Maximal Extractable Value (MEV)

MEV refers to the maximum value a miner or validator can extract from manipulating transactions when producing a block on a blockchain network. It was first predicted by an algorithmic trader under the pseudonym “Pmcgoohan” in 2014 and was later popularized by researchers Phil Daian, Dan Robinson, and Georgios Konstantopoulos. In their paper, “Flash Boys 2.0,” they referred to MEV as the total amount of ETH (Ethereum) miners could extract from transaction manipulation.

The Risks of MEV

While MEV might seem like a way for miners to profit from the network, the reality is that not all methods of MEV extraction are ethical. Some methods can result in a worse user experience and create risks for the network. Research and development groups like Flashbots are working to mitigate these risks.

How Does MEV Work?

There are different methods of extracting MEV from block production on a blockchain network like Ethereum. For example, the Ethereum Foundation notes that, in theory, miners or validators should get the full MEV amount. Still, in practice, a large portion of it is retrieved by independent network participants called “searchers.” These searchers run complex algorithms to detect profitable MEV opportunities and use bots to automate the process.

Examples of MEV Tactics

Several tactics are used to extract MEV, including front-running, sandwich attack, DEX (Decentralized Exchange) arbitrage, and liquidation.

Front-running:

This is a tactic where a bot scans the mempool (a pool of pending transactions waiting to be processed) for profitable transactions. Once a profitable opportunity is detected, the bot replicates the user's transaction with a higher gas price so that miners will choose that transaction over others. The bot will then benefit from the difference in price between the original and replicated transactions.

Sandwich Attack:

This is a malicious type of front-running that occurs when a bot detects a large pending trade on a DEX and places a trade right before and right after it to benefit from an artificial price change. This will ultimately affect the amount of cryptocurrency the user who puts in the initial transaction will receive, while the attacker will benefit from the price difference.

DEX Arbitrage:

Tokens often have different prices on different DEXs due to varying demand. When there is a significant price difference between exchanges, MEV bots buy lower-priced tokens and sell them on another exchange at a higher value. This makes the DeFi market more efficient, but it can also be lucrative for the bots.

Liquidation:

In DeFi lending protocols, users deposit cryptocurrency as collateral. When a user can't repay their loans, the protocol typically allows anyone to liquidate the collateral and earn a liquidation fee from the borrower. MEV searchers will compete to determine which borrowers can be liquidated and collect the liquidation fee for themselves.

The Future of MEV

The Ethereum network is shifting from proof-of-work to proof-of-stake, and the MEV extraction methods will continue even after this transition. However, the move to proof-of-stake is expected to make the network more efficient and reduce the risks associated with MEV.

To Conclude

MEV is a complex and often misunderstood phenomenon in the world of cryptocurrency. While it can be a source of profit for miners and validators, it also has the potential to cause harm to users and the network. Therefore, it's essential to stay informed and understand the risks associated with MEV to make informed decisions in the crypto world. With the move to proof-of-stake, the future of MEV remains uncertain, but what is clear is that the crypto industry will continue to evolve, and new challenges and opportunities will arise.