MEV Demystified: Uncover the mystery of the benefits of the Ethereum MEV industry chain

With the development of technology, more and more people realize the scope of influence of MEV on larger industries and propose more coping strategies, and the "arbitrage opportunities" of MEV may gradually decrease.

Written by: Ebunker, WebX Labs

Blockchain technology empowers people around the globe to transact freely, bringing entirely new modes of economic activity to the forefront. Innovations such as censorship-resistant P2P payments, decentralized exchanges, and permissionless lending protocols create fair opportunity for all.

But the picture behind cryptonetwork activity is more complex – players with asymmetric information advantages are exploiting or stealing opportunities from ordinary users using various channels and techniques, most notably through MEV (Maximum Extractable Value).

Introduction to MEV

MEV is used to describe the act of reordering transactions to maximize profit (ie "maximum extraction benefit") when generating a new block (to be added to a blockchain). It can also be understood as the extra value squeezed out of a block beyond standard rewards and gas fees by choosing which transactions to add in which order.

MEV is often associated with the Ethereum network because Ethereum has an extremely important DeFi ecosystem. The more complex transactions involved in a block (such as smart contracts related to loans or transactions), the more opportunities for block producers to make additional profits by deciding to add, delete, or reorder certain transactions.

Fundamentals of MEV

Block producers (commonly known as "miners") play a key role in securing and maintaining the blockchain network by validating transactions and adding those transactions to the network in blocks. Which transactions are added to a block is up to the block producer. In a perfectly fair economy, transactions should be processed in a "first come, first served" chronological order.

**However, the incentive mechanism of the blockchain makes block producers choose transactions based on profitability, which means that those transactions with high transaction fees will be selected first, which is why users will pay more during busy hours The reason for the gas fee. **Block producers will earn more profit if they choose transactions with higher transaction fees. As a result, transactions with lower transaction fees take longer to be added to a block.

Miners are responsible for packaging user transactions into blocks, and can also determine the order of transactions. This allows them to gain additional profits from the market in some cases by rearranging trades, inserting their own trades, or delaying other trades.

For example, suppose someone initiates a large transaction to a decentralized exchange (DEX), which may cause a change in the price of a certain token on the exchange. **A miner can insert his own transaction before this large transaction, buy the token that is about to rise in advance, and then sell the token immediately after the large transaction is completed, and profit from it. This phenomenon is very similar to being caught between two pieces of bread, so it is called "sandwich attack" for some reason. **

MEV can lead to several problems, including more competition among miners, higher transaction fees, and reduced security of the blockchain network. To address these issues, researchers and developers are looking for ways to reduce the impact of MEV, such as improving consensus algorithms or designing more secure and transparent decentralized finance (DeFi) applications.

The form of MEV

Of course, MEV is not equivalent to a "sandwich" attack, and "sandwich attack" is just a type of MEV. At present, MEV mainly has several main forms such as front-running trading, arbitrage trading, and loan liquidation.

Front-running trade

MEV Seekers and Block Producers can take advantage of its ability to order transactions in blocks. For example, preemptively trade an important buy order that is still waiting to be executed in the trading pool, and another example, preemptively participate in some NFT whitelists. MEV is created when a similar buy order is inserted before that trade to get a more favorable price before the larger buy order goes through.

Arbitrage Trading

Arbitrage opportunities arise when the price of an asset is inconsistent across trading platforms. In the cryptocurrency space, the same token may be priced differently on two different DEXs. Arbitrageurs take advantage of pricing differences to trade to profit. MEV is created when a Seeker's bot identifies a pending transaction and inserts its own transaction ahead of it to extract the value provided by that arbitrage opportunity.

Clearing Transactions

DeFi allows users to take out loans with deposited digital assets as collateral. If the market fluctuates and the value of the collateral falls below a certain price, the position will be liquidated. The smart contracts involved typically pay rewards or fees to transactions that trigger liquidation. When any searcher or block producer running a bot discovers such a transaction, they can get rewarded by inserting their own liquidation transaction in the block before everyone else.

**There are two places where MEV can be acquired in liquidation. **

**The first case is to become a liquidator. **Taking AAVE as an example, user A deposits 5 ETH to obtain a USDT loan of 10,000 USD when the ETH price is 4,000 USD. When the ETH price drops below $2,100, its position is automatically liquidated to repay the lender. Liquidation bots can monitor these events and step in at the exact moment of liquidation to effect liquidation, charging the appropriate fee.

**The second case is a liquidation premium that the borrower must pay in breach of the agreement. **In addition to charging service fees, the liquidation robot will also collect additional fees from the borrower.

Type of MEV

From the perspective of type, MEV can also be divided into the following categories:

Sovereign MEV

The blockchain community can try to control its own MEV through sovereign MEV, that is, set the protocol rules for extracting MEV, allow or disallow certain strategies for MEV extraction, and specify which links may obtain MEV benefits. Sovereign MEVs allow the protocol community to decide on priorities and how MEVs are generated. For example, for some blockchains with sovereign MEV rules, violating validators may face corresponding penalties.

