Flipping the Table on the MEV Game

Can we transform users from MEV prey to MEV chads

Most assume MEV to be a necessary evil: MEV bots and validators extract value from helpless users traveling the Dark Forest.

I’d like to explore an alternative, stemming from 2 insights:

1) Users control the order flow, and much of the MEV opportunities

There are strong similarities between “Users vs MEV bots” and “general public vs lobbyist groups”; users actually have more power, but it’s diffused and unorganized.

2) PoS introduces a new actor — Stakers.
While validators are incentivized to maximize MEV, Stakers hold a HUGE bag which benefits if front-running “magically” disappears

It’s hard to quantify the effect of “magically” eradicating front-running on ETH usability and price; how much higher would ETH price be in 5 years if DeFi isn’t burdened by front-running? 20% higher? 50%? x2?
If eradicating front-running increases ETH price by only 10% over the course of 5 years, it’s worth $280M /yr for the stakers— significantly more than the $100M/yr front-running pays*.

Can these 2 levers be used to empower ETH users? Maybe.
Let’s explore!

We’re hosting a round-table discussion and panels during EthCC Paris (July 20 , 1pm). If you’re interested to participate DM me or follow up on Twitter for details.

*the effect is continuous, and doesn’t assume stakers actually hold ETH for 5 yrs. While holding it pays more for front-running not to exist. Also, we really can’t tell whether the effect is 10% or 100% over 5 yrs, but math checks out even for 3.5%.

Some Background

Previously on ETH…

If you’re not super well-versed in MEV history, here’s the a short recap:

1. 2020 — DeFi gets serious. Traders start brutal gas outbidding wars, trying to put their Tx first in the block to capture best opportunities.
2. Traders figure out they can see other trades in the mempool, before they execute, and try to place their Tx to execute just before (front-run) or after (back-run) these “trigger Tx”.
3. Tx fees spike, hurting everyone. Mining pools start accepting under-the-table deals to include Tx at the top of the block. Not good.
4. bloXroute provide networking tools to see opportunities and execute faster, as well as private Tx which are never broadcast to the mempool.
5. Flashbots coming out, suggesting “MEV Searchers” will offer competing “bundles” of Tx to miners offline, siloing the gas war from normal users.
6. As competition intensify, MEV Searchers offer >90% of bundles’ profit to miners to be included in the block.
7. In preparation for the Merge, Flashbots released mev-boost; a patch to ETH2 validators which:
   * Validators receive “sealed” blocks from MEV block-builders (BBs)
   * Propose the highest-paying sealed block (not knowing its content)
8. All major validators and staking pools, including Coinabse and Lido, are supporting mev-boost.

How to Define MEV and Fairness? I don’t care.

There’s a long debate what MEV is or isn’t, however I really only care about:

• Front-running, which is the big bad MEV that takes advantage of users, extract value from them, and is basically DeFi friction.
• Arbitrage, which should be captured by someone in an efficient market, and might as well be captured by validators and MEV bots.
• Back-running, which is a fancy name for arbitrage that happens immediately after a specific Tx.

There’s a similar debate whether including Tx in a block according to their time (FIFO) is more or less “fair” than ordering it by the fee users pay.
In my opinion paying to reorder someone else’s Tx in order to front-run them falls outside both definitions.

The “User Power” Angle

Users’ strongest leverage is choosing with whom to share their DeFi Tx. If you’re just sending ETH, tokens, or other non-DeFi stuff, you can just broadcast your Tx to the P2P network. But if you’re sending your trades, NFT minting, rebalancing, yield, etc, to the P2P network — you’re going to be taken advantage of.

But this isn’t just about whales. The ability to order everyone’s Tx means that even small Tx not worth front-running can be batched together and get sandwiched (frontrun+backrun).

Very hypothetically, all the DeFi users could cut a deal with a single MEV Searcher —they’ll all send the searcher their Tx, who will be able to capture all the back-running value, if he doesn’t front-run them. If he does, they move to someone else.

A more realistic scenario, is sending these Tx to MEV Block Builders (BBs) who would only capture arbitrage, but won’t front-run. If enough users will do so, then such BBs would be able to construct more valuable blocks than the predatory front-running BBs, since they’ll have more back-running value, and nobody will capture front-running value.

Our Actionable Items

We at bloXroute are exploring this path.

1. We will run a “good” block-builder which only captures arbitrage, and doesn’t front-run. We believe several other teams will do the same, but these builders’ success will depend on the community’s choice to use them.
2. We’ll further explore sharing back-running profits with users, reversing the dynamics and incentivizing BBs to bid users for their order flow.
3. We’ll also run a “regular” front-running block-builder which will not have access to these Tx, to compete with the “good” block-builder.
4. As a network-infra company, we will provide an RPC point capable of sending Tx to all the “good” BBs, to all the BBs, or to a subset of them.

The “Staker Incentive” Angle

There’s a lot of money in MEV, roughly 160K ETH (~$200M) per year, and roughly 50% of it is extracted from front-running. However these sums are dwarfed by the sums of ETH staking, currently at 12.5M ETH (~$15B).

Any rational staker who believes front-running is hindering the usability of ETH and affects its long-term price, will choose to minimize front-running, which in turn affects validator incentives.

