What Is Maximal Extractable Value (MEV) and How Does It Work?

Maximal extractable value (MEV) is a term that describes the maximum profit that can be derived from manipulating transactions in a block. MEV can be achieved by including, excluding, or changing the order of transactions in a block. MEV can provide additional revenue opportunities for miners and validators, but it can also pose risks and challenges to network security, fairness, and stability.

In this article, we will explain what MEV is, how it works, why it matters, and what are some of the solutions and implications for the future of blockchain and cryptocurrency.

What is MEV?

MEV stands for maximal extractable value, which is also sometimes referred to as miner extractable value or miner extractable profit. The term was coined by Phil Daian and his co-authors in their paper "Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges", which analyzed the phenomenon of arbitrage bots exploiting inefficiencies and information asymmetries in decentralized exchanges (DEXs).

MEV is defined as the difference between the current state of the blockchain and the state of the blockchain with an optimal transaction ordering. In other words, MEV is the amount of value that can be captured by a miner or validator by strategically choosing which transactions to include in a block, and in what order.

For example, suppose Alice wants to buy 10 ETH for 1000 DAI on a DEX. She submits a transaction with a gas price of 10 gwei to the network. Bob, an arbitrage bot, sees Alice’s transaction in the mempool (the pool of pending transactions) and realizes that he can buy 10 ETH for 900 DAI on another DEX and sell them back to Alice for 1000 DAI, making a profit of 100 DAI. Bob submits a transaction with a gas price of 20 gwei to execute this arbitrage opportunity. If Bob’s transaction gets included in the same block as Alice’s transaction, he can ensure that his transaction gets executed before Alice’s transaction by paying a higher gas price. This way, he can front-run Alice and extract some value from her trade. The MEV in this case is 100 DAI, which is the difference between the state of the blockchain with Alice’s transaction only and the state of the blockchain with both Alice’s and Bob’s transactions.

MEV can arise from various sources, such as:

• Arbitrage: exploiting price differences across markets or platforms
• Liquidations: profiting from undercollateralized loans or positions
• Sandwich attacks: inserting transactions before and after a victim’s transaction to manipulate the price
• Reorgs: rewriting the history of the blockchain to undo or alter transactions
• Censorship: preventing certain transactions from being included in a block
• Bribery: paying miners or validators to favor certain transactions

MEV can be positive or negative, depending on whether it adds or subtracts value from the network. Positive MEV can be seen as a form of market efficiency, where arbitrageurs help eliminate price discrepancies and improve liquidity. Negative MEV can be seen as a form of market manipulation, where attackers exploit vulnerabilities and information asymmetries to harm users and platforms.

How does MEV work?

MEV works by taking advantage of the design and limitations of blockchain systems. Specifically, MEV exploits two key features:

• The sequential execution of transactions within a block
• The probabilistic finality of blocks

The sequential execution of transactions within a block means that the order of transactions matters for the outcome of each transaction. For example, if Alice and Bob both want to buy 10 ETH for 1000 DAI on a DEX, but there are only 10 ETH available at that price, then whoever gets their transaction executed first will get the deal, while the other will have to pay a higher price or get their transaction reverted. Therefore, the order of transactions can affect the value transfer between users.

The probabilistic finality of blocks means that blocks are not immediately confirmed and irreversible, but rather subject to reorganization or fork if a longer chain emerges. For example, if Alice sends 10 ETH to Bob in block A, but then block A gets replaced by block B that does not include Alice’s transaction, then Alice still has her 10 ETH and Bob has nothing. Therefore, the finality of transactions can affect the value transfer between users.

These two features create opportunities for miners and validators to manipulate transactions in a block to maximize their own profit. Miners and validators have two main powers:

• The power to choose which transactions to include in a block
• The power to choose which block to build on top of

By choosing which transactions to include in a block, miners and validators can decide which users get their transactions executed and which do not. They can also decide the order of transactions within a block, which can affect the outcome of each transaction. For example, a miner can include Bob’s arbitrage transaction before Alice’s trade transaction, and extract some value from Alice.

