What is Maximal Extractable Value (MEV)?

Maximal Extractable Value (MEV) has recently become a crucial topic in the cryptocurrency world. MEV allows miners or validators to exploit their control over the ordering of blocks for profit. This concept is often seen as a hidden cost or an economic impact on users and the fairness of the blockchain ecosystem.

As transactions await confirmation in the mempool, a public queue before they are added to the blockchain, miners or validators can influence which transactions are included and their order. This ability to manipulate transaction processing can lead to various revenue opportunities for those with block control.

Although MEV is often linked to Ethereum due to its advanced smart contract, it can affect any blockchain, regardless of the consensus method. So, what is MEV, and how does it work? Let’s dive in.

What is MEV?

A blockchain’s Maximum Extractable Value (MEV) is the amount of money miners or validators may extract by manipulating transaction arrangements within a block. This includes making the most of their capacity to reorder, include, or exclude transactions to increase their profit. MEV, in essence, allows block producers to earn extra profits beyond conventional block rewards and transaction fees by altering transaction processing.

History of MEV

Maximal Extractable Value (MEV) was earlier addressed in 2014 by the algorithmic trader Pmcgoohan as an opportunity for miners to profit from their control over transaction ordering. In 2019, Phil Daian and his team defined the phrase “Miner Extractable Value” in the “Flash Boys 2.0” publication, which detailed certain data concerning miners reordering transactions for profit. After Ethereum migrated to the Proof of Stake model in 2022, the term Maximization Extractable Value expanded to include validators with miners.

How Does MEV Work?

In order to grasp how Maximal Extractable Value operates, it is crucial to understand the role of different blockchain participants. Block producers, which consist of miners in a Proof of Work system or validators in Proof of Stake, select transactions and sequence them within a block. They can reorder, include, or exclude transactions, which may create opportunities to extract additional value beyond standard fees. This ability allows them to profit from opportunities such as arbitrage or liquidation.

Searchers, who are often independent operators utilizing sophisticated algorithms and bots, identify these profit opportunities. In order to profit from transactions, they package them in bundles and send them to builders, who are responsible for aggregating these bundles into complete blocks. In some systems, particularly with Ethereum’s transition to PoS and Protocol/Builder Separation (PBS), builders pass these blocks to relayers. These relayers serve as intermediaries, passing blocks from builders to block producers, including validators in Proof-of-Stake (PoS) systems.

With Ethereum’s transition to PoS, validators now take on the role of block producers and must adapt to new mechanisms like PBS to manage MEV. This shift has led to innovative strategies for MEV extraction and introduced a new dynamic in how transaction sequencing impacts value extraction. PBS differentiates between the activities of block production and transaction ordering. This helps to minimize the impact of validators on MEV and to make the block production process more equitable and transparent.

Maximal Extractable Value (MEV) involves strategies that exploit network inefficiencies for profit.  Here are some prominent MEV approaches:

Arbitrage

This tactic capitalizes on price discrepancies between markets. For instance, when a token is available at a lower price on one decentralized exchange (DEX) compared to another, bots can purchase it at a lower rate and then sell higher on a different exchange.This practice, though highly competitive, helps align token prices across exchanges.

Front-Running

In front-running, bots detect pending transactions in the mempool and execute their own transactions first to benefit from the anticipated price movement. For example, if a bot notices a big buy order coming through, it might place its own buy order with a higher gas fee to make sure its order is processed first, allowing it to benefit from the price change that follows.

Sandwich Attacks

This malicious strategy involves placing transactions before and after a target trade. For instance, if a large swap order is detected, a bot might purchase the token before the trade goes live to increase the price and sell it to the target trade at the inflated price, exploiting the slippage in the target’s transaction.

Liquidations

In DeFi lending, if the collateral backing a loan decreases in value and falls below the required threshold, the loan can be subjected to liquidation. MEV bots can identify such opportunities, purchase the collateral at a discounted price, and sell it for a profit after repaying the loan, similar to margin calls in traditional finance.

How to Protect Against MEV Attacks

While MEV attacks can occur, certain strategies can help to minimize the risks. Below are some of the ways to prevent MEV attacks:

MEV Auction Mechanisms

Adopt auction-based systems where participants bid for transaction placement. This method ensures that transaction inclusion rights are fairly distributed. This diminishes direct MEV extraction by promoting a more open and competitive process.

Protect RPC Endpoints

Send transactions through RPC endpoints that link to private mempools. This technique hides transactions from the public mempool, thereby shielding them from being detected and manipulated by searcher bots until they are finalized on-chain.

Private Transaction

Use services that allow you to submit transactions directly to miners, bypassing the public mempool entirely. This practice keeps transaction details confidential and prevents potential attackers from exploiting them before they are included in a block.

Slippage Controls

Implement rigorous slippage limits to restrict how much the trade price can vary from the initial expected price. This strategy helps reduce vulnerability to manipulation tactics like sandwich attacks, which exploit price changes to extract value.

Anti-MEV Features on DEXs

Use decentralized exchanges that have features to counteract MEV. Features such as transaction commitment schemes or novel ordering techniques can help prevent front-running and other forms of exploitation.

Protocol Upgrades

Support and integrate blockchain protocol enhancements aimed at reducing MEV opportunities. Upgrades that refine transaction ordering and block production can make it more challenging for MEV strategies to be effective.

What are the Advantages of MEV?

Maximal Extractable Value (MEV) offers several notable benefits to the blockchain ecosystem, despite its controversial aspects.

Firstly, MEV can enhance market efficiency. Through the exploitation of price discrepancies and other opportunities, MEV helps address inefficiencies in decentralized markets. This activity contributes to better resource allocation and more accurate pricing, ultimately improving the efficiency of blockchain networks.

Incentivizing liquidity provision is another advantage of MEV. In decentralized finance (DeFi), liquidity providers are rewarded, a process often influenced by MEV activities. This incentive structure boosts liquidity, making DeFi platforms more functional.

Furthermore, DEX arbitrage represents a positive application of MEV. Arbitrage bots exploit price differences across exchanges, stabilizing token prices and increasing market efficiency. This process benefits the ecosystem by ensuring more consistent pricing and enabling more participants to engage in arbitrage without incurring losses.

Additionally, MEV can improve blockchain security. The competitive environment it fosters among miners or validators to secure block production can enhance overall network security. Moreover, MEV facilitates rapid liquidations in DeFi lending, ensuring that lenders are repaid when collateral values fall, which helps maintain the stability of lending platforms.

What are the Disadvantages of MEV?

Maximal Extractable Value (MEV) poses significant drawbacks in blockchain networks. It often leads to unethical behavior, such as front-running and sandwich attacks, which exploit users by manipulating transaction prices to their disadvantage. This practice drives up transaction fees and reduces liquidity, making the network less efficient and more costly for everyone.

Additionally, MEV can lead to a concentration of wealth and power, undermining the network’s decentralization. In extreme cases, the potential for MEV to surpass block rewards may incentivize miners to reorganize previous blocks, causing consensus instability and further compromising network integrity.

Final Thoughts

Maximum Extractable Value (MEV) is the profit miners or validators derive from the control over the order of blocks in a blockchain. Although it could create incentives in decentralized finance, it is problematic due to higher transaction fees and unethical behavior. In order to tackle these issues, it is important to use tools such as MEV auction mechanisms, slippage control, private transactions, RPC endpoints, anti-MEV features, and protocol updates that achieve a healthy balance of MEV advantages and the need for a safe blockchain environment.