ELI5: What is MEV (Maximal Extractable Value)
non-tech noob explaining what is MEV (Maximal Extractable Value)
TLDR
MEV is the benefit that block producers can get from end users by including/reordering/excluding transactions when producing a new block.
The “quick reseller”
Imagine you’re at a farmers’ market looking for the best deals on fruits and vegetables. You see some people seem to always get to the best products before anyone else, and they often resell these items at a higher price. These people are quick, they know the market well, and they have a strategy to spot the best opportunities to act on before the others.
In the world of blockchain, there is a similar phenomenon called MEV (Miner Extractable Value), block producers are the quick resellers in the above analogy.
What is MEV
MEV is the maximum value that block producers can obtain by include/reordering/exclude transactions when producing a new block.
In layman terms, MEV is like when someone taking advantage of their position and use inside knowledge to make extra money.
MEV is a hidden tax of Ethereum transactions, which has accumulated over $1 billion loss in value to date.
How does MEV work?
When a user submits a transaction, the transaction goes to the mempool (where transactions pending to be put into blocks are). The block producers can decide to include, exclude, or reorder the transactions within the next block. By design, block producers tend to prioritise transactions with the highest transaction fees because it is more profitable.
MEV is value that block producers can earn by influencing the order of transactions in a block.
Sources of MEV
- Arbitrage
Arbitrage involves exploiting the price difference of an asset across different markets or platforms. For instance, if a trader spots that the price of a particular token is priced differently on two different DEXs (Decentralised Exchanges), they can buy the token on the platform where its cheaper and sell it on the other platform where its more expensive and profiting from the price difference.
People often use an arbitrage MEV bot, a sophisticated software designed to automatically detect and exploit price differences for the same asset across different markets.
2. Liquidation
Liquidation happens in leveraged trading when a trader’s position is forcibly closed because they can no longer meet the margin requirements (minimum amount of money to keep to cover potential losses) for their trade. The crypto market is volatile therefore market rapidly moves against the trader’s position, which may result in users not having sufficient funds to cover the losses.
MEV bots may monitor the market for accounts that are close to being liquidated, and place their own transactions before the liquidation transaction to profit from the price movement that the liquidation causes.
Types of MEV
- Front-running
Front-running happens when a MEV bot makes transaction before the user using advanced knowledge it gets from pending transactions, in order to make profits.
MEV bots may buy or sell an asset before large orders are executed (as large orders cause price movements) to make profits, they benefit from the impact the latter trade has on the price. - Back-running
Alternatively, MEV bots can place trades immediately after a significant transaction that has been executed, to profit from the price movement.
Back-running can be less risky than front-running because it relies on reacting to confirmed transactions instead of anticipating the outcome of pending transactions. - Sandwich attack
Sandwich attack is when a bot places a buy order before a large order and then sells after the large order has been executed, effectively buying low and selling high (or sell low buy high depending on whether the larger order is a buy order or sell order) by “sandwiching” the large order. This is also taking advantage of the price movement caused by the large order.
Pros and cons of MEV
Pros of MEV
- Network Security
MEV provides block producers revenue sources in additional to regular block rewards and transaction fees, giving them more incentive to participate in the network. Hence, some argue that it increases network security. - Market Efficiency
MEV helps token prices on different DEXs more closely reflecting market demand and ensure DEXs remain solvent. Also it helps to ensure lenders get paid back when borrowers fall below certain collateral ratio. - Traditional Market Behaviour
MEVs in form of arbitrages, reflect established market mechanisms where participants profit from price discrepancies across different platforms, like traditional market behaviour.
Cons of MEV
- Slippage
High slippage created by MEV sandwich attackers worsens end-user experience. - Consensus Instability
MEV exceeding the block reward may lead to consensus instability, where the block producers are incentivised to reorder previous blocks to extract MEV. - Congested Network
When frontrunners are willing to pay more gas fees to compete for their transaction, the network may become congested which raises price for all transactions on the network. - Erode Market Confidence
When traders realise they are consistently at a disadvantage due to front-running, they may lose faith in the integrity of the market and leave. This could result in diminished market participation and liquidity, both of which are critical for overall market health and efficiency.
Is MEV malicious?
MEV itself is not inherently malicious, but it can lead to behaviours that are detrimental to the overall fairness of a blockchain.
Because of the above mentioned potential negative impacts, some people view certain MEV practices as unfair or unethical, even if they are not explicitly against the rules of the protocol.
Final Thoughts
MEV is a complex issue in the world of Defi. While it can provide some benefits, the potential downsides are significant and should not be overlooked.
The ability of block producers to front-run, back-run, and execute sandwich attacks can lead to poor user experiences, increased network congestion, and a potential erosion of market confidence. These negative impacts raise questions about the fairness and integrity of the system, even if the MEV practices themselves are not explicitly prohibited.
There is ongoing research and discussion within the blockchain community about how to mitigate the negative aspects of MEV while preserving the decentralisation and security of blockchain networks.
neko x
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