By choosing which block to build on top of, miners and validators can decide which blocks become part of the canonical chain and which do not. They can also create forks or reorgs to undo or alter transactions that have already been included in previous blocks. For example, a miner can create a fork that excludes Alice’s payment transaction to Bob, and keep Alice’s 10 ETH for themselves.

Miners and validators are incentivized to maximize their own profit by collecting block rewards, transaction fees, and MEV. However, they also face some costs and trade-offs, such as:

• The risk of losing block rewards and transaction fees if their block gets orphaned or reorged
• The risk of damaging the network security, fairness, and stability if their actions trigger chain splits or consensus failures
• The risk of losing users and platforms if their actions erode trust and confidence in the network

Therefore, miners and validators have to balance their short-term gains from MEV with their long-term interests in the network.

Why does MEV matter?

MEV matters because it has significant implications for the blockchain and cryptocurrency ecosystem. Some of the main effects of MEV are:

• Increased revenue for miners and validators: MEV can provide an additional source of income for miners and validators, on top of block rewards and transaction fees. According to Flashbots, a research and development organization that aims to mitigate the negative externalities of MEV, the total amount of MEV extracted on Ethereum reached over $1.4 billion in 2021. This represents about 13% of the total miner revenue in the same period.
• Increased competition and centralization among miners and validators: MEV can create a positive feedback loop, where more profitable miners and validators can invest more in hardware, software, and network resources to increase their chances of winning blocks and extracting MEV, while less profitable ones get squeezed out of the market. This can lead to increased competition and centralization among miners and validators, which can reduce the network security, fairness, and stability.
• Increased complexity and cost for users and platforms: MEV can create a negative feedback loop, where users and platforms have to deal with more complex and costly transactions to avoid or mitigate MEV. For example, users may have to pay higher gas fees, use advanced tools like meta-transactions or flashbots, or resort to off-chain or layer-2 solutions. Platforms may have to implement more robust and resilient protocols, such as using batch auctions, time locks, or zero-knowledge proofs. These measures can increase the complexity and cost for users and platforms, which can reduce the network usability, scalability, and adoption.
• Increased innovation and research for solutions and implications: MEV can also create a positive feedback loop, where more researchers and developers are motivated to explore solutions and implications for MEV. For example, researchers may study the theoretical and empirical aspects of MEV, such as its sources, measurement, distribution, impact, etc. Developers may design and implement solutions for MEV, such as improving consensus algorithms, transaction ordering mechanisms, protocol designs, etc. These efforts can increase the innovation and research for solutions and implications for MEV.

What are some of the solutions and implications for MEV?

MEV is a complex and multifaceted phenomenon that poses many challenges and opportunities for the blockchain and cryptocurrency ecosystem. There is no silver bullet solution for MEV, but rather a spectrum of possible approaches that vary in their effectiveness, feasibility, trade-offs, etc. Some of the main categories of solutions are:

• Consensus-level solutions: These are solutions that aim to change the way blocks are produced and finalized on the blockchain. For example, proof-of-stake (PoS) is a consensus algorithm that replaces proof-of-work (PoW) by using validators instead of miners to produce blocks. PoS can reduce MEV by lowering the cost of block production, increasing the finality of blocks, introducing penalties for malicious behavior, etc. However, PoS also has its own challenges and limitations, such as requiring more coordination among validators, being more vulnerable to long-range attacks, etc.
• Protocol-level solutions: These are solutions that aim to change the way transactions are ordered and executed on the blockchain. For example, fair ordering is a protocol design that aims to prevent front-running by using random or deterministic methods to order transactions within a block. Fair ordering can reduce MEV by eliminating arbitrage opportunities based on transaction order manipulation. However, fair ordering also has its own challenges and limitations, such as requiring more computation or communication overheads, being incompatible with some applications or platforms, etc.
• Application-level solutions: These are solutions that aim to change the way applications and platforms are designed and operated on the blockchain. For example, batch auctions are a mechanism that aggregates orders into discrete time intervals and executes them at a uniform clearing price. Batch auctions can reduce MEV by eliminating time priority and price fluctuations within each batch. However, batch auctions also have their own challenges and limitations, such as increasing latency and uncertainty for users, requiring more coordination and trust among participants, etc.

