Oiler Network — Oracle-less Blockchain Native Derivatives

Our Oiler Thesis

DeFi money legos empower developers to construct complex financial systems by composing and remixing together simple building blocks. While DeFi has captured the world’s imagination in recent months, increasing levels of demand have led to subordinately high and unpredictable gas prices. As such, market participants dealing with blockchains such as exchanges, miners or traders experience growing levels of exposure to external risk factors that jeopardise the sustainability of their operation.

Despite this having to do with the scalability limitations of Ethereum, the need for market participants to hedge their risk exposure to gas prices pre- and post-network upgrade remains of paramount importance. Over the short life-span of DeFi, we’ve seen several projects trying to work on introducing hedging instruments such as ‘gas tokens’ (GST2 or CHI) or UMA and YAM’s binary options via their joint venture, Degenerative Finance. While these attempts are a step in the right direction, the future of these products remains questionable, and in most cases, their design opens up several attack vectors bad actors or a single miner can manipulate or compromise.

The growing complexity of DeFi has also brought to the forefront more novel risks. One of these risks is Miner Extractable Value or MEV. MEV is a measure of the profit a miner (or validator, sequencer, etc.) can make through their ability to arbitrarily include, exclude, or re-order transactions within the blocks they produce. Since MEV creates more opportunities for miners and/or traders to profit from blockchain-specific arbitrage opportunities, we are witnessing unpredictable levels of demand for hashrate. In response, several centralised exchanges such as Binance and FTX have recently launched their versions of hashrate future contracts. However, as with any product or solution originating from a centralised counterpart, there is always an array of single-point-of-failure (SPOF) risks as well as market-wide trust issues regarding verifiability of the underlying. While this opens up the door for decentralized alternatives, few protocols offer the products that satisfy the full suite of hedging needs as well as the security guarantees necessary to attract mass-market.

In this brief, we are pleased to present Rarestone’s latest addition to its portfolio — Oiler Network. Oiler is Rarestone’s best bet at bringing to market a suite of derivatives deriving from blockchain-parameters that will seek to help market participants hedge risks inherent to blockchains themselves. Oiler’s unique and thoughtfully designed oracle-less system architecture offers a first-of-its-kind solution bringing much-needed security and trust guarantees to the decentralised derivates market.

At Rarestone, we see Oiler’s technology and offering as a natural evolution of the market for hedging blockchain-associated risks, namely gas fee volatility. While ‘gas tokens’ in the form of a physical delivery commodity is the market’s current solution to the widely-felt problem, we are not particularly optimistic about its future given Vitalik’s recent proposal to remove the gas refund functionality. Effectively, this would render gas tokens useless and current market demand would need to find alternative ways to hedge their exposure.

Read on to learn more about Oiler and why it excites us about the future of derivatives in DeFi.


Project Description

What?

Oiler is a derivatives trading protocol that allows individuals and/or businesses to trade on changes to blockchain-specific parameters.

Options issued on the Oiler Protocol are priced and settled without interacting with oracles.

Empowering option buyers with these new financial products in a trustless and truly decentralised fashion allows for risks inherent to blockchains (such as transaction fee volatility or protocol changes) to be hedged appropriately. Oiler Protocol will begin by offering option writers the ability to underwrite American binary options.

Binary options serve as a tool for reducing risks, however, they can never serve as a perfect hedge. As the strike price of an American binary option is reached, it can be exercised and therefore prevent further monetary gain from continued growth of the underlying. Resultantly, Oiler plans to explore more risk-aligned hedging instruments in the future, such as vanilla options and even futures.

Options issued by the Oiler Protocol will be made available for trading via:

  1. OTC — Option writers will be able to sell their options directly to known buyers.
  2. OptiSwap — To support the trading of binary options, Oiler will launch its own Automated Market Maker (AMM) called OptiSwap, which is a fork of Balancer’s technology. Option writers will be able to also supply liquidity to the option pools in return for market-making fees.  
  3. Centralized Exchanges — The Oiler team foresee centralised exchanges listing Oiler-native derivatives in the future once the ecosystem matures.

The following binary options will be launched initially:

  • Gas Option: The Block Gas Option is designed to help Ethereum users hedge against changes to Ethereum gas prices. The underlying of the Gas Option is BASEFEE – a transaction cost parameter used in the EIP-1559. BASEFEE fluctuates as a result of the supply and demand changes. The Supply-side is represented by the block gas limit and is set by miners and/or core developers. Demand-side is defined by the demand for the storage and computation on the Ethereum network.
  • Hashrate Option: The hashrate option is designed to help miners hedge against block reward changes. The underlying of the hashrate option is block difficulty. When buying or selling a hashrate option, investors may be expecting some sudden difficulty change due to a new ASIC introduction (technological progress) or a network upgrade to happen, or miner exodus.
  • Capacity Option: The underlying of the capacity option is the block gas limit. Block gas limit defines how much computation and storage can be used within the single block. Block gas limit fluctuation can be caused by one of the few factors e.g., miners deciding to move the block size up or down, or when core protocol developers advise miners to change the block gas limit and miners following the advice.
  • Ice Age Option: The Ice Age Option is designed to help in hedging the risks associated with fluctuating block times, which could severely impact miner revenue. The underlying of the Ice Age Option is the blocks’ timestamp delta in relation to their parents.