Economics

There’s an Econ research paper we’re working on, which we won’t explore here:

1. How would eradicating front-running affect ETH price?
   There seems to be an agreement that Ethereum’s usability translates to ETH price, but even ignoring market volatility cycles, how large is the effect?
2. Is the relationship linear?
   Does reducing front-running by 50% translate to 50% of the effect on ETH price? Does the marginal 90%→91% affect more or less than 50% →51%?

These are great questions we won’t be discussing here. Instead, imagine this:

• It’s 2027, the current bear market is over, as is the bull market which followed it, and we’re in a bear market again. The price of ETH is $X.
• Now, imagine that during these 5 years PoS stakers and validators completely eradicated front-running, allowing DeFi usability to evolve faster for 5 years.
• By how much you think ETH price will be higher? 20%? 50%? x2?

I don’t know the exact answer, but 10% feels VERY conservative for 5 years of additional usability. These 10% over a course of 5 years translate to ~$300M per year — x3 more than front-running pays!

Similarly, I don’t know if the effect is linear, sub-linear, or super-linear, but assuming that significantly reducing front-running translates to significantly more usability feels like a very safe assumption.

Lastly, this is a continuous effect, and so while ETH stakers are holding their ETH, their average return on eradicating front-running is higher, whether it’s a year, a month, or a week.

Oh, the Tragedy

This is all a bit too good.
If it’s in the stakers’ interest to eradicate front-running, shouldn’t it just happen? unfortunately no.

• If there was just one staker with 100% of the stake, she’d be better off netting $300M/yr (see above example) over making $100M /yr from front-running.
• But if there are 10 stakers, each holding 10% of the stake, it’s a different story. If one of them chooses not to front-run, it eradicates 10% of the front-running, so it misses out on $10M/yr, and increases everyone’s bags by $30M (assuming the effect is ~linear).
  BUT his own personal bag only increases by $3M!

Eradicating front-running is in the best interest of stakers, but each staker would like the other stakers to eradicate front-running, while at her turn to capture front-running MEV.

How Stakers affect Validators

Validators are incentivized to maximize MEV, but their revenue is determined by the their amount of stake in two ways:

1. The validator’s share of the blocks’ MEV is proportional to their stake. less stake, less MEV .
2. The validator share of the much more substantial $600M/yr staking reward is proportional to their stake. less stake, less reward.

(In both cases you can assume the validator only keeps a small % of the revenue, but this doesn’t change the math)

To better outline the staker-validator dynamics, consider the following:

1. Imagine 50% of the stake is delegated to validators proposing front-running MEV, and 50% to those who don’t. Their revenues are basically the same, since they all share the rewards.
2. Now, imagine 10% of the stake supporting front-running realize they’re better off banning front-running, and move their stake to such validators.
3. The front-running validators lose 20% of their staking reward and 20% of their MEV reward. The total MEV reward also decreases, because now front-running is only captured in 40% of the blocks.
4. The front-running validators will find themselves competing on a smaller pie, until 10% of them will stop and equilibrium will be restored.

This over-simplistic example outlines how stakers are the real decision makers, and have the power to determine validators behavior.

What Now?

While it is in the stakers’ incentive to eradicate front-running, their Tragedy of the Commons hinders their ability to achieve it. However, users might be able to tip the scales by depriving opportunities from front-running Block-Builders, and providing an edge to “good” Block-Builders who don’t.

This isn’t a concrete suggestion — it’s an invitation for the ETH community to engage a significant discussion, and an attempt to awareness to this topic which isn’t even considered .

We will discuss this and more in Paris 7/20 at 1pm — food & drinks on us! (you deserve it if you made it this far…)

Additional Thoughts

I tried to keep this relatively short, but I’m quite terrible at it… 🙈
So — I pushed all my additional thoughts here!

The Issue with Good Block-Builders

The “User Power” is all well and good, but how can users know the BBs won’t front-run them? Trying to solve it using staking, slashing, or even a new token quickly:
1. take us back to just using validators, no need for BBs.
2. lead us to something like Ari Jules’ fair chain-merging.

Maybe Ari Jules’s approach is better 🤷‍♂️ but Vitalik had put PBS on the roadmap and validators using mev-boost will be a reality within 2 months. So unless this changes — staking/slashing is likely a dead-end.

There’s still hope though.
If we can provide the tools showing users if they’re likely being front-run, then users will converge to using the BBs which don’t front-run them. And while providing a smoking gun for front-running is hard, identifying if a Tx was likely front-run is much easier.

The Metamask Dilemma

Metamask are faced with an impossible dilemma. To be neutral means to send user Tx to the P2P network, and getting their DeFi users rekt.
They could also send their Tx only to “good” BBs, but that might lengthen the time until a Tx executes, as well as an awful lot of responsibility to decide which BBs are actually “good”. It also makes them somewhat of kingmakers, as they’ll control which BBs will have access to their significant order flow.

I hope their new plugins architecture would allow for more flexibility, but would really love to get their feedback and perspective on the matter.

Special thanks to P McGoohan, Barnabé Monnot, Sreeram Kannan, Stephane Gosselin, and the MEV Pirate ship group for providing critical feedback and pointing out my mistakes.