MEV has various implications for the future of blockchain and cryptocurrency, such as:

• The evolution of the mining and validation market: MEV can affect the incentives and behavior of miners and validators, leading to new forms of competition and collaboration. For example, MEV can create new types of mining pools, such as Flashbots, that specialize in extracting MEV and sharing it with miners. MEV can also create new types of attacks, such as time-bandit attacks, that exploit the probabilistic finality of blocks to rewrite history and capture MEV.
• The development of the decentralized finance (DeFi) ecosystem: MEV can affect the performance and security of DeFi applications and platforms, leading to new challenges and opportunities. For example, MEV can create new risks for users and platforms, such as frontrunning, sandwich attacks, liquidations, etc. MEV can also create new innovations for users and platforms, such as meta-transactions, flashbots, flash loans, etc.
• The regulation and governance of the blockchain network: MEV can affect the social and economic outcomes of the blockchain network, leading to new issues and debates. For example, MEV can create new questions about the fairness and efficiency of the network, such as who should benefit from MEV, how should MEV be distributed or taxed, etc. MEV can also create new conflicts between different stakeholders of the network, such as users, platforms, miners, validators, developers, regulators, etc.

Conclusion

MEV is a term that describes the maximum profit that can be derived from manipulating transactions in a block. MEV can provide additional revenue opportunities for miners and validators, but it can also pose risks and challenges to the network security, fairness, and stability. MEV can arise from various sources, such as arbitrage, liquidations, sandwich attacks, reorgs, censorship, bribery, etc. MEV can be positive or negative, depending on whether it adds or subtracts value from the network.

MEV works by taking advantage of the design and limitations of blockchain systems. Specifically, MEV exploits two key features: the sequential execution of transactions within a block and the probabilistic finality of blocks. These two features create opportunities for miners and validators to manipulate transactions in a block to maximize their own profit. Miners and validators have two main powers: the power to choose which transactions to include in a block and the power to choose which block to build on top of.

MEV matters because it has significant implications for the blockchain and cryptocurrency ecosystem. Some of the main effects of MEV are: increased revenue for miners and validators; increased competition and centralization among miners and validators; increased complexity and cost for users and platforms; increased innovation and research for solutions and implications.

MEV is a complex and multifaceted phenomenon that poses many challenges and opportunities for the blockchain and cryptocurrency ecosystem. There is no silver bullet solution for MEV, but rather a spectrum of possible approaches that vary in their effectiveness, feasibility, trade-offs, etc. Some of the main categories of solutions are: consensus-level solutions; protocol-level solutions; application-level solutions.

MEV has various implications for the future of blockchain and cryptocurrency, such as:

• The evolution of the mining and validation market: MEV can affect the incentives and behavior of miners and validators, leading to new forms of competition and collaboration. For example, MEV can create new types of mining pools, such as Flashbots, that specialize in extracting MEV and sharing it with miners. MEV can also create new types of attacks, such as time-bandit attacks, that exploit the probabilistic finality of blocks to rewrite history and capture MEV.
• The development of the decentralized finance (DeFi) ecosystem: MEV can affect the performance and security of DeFi applications and platforms, leading to new challenges and opportunities. For example, MEV can create new risks for users and platforms, such as frontrunning, sandwich attacks, liquidations, etc. MEV can also create new innovations for users and platforms, such as meta-transactions, flashbots, flash loans, etc.
• The regulation and governance of the blockchain network: MEV can affect the social and economic outcomes of the blockchain network, leading to new issues and debates. For example, MEV can create new questions about the fairness and efficiency of the network, such as who should benefit from MEV, how should MEV be distributed or taxed, etc. MEV can also create new conflicts between different stakeholders of the network, such as users, platforms, miners, validators, developers, regulators, etc.

This article has provided an overview of what MEV is, how it works, why it matters, what are some of the solutions and implications for MEV.

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