DeFi Project Spotlight: Trading On-Chain Ethereum Derivatives With Oiler Network
Oiler will allow institutions, exchanges, and other big players to invest in cryptocurrency while hedging against network risks.
- Oiler is an on-chain trading protocol for blockchain parameters like gas fees or network hashrate.
- Oiler’s clients will most likely be Ethereum power-users like exchanges, wallet operators, or Layer 2 providers.
- Oiler functions without oracles. All information they use is available directly on the blockchain, thus limiting oracle attack risks.
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By offering on-chain derivatives, Oiler Network allows companies to hedge the risks of adverse network events. For most users, fluctuating gas prices or a blockchain’s hashrate is not of the utmost concern; for companies, exchanges, or whales, however, Oiler provides stability and insurance around what they can’t control.
Hedging Gas Fees and Network Shocks
Oiler Network provides insurance for heavy blockchain users such as exchanges, institutional clients, Layer 2 (L2) providers, miners, and DeFi power users. To do so, it has built an options trading platform of blockchain-native derivatives. These derivatives could be the total hashrate of the network (the computing power currently supporting the Ethereum blockchain), the cost of gas fees, or the state of any other blockchain parameter.
In practice, exchanges are some of the most gas-hungry participants in blockchain networks.
Very often, they will pay millions to subsidize withdrawals from their custody to on-chain addresses. With the rise of gas prices in the last year, exchanges like FTX have decided to stop allowing free withdrawals on the Ethereum blockchain after paying more than $20 million to subsidize these withdrawals.
FTX will always do what it can to let you withdraw.
So far we've even made them *free*, paying > $20m in gas.
But ETH fees are getting unreasonable.
a) non-ERC20 withdrawals are free
b) ERC20s are free if you stake >= 150 FTT
c) otherwise you'll pay blockchain fees
— FTX – Built By Traders, For Traders (@FTX_Official) February 24, 2021
Any entity that needs to use the Ethereum blockchain is exposed to these changing parameters. While a retail investor might choose to wait for lower gas prices before reorganizing their on-chain portfolios, this is not a luxury that large entities can afford.
This is where Oiler’s on-chain derivatives options come in.
Hedging is a necessity for many businesses. In essence, hedging is purchasing insurance on the future of undecided outcomes. A farmer, for example, might hedge his next crop by buying an option from a market maker granting him a significant sum if no rain falls in the next year. If rain does fall and he has a successful harvest, the option’s price can be seen as insurance. In the unlikely case it doesn’t, the money he makes from his option will cover his losses.
Oiler Network will provide a marketplace for these options to help hedge against network shocks.
Anyone will be able to write and trade options to hedge high gas fees, suddenly falling hashrate and protect their businesses from unpredictable events. These options will be traded on-chain, providing guarantees of equality, availability, and trustless transfer that traditional finance can’t match.
One of Oiler’s key design decisions was to forgo oracles. Oracles are third-party services that provide external information to smart contracts. This could be price information, payment completion, the sale of a physical asset, outside temperature, or even the number of votes a political candidate received. These oracles relay information to a smart-contract program which then executes its code.
Oracles are key to improving the utility of smart contracts and help bridge DeFi to the real world. However, their data feeds can be corrupted and can quickly become a dangerous vulnerability for smart contracts.
The Oracle Problem refers to the issue created by the potential falsification of data in the real world influencing an otherwise well-functioning smart contract.
These can be exploited for profit by savvy traders, as when a user manipulated the feed of bZx’s price oracle by crashing the price of WBTC after opening a BTC short on their platform. But oracles can also be hacked, as when more than $100 million worth of assets were liquidated on Compound following an oracle exploit.
In an interview with Crypto Briefing’s team, the founder of Oiler Network Tomasz Stanczak explained that the vision for Oiler, at the moment, does not include oracles. As Oiler offers options on blockchain parameters, they do not need to use an oracle to keep smart contracts informed of current gas prices. Parameters can all be retrieved directly from the Ethereum blockchain without the need for an oracle.
This design decision removes the risk of oracle exploits and improves the value proposition of Oiler for their bigger clients. Exchanges, L2 providers, or any entity spending large sums regularly on gas fees can’t expose themselves to the same kinds of risk retail users do.
Managing Risks: A Whale Game
In many ways, Oiler Network is a niche product. For most users, hedging gas prices or network shocks is not worth their time as they enjoy greater flexibility in the market. Oiler’s main clients are those who can’t. Wallet operators, for example, pay high gas fees every time they create a new wallet. In the case of Argent, this cost is reflected in the first deposit a user makes in their new wallets.
Layer 2 providers pay high gas fees for any transfer of funds between the Ethereum blockchain and their sidechain. Polygon partly subsidizes these transfer fees and, depending on gas prices, spends a fortune on them. Perhaps no single centralized entity is as affected by these high prices as exchanges like Binance or FTX. If they subsidize any withdrawal to addresses on the Ethereum blockchain, they’re vulnerable to high gas prices.
