DappCon 2023: Can Order Flow Auctions Monetize Wallets, Fairly? - Max Sherwood

Transcript

all right hey everybody can't quite see familiar faces here but uh maybe some of you were at our meet up last night um yeah dcon 2023 it's good to be back it's crazy how fast the year goes um so yeah this is uh a talk that's kind of meant to just get the conversation started around wallets and monetization um you know probably most of us still use metamask um I work at ultimate which is a mobile wallet um and yeah the question is really like the title says you know can we make a wallet it zero fee and still monetize it fairly without centralizing ethereum um so yeah a bit about me I'm Max Sherwood I guess in three words I would describe myself as an Enthusiast an analyst and a validator as well um so I'm researching growth at

ultimate and I also co-founded a validator company last year called H2O nodes so let's get straight into it um where are we today in terms of like Dex versus sex trading so Dex trading makes up about 15% of the crypto trading volume uh the other uh 85% obviously being centralized exchanges um obviously these are these are rookie numbers right we want to pump those numbers up uh ideally we would we would flip the uh amount of volume that decentralized exchanges are doing uh and have there be more than even the centralized exchanges they're doing um but maybe you say okay well I don't really you know trade in defi I don't really you know trade shitcoins I don't really care well I have news for you if

you're staking your eth um you should care because thanks to boost and the new paradigm that we live in now where validators are collecting me um anytime there's a big spike in Dex trading or just defi activity generally uh we see a big spike in the staking apy um and here's a couple examples of that um and yeah sure it might only last a day or two but um you know I think you you get the idea here we should all want more Dex activity um as holders and stakers of eth uh so how do we get more Dex activity more users more volume onto dexes off of centralized exchanges probably not with um Antiquated uh uis no hate to curve of course but um you

know I think they almost did this T tongue and cheek uh because it looks pretty terrible um so you know at ultimate we're uh fully convinced that we need to move on to mobile uh this is already where uh trafi has gone you know most of us probably do a lot of our online banking on mobile um and 's no reason why you know we should all still be on our PCS on web extensions I saw people in line to collect merch uh a couple days ago with you know their laptops uh having their wallets open so uh you know we're still a little a little behind perhaps in crypto so when I started ultimate I thought okay well a wallet is you know just taking data from the blockchain it's just interacting with the blockchain it shouldn't be too hard to build a wallet right uh yes and no um

building a great wallet takes a great team and so some apis which are not cheap so uh you know if you load into a new wallet and you or let's say you import a seed phrase and you instantly see you know portfolio chart over the last three months like that's a lot of data right you're taking a lot of token balances historical balances even looking at your transactions you know you need to parse through transactions uh so there's a lot of stuff going on in the back end I guess is what I'm saying um and that needs to be built by some very skilled Engineers who uh typically like to be paid quite a nice salary um and the apis as well need to be fast and reliable and those are not cheap either so building a great wallet does cost money um and it begs the question how

should a wallet monetize right uh because nothing is for free so let's talk about metamask of course uh many of you know but actually let's see a raise of hands like who has actually used the built-in swap function inside of metamask before okay 1 three five some people okay uh a lot of people don't even know this exists especially the more advanced uh people amongst us but uh they do have a built-in swap function they uh aggregate liquidity from multiple sources and try to give you the best price and what do they do then they slap a 0.875 per fee uh onto your order which is probably going to ruin your price um and yet they've made somewhere between 2 200 and

$400 million uh so that's like the top right is the total revenue uh I've seen estimates higher than that as well as well um and the the figure the $58 million is the amount of volume they did last week when I put these slides together so definitely a lot of volume going through metamask um and they've made a lot of money you can see in the last bull market many weeks they were doing over 2 million uh in Revenue per week so pretty impressive uh but from a user's point of view are we really going to trade on wallets that use 8 75% as you know the fee probably not if any anything that's a reason not to use a wallet right because we can go directly to a de front end we can connect directly with a DEX and we don't have to

pay an extra fee um so I would say the added fees are a reason not to use a wallet and if we want to increase uh you know adoption and users and and Dex trading volume we actually need to remove hurdles from defi trading right if we think about what Robin Hood did in the US with uh you know trafi brokerage They removed all the fees uh they made it possible on your phone super easy so they kind of removed all the the hurdles so the question was not why should I trade on Robin Hood the question became why shouldn't I trade on Robin Hood uh and I think we need to do the same thing here so ultimate right now has no fees on swaps um that begs the question how can you monetize with zero fees uh so

