What is Miner Extractable Value?

SUMMARY

Cryptocurrency’s security depends on miners as they validate transactions through a process known as crypto mining. Miners continuously compete to validate blocks. This competition helps maintain the integrity and security of the network.

In traditional mining, miners earn rewards by successfully adding new blocks to the blockchain and getting transaction fees. However, this isn’t the only way miners can earn. Have you ever thought about the possibility that miners might have additional ways to extract value beyond just block rewards?

Miners often hold a powerful position that allows them to interact with the blockchain in more strategic ways. Are there any other profit-making opportunities for miners? Exploring these possibilities opens up a broader discussion about how miners might use their access and authority not just to support the network but to maximize their own gain, sometimes in ways beyond the basic principles of standard block production.

What is Miner Extractable Value (MEV)?

In traditional Proof of Work (PoW) systems, Miner Extractable Value (MEV) refers to the profits miners can generate by manipulating the ordering, inclusion, or exclusion of transactions within the blocks they produce.

However, with Ethereum’s transition to Ethereum 2.0 and its shift to a Proof of Stake (PoS) consensus mechanism, the term has evolved. In PoS systems, MEV is now known as Maximal Extractable Value (MEV). Here, the block proposers act as validators instead of miners. Thus, they are the ones with the ability to extract this value.

In Ethereum’s PoS systems, miners or validators have the privilege of confirming transactions in blocks. They are a step ahead of other users in assuring the final transactions. Ideally, transactions are ordered with the highest fees at the top. However, miners get the opportunity periodically to rearrange the transactions strategically to gain an additional profit.

So, what is the problem with miners making that extra profit? Though it seems superficial, the real concern arises when a few of these miners have access to advanced equipment with high-level capabilities and robust computing, which can help them spot and exploit MEV profit possibilities much more efficiently than other users in the network.

Often, these MEV profit possibilities are not straightforward. Users should analyze the chain to identify such opportunities. Users with specialized bots to do these identifications have an upper hand in gaining more incentives. Thus, this puts a big question mark in the decentralized nature of the blockchain, paving the way for a centralized network.

Understanding Maximal Extractable Value (MEV)

To better understand the concept of Maximal Extractable Value (MEV), one should view it as the profit that can be obtained by altering the sequence or selection of transactions within a block. This manipulation may involve inserting specific transactions, reordering existing ones, or even excluding (censoring) certain transactions entirely.

In the context of Ethereum’s Proof-of-Stake (PoS) model, validators who are responsible for proposing new blocks have significant control over which transactions are included and in what order. This ability to influence transaction processing gives validators a powerful tool to extract additional value beyond standard block rewards and transaction fees.

MEV takes advantage of the delay and competition involved in processing blockchain transactions. When a user sends a transaction, it first enters a waiting area called the mempool before being confirmed.

Validators pick transactions from this mempool and often choose the ones offering the highest fees. However, they can also rearrange the order of transactions to benefit themselves. By doing this, someone with control over the block creation process can increase their own profits, sometimes at the cost of regular users.

Opportunities for MEV can emerge from several factors, including price discrepancies across decentralized exchanges (DEXs), liquidation events on lending platforms, or other market inefficiencies. Those who have control over the ordering of transactions, like validators, can exploit these situations to their advantage.

The potential to extract MEV has sparked risks in the blockchain community, as it can lead to several issues, including centralizing power, giving certain participants unfair advantages, and posing threats to the network’s overall security. Common examples of these exploitative practices include front-running, sandwich attacks, and different types of arbitrage strategies.

Maximal extractable value is a crucial concept that every miner should be aware of. With the blockchain and Decentralized Finance (DeFi) space evolving rapidly, following the blend of both PoW and PoS chains, addressing the challenges like MEV becomes crucial. Thus, we can maintain the decentralization, security, and integrity of the crypto/blockchain space.

Miner Extractable Value (MEV) History

Both the terms Miner Extractable Value (MEV) and Maximal Extractable Value are often used interchangeably. But, in reality, Maximal Extractable Value refers to any actor who manipulates blockchain transactions and is not just limited to miners.

MEV became a potential concern as the Decentralized Finance (DeFi) field is constantly growing. Moreover, most DeFi platforms depend on smart contracts and crypto transactions. Hence, we can’t entertain a single chance of exploitation as it could cause severe damage. All of that led to significant research and discussion on the MEV concept.

Although the concept has existed for some time, it gained significant attention as Ethereum grew in popularity, largely due to the rise of decentralized applications on its blockchain. The term “Miner-Extractable Value” was introduced by researchers Phil Daian, Steven Goldfeder, Tyler Kell, and Ari Juels in their 2019 paper titled “Flash Boys 2.0: Frontrunning, Transaction Reordering and Consensus Instability in Decentralized Exchanges.”

This groundbreaking work highlighted the risks and challenges MEV poses and sparked ongoing research and discussion within the Ethereum community.

How does MEV work?

Blockchain networks like Bitcoin and Ethereum work as permanent digital records, secured by a decentralized group of computers called “block producers.” In Proof-of-Work (PoW) systems, these are miners, while in Proof-of-Stake (PoS) systems, they’re known as validators. Their job is to collect pending transactions, group them into blocks, and add those blocks to the blockchain after the network confirms them.

While these networks make sure that all transactions are valid (such as preventing double-spending) and that new blocks are consistently added, they don’t guarantee that transactions will appear in the exact order they were submitted.