Why?

Target Markets

Supply-side
  • Option Underwriters — Opportunity to make attractive returns through writing options and selling for a premium.
  • Market Makers — Option underwriters, as well as other market participants with ample amounts of financial capital, are motivated to make an attractive return on assets by supplying liquidity to markets and capitalising from market-making fees.

Demand-side
  • Miners — Currently miner revenue originate from the block rewards, transaction fees and miner extractable value (MEV). All of these sources of revenue are subject to changes and volatility due to external factors, which makes financial planning for purchasing new hardware and the efficiency of such error-prone and potentially costly.
  • Exchanges — Cryptocurrency exchanges need to cover the highly volatile on-chain assets withdrawal costs, which can prove to be very costly during peak hours.
  • Institutions — Businesses with exposures to many blockchains may need to hedge the protocol-level risks in order to manage working capital appropriately.
  • Traders — Trading of blockchain native parameters is not possible at the moment for the most part. Some centralised exchanges, like FTX, offer synthetic hashrate futures and Binance recently listed tokens backed by actual hashrate. However, none of these is truly trustless and decentralised. Current solutions for trustless trading of similar instruments rely on oracles, exposing traders to a considerable amount of technical risk.

Oiler – Value Propositions

  • Ability to hedge blockchain-native risks Option buyers will be able to mitigate volatility risks by enabling them to lock-in a price of the underlying at an agreed-upon date.
  • Security Oracles are often the biggest attack vector for decentralised applications and protocols, whereas Oiler Protocol’s oracle-less structure eliminates these risks entirely.
  • User Acquisition — Centralised Exchanges that decide to list Oiler based financial derivatives may attract institutional miners to their trading platform and experience more trading volume.
  • Yield (for option writers and OptiSwap market makers) Oiler presents a new investment proposition that potentially offers an attractive risk/return profile. 
  • Trading edge for option writers — Market making on Oiler Protocol will require specific domain knowledge.  First of all, in-depth knowledge of hedging and pricing is necessary for option writing. Furthermore, a market maker will also need a fundamental understanding of all Ethereum protocol related events and their effects on the tradable parameters. As this is a big barrier to entry, market makers who have the required knowledge will have an edge and can profit from it.


How?

Querying blockchain parameters

Oiler Protocol achieves an oracle-less architecture by solely relying on parameters that are available on-chain. Since there is no need for any off-chain information, the technical risks and attack vectors associated with the usage of oracles are mitigated.

In order to cater to the needs of the options issued on Oiler, the data points needing to be captured are attainable whenever a transaction is made. Viewing a transaction of Etherscan shows an accurate recording of each of the blockchain parameters such as difficulty, block reward, etc.

Similar to how Yearn Finance queries blockchain data for its investment rebalancing function, Oiler captures all the data it needs each time a user sends a transaction that interacts with the Oiler Protocol. Alternatively, the EIP-2935 mechanism may be used in the future for querying historical block data when needed.

Since each parameter can vary with each block, bad actors can take advantage can try to manipulate parameters for financial gain. In an effort to prevent such events, Oiler captures data over a period of time and calculates the average value before making it actionable.

Note — Querying blockchain parameters is not always needed. Oiler will need to query the chain only when collecting averaged values over time (practically only for the gas price). In most other cases Oiler will not necessarily require it. Oiler contracts find multiple ways to extract the data from the blockchain (sometimes via the Yearn Finance-like mechanisms, sometimes in simpler and less costly ways).

Option Writing

Option writers need to back every binary option they issue on Oiler with 1 USDC, until the expiration date. As with all binary options, option purchasers may wish to exercise the put (or call) option when the contract is below (or above) the strike price. If an option gets exercised, the collateral can no longer be withdrawn by the option writer. Instead, the collateral is redeemed by the option buyer.

Option writers can capture the option premium in multiple ways:

  • The options can be sold OTC,  which may be deemed suitable for higher-volume traders.
  • Users can trade the option on OptiSwap.
  • In the future, option writers can trade the option on a centralised exchange.

Oiler OptiSwap

Oiler Protocol will launch its own AMM (a fork of the Balancer Protocol). Option writers and Option holders will be able to supply liquidity for the options on the AMM in return for market-making fees.

Market making on Oiler Protocol will require very specific domain knowledge related to Ethereum network parameters. This will be a considerable edge for market makers and a barrier of entry for others.

Utilizing Balancer’s technology is integral to the integration of a time decay function. Such a function is needed to properly account for inherent properties of options, specifically their declining extrinsic value.  With the time decay functionality, the value of the option would continue to decline towards $0 even if there are no trades in the pool.

