What Is Miner Extractable Value (MEV)?
In its current state, Ethereum utilizes a Proof-of-Work (PoW) consensus protocol whereby a group of network participants, also known as miners, play a critical role in securing the network and validating transactions on the blockchain.
These miners are in charge of selecting and aggregating network transactions into blocks, ultimately deciding which transactions from the mempool, or the memory within a node that holds pending transactions before they’re mined, they will include in these mined blocks.
Miners and other key players, such as validators and sequencers, continuously explore ways to earn a profit for their efforts in helping support the network. In order to do this, they typically prioritize the transactions which have the highest value and gas fees, to access the highest profits.
The protocol doesn’t restrict miners with any rules in regards to following this specific process. Miners have tremendous flexibility and can utilize their power to manipulate transactions, thereby pulling additional profits from users. This constitutes an “irregular” stream of revenue for miners, commonly known as miner extractable value or MEV.
But what exactly is MEV, and how does it affect Ethereum users and miners? We will explore this topic in greater detail, present further background information, and determine what the future holds.
What is MEV?
MEV has been a widely discussed topic and growing concern within the Ethereum community ever since DeFi first rose to prominence. Simply put, MEV represents the total value that miners permissionlessly extract from the Ethereum network’s users by reordering, inserting, and censoring transactions within the blocks being produced.
For those familiar with how decentralized exchanges (DEXs) operate, transaction ordering is absolutely critical, especially when large volumes of trades are simultaneously being submitted. Traders are constantly looking to get their transactions prioritized at the very top of the list, although high gas fees have become a major concern.
As previously mentioned, miners have the authority to essentially reorganize transactions occurring on the network. This means that they have ultimate control over which transactions are processed and where, allowing them to get the best deal wherever possible. The majority of Ethereum-based DeFi trading occurs on major DEXs like Uniswap and SushiSwap, so this is where these arbitrage opportunities are plentiful and most available. Currently, there’s over $6.5 billion in 24H trading volume across DEXs today — the majority of this volume comes from those running on Ethereum.
Additionally, if there’s lower liquidity present on these DEXs, there’s a greater potential ROI for miners to extract through MEV due to the high volatility and plentiful arbitrage opportunities.
How does MEV work?
Front-runners browse through submitted transactions, always looking to identify arbitrage opportunities that have the highest potential ROI. These front-runners pay the miners increased gas fees for the exact same transaction in order to benefit from arbitraging — of course, the miners select those transactions which have the highest gas fees assigned to them.
In order to illustrate this concept in a clearer manner, let’s go through an explicit example of how MEV works in actuality:
A user places an order for 10 ETH on a DEX, with each ETH token equating to 1,000 USDT — therefore, the total transaction amount equals 10,000 USDT. The user’s order will increase the price by a certain amount, and the miner can execute their own order that falls in front of that specific transaction. This refers explicitly to front-running, as mentioned earlier.
The miner does this because they know that the traders’ executed order will bump the token price higher. Once the user’s order is executed, the miner creates an additional transaction that immediately precedes it. To successfully front-run a transaction, bots that peruse the Ethereum network for high-value orders, and then execute new transactions so that they’re mined first are used.
This entire process allows these miners to sell their tokens at a profit before the original trade is executed. It’s a highly efficient way to lock in large revenue opportunities with minimal risk, making it highly attractive amongst miners everywhere.
In summary, once the transaction enters the mempool, miners can front-run the transaction and pass on a higher token price to the user, leveraging their power as miners to sequence transactions within blocks as they please. Additionally, the arbitrage or front-running bots can also spot MEV opportunities and capture them by “bribing” miners with exorbitant transaction fees in order to get their transactions executed in the specific order they please.
This, in a nutshell, embodies the concept of MEV. While it may present fantastic opportunities for miners and arbitrageurs, there are inherent issues that the average retail investor suffers from as a result.
The Underlying Problems with MEV
A major problem with MEV is that it often disincentivizes DeFi traders to execute transactions and exchange tokens on DEXs because miners can extract a hefty portion of their overall trade. Even worse, many DeFi traders are completely unaware of this problem, which can often be complex to understand and combat.
Retail investors play an essential role in the widespread adoption of DeFi and Ethereum, and the fact that MEV is creating a rather toxic environment is drawing users away from using decentralized protocols.
More than $730 million of value has been extracted from traders through MEV in 2021 alone. One Coindesk expert believes that, if Ethereum does indeed become the global financial marketplace by 2035, there could be upwards of $2 trillion in wealth extracted from users through MEV annually. These numbers put the sheer scale of this problem into perspective.
While DeFi and crypto have their benefits over traditional finance, they open the door to what could be considered deceptive practices. However, it can be fair to say that miners and arbitrageurs are simply taking advantage of the system that’s been put in place while maintaining the network that’s been put forth.
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MEV also undermines Ethereum as a protocol given that it comprises the certitude and permanence of blockchain transactions. If the reward potential is high enough, miners become more motivated to propose competing blocks that contain altered transactions, otherwise known as time-bandit attacks. In these situations, there’s a cost to users and other participants as a result. Given that miners have the power to reorder previously mined transactions as they please, this compromises the idea of the blockchain being a secure, predictable, and permissionless environment.
