Maximal Extractable Value (MEV) is a method for miners or validators to increase their profits by changing the order of transactions before approving a new block on the network. Is it really profitable? How does it work? Let’s find out!

MEV is used to boost network commissions at the expense of increased user costs, which are commonly associated with transactions in decentralized applications. Miners or validators, in particular, try to gain an arbitrage position so that the user pays the extra commission that was not accounted for before the transaction is sent. MEV is regarded as an unethical practice.

MEV was first seen in Ethereum and EVM-compatible networks. Flash bots were one of the most effective solutions to this problem.

According to experts, the switch to Proof-of-Stake (PoS) will not eliminate MEVs from Ethereum, but it will result in the separation of validators into professional categories, the emergence of different types of blocks, and the creation of long-term strategies based on MEVs.

How does MEV work?

Blocks recorded in a blockchain, as we know, are immutable information that cannot be rewritten. However, before a transaction is validated, miners or validators can include, exclude, or reorder it in a future block at their discretion.

Each unconfirmed transaction is routed through the public mempool first. Following that, miners select which transactions from the mempool to include in the block. The miners form the most profitable combination of user transactions for themselves in this manner.

This results in abuse. Miners (and, since Ethereum’s transition to PoS, validators) prioritize the largest transactions, descending in size from largest to smallest, and add them to the next block to be written to the blockchain.

This feature led to the creation of a mechanism for extracting value by substituting transactions in the right order. This method is known as maximum extractable value, or MEV.

The MEV strategy entails validators searching for speculative transactions based on available unconfirmed transactions and increasing the actual fees for their execution.

Let’s look at an example where an Ethereum user decided to exchange 10,000 USDC for ETH at $2,000 per coin on DEX in the USDC/ETH liquidity pool. Here’s what happens after you submit an exchange request:

Because MEV results in higher commissions for the user, it is also called an “invisible tax,” which is not unique to Ethereum.

When did the “invisible tax” appear in MEV?

The problem of “spoofing” user transactions, now called MEV, was first raised on Reddit by algorithmic trader and analyst Pmcgoohan in 2014, , prior to the launch of Ethereum mainnet. He proposed that miners could manipulate user transactions for their own gain without violating any consensus rules.

The term MEV was not coined until 2019 in “Flash Boys 2.0” which was the first publicly available publication to explore the severity of the problem described by Pmcgoohan.

The scale and seriousness of the problem was only brought up in 2020 in articles such as “Ethereum is a dark forest” and “Escaping the Dark Forest” written by Dan Robinson, Georgios Konstantopoulos, and crypto investor Samczsun. These publications were intended to inform Ethereum users about the “invisible tax” levied on them.

Varieties of MEVs

The growth of the decentralized finance (DeFi) sector and specific elements of the Ethereum ecosystem, such as price oracles, liquid tokens, and cross-chain bridges, has resulted in the emergence of various MEV strategies.

Front-running

The most common strategy where an MEV transaction is attempted before the original transaction. Special bots can track potentially profitable transactions by simply copying users’ transactions, acting ahead of the curve.

Back-running

Issuing a transaction as a consequence of an event. For example, as soon as a new pool appears on Uniswap, the exploiter may buy back a significant portion of the tokens and take first place in the queue, effectively emptying the pool. He then lets the other participants sell before selling himself at a higher price.

Sandwich Attack

A combination of the previous two schemes. If the bot finds a large buy order in the mempool, it places its own order in front of it to buy tokens at a lower price using frontrunning. The large order is executed, causing the price to rise. The coins are then sold at a profit ahead of the other users using back-running.

Liquidation

A strategy used by the validator to make profit by redeeming the pledged position in the lending protocol immediately after it has been liquidated. The user notices that the position can be liquidated in the next block and sends a transaction to redeem the collateral.

Uncle bandit attack

A complex type of MEV strategy based on a speculative chain of transactions found in a competing block. There are times when miners find two blocks at the same time. At that point, miners can use the data from the “neighboring” block to their advantage.

Time bandit attack

Involves a process of reorganizing previous blocks in which miners specifically suggest competing blocks containing other transactions. This results in the disappearance of transactions and their inclusion in a completely different block.

How to self-protect from MEV?

MEV is not unique to Ethereum. Bots moved into EVM-enabled blockchains such as Polygon and BNB Chain as the DeFi-application sector evolved and competition became more intense. However, in terms of combating this problem, Ethereum has become the most advanced network.

According to 2021 data, Ethereum miners earned $730 million in MEV extraction rewards, accounting for 4.3% of total annual revenue. This indicates the growth of “dishonest markets,” which leads to a worsening user experience through higher fees and a lack of predictability in the transaction execution process.

As a solution, a centralized Flashbots system, funded by venture capital firm Paradigm, emerged in 2020. It does not seek to eliminate the problem, but rather to take control of it by creating an open market through the development of a public auction of ETH transactions.

The solution quickly gained popularity. According to BitMEX, the research arm of the cryptocurrency exchange, more than 90% of miners on the Ethereum network were connected to the Flashbots server in May 2022. According to the researchers, 63% of the rewards for MEV transactions went to operators, while the remaining 37% went to miners.

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