MEV: Crypto MEV (Maximal Extractable Value) Explained

What is MEV in Cryptocurrency?

Maximal Extractable Value (MEV) is an important concept in the cryptocurrency sphere, especially within blockchain networks. It symbolizes the highest potential value obtained from block production in addition to the usual block reward and gas fees. This retrieval happens by strategically including, excluding, or reordering transactions in a block.

The Evolution of MEV

Originally referred to as Miner Extractable Value (MEV), this concept originated during the proof-of-work (PoW) period in which miners had control over processing transactions. Yet, after The Merge, Ethereum’s transition to proof-of-stake (PoS) caused the term to develop into “Maximal Extractable Value”. In PoS, validators take over from miners in managing transaction inclusion and ordering, but the fundamental concept of MEV remains.

Understanding MEV

Understanding the fundamentals of blockchain transactions and block creation is crucial in understanding MEV processes. Once users start transactions on a blockchain, those transactions go into a pool called the mempool. Miners or validators choose and arrange these transactions into blocks for inclusion in the blockchain.

MEV occurs as miners or validators can choose the sequence of transactions included in a block. By strategically arranging transactions, they can gain extra value.

Common strategies include:

1. MEV Extraction:

In theory, validators are the primary beneficiaries of MEV, as they can ensure the execution of profitable opportunities. Yet, independent network participants known as “searchers” often capture a significant share of MEV.

Searchers use sophisticated algorithms and bots to identify and exploit profitable transactions, paying high gas fees to validators to secure their inclusion in the blockchain.

2. Gas Golfing:

A critical aspect of MEV extraction is gas golfing, which is optimizing transactions to minimize gas usage. This competitive advantage allows searchers to offer higher gas prices while keeping overall gas fees lower.

Techniques like using addresses with leading zeroes or maintaining small token balances are common gas-saving strategies.

3. Generalized Frontrunning:

Some searchers employ generalized frontrunners- bots that monitor the mempool for profitable transactions. This involves placing a transaction ahead of a pending successful transaction to profit from the expected outcome.

For example, if a miner notices a large buy order for a token, they might place their buy order first to benefit from the price increase.

4. Flashbot:

To counteract frontrunning and maintain transaction privacy, Flashbots offer a solution. They enable searchers to submit MEV transactions directly to validators, bypassing the public mempool and reducing the risk of being frontrun.

Examples of MEV Opportunities

MEV appears on the blockchain through various means.

1. DEX Arbitrage:

This is one of the most well-known MEV opportunities. It involves exploiting price discrepancies between decentralized exchanges (DEXs). For example, if a token is cheaper on one DEX compared to another, a searcher can buy it at a lower price and sell it at a higher price in a single transaction.

2. Liquidations:

In lending protocols like Maker and Aave, if the value of a borrower’s collateral falls below a certain threshold, their collateral can be liquidated. Searchers race to identify these opportunities and submit liquidation transactions to earn fees.

3. Sandwich Trading:

This involves monitoring large trades on DEXs and executing a buy order before the large trade and a sell order after, effectively “sandwiching” it. This can be used to manipulate prices and extract value from unsuspecting users. This strategy benefits from the price impact of the large trade.

4. NFT MEV:

Although newer, MEV in the NFT space involves buying NFTs at undervalued prices or securing NFTs in high-demand drops. This can include front-running other buyers or capturing undervalued NFTs.

The Impact of MEV

MEV on Ethereum has both positive and negative outcomes.

Positive Aspects

1. Economic Efficiency: MEV has the potential to improve the effectiveness of decentralized finance (DeFi) protocols by fixing pricing inefficiencies and guaranteeing prompt liquidations.

2. Incentives for Validators and Searchers: MEV offers extra ways to earn money for validators and searchers, promoting creativity and rivalry within the network

Negative Aspects

1. User Experience: Engaging in activities such as sandwich trading can have adverse effects on user experience by raising slippage and transaction costs.

2. Network Congestion: Gas price auctions influenced by MEV may cause network congestion and increased gas fees for regular users.

3. Consensus Instability: Potential for high MEV rewards could lead validators to manipulate block order, putting blockchain stability at risk due to consensus instability.

How to Mitigate MEV

Maximal Extractable Value (MEV) in Ethereum’s transition to a proof-of-stake (PoS) consensus mechanism presents unique challenges. MEV poses risks to both user experience and consensus-layer security.

The shift to PoS, known as “The Merge,” introduces new MEV-related risks, including validator centralization and the emergence of permissioned mempools. However, several strategies have been proposed to mitigate these issues:

1. Centralization of validators

After Ethereum’s integration, validators are required to deposit 32 ETH in order to take part in the agreement procedure. This obstacle could cause a significant number of individuals to participate in staking pools, potentially consolidating validator authority.

Bigger staking pools, which have more resources, are able to optimize MEV extraction more effectively than individual stakers, leading to their greater dominance. In order to mitigate this risk of centralization, it is crucial to implement the following strategies:

Promoting Solo Staking: Offering rewards to individual stakers and lowering the obstacles to entry can support decentralization. This might include reducing the necessary deposit or offering enhanced tools and assistance for individual validators.

Proposer-Builder Separation (PBS): This entails partitioning the responsibilities of block producers and block proposers. Validators would concentrate on suggesting and voting on blocks, while specialized block builders would manage transaction ordering and block creation.

This division lessens the motivation for validators to participate in MEV extraction, thus reducing risks of centralization.

2. Permissioned Mempools

To avoid frontrunning and sandwich attacks, traders might resort to off-chain deals with validators, leading to the creation of permissioned mempools or “dark pools.” These pools could undermine Ethereum’s permissionless nature and concentrate power. Mitigating this requires:

Proposer-Builder Separation: As mentioned, PBS reduces the direct involvement of validators in MEV extraction, making it harder for permissioned mempools to thrive. By having block builders handle transactions, it democratizes access to MEV opportunities.

Builder API: This interim solution before full PBS implementation allows validators to source blocks from external builders via a secure API. Builders create transaction bundles and bid for inclusion in blocks.

This system lowers the barrier for solo stakers to participate in MEV extraction and discourages the formation of permissioned mempools by increasing competition among block builders.