswap and trading shitcoins. Okay, so what's the worst that can happen if you don't get to buy this position now? Okay, you maybe incur some kind of opportunity cost, but the lending market, you could argue, has a m... |
B | Astute the only thing I'd add is there is a trade off here too. Where in the maker design, when you have that hour price delay and then the slower liquidation process, you need to have higher collateral requirements. Because if you do have a worst case scenario where price is trending in a negative direction in the mak... |
C | So big trade off space, definitely. And so why do we care about, I guess, MeV in general? By the way, the connection that I would draw between MEV and OEV is that MEV is basically money that privileged parties in any system can extract from other participants of that system through asymmetry of power or information. An... |
A | Right? Yeah. This has been my understanding since we did our endgame episode with Vitalik, where centralization in the block building layer has more optionality and checks upon the block builders than we do with validators. Once centralization happens at the validator level, it's a one way street. Hard to come back fro... |
B | Yeah, totally. Checkout checks out. And I think where you're going with this, David is on more of like the business side, the business strategy side, or application revenue side. So Hasu's perspective, he wants to kill Mev because he worries about the centralization risks it creates, which I completely agree with. But ... |
C | Yeah, I definitely agree with that. I would say we definitely don't only care about the decentralization of Ethereum, it's very important because without the decentralization of Ethereum, the whole experiment basically comes to stop. There's still gambling technology that's built on top of it. But especially kind of th... |
A | And I will add, as the industry of Defi has progressed, it is a story of efficiencies and capital efficiency and less leakage over. This has just been the arc that DeFi is on. This isn't something brand new. All applications are innovating on how to be more capitally efficient, how to best serve their customers. And th... |
B | Yeah, absolutely. Oval is a mechanism for OEV capture or capturing this specific type of oracle created MeV. Oval is not an oracle. It uses Chainlink price updates. But what it essentially does is say, hey liquidators, searchers, if you want to use this chainlink price update, if you want to be the first one to use it,... |
A | To the protocol seems like a relatively simple mechanism. This is an opt in mechanism by lending applications like AavE compound maker, for example, these things need to elect to use oval, correct? |
B | Correct. You can think of this as like a bolt on for Chainlink. Okay, it wraps a chainlink price update. So right now aave and compound and many, many other Defi protocols have an address where they're like give me the Eth USD price feed from chainlink and what Oval does it says. Okay, we have a contract that looks lik... |
A | So it's like an auction module that's being appended onto the Oracle price updates that Chainlink is providing. Defi, how did this make sense as to how you brought up the Robinhood analogy, where at one phase in Robinhood's life they were just casting off their user's order flow into the wild and then suffering worse e... |
B | Yeah, exactly right. That analogy totally holds. And if we go back to the kind of slippage analogy where were saying, hey, this liquidation is going to have a fixed 10% liquidation bonus. Were going to run an auction that says, okay, what does it actually cost? What will people pay here? And people say, okay, ill actua... |
A | So this solves the problem of some of these lending markets not knowing what the fair price of their collateral is, whether it's a large supply of ether or a supply of shitcoins. They don't know the governance parameters around collateral in aave, compound maker, et cetera. They don't know what the market price is. So ... |
B | Yeah, I like this best execution module that I'm going to use that Hasu said it really well. You go back and you think about on Uniswap, I'm wanting to buy a shitcoin price is all over the place. So I set a wide slippage limit just to guarantee I get a fill or I set it tight to keep the price more price guarantee, I do... |
C | I have some follow on thoughts to that. So this is one of my favorite topics for years, and it's very hard to like nerdsnip people on it. So now is my time. Okay, so give me like my born for this, but so both you actually, so we talk about oracles, which is funny because like both setting your feet, your fee, how much ... |
B | Yeah, well, to keep going on this, the nerd sniping of it, the liquidators in this system are off chain actors that have full visibility into all these costs and fees. And then through forces of competition, they're figuring out who's going to serve you the best price. So we're able to utilize off chain actors to know ... |
