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What Is MEV (Maximal Extractable Value) In Crypto?

Last Updated June 26, 2024 1:40 PM
Andrew Kamsky
Last Updated June 26, 2024 1:40 PM

Key Takeaways

  • Maximal extractable value (MEV) can impact transaction costs and network congestion in blockchain systems.
  • Arbitrage opportunities through MEV help balance prices across different cryptocurrency exchanges.
  • Front-running allows miners to capitalize on pending transactions by manipulating the order.
  • Flashbots mitigate MEV by enabling private transaction submissions to miners, preventing front-running.

The term maximal extractable value (MEV) within the cryptocurrency industry represents a hidden profit source, where blockchain validators manipulate transaction orders for financial gain. 

This article will explain how bad actors can do this along with the MEV’s significance, how it impacts blockchain networks, and why it has become a topic of conversation amongst cryptocurrency experts.

Maximal Extractable Value (MEV) in Crypto, Explained

An MEV is the maximum profit a blockchain validator can extract when reordering and including, or excluding transactions within a block. The MEV directly affects a blockchains integrity and fairness which leads to increased transaction costs, network congestion, and potential instability.

Understanding the MEV meaning is required to develop strategies that aim to mitigate the impact of bad actors and hold more secure and equitable blockchain ecosystems.

Types Of MEV

Understanding the different types of MEV is useful to understand how MEV impacts the cryptocurrency ecosystem. Here are two primary types:

Miner Extractable Value (MEV)

Miner extractable value refers to the MEV directly captured by miners or validators who have the power to include, exclude, or reorder transactions within a block. By manipulating transaction sequences, miners can prioritize transactions that yield higher fees and exploit arbitrage opportunities. 

User Extractable Value (MEV)

User extractable value involves MEV captured by sophisticated traders where users monitor transaction pools and network activity to front-run or back-run transactions, capitalizing on price discrepancies or other advantages. 

Sophisticated bots exploit arbitrage opportunities within a blockchain.

Features Miner Extractable Value (MEV) User Extractable Value (MEV)
Who captures the value? Miners/Validators Sophisticated Traders/Bots
Control over transaction order High None
Impact on network Increased fees, congestion Exploitation of arbitrage opportunities
Required expertise Understanding of mining/validating Advanced trading algorithms, monitoring
Primary tools used Mining software Trading bots, algorithms

 

How Do MEV Orders Work In Crypto Exchanges?: A Step-By-Step Guide

Here is a step-by-step guide on how MEV orders work on crypto exchanges:

Step 1: Transaction Pool (Mempool)

All pending transactions are collected in a transaction pool, known as the mempool. This pool is where transactions wait to be included in the next block. Miners and validators have access to this pool and can see all pending transactions.

Step 2: Miner/Validator Selection

Miners or validators are chosen based on the consensus algorithm of the blockchain such as proof of work or proof of stake. The selected miner or validator holds the authority to decide the order of transactions in the next block.

Step 3: MEV Opportunity Identification

Once selected, the miner/validator analyzes the mempool for MEV opportunities. Normally this involves identifying transactions that can be reordered, included, or excluded to maximize profit. For example, a miner might prioritize transactions with higher fees or those that create arbitrage opportunities.

Step 4: Transaction Ordering/Manipulation

The miner/validator reorders transactions in a way that maximizes extractable value. The manipulation includes the game of ‘front-running’ by placing a transaction ahead of another to profit from the price change or ‘back-running’ by placing a transaction immediately after another to capture the resulting profit.

Step 5: Block Creation

Finally, the miner/validator creates the block with the reordered transactions and adds it to the blockchain. The new block is broadcasted to the network, completing the process. The manipulated order ensures that the miner/validator extracts the maximum value possible.

Common MEV Strategies

Some common MEV strategies that are adopted might include:

Arbitrage

Arbitrage involves taking advantage of price discrepancies across different exchanges or markets. Miners/validators aim to prioritize certain transactions for which they can engineer a profit on price difference. Such strategies require quick action before others do.

Front-Running

Front-running occurs when a miner or validator sees a pending transaction in the mempool and inserts their own transaction just before it. The intention here is for the miner to capitalize on the price movement that the original transaction will cause.