Internal MEV

Internal MEV refers to MEV generated directly on the application-specific blockchain. This form of MEV allows application developers to set rules that properly capture MEV methods. For example, an arbitrage trading strategy can be used where a buy order is placed on one trading platform while a sell order of the same amount is placed on another trading platform.

CeFi-DeFiMEV

Arbitrage by taking advantage of order price differences between centralized exchanges and DeFi applications. Crypto asset prices on centralized exchanges tend to update ahead of the relocation of on-chain trading pools and DEX liquidity providers. Due to the frequent activity of arbitrage traders, CeFi-DeFi MEV is one of the largest generation sources of MEV.

Cross-chain MEV

Take advantage of the fact that most blockchains operate in "islands", that is, they are not allowed to see what happens on the native blockchain on other blockchains. For example, the Bitcoin network (without the use of third-party oracles) cannot see transactions on the Ethereum blockchain.

Cross-chain MEV allows traders to analyze data from different blockchains through a cross-chain bridge or DEX to profit from cross-chain asset exchanges. Cross-chain related arbitrage strategies usually occur in blockchains such as Cosmos.

Pros and Cons of MEV

Whether MEV is good or bad depends on whose standpoint you look at this issue. From an objective point of view, MEV is beneficial to the long-term security and price accuracy of the blockchain, but it is not good for end users.

** On the one hand, MEV incentivizes economic coherence. **By constantly monitoring prices, arbitrage bots tighten price spreads and minimize variance, ultimately providing more accurate and consistent prices. In addition, higher network fees also provide higher security guarantees. Given the potential for more profits, more robots participate in the calculation process, making the network more decentralized. This also further urges block producers to maintain online mining or verify nodes to increase participation, thereby improving network security.

**On the other hand, MEV is not friendly to the vast majority of end users. **The various arbitrage operations mentioned above tilt the balance of potential user groups towards the group of "scientists (professional users who can use programs)". These professional users have crushed most ordinary users in terms of capital and technical knowledge. users and extract value from them.

The development trend of MEV and various ways to deal with it

Ethereum founder Vitalik Buterin admitted that MEV will always exist in Ethereum. Validators can always prioritize transactions with higher fees, even if those transactions are clearly from "front-running" or "sandwich attacks". MEV traders will try to use arbitrage and other technical variations to maximize profits.

On the bright side, MEV can also be intervened, for example, developers can add relevant rules through the sovereign MEV mentioned above to determine who can get rewards and how to withdraw MEV from the blockchain.

**Ebunker partner 0xTodd said that from a technical point of view, because Ethereum is a distributed network, it will never be possible to confirm what is absolutely fair and "first come, first served". Therefore, it is technically impossible to "cure malicious MEV". possible. **However, ETH can alleviate the exploitation of certain users by MEV from a mechanism. For example, the PBS to be updated by Ethereum advocates the separation of roles between block producers and packagers. The introduction of more roles will significantly increase the privacy of user transactions, thereby reducing the impact of sandwich attacks on users.

The following are some countermeasures against MEV arbitrage in the market:

**The developer "Codeforcer" proposed a method of using the smart contracts of Salmonella and Uniswap pools to combat "sandwich attacks". **The smart contract uses a "Poisoned" token, and if a "sandwich attacker" targets smart contract transactions, the assets used for the attack will be depleted. CodeForcer once used this strategy to drain more than 100 ETH of the attacker (but the current arbitrage bots on the market have been upgraded and adapted to this strategy).

According to statistics from an organization called "MEV Blocker", the value of DEX users acquired by validators using "front-running transactions" is as high as $1.3 billion. **MEV Blocker users can add RPC endpoints to their Ethereum wallets to avoid "front running" and "sandwich attacks". **

**Also trying to solve the front-running bot problem is FlashBots' "MEV Protection". **As the largest MEV protocol on Ethereum, it also provides a free private RPC service, allowing users to submit transactions directly to verifiers, making their transactions invisible in MEMPOOL. In theory, if the transaction is not visible, then the bot cannot perform "front running" or "sandwich attack".

**The non-custodial wallet Blockwallet also integrates a feature called "FlashBots Protection". **

**Ethereum Research has proposed a method of MEV Smoothing, which will make the validator's MEV income more uniform. ** This method shows that the committee can confirm new blocks of transactions and distribute the rewards evenly.

**Additionally, Chainlink's FSS (Fair Sequencing Service) also proposes a solution to the MEV problem. **First, FSS aggregates transactions into blocks and arranges them in chronological order. It then encrypts the data on-chain to protect it from being shown to miners or block producers ahead of time (it is not visible until the transaction is packaged). According to the description in Section 5 of Chainlink2.0, FSS tries to ensure the fairness of this activity through smart contracts using this function (rather than individual nodes).

In the long run, with the development of technology, more and more people realize the scope of influence of MEV on larger industries and propose more coping strategies, and the "arbitrage opportunities" of MEV may gradually decrease.