The current bull run has been dominated by a new variety of investors, led by the likes of MicroStrategy or Tesla. Companies like this need much more robust insurance in case of drastic changes in the health of the blockchain.
These late entrants to the blockchain space will be more risk-averse than the current DeFi community, which prides itself on being true “degens.” The more they can offset risks beyond their control, the more likely they are to invest in blockchain technology.
When Visa declared they would settle digital currency transactions on the Ethereum blockchain, they accepted the risk of a sudden surge in gas fees or a drop in the hashrate securing Ethereum. The instruments developed by Oiler Network could allow a company like Visa to continue in this direction and remove some of the risks associated with the new system.
Oiler isn’t the only project who understands the risks posed by high gas fees and network changes.
Oiler’s main competitor when it comes to hedging high gas prices is the famous gas tokens. These gas tokens store gas inside smart contracts, which, when destroyed, allow users to make transactions on the blockchain. This is another option to hedge high gas prices, but Ethereum founder Vitalik Buterin recently proposed to remove the possibility for gas refunds using these tokens.
EIP 1559: Providing New Parameters for Oiler
Oiler Network is a very technical product whose foundation is blockchain parameters. If Oiler can know something about the blockchain directly, then they can offer trading for it. One of the main features of EIP 1559, the upgrade to Ethereum’s network expected in July, will be to provide many more visible blockchain parameters.
Most importantly, the introduction of gas-burning will remove the possibility for miners to manipulate gas prices and offer a new indicator. This base fee will be burned with every transaction. While miners can still manipulate prices right now by artificially driving the price of gas up and recuperating it, gas-burning will provide a fixed-per-block base fee which will truthfully attest to the current network usage.
This will be another blockchain parameter for which Oiler can provide a market. Ethereum 2.0, the much-expected transition to Proof-of-Stake, could also be a catalyst for Oiler’s growth.
“Gas prices will stay in Ethereum 2.0. Ethereum 2.0 will be a more complex protocol, so that makes Oiler more exciting. The more blockchain parameters we can check, the more options we can create for our users,” said founder Tomasz Stanczak.
Stanczak is well-placed to bring this project to fruition. Before joining the crypto space, he worked as a software developer at the Chicago Mercantile Exchange (CME) and as a technology lead at CitiBank. Unlike many crypto-natives, these experiences offer insight into how larger organizations assess risk before investing in products. This also explains Oiler’s commitment to such a specific type of crypto user.
He has also worked closely with the Ethereum network itself. In 2017, Stanczak and his team began building Nethermind. It doubles as an Ethereum client to help developers build on top of the network and a data marketplace for interested parties.
After Nethermind, he has also contributed research and code to the Flashbots research group. Flashbots is a small group of researchers and technologists working to shed light on the “Dark Forest” of on-chain activity. They are specifically focused on the subject of Miner Extractable Value (MEV) and its “negative externalities.”
The Flasbots team provides the following as just one example of MEV:
“One example of such structural arbitrage opportunities are Uniswap price arbitrage trades: when a Uniswap pool’s assets become mispriced, a profit opportunity is created to arbitrage the Uniswap pool back to parity with other trading venues. Of course, rather than letting the trader pay them a transaction fee for the privilege of collecting the arb profit, a miner could simply decide to run this strategy themselves.”
For a deeper dive into MEV, readers are advised to read Crypto Briefing’s feature on ArcherDAO.
From traditional finance to mitigating the impact of MEV, all of these experiences suggest that Stanczak has a firm grasp of the niche he and his team are exploring. Whether the market agrees, however, remains to be seen.
The project already enjoys support from many long-time crypto users, developers, and investors.
We wanted to take the time to disclose our list of backers and thank them for trusting us with our ability to build Oiler!
— Oiler Network (@OilerNetwork) May 7, 2021
Final Thoughts: Oiler Network
Retail users are acutely aware of the prohibitive costs of using the Ethereum network.
Still, they are relatively shielded from these costs. Instead of rebalancing when the network is expensive, they can wait for costs to drop or risk sending a slow transaction. In either case, the stakes are much lower.
For larger users, this is not the case. If one’s business model hinges on performing on-chain operations at will, then gas costs become a much more important issue. This challenge is not lost on many emerging projects.
Like Oiler Network, gas tokens, synthetic gas futures, and other varieties of hedging mechanisms have emerged. One of the key differences between Oiler and its competition is that it does not rely on an oracle. Crypto-specific businesses are as aware of oracle vulnerabilities as they are gas costs. Thus a solution that removes this vulnerability may be extremely enticing.
In theory, this makes Oiler a promising solution for this demographic. The project is, however, still very nascent. They have only recently launched their native OIL token and a staking feature for interested users.
The project’s success hinges on the continued growth of Ethereum, whether its technical differences are seen as an advantage by its target market, and, of course, execution.
Disclosure: Both authors of this piece held ETH at the time of writing.