MEV is inherently a hidden tax on users that miners put in their pockets, robbing traders’ hard-earned crypto at their very own expense. Coupled with extremely high gas fees, this makes Ethereum quite undesirable to use for the average trader.
Many experts believe that the harms MEV is causing to the Ethereum network are greater than most may think and are being swept under the rug. Given that miners want to profit from the reordering of transactions, they may even go as far as attempting to execute aforementioned time-bandit attacks by reorganizing the blockchain’s history, signifying a massive attack on Ethereum as a whole.
The original vision for DeFi was for it to provide a decentralized, safe, and cost-effective method to trade and engage in lucrative financial opportunities. Unfortunately, MEV is posing a huge threat to the notoriety and balance of the Ethereum ecosystem, threatening its usability, immutability, permissionlessness, and decentralization.
Can Traders Avoid MEV?
But how can the average trader combat paying higher prices through MEV? If users attempt to increase their gas fees, even in excess of the highest recommended amount, bots will still front-run those trades as long as it’s a profitable move.
For the average retail investor, it’s unlikely that MEV will be a larger issue than the extremely high gas fees they already face. This is because their transactions aren’t as high in value, so they become less of a target for key MEV actors. Larger transaction amounts are far more likely to be subject to MEV attacks, so traders can attempt to reduce slippage to help mitigate the effects.
Unfortunately, miners and front-running bots have a clear upper hand, leaving the users with little to no options when facing the issues brought about by MEV.
Ethereum 2.0 and EIP-1559
Many across the community are arguing that the long-awaited deployment of Ethereum 2.0 (shift to PoS) and the EIP-1559 upgrade will help eradicate the issue of MEV. This, however, is far from the truth.
Ethereum 2.0’s shift to PoS was proposed to increase participation to secure the network, further decentralize the blockchain, and increase scalability. With a PoS consensus mechanism, users need to stake their ETH in order to become a network validator. It’s similar to PoW in that these validators are also responsible for ordering transactions and producing new blocks, but the key difference is that they don’t need to use large amounts of electricity and computer power. However, they’re still competing to hold more ETH, and therefore have a larger share of validation opportunities.
The process of MEV on Ethereum 2.0 will work almost identically to its current state on Ethereum. The main difference is that MEV will be done by validators instead of miners.
EIP-1559 is designed to alter the predictability of transaction fees via an automatic bidding system, where the fee amount changes relative to the overall network activity. Miners have expressed great frustration with this upgrade, as a portion of each transaction fee is burned, thereby hurting their profits. In the end, this may actually encourage miners to engage in more MEV extraction to make up for their lost profits.
Can MEV be Solved?
Due to the existence and ongoing issue of MEV, the power is slowly shifting away from the users and further towards miners and other MEV-extracting entities. If the issue of MEV isn’t eventually resolved, miners will have an even greater ability to manipulate user transactions in more lucrative and potentially damaging ways. Of course, this is a growing concern across the entire community, with many desperate to find a solution.
The blockchain was designed to offer a greater balance between miners and users, providing incentives to both while maintaining the concept of fairness and decentralization. Without this philosophy intact, one party has far more control than the other, essentially eliminating the purpose of crypto as a whole.
Inevitably, any blockchain that gives a key player the ability to order transactions will allow MEV extraction opportunities to thrive. If this is the case, how can the issue of MEV be tackled?
There’s a strong divide between those who believe MEV won’t go away and others who think it can be solved through further efforts. Some researchers are attempting to combat MEV through the creation of new protocols focused on fairly ordering transactions.
How Onomy Protocol Fixes Front-running
Miner Extractable Value or front-running isn’t exclusive to the Ethereum network; in fact, it’s the case on multiple other proof-of-work and proof-of-stake chains.
Onomy Protocol recognizes the challenges posed by MEV, and is consequently developing Equity — a new consensus algorithm that will provide the required transaction throughput as well as leaderless ordering, addressing validator front-running.
Simply put, Equity is a leaderless way of ordering operations in decentralized networks. In leader-based consensus, a leader node orders transactions within a block to be submitted to the other validators for approval. Because the leader has the power to order the transactions from the mempool, it gives them the ability to introduce transactions within the block they are creating, thus causing front-running.
In Equity, there is no mempool as the users are the leaders while the nodes collaborate to determine the order of transactions submitted by the users based on network conditions. This happens without slowing down the network, as other solutions do — in fact, Equity has the ability to self-optimize to increase transaction throughput. Due to this, Equity’s specs are well suited for high frequency Forex trading, and will facilitate significant throughput that exceeds all other on-chain deployments.
Diving deeper into how Equity solves front-running, the consensus protocol is the first one to collaboratively order transactions by validators, whilst being concurrent and parallel. Equity is the first in the family of smart consensus mechanisms in which all nodes collectively decide the order of all transactions. Individual nodes are only able to influence the order of transactions that have been seen by at least ⅔ of nodes. They are not able to introduce transactions for ordering without first communicating the transaction to at least ⅔ of the other nodes on the system.
This solves most of the challenges associated with front-running, as there is no leader to introduce advantageous transactions into a block. Instead, Equity ensures that value is not extracted from the Onomy cross-chain DEX by profit-seeking validators in unintended ways. This opens the door to institutional DeFi by allowing large trades to be executed at once, without the risk of losing obtainable profits due to front-running practices.