Sandwich Attacks

Sandwich attacks are a more sophisticated form of front-running where the attacker places two transactions around a victim’s transaction. If a large buy order is detected an attacker will front-run, afterwhich the victim’s buy order will execute, which will drive up the price. Lastly, the attacker places a sell order to take advantage of the increased price. 

Liquidations

Liquidations occur in decentralized finance (DeFi) platforms where loans are collateralized by other cryptocurrencies. If the value of the collateral falls below a certain threshold, the loan can be liquidated. MEV attackers can monitor for vulnerable positions and trigger liquidations by manipulating transaction orders to profit from the penalties or fees associated with the liquidation process.

The Impact of MEV

Some strategies to prevent MEV attacks might include:

Positives

  • Network security: MEV incentivizes miners and validators to secure the network by offering additional profit opportunities. This extra income can motivate them to maintain and improve the blockchain infrastructure, enhancing overall network stability and resilience against attacks.
  • Market efficiency: Arbitrage opportunities within MEV can help balance prices across different exchanges. By exploiting price discrepancies, arbitrageurs ensure that prices converge, which aids a more efficient market where assets are priced consistently.

Negatives

  • Higher transaction fees: Competition for MEV drives up gas fees, especially on networks like Ethereum. As miners prioritize transactions with higher fees to maximize extractable value, regular users face increased costs for processing their transactions.
  • Unfairness: MEV creates an environment where sophisticated actors with advanced tools and knowledge have an advantage in capturing value. Leading to an imbalance because ordinary users lack the resources to compete effectively.
  • Network congestion: MEV-driven activity can overload the network as actors flood the blockchain with transactions to capture opportunities. Such congestion slows down transaction processing times and reduces the efficiency and usability of the network.

How To Prevent MEV Attacks?

Strategies that may prevent MEV attacks from occurring include:

Flashbots

Flashbots is a research and development organization that aims to mitigate MEV attacks by creating a transparent and efficient marketplace for MEV extraction. It reduces network congestion and prevents front-running by keeping transaction details hidden from the public mempool until they are included in a block. Reducing the chances of front-running.

MEV Auctions And Order Flow Auctions

MEV Auctions and Order Flow Auctions are mechanisms designed to decentralize the process of capturing MEV. 

These auctions allow searchers to bid for the right to reorder transactions in a block. By making the process competitive and transparent, these auctions aim to reduce the negative impact of MEV on regular users, such as increased transaction fees and unfair advantages for sophisticated actors.

Fair Sequencing Services

Fair Sequencing Services (FSS) aim to ensure that transactions are ordered fairly based on their arrival times. By using cryptographic techniques to commit to transaction orders before they are revealed, FSS can prevent front-running and other forms of transaction manipulation.

Proposer-Builder Separation (PBS)

Proposer-Builder Separation (PBS) is a proposed protocol change that separates the roles of block proposers and block builders. Proposers select transactions to include in a block without knowing their contents, while builders determine the transaction order. The separation makes it harder for any single party to manipulate transaction order for MEV. 

Conclusion

Maximal extractable value is a term that describes a situation where a significant hidden profit source can be taken advantage of, within the cryptocurrency industry, where blockchain validators manipulate transaction orders for financial gain. It may exploit blockchain integrity and fairness, leading to increased transaction costs, network congestion, and potential instability. 

Various strategies like Flashbots, MEV Auctions, Fair Sequencing Services, and Proposer-Builder Separation aim to prevent MEV attacks in an effort to maintain a fairer and more efficient blockchain environment. 

FAQs

Can everyday crypto users get involved in MEV, or is it primarily a game for advanced traders and bots? 

MEV is primarily exploited by advanced traders and bots due to the technical expertise and tools required to identify and execute MEV opportunities effectively.

Is MEV ultimately a positive or negative force in the crypto world? 

MEV has both positive and negative impacts, improving network security and market efficiency but also causing higher fees, unfair advantages, and network congestion.

Is MEV unique to proof-of-work (PoW) blockchains, or does it also exist in proof-of-stake (PoS) systems? 

MEV exists in both PoW and PoS systems, as validators or miners in either system can manipulate transaction orders for profit.

Are there any regulatory concerns or potential legal issues surrounding MEV practices in the crypto space? 

Yes, MEV practices raise regulatory concerns due to potential market manipulation, fairness issues, and the overall impact on transaction costs and network stability.

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