there's a few kind of ideas out there uh subscriptions uh so a monthly subscription coinbase does this with their centralized exchange um I don't remember if it's like 20 or 30 bucks a month but uh they basically cancel out all your trading fees if you subscribe to this service um you could also do tipping where users could you know add a tip to their transaction which has worked for some companies in the past um I'm not really a fan of of either of those to be honest uh but the the last two points on here is kind of where we're going to go uh and is also more interesting for you know the ethereum community is uh talking about payment for order flow or meev rebates um so this is a picture I took last year downstairs uh that's Stefan from flash Bots or at least he was from

flash Bots back then now he's doing Frontier research uh and this is the mbv supply chain right crazy how fast stuff changes in a year uh this felt you know new back then um we were mostly talking about proposer Builder separation of course uh which is kind of the the latter half of the M Supply Chain uh but today I'm interested in talking about the front half which is users and and wallets uh so let's talk about order flow auctions which sit kind of in the middle here um so order flow auctions there's a few types out there so for example an RFQ a request for quote uh you might see this in like zerx API where there's market makers who are uh giving you quotes or giving the user quotes um and the lowest one will obviously win so

this is for like price discovery on swaps there's also exclusive B exclusive batch auctions which is more like cow swap for example which uh you'll be familiar with um and that's more for swap execution so that sits in the middle of this m supply chain and there's uh biders obviously trying to to fill this bid so Stefan wrote a piece in March I think of this year called the orderflow auction design space um and if you'll excuse me for reading off the slide stafon wrote orderflow auctions promis to return users the value they create via their orders we believe this year will be the year of orderflow auctions and we expect significant competition happening between orderflow auction designs and their implementations in the next 6 months so um that that's all fine and well but

actually it's still quite early for uh orderflow auctions and also payment for orderflow um I'm going to make the case that uh you know in wallet swaps still play a very minor role in in Dex order flow um because most Dex volume is still coming from Dex front ends and apis directly not from wallets integrated swap features um and as such we haven't really seen the effects of payment for order flow um so let's go back to metamask I said they did around about 50 million in volume last week so almost half of it came from Unis Swap and almost half of it came from ZX API um I'm talking about the liquidity of course um so if you consider the fact that the entire Dex space does about $10

billion uh per week in in Dex volume um you know you'll see that about a half a percent of the Dex volume today is coming from metamask SWAP functions so uh even though you know $50 million a week is is quite a lot it's it's just scraping the surface of uh total Dex volume so this is really just me saying that you know metamask hasn't completely taken over uh the the the Dex trading landscape with their swap function and by the way it's still early days for for aggregators too so only about 20% of uh deck volume comes through aggregators um and it it doesn't seem to be trending up at all um yeah this is a 2-year chart so it really hasn't changed in in 2 years I was quite surprised when I saw this um

and by the way from from ZX uh the the aggregator uh only about 5% of their volume comes from RFQ so RFQ is also not widely used today so it's still early days um yeah basically my my point is just that you know people are still connecting directly with dex's uh on the front ends on the apis and trading directly they're not really doing it through aggregators they're not really doing it through wallets um at least not yet so it's still a early days but let's think about the future right because that's what we do here is we think about opportunities and and challenges for the future so um let's imagine there is a a wallet that's completely dominating the the Dex trading landscape and um creating a ton of order flow through a

built-in swap function um would that create centralization for ethereum if they're engaging in in payment for order flow um I think we can all agree that for a wallet to succeed it should profit with its users and not from its users that seems pretty straightforward um but quintis from from flash Bots wrote two pieces in September of last year about order flow auctions and and centralization the first one was called a warning so clearly he's uh he's got something on his mind um so it's useful to think about these things in terms of utopia and and dystopia right which is something we do quite a lot in the m space um I think we all know that decentralization is is good for ethereum right especially on the Block building side we want open diverse competitive

market for for Block Builders um and centralization is is bad for ethereum so we don't want a domination of uh large block Builders due to exclusive order flow so what would this look like um by the way this chart here's a picture I took of Stefan last year down in the boat stage which is sadly not available this year but uh it's good to be up here um so yeah this this chart that he presented last year if we start at the Top If a block Builder is getting exclusive private order flow from let's say a wallet uh they're going to be able to build higher value blocks because they have more transactions to to pick and choose from they're going to consistently win block building uh competitions because their blocks are higher value which is in turn going to

justify the exclusivity agreements that they have with the wallets because they can say hey look we're we're building most of the blocks are blocks are the highest value so this is kind of how a dystopia flywheel could start um so yeah sorry to pick on metamask and consensus uh but nothing against metamask or consensus but let's just just imagine for a for a second that that metamask and consensus uh did like vertically integrate or in this example horizontally integrate uh across the M Supply Chain so you know starting from the left with the wallet obviously metamask plugs into infura RPC uh but let's imagine that consensus wanted to launch a uh a block Builder right um and uh you know they do have a validator