With normal AMMs, arbitrageurs would be incentivised to mint new options and sell them against the liquidity provider, pushing the price of the option towards $0. Consequently, liquidity providers would suffer significant losses, thereby undermining the viability of protocol liquidity provisioning. Therefore, OptiSwap’s time decay functionality aims to protect liquidity providers during times of low trading activity. Moreover, OptiSwap will launch with an above-than-average fee to offset any potential downside. The fee will aid supply-side option liquidity provisioning and counter impermanent loss, while generally increasing the incentive to provide liquidity on the AMM.

It is important to note that the current iteration of the time decay function does not fully solve the impermanent loss issue related to providing liquidity for options. It should be considered a step in the right direction and help improve the design of existing AMMs.

EIP-1559

The gas-related options on Oiler are dependent on the successful integration of EIP-1559. The upgrade is ready within the next weeks and will be implemented during the London network upgrade, which is scheduled for July 2021. Even before the integration Oiler Protocol will still launch and offer some options products.


OIL Token

Value Accrual Thesis

The OIL token will be structured as a governance token and encourage community participation, code contributions and technology improvements. As a result, further ecosystem integration of the token is up to the token holders to decide. 

Token Metrics

Note – changes to the token metrics (an extension of the vesting periods is currently being deliberated) are potentially subject to change.

Oiler will engage the public through a Liquidity Bootstrapping Pool (LBP) Program. More details to come from the team about this soon.


Executive Team

Tomasz Kajetan Stańczak | Founder

  • 3+ years of experience in Ethereum core protocol development as the Founder of Nethermind
  • 8+ years of experience as a software developer in traditional finance, including VP, FX eTrading Technology at Citi Bank for 1.5 years.
  • MSc in Information Technology.

Antonio Sabado | Head of Community & Partnerships

  • 10 years of business development and community building experience.
  • Founded Work On Blockchain, which grew to a considerably sized blockchain developer community.

Gregoire le Jeune | Head of Growth

  • 8+ years capital markets experience
  • Former investment analyst at C4 Ventures 
  • MSc at ESCP Europe


Stage of Maturity

Oiler Protocol is currently in beta.

Interested parties can request an introduction to the team to join the testing phase.


Why we like Oiler

Team

  • Energetic and highly compatible team with a unique mix of experiences, ranging from traditional finance and banking development experience, Ethereum core protocol development and involvement in many relevant web3 projects.
  • The team demonstrate a deep understanding of future business opportunities based on detailed knowledge of Ethereum’s tech stack and the blockchain parameters changes. Their ability to develop financial products that align with the Ethereum roadmap is —in our view — ahead of the competition.

Project

  • Novel tech strategy with little reliance on third-party protocols or price feed oracles. The robustness of the system and security guarantees will serve to attract target mass-market consumer and institutional participants.
  • The growing importance of miner hedging could result in network effects for the protocol. As trading volume increases, fees collected by OptiSwap LPs will rise and subsequently result in growing interest from more supply-side option writers. Oiler Protocol can leverage such positive feedback loops and create a closer alignment between the interest in purchasing the offered options, writing options and increasing the liquidity of the AMM.

Market

  • Opportunity to capture a significant portion of an underserved market segment and scale with additional products in the future.
  • Good market timing with an increased awareness of the importance of hashrate due to MEV products and an uncertain political landscape for the future of Ethereum mining.


Risks

  • The adoption of layer-2 scalability solutions could lead to a reduction of significant gas fee volatility and reduce demand for hedging instruments.
  • The risk of EIP-1559 not being integrated and, therefore, Oiler Protocol only offering a small variety of options.
  • Due to the educational barriers of entry for OptiSwap market makers/liquidity providers, it may prove difficult to attract a sufficient amount of liquidity post-launch. Note — as mentioned above, education barriers can also be perceived as an opportunity for market makers to gain an edge and profit substantially, thereby attracting skilled market makers with ample amounts of liquidity.
  • The liquidity on the AMM would need to scale together with the interest in option writing. If there’s low AMM liquidity, writing a sizeable amount of options may be risky. Note — Oiler tackles this risk by introducing high AMM fees in a bid to make liquidity provision more attractive. Therefore, there will be incentives to write a large number of options and provide liquidity for such, instead of directly selling them for the premium. This is further supported by Oiler Protocol’s detailed calculations about the impermanent loss and OptiSwap — more details can be requested from the team (request an intro).


Disclosures

Rarestone Capital has recently taken a position in OIL based on the analysis provided in this report. This is meant to disclose any perceived conflict of interest and should not be mistaken as a recommendation to purchase OIL tokens. This overview has been prepared solely for informational purposes and is not to be considered as investment advice. It does not purport to contain all of the information that may be required or desirable to evaluate all of the factors that might be relevant to a potential investor, and any recipient hereof should conduct its own due diligence investigation and analysis to make an independent determination of the suitability and consequences of any action.