Investment Highlight: Automata
We would like to thank Deli Gong (Co-Founder ) & Sam Koh (PR & Marketing) from Automata Network for their feedback and contribution to this article.
A key talking point in the Ethereum ecosystem is the concept and problem of miner extractable value (MEV). MEV is a relatively new and understudied phenomenon where miners and arbitrage bots can manipulate transaction data for economic gain at the expense of users.
In February 2021, Apollo Capital spoke to the team from Automata, a leading solution to MEV, and ultimately received an allocation in their private sale at a purchase price of US$0.02 per token. On June 7, Automata (ATA) launched through the Binance launchpad and hit a staggering all time high of US$1.97 within hours of trading. While ATA now trades at $0.54, this investment highlights our ability to receive allocations into highly prized primary offerings and is a current return of 2,600%.
Miner (Maximum) Extractable Value
There are two main forms of MEV. The first form of MEV is arbitrage bots frontrunning transactions that are submitted to decentralised exchanges (DEXs). These transactions are able to be front run by setting a higher gas price, enabling preferential ordering in a block. Arbitrage bots can carry out this process because transactions are publicly broadcasted to the Ethereum blockchain’s mempool before confirmation, the mempool is also known as ‘The Dark Forest’ where savvy bots and miners prey on innocent DeFi users.
The next common form of MEV stems from the ability of block producers (miners in PoW systems and validators in PoS systems) to rewrite the order of transactions in a block as well as the ability to reorder blocks entirely, as is the case with the Ethereum blockchain. This form of MEV is particularly troubling as it means that particular malicious actors have an unfair advantage due to either being a block producer or paying a block producer to prioritise their transactions. It is not feasible for ecosystem participants to compete on a level playing field with these actors.
History of MEV
The concept of MEV was first formally introduced in April 2019 by Phil Daian and his Cornell colleagues in “Flash Boys 2.0”. The research paper concludes with “They [MEV profits] constitute an economic vulnerability that should be a current cause for concern in Ethereum.” Following this initial conclusion, MEV continued to be a fringe topic of discussion in the Ethereum community as the negative effects of MEV remained relatively unnoticeable to everyday users. MEV was later popularised through the articles ‘The Dark Forest’ & ‘Escaping the Dark Forest’ as well as the fact that frontrunners were adding to the high gas fee problem that Ethereum has suffered from.
Since the initial research paper published in April 2019, Phil Daian and the organisation ‘Flashbots’ have been leading the research and early solutions to MEV. Flashbot Auctions aims to make the MEV extraction process more fair and transparent by providing a private communication channel between Ethereum users and miners for efficiently communicating a preferred transaction order within a block. This communication channel is off-chain, which frees up block space and has proven to have a positive impact on gas fees as arbitrage bots are no longer competing on-chain.
The Cost of MEV
The best resource to explore the cost of MEV is the MEV-Explore v0 Dashboard by Flashbots. This dashboard states that the Total Extracted MEV (since Jan 1, 2020) is US$750 million. We can see from the Cumulative Extracted MEV chart that MEV has been accelerating in recent months, which is particularly worrying for the Ethereum ecosystem.
Ethereum 2.0 & MEV
The term ‘Miner Extractable Value’ can be misleading when predicting whether MEV will continue to be a problem once Ethereum moves to proof of stake. This explains why organisations such as flashbots are now referring to MEV as ‘Maximum Extractable Value’. MEV will continue to be a problem on Ethereum 2.0 as the transaction ordering as we know it today will still exist on Eth 2.0. Early research also shows that Eth 2.0 MEV may actually cause greater problems because MEV on Eth 2.0 increases the variance of returns between the luckiest and unluckiest validators. This may cause additional pressure for oligopoly dynamics to form as validators will want to smooth out the variance of luck, this will potentially be prohibitive to solo validators.
Solutions & Opportunities
At Apollo Capital, we have been actively studying and following MEV for the past 8 months as discussion and debate have been increasing rapidly in the community. We are now seeing ‘first generation’ solutions to the problem come to market and witnessing early adoption. Examples include ArcherDAO’s Archerswap, Chainlink’s Fair Sequencing Services, Gnosis’s COWSwap, Flashbot’s Flashbots Auction and Automata’s Conveyor. It is widely recognised that there is no ‘silver bullet’ solution to the MEV problem and that long term progress will come from technical breakthroughs and thoughtful dapp/DEX design.
“Automata Network is a decentralised service protocol that provides middleware-like traceless privacy services for dApps on Ethereum and Polkadot to achieve privacy, high assurance and frictionless computation.” – Automata Network
These traceless privacy services include a MEV solution known as ‘Conveyor’ and an anonymous governance voting service known as ‘Witness’. Conveyor is a service that ingests and outputs transactions in a determined order, creating a front-running-free zone that removes the ability to reorder transactions. Automata is implementing ‘Oblivious RAM’ (ORAM) in order to achieve this breakthrough, this is the first time that ORAM has been used in a blockchain protocol/project.
The team behind Automata have extensive blockchain expertise and experience with many team members being highly involved in Zilliqa (ZIL), a Layer 1 blockchain with a current fully diluted valuation of US$1.8 billion. Beyond Zilliqa, the team includes researchers from top universities who have published multiple papers on ORAM and blockchain technology in recent years.
For Automata’s MEV solution to be successful it will require adoption at the dApp level, rather than the user level. For example, major exchanges such as Uniswap or SushiSwap will need to integrate Conveyor into their product in order for users to get protection from front running rather than users choosing to get protection by using something like Archerwap or COWSwap. Automata’s Conveyor is designed to be lightweight and easy to implement. We believe that as the ecosystem develops and the negative effects of MEV become continually apparent, developers will be motivated to explore MEV solutions such as Conveyor in an attempt to gain and retain ‘MEV conscious’ users.
With a market capitalisation of $115 million and a fully-diluted valuation of $669 million, it is not inconceivable that the price of ATA will continue to trend down as early investors receive vested tokens. However, this strong initial price performance is a sign that the market is focused on gaining exposure to MEV solutions and that Automata is a potential market leader. Apollo Capital will continue to follow MEV developments and attempt to gain exposure to the value capture that may arise from successful solutions.