A | The off chain actors, they're just the market, and the market knows a lot. The market is the aggregate of all information. And so it's a place where, just like, the aggregate knowledge of the market can actually become to be expressed and then leveraged by the Defi applications. |
B | Yeah, exactly. And while we're talking parameterization, there's interesting knock on effects here, too. So lending markets like Aave, they can't easily onboard shitcoin collateral because the price moves too much or whatever. It could create bad debt for the system. But you could imagine where they onboard shitcoin co... |
A | Right. The net effect of this is that blue chip collateral in systems like AAVE, compound maker ether, will probably be able to achieve even better collateral factors. It will be even more efficient to use ether, and this will be true for all the collateral that's currently in there. There's more efficiency, more capit... |
B | Yeah, they have a useful new tool in their toolbox to make Aave more efficient and support more collateral types. |
A | Hazu Hart talked about how we use some of the MEV share infrastructure in the background. We've talked about the pattern here. We actually haven't talked about so much of the parameters. Maybe you can go into the specifics of, if you pop open the hood of this system, what does it look like in the background? How does t... |
C | Mev share. |
A | Yeah. The part of Mevshare that overall taps into. |
C | Yeah. So Mev share is what I would say, what I would call an order flow auction protocol. So it introduces one new party that we don't typically talk about. And it's called the MEV share node. And it has advised it a protocol because it allows basically for ofas or like, applications to. To be built on top by wallets, ... |
A | The pattern that I'm seeing here, I'm just going to go back to my line from earlier, is that the cool thing about Mev is that we once thought it was this massive problem. And one of the patterns that I've seen over time is actually mechanisms are allowing us to leverage this problem into market clearing forces. Hazel, ... |
C | Yeah, for sure. You're absolutely right. The Mevshare node is a new centralized actor in the system. So I think in this case, it's not a problem because the search, it doesn't introduce any new trust assumptions in the sense that flashbots is already a block builder and a relay. And so effectively, everybody already tr... |
A | So if listeners are curious into going down that rabbit hole, Hauser just pointed to the bankless episode about suave that we did. I don't think it would be a mistake to rehash all of that here, but I think this is where that part of the conversation leads. Heart. Go for it. |
B | Yeah. No, no. To add to that, first of all, that episode is really, really good. And I do think of, like Hasu said, mevshare is a protocol for building for order flow auctions with some points of centralization. I look at Suave. Suave is a lot more than that, but I look at suave as going to be a decentralized protocol ... |
A | The worst case is table stakes. |
B | The worst case is table stakes. The other answer here, just because there have been some questions around centralization concerns in the oval design. Even if the MEV share node goes down or the oval node goes down, that infrastructure all breaks as soon as this short auction passes. The oval contract on chain on Ethere... |
A | You talk about this short auction, how long is it? |
B | It's a parameter of the protocol. They can set it to what they want. And this gets a little bit technical in terms of why would it be more than one block? And the answer is not every block builder or not every block builder is connected to MeV share. And so you don't necessarily have complete coverage on every slot. So... |
A | Otherwise it's one block. It's supposed to be one block. |
B | Yeah, 90% of the time you're going to happen the same price update or the same block that the chainlink update would get mined if you didn't use oval. |
C | And the nice thing about MeV shares that it doesn't actually increase the latency of transactions go on chain because it runs during the one block window. And yeah, so as Hart was saying, in the positive or like the normal case, you don't incur any additional penalties. So this is really more of a fail safe mechanism. ... |
A | Cool, cool. Understood. So, Hart, I think this kind of brings us to the last bit of conversation which we looked at the technical conversation under the hood, the economic conversation as to the incentives, as to why protocols will adopt this. But I think now we have to get into the bd conversation, because ultimately,... |
