UMA’s Data Verification Mechanism – All You Need to Know
We talked before about Universal Market Access (UMA) and its revolutionary mission to provide access to all-known assets to anyone in the world. If the project powered by Risk Labs had your investor’s sense tingling with joyous expectation, you would be glad to know that today we dive deeper into UMA and explain its Data Verification Mechanism (DVM) in detail.
Why DVM is Necessary
UMA is an ambitious initiative, to say the least. The plan to drag legacy financial markets, especially derivatives, onto the blockchain and give them access to crypto investors worldwide is a fantastic feat.
However, it comes at a price, which consists of replacing blockchain oracles from verifying transactions. UMA aims to do so through the Data Verification Mechanism (DVM).
The DVM incentivizes participants to check if the users who issue a token through the Token Facility on UMA have collaterals to back it up. The mechanism also answers liquidation claims from participants who encounter users without collaterals and rewards the winning party in the subsequent investigation.
So far, the DVM sounds like a nifty tool from UMA, but why does it have to replace oracles?
Well, the answer is quite simple: oracles are susceptible to bribe and corruption, and when they go rogue, they might provide false price feeds on the blockchain.
Are all Oracles Corruptible?
It isn’t easy to say. Nevertheless, UMA is thoroughly convinced that all oracles can be corrupted, which in turn translates into the risk that every smart contract relying on off-chain data coming through oracles can be corrupt as well. A long chain of corrupt smart contracts would spell the end of any DeFi out there.
Since the Ethereum blockchain does not impose any laws against corruption, nothing stops random entities from altering critical data and feeding into the chain through crooked oracles.
As the DeFi market grows stronger and more valuable, it becomes the perfect target for scammers and con artists. The temptation to corrupt oracles is too big even for seasoned hackers to resist.
On the other hand, there is no way of proving that an oracle cannot be corrupted. Instead of waiting for a trillion-worth market to crash, certain mechanisms can replace oracles and ensure smart contract-based DeFi applications. The solution may come from UMA’s Data Verification Mechanism (DVM).
How UMA came up with the DVM
Solving the problem of corruption risk in oracles is not an easy task. UMA had to start somewhere, and it began by defining what an incorruptible oracle would look like. After doing the math, the UMA developers came up with three conditions that such an oracle would have to meet:
- Have an un-payable Cost of Corruption
The Cost of Corruption (CoC) is the smallest possible bribe that an oracle would take to provide false data.
- Have a small Profit from Corruption
The Profit from Corruption (PfC) is the highest amount that the oracle would obtain from becoming corrupt.
- The Cost of Corruption must always be higher than the Profit from Corruption.
If these conditions are met, it means that the oracle will not gain anything from becoming corrupt. Furthermore, the entity attempting to alter the data would also fail to find any incentives to do it in the first place.
UMA’s DVM Explained
According to the conditions above, UMA had to design a mechanism that would always ensure the superiority of the cost of corruption over the profit that would derive from it.
The first step involved measuring the Cost of Corruption (CoC). Through the DVM, UMA ensures that its token holders have voting rights that ensure their reward as long as there’s an honest majority. Therefore, participants will be incentivized to remain honest and together to the minimum majority of 51% of honest votes, ensuring control for the incorruptible.
Secondly, UMA asks that all the contracts on the platform register through the DVM and confirm the value that could be stolen if their price feed was corrupted. This value becomes the contract-specific PfC value. The DVM then sums each contract’s PfC into a system-wide PfC number.
Lastly, the DVM enforces the formula through which the CoC remains higher than the PfC at all times by using a variable-fee policy.
UMA manages to replace blockchain oracles by having the DVM monitoring the CoC > PfC status quo permanently. Whenever there is a risk on the horizon, the mechanism initiates a process of buying back tokens repeatedly until the voting token price gets back above the target.
Next, it burns all the tokens that it purchases, thus reducing the token supply and increasing the market cap at the same time. The mechanism manages to purchase these tokens with funds raised by levying pro-rata fees on the system’s contracts.
If that wasn’t good enough, the DVM is purposely developed to minimize the fees required to maintain the system’s security. Therefore, UMA participants have a higher incentive to vote honestly than to corrupt data regardless of the contract that they subscribe to on the platform.
The Bottom Line
UMA’s Data Verification Mechanism is an exciting innovation for the DeFi market, which has struggled with scam and corruption accusations during its recent emergence.
Nevertheless, there is always room for improvement. UMA is well-aware of it, so the platform plans to release smart contract templates that would enable users to create DVM-compatible contracts and gain access to any asset they want without fearing the risk of corruption.