Each block on the blockchain has limited space, so block producers get to choose which pending transactions from the mempool, a temporary holding area for unconfirmed transactions, they want to include. Although they usually prioritize transactions offering the highest fees (gas prices) to earn more profit, they aren’t required to follow this order. This freedom allows them to rearrange transactions in ways that benefit them financially, a practice known as maximal extractable value (MEV).

Since extracting MEV requires significant technical skill and resources, block producers often rely on third-party networks to help build blocks. These networks typically involve three key players: searchers, builders, and relayed.

Searchers identify MEV opportunities and create bundles of transactions, often including other users’ transactions. These bundles are then sent to builders, who assemble them into complete blocks. The builders pass these blocks to relayed, who act as intermediaries between the builders and the blockchain’s block producers. While this is just one common setup for MEV extraction, the structure and roles in this ecosystem are constantly evolving.

MEV is often extracted at the expense of regular users, sometimes in subtle ways that aren’t obvious until after the transaction is completed. For example, users may receive worse trade execution, with the value effectively being taken from them by those exploiting MEV.

MEV Examples

It’s difficult to create a complete list of MEV extraction methods because the practice is constantly evolving, and searchers often keep their strategies secret to protect their profits. However, there are several well-known and documented examples of MEV in action.

1. Frontrunning and Sandwich Attacks

A clear example of MEV that harms users is when bots front run trades on decentralized exchanges (DEXs). Since user transactions usually pass through a public mempool, a waiting area for unconfirmed transactions. These bots can spot large trades and quickly place their own transactions first to take advantage of the price change, often at the user’s expense.

For instance, if a large trade is detected, a frontrunning bot can copy the user’s trade and create a transaction bundle where its own trade is placed first. This causes the asset’s price to move before the user’s trade goes through, leading to higher slippage, the difference between the expected and actual trade price.

Once the user’s trade is completed and the price moves even more, the bot quickly sells the asset in a follow-up trade to lock in a profit. This strategy is known as a “sandwich attack.”

Subsequently, the user’s trade goes through at a worse exchange rate, making it more expensive to use decentralized exchanges. This creates an “invisible fee,” where the user ends up receiving fewer tokens than expected.

2. Exchange Arbitrage and Liquidations

MEV can also happen when third-party bots carry out arbitrage between two or more decentralized exchanges (DEXs). Arbitrage opportunities arise when the price of a crypto asset differs between exchanges, often due to a large trade on one of them.

Bots take advantage of this by buying the asset where it’s cheaper and selling it where it’s more expensive, making a profit while helping to balance the prices across exchanges. This type of arbitrage can also happen between on-chain DEXs and off-chain centralized exchanges, or even between DEXs on different blockchains, known as cross-domain MEV.

As DeFi adoption and DEX liquidity have grown, arbitrage opportunities have become more common and profitable. This has led to intense competition among arbitrage bots. To get their transactions included in a block, these bots often enter bidding wars, offering higher and higher fees to block producers to win the race.

While arbitrage is generally a healthy part of market activity, MEV bots can unfairly take these opportunities from regular users. They do this by watching the mempool for pending arbitrage trades, copying them, and offering higher fees to block producers so their own trades are included first. A similar situation happens in DeFi lending platforms, where MEV bots compete to profit from loan liquidations before others can.

3. Generalized Frontrunning

A more advanced way to extract MEV is through bots that do something called generalized frontrunning. These bots scan transactions waiting in the public mempool and quickly submit the same transaction with a higher fee to block producers, but they replace the original user’s address with their own.

The tactic has even blocked attempts by white-hat hackers trying to save at-risk user funds. These bots don’t fully understand what the transactions do. Instead, they use algorithms to copy transactions, swap addresses, and test if the transaction will make a profit before submitting it.

These are just some examples of how MEV is taken and how it can hurt users. But MEV can happen in many other ways, too. If block producers start capturing more MEVs for themselves, they might use even more advanced methods to reorder transactions and take even more value from users.

MEV – Pros & Cons

Though MEV is negative and is not good for crypto or decentralized space, there are a few pros associated with it.

• Pros

MEV helps reduce economic problems in DeFi protocols. For example, fast liquidations made possible by MEV ensure lenders get repaid when borrowers don’t keep enough collateral. Arbitrage traders help keep token prices on different DEXs aligned with overall market demand.

By using MEV to maximize their profits, these actors help fix inefficiencies in individual protocols, making the DeFi ecosystem stronger and more efficient. Supporters also say that MEV improves blockchain security by encouraging miners or validators to compete for the chance to create new blocks.

• Cons

MEV can make things worse for regular users. For example, a DEX sandwich attack can cause a trade to have high slippage, meaning users get less value than expected. Also, generalized frontrunners often pay higher gas fees to get their transactions included first, which can slow down the network and increase transaction costs for everyone.

Additionally, if the MEV rewards become bigger than the normal block rewards, block producers might try to rewrite past blocks to capture more MEV, which can cause problems with the network’s stability.

CONCLUSION

Miner Extractable Value (MEV), now known as Maximal Extractable Value in proof-of-stake systems, features the complex relation between blockchain design, incentives, and user experience. While MEV can improve market efficiency through arbitrage and liquidations, it often comes at the cost of fairness and security, impacting regular users through tactics like frontrunning and sandwich attacks.

Addressing MEV-related risks will be crucial to ensuring a more transparent, secure, and user-friendly ecosystem. The current innovation and research will play a key role in balancing profit incentives while maintaining decentralization and network integrity.