infrastructure product currently let's say they also had a validator you know a a block proposer um so really as a user if you were plugged into this this stack you know you'd be using metamask and um your orders would be being batched together into blocks built by consensus and proposed by consensus so uh it kind of begs the question is this even defi anymore right is this even Dex trading when um pretty much every step of the the process is being uh administrated by you know the the same party right so uh again nothing nothing against metamask but this is just to kind of uh get your get your brain going so what's going to happen next uh auction models are going to be

tested wallets are going to launch and compete for market share we've already seen tons of wallets launching uh so 1-in and and Unis swap interestingly uh announced wallets I think this year fairly recently um so 1 in is obviously an aggregator Unis swaps obviously a DEX how do we feel about that I don't know it's up to you to say it kind of begs the question who will win the wallet Wars and who should win the wallet Wars so you know there's kind of two strategies here right if a wallet captures more value um it can you know spend more on on marketing and a bigger team so maybe this is uh like what metam Mas currently does with their High fee but if wallets return more value to their users either by cutting fees or giving them me rebates um you know they

might get more users and more volume organically so that might be interesting as well but who should win the wallet Wars you know should it be dex's aggregators uh should it be block Builders if they're going to launch wallets themselves um what are the conflicts of interest here in terms of centralization um you know am I making a big deal out of out of nothing or you know is it something we should have our eye on um definitely uh Curious to hear your thoughts and and uh your questions and your comments um so yeah in summary uh the entire e ecosystem benefits from increased uh Dex trading and increased Dex market share defi needs Fair markets and infrastructure uh unsophisticated Traders need access to liquidity and protection from adversarial

me wallet need a fair way to monetize their order flow um it costs money to build and develop a great wallet and uh High fees on swaps are unacceptable at least in my view um orderflow auctions should protect against Builder centralization uh so let's see what the future brings um yeah I kind of sped through that here so we've we've still got some time but uh thank you for your attention and uh looking forward to your questions so much Max the floor is open for questions okay um from your talk it just gets me thinking why doesn't metamask

just take all the funds it's making make its own nodes and then try to just Corner the block producing space and then just say hey if you're using metamask we won't front run you but every me every transaction that doesn't come from metamask we're going to just basically put some graphics card up and make sure we squeeze out every single little last piece of minor extracted value and give it back to our team yeah right I mean they could that's that's pretty much what I'm talking about um I I don't think they're going to do that but you know if if we do get to a place where there's a wallet that has uh you know huge success and is is just generating a huge amount of order flow you know I mean in an extreme case if we imagine like more than half of all Dex

trading coming through a single wallet there's tons of stuff that that that wallet could could do right and and I think building you know creating a block Builder would probably be the first thing if they wanted to to vertically integrate but I'm not a not a huge expert there so okay thanks any other questions from Ax if we look at trafi and how payment for order flow was being treated in Europe and in the US with major concerns by regulators and policy makers over misdoing by let's say large financial institutions how do you see let's say if

if if crypto is now excited about payment for overflow today aren't we running into the same problems tomorrow from a regulatory perspective yeah so here in Europe um as far as I'm aware I think payment for order flow is uh quickly becoming illegal or is already illegal um so uh yeah I mean if if we're going to engage in this in the future either we have to make the argument to Regulators that it's not the same as Trad five payment for order flow you know because we do have a kind of a more sophisticated uh supply chain that we're talking about here so um you know not not everything like not every you know payment for order flowes mechanism that Wallace could use might fall under the

same regulation but here in Europe yeah it's definitely quickly becoming like very popular yeah thanks for the talk it was really excellent and very astutely presented um there's a lot of interesting work done at the moment on meol encryption and attempts to Blind uh transactions in general just to really counter M right as I'm sure you're aware can you comment a little bit on how that would affect um uh autoflow auctions sorry what were the first two words the how how how the meol encryption better menol encryption would affect orderflow auctions and how General work against M

extraction would affect orderflow auctions in the value chain you're talking about like privacy uh transactions yeah yeah I mean I I don't count myself as a huge expert on the technical side but my understanding is like the challenge is you don't want to um I mean you need to make your intent known obviously because you want to trade and someone needs to fill the other side trade but you know the moment you kind of publish the fact that you're going to the marketplace with the trade you open yourself to potential front running right so I'm sure uh private transactions and encryptions like you said have you know a role to play here um the question is like how do you stay private enough to protect yourself from front running but not so private that you don't find anyone to to trade with right so but I'm not an

expert any other questions for this talk in that case thank you Max thanks everybody that for him