Summary
Liquidations on Morpho Blue have resulted in up to $2.4M of Oracle Extractable Value (OEV; a subset of MEV created by oracle updates) leaving the Morpho Blue system. This value is lost with very little value to the Morpho ecosystem or its users. Oval is an OEV recapture tool that can recapture this value in a risk minimized way and return it to market lenders to incentivize market growth.
Introduction
The OEV Problem
Morpho Blue markets, like most DeFi lending platforms, use permissionless liquidations that are incentivized by a fixed rate Liquidation Incentive for a given Liquidation Loan-To-Value (LLTV) to clear unhealthy user positions. The Liquidation Incentive is set conservatively high, as the protocol’s first priority is to ensure liquidations happen quickly, not to price the liquidation efficiently.
Liquidations are executed by the first liquidation transaction after the user’s position becomes unhealthy, which usually happens due to a price feed update. This creates competition amongst liquidators to place their liquidation transaction directly after a price feed update transaction creates an unhealthy position. This leads to liquidators paying all excess profit to block builders through MEV, or more specifically Oracle Extractable Value (aka OEV, a subset of MEV created by oracle updates).
Below is how typical Morpho liquidations are currently processed through the MEV supply chain:
- Oracle price update tx submitted to public mempool
- Liquidators submit liquidation tx with a bid to builders
- Builders select the highest paying bid and includes liquidation tx behind the oracle update tx
- Builders submit blocks to proposer
- Proposer appends the most profitable block to the blockchain
From our research, typical liquidations end up paying 70-90% of the liquidation incentive to OEV. To date, Morpho Blue liquidations have paid $2.7M in liquidation incentives which results in an estimated $2.4M of OEV leaving the Morpho ecosystem. This OEV has no benefit to Morpho Blue markets as the actual cost for the liquidation to be included in a block is a tiny fraction of what liquidators pay to be first to the opportunity.
It is very difficult to predict on which markets or at what time liquidations will occur, but they occur most during bull markets when DeFi leverage is highest and prices have large pullbacks. Therefore, we think the OEV generated on Morpho markets will continue to grow and integrating Oval into new markets now could result in recovering large amounts of OEV.
Oval’s Solution
Oval allows Morpho Blue markets to recapture the maximum amount of OEV lost on liquidations. It does this by wrapping any oracle price feed in a simple smart contract that locks access to the newest price for an auction period. The default auction period is only 2 blocks. Liquidations that occur during the auction period must first unlock the new price by winning an auction built on Flashbot’s MEV-Share. MEV-Share is an industry leading MEV tool that underlies the popular Flashbots Protect tool that allows transaction signers to recover MEV created by their transaction. Oval uses this industry leading, battle tested MEV tool to fit the Oval auction into the MEV supply chain that is already used on DeFi liquidations. See the bolded text below for how Oval fits into the liquidation MEV steps from the OEV Problem section:
- Oracle price update tx submitted to public mempool
- Liquidators submit liquidation tx with a bid to Oval node
- Oval node bundles unlock tx & liquidation tx and sends to MEV-Share
- MEV-Share releases bundle & refund parameters to builders
- Builders select the highest paying bid and includes the liquidation tx behind the Oracle update tx
- Builders submit blocks to proposer
- Proposer appends the most profitable block to the blockchain
The Oval smart contracts enforce that Oval will never delay new prices for more than the auction period. For example, new price updates will commonly create no liquidation opportunities. In this case, the auction period expires with no winner and the Oval smart contract unlocks the newest price to be accessed by the market. In the unlikely case that the Oval node is temporarily down, the same onchain unlocking mechanism will limit new prices to being delayed by the auction period.
The offchain centralized components of Oval are designed to provide no new risks to the market. A malicious Oval node can only steal the OEV that is currently not captured by Morpho Blue markets.
Oval has been designed to be as easy as possible for current competitive liquidation bots to integrate. These bots only need to add the Oval Node RPC to the list of block builders they send their MEV bundles to. UMA is in contact with multiple parties that run liquidation bots to gather feedback and alert them to new Oval deployments.
Oval on Morpho
Consideration
When planning a market Oval should be considered along with other market parameters for determining appropriate market risk parameters. The main Oval parameter to decide is the auction period (or unlockWindow). This is the maximum length of the Oval auction and the maximum delay for new price feed updates to reach the market. A longer unlockWindow results in the market being exposed to more stale prices, while a shorter unlockWindow can result in missed OEV due to block inclusion rates. The default unlockWindow is 24 seconds (or 2 blocks), but further consideration should be given for volatile token pairings.
OEV Redistribution
The OEV redistribution plan for Oval enabled Morpho Blue markets has been designed to align with the Morpho Blue design and incentivize growth of Oval enabled markets. All Oval enabled markets will use the same Oval settings (except for the configurable unlockWindow) and OEV redistribution scheme to prevent market fragmentation. OEV will only be redistributed to the same market in which it was recaptured so that markets are independent and isolated from each other. Recaptured OEV will be redistributed to lenders to mitigate their risk of bad debt and increase lending APYs. Lenders were chosen as the beneficiaries as we believe this creates healthier market incentives than returning it to liquidated users, and similar to Morpho’s approach to rewards, we believe this is the best way to incentivize market growth.
All OEV that is captured on Morpho Blue markets will be redistributed to lenders through the Morpho Universal Rewards Distributor similarly to how other protocols incentivize markets. If preferred by the community, we are open to adding the Morpho Rewards Committee Multi-sig as the owner or co-signer on this multi-sig as well.
Funds will be pooled and distributed in the following manner:
- Funds will be pooled over a calendar month
- At the end of each month, any OEV generated will be returned to market lenders in 2 ways:
- In the rare occurrence that bad debt was accrued on the market in the previous month, OEV will first be used to compensate lenders that experienced a loss due to this.
- All remaining OEV will be distributed as lending rewards over the next calendar month
UMA will develop scripts to generate the URD merkle trees and use Gelato bots to automate this process as per the Morpho docs.
Transparency
UMA is committed to providing public transparency on Oval’s performance on Morpho Blue markets and the amount of OEV recaptured and redistributed back to lenders. UMA is currently developing Dune dashboards to serve this purpose.
Deployment
To use Oval on a new Morpho Blue market, a simple Oval wrapper contract should be deployed for all supported price feeds used for the market. Note, not all price feeds used for a market require an Oval wrapper contract, but OEV will only be captured from liquidations made possible by new prices unlocked by Oval wrappers.
Similar to Morpho Blue, Oval is oracle agnostic and currently supports Chainlink, Chronicle, Pyth and Redstone Classic price feeds and outputs a Chainlink-like price feed that is compliant with the MorphoChainlinkOracleV2 contract commonly used by Morpho Blue markets.
Fees
Oval was developed to be maximally easy to integrate and compatible with lending protocols without requiring any changes to protocol smart contracts. UMA also runs and maintains high performance offchain infrastructure to service Oval. As such, UMA typically takes a 50% fee of all OEV generated by Oval. However, to demonstrate our long term commitment to the Morpho ecosystem UMA is committed to not taking any fees on Morpho markets for the first 6 months.
Resources
- Oval contact form: uma.xyz/oval?modal=integrate-oval
- Oval Docs: docs.oval.xyz