At the heart of cryptocurrency is blockchain technology. This technology facilitates seamless transactions between the buyer and seller without an intermediary. Transaction processing takes a few minutes to a couple of hours, depending on the blockchain protocol and consensus method. All pending blockchain transactions collect in a public waiting area called the ‘mempool.’
They will remain there until a validator or miner picks them and creates a block, which is then validated by nodes and later added to the blockchain. Miners and validators have, however, discovered ways to profit from pending transactions as they sit in the mempool. The process is known as Maximal Extractable Value or Miner Extractable Value (MEV).
What is MEV?
MEV is an invisible tax that miners collect from blockchain users. It’s the maximum value a miner extracts from transactions when creating a block on a blockchain network. An algorithm trader under the username “Pmcgooghan” first discovered this activity in 2014. He warned of the possibility of miners moving around transactions to profit and benefit them.
Phil Daian further explained the MEV phenomenon in 2019 in the “Flash Boys 2.0” research paper. The research highlights how MEV dynamics behaved in real-time and its effects on the blockchain and users. The concept became popular after researchers Georgios Konstantopoulos and Dan Robinson underscored in a 2020 blog post that the mempool is a ‘dark forest’ because of the intense competition and shady methods used to capture MEV.
MEV has since grown into a considerable industry, encouraging researchers in blockchain to double their efforts in responding to this growing trend. As of today, miners have been reorganizing transactions on Ethereum account for millions of dollars of extracted value since the start of 2020.
How does extracting MEV work?
There are many ways to extract MEV from block production. A concept first utilized in proof-of-work, where miners were able to rearrange transactions in a block, hence the name ‘mine extractable value.’
The Ethereum Foundation recommends that validators and miners receive their full amount because they guarantee the successful extraction of an MEV. However, it notes that independent network participants known as ‘searchers’ extract a significant portion of MEV. The searchers use complex algorithms to find profitable MEV ventures. They also use bots to program the process.
Validators and miners often receive a share of the total MEV amount because searchers are usually keen on paying a fee in exchange for the chances of including their profitable transactions in a block.
Here are the various tactics used to extract MEV:
Front-running Bots
Known as ‘generalized front-runners’ are often used to identify profitable transactions and replicate a transaction with a high gas price to convince miners to pick their transactions over others.
Sandwich attack
A malicious form of front-running used to manipulate cryptocurrency prices. Sandwich attacks often happen when a searcher spots a large pending trade on a DEX (decentralized exchange) and places a future trade on it so they can benefit when there’s a price change. Ultimately, the sandwich attack will impact the total cryptocurrency a user receives as the attacker benefits from the price difference.
Dex arbitrage
The varying demand for tokens often leads to different prices on the DEX. If there are substantial price differences between exchanges, MEV bots usually buy cheaper tokens and sell them to another exchange at a higher price. In the end, token prices for exchange remain the same, making DeFi (decentralized finance) market more efficient. This strategy may be competitive, but it’s highly profitable.
Liquidation
DeFi lending platforms, also known as DeFi lending protocols, allow you to secure a loan. However, you must first deposit some cryptocurrency as collateral. If you cannot repay the loan, the platform will allow another user to liquidate the collateral and collect a fee from the borrower. In this case, MEV searchers will seek to find borrowers who can be liquidated and earn the fee.
Use cases – Is MEV good or bad?
MEV extraction methods like sandwich and front-running attacks are harmful and often result in network congestion and increase gas prices for other users. However, tactics like arbitrage help users get the best prices on different exchanges. Efforts have been put in place to curb the effects of malicious MEVs like Flashbots.
Conclusion
There’s so much to cover about MEV. Cases MEV extraction have been increasing every day, which has led to high gas prices of Ethereum. Searchers and miners often use bots to capture MEV extraction, even though some are harmful. It’s, however, recommended to use safer tactics. It’s also important to remember that MEV is risky and not guaranteed despite the high levels of blockchain security. You always have to be careful when mining or searching.
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