B | Going well, we put a proposal up to Aave to adopt oval in a very, very limited way. One of the advantages of AAVE, their standard markets are all interlinked, and they want to be very, very cautious of changing anything because there's billions of dollars at risk. But they also have AavE three isolated markets, which a... |
A | Interesting. I want to actually go down a side quest that's parallel to this, I think. Hash, I think you might be familiar with this. Maybe both of you are. Sorello Labs and their uniswap V four hook. Maybe I can set this up and hash, you can take the rest of it. It's a very similar mechanism, although it's not at all ... |
C | Yeah, so you're exactly right. So it's the exact same pattern. And I think the pattern is what's most interesting to understand. So if we kind of go back to what we said earlier. So a user wants to trade a token, they don't know what feed to set, they don't know what slippage tolerance to set. So you kind of have this ... |
A | And I'm going to go ahead and. Hart, do you want to say something? |
B | No, I just think the Sorello solution, it is using the gating mechanism. I mean, again, we should have Ludwig and all them talk, but it is a very cool, elegant solution that says, hey, we know there's sec sex arbitrage that's getting leaked here. So if you want to trade against this pool, you got to pay us. And that go... |
A | So one last conversation here. So we have oval and this gate, we have this pattern that we were seeing applied on to uniswap with V four, with the project that we just brought up, Sirella Labs. But each of these are taking a cut, right? Because, come on, we are rational economic actors. We want our upside. I'm assuming... |
B | Yeah, there is. I think it makes a lot of sense. Like Hasu said at the beginning, Mev should go back to the protocol that created it or the source that created it. And we very much believe that. So this MeV that we're capturing should go back to aave or compound, and they can mostly go back to aave in compound and they... |
A | Compound maker, maybe not. Maker are consuming Chainlink oracle prices and Chainlink is just giving this out to Defi for free. I'm assuming they make money on that somehow. Maybe not. |
B | That's complicated. That's a good question to ask Chainlink. But the price feeds are permissionless. Anyone can access these price feeds for free. |
A | Chainlink itself or insert your generalized oracle provider here also needs to be a part of this process of achieving some sort of take rate in order to make themselves a sustainable business. Otherwise they go away. |
B | Yeah, I agree. Again, Chainlink has many different kind of products and business lines and they do charge or have fees in other circumstances. But the core product that supports most of Defi, like their ETH USD price feed, it's freely accessible and Defi is built on top of it. And figuring out a way to make that be sus... |
A | Totally, totally. Hazu, I have learned a ton in this conversation. Is there any stone left unturned or maybe just future questions that you have or future topics that I think that you guys might think are next in this conversation? Maybe if we were to resume this conversation in a year or so, maybe what are some ideas ... |
C | I need to think about this. Can heart go first? |
A | Heart you first? |
B | Well, I'll give you an easy one. How does this work on layer twos? What does the mev supply chain on layer twos look like? What's the type of oracle or oracle related mev that gets leaked on layer twos? And theres actually a whole slew of mev that gets leaked by perpetual exchanges like perp exchanges, decentralized pe... |
C | Yeah, I agree with that I think if you come back in one year, I would be very interested to just do a checkup on how much mev is still being leaked at the application layer, how much basically extra money is leaked by lending protocols. But also we talked about LP's. So for me, that would be interesting if that paradig... |
A | Beautiful. Guys, I think we have a long roadmap of content ahead of us. There's a lot of juice left to squeeze out of these conversations. A lot of juice left to keep in the defi apps. Heart Hazu, thank you so much for coming on and explaining this part of the Defi world to us. |
B | Thanks, David. |
C | Thanks, David. Thanks for having us. |
A | Heart. If people are just interested in learning more about Oval, where should they go? |
B | Yeah, so Oval is an UmA product. Go to Uma Xyz and you can read all about it. And then Twitter. It's ooma protocol. Yeah. |
A | Guys, this has been fantastic. Thank you so much for coming on bankless nation. You know the deal. Crypto is risky. Defi is risky. Hopefully it's becoming a little bit less risky, but you could still lose what you put in. We are headed west. This is the frontier. It's not for everyone. But we're glad you are with us on... |
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