Copyright © 2023 by Verilog Solutions. All rights reserved.

April 26, 2023

by Verilog Solutions

TLDR

• This research is aiming to be an easy-to-understand guide for everyday on-chain users on:
  • what is MEV
  • the lifecycle of a block-building process
  • the status quo of the MEV economics
  • some interesting ideas and discussions about the MEV
  • how to reduce your MEV exposure
• MEV supply chain
  • MEV supply chain can be broken down into multiple segments, including wallet, RPC provider, searcher, builder, relay, and validators
  • Players in each segment compete both horizontally (against other players in the same segment) and vertically (against players in the upstream and downstream)
  • Each segment has its own unique ways of developing moat and varying degrees of the barrier of entry
  • There are also possibilities for horizontal and vertical integration within and across different segments
• Not all MEVs are bad and malicious
  • Good side: Several DeFi projects depend on economically rational participants to maintain the effectiveness and stability of their protocols. One example is that decentralized exchange arbitrage, as a form of MEV opportunity, makes the market efficient by removing price discrepancies across different DEXes. In addition, back-running Oracle updates to quickly liquidate at-risk lending positions is a form of MEV opportunity that makes lending protocols economically solvent
  • Bad side: Some MEV opportunities such as sandwiching are malicious and harms the user’s economic benefits. Sandwiching victims often encounter greater slippage and poorer trade execution.

1. Introduction

Maximal Extractable Value (MEV) refers to the maximum value a blockchain miner or validator can make by including, excluding, or changing the order of transactions during the block production process.

The term MEV, originated during the Proof-of-Work era of Ethereum when miners controlled which blocks and transactions were inserted into the blockchain. Ethereum’s move to Proof-of-Stake (PoS) saw power over block proposal transition from miners to validators, but the pursuit of profit through manipulating transactions remained, so now the term “Maximal Extractable Value” is used.

MEV and transaction reordering are not just explained as a theoretical concept, but as a dynamic that is already occurring at scale in the form of transaction frontrunning on decentralized exchanges and which can have a significant impact on the user experience. From what has been able to be uncovered, over $908.3 million worth of MEV has been extracted since 2020. Quantifying the exact amount of MEV is challenging, given that many extraction techniques are designed to be concealed to maintain a competitive advantage.

MEV occurs when block producers in a blockchain (e.g. miners, validators) are able to extract value by arbitrarily reordering, including, or excluding transactions within a block, often to the detriment of users. Simply put, block producers can determine the order in which transactions are processed on the blockchain and exploit that power to their advantage.

The key players involved in MEV are wallets, searchers, validators, mempools, and relays.

Credit: The MEV Supply Chain: a peek into the Future of this Industry by Thegostep and Flashbots

Credit: The MEV Supply Chain: a peek into the Future of this Industry by Thegostep and Flashbots

Wallet

A wallet is a digital or physical device that stores your private keys, which are used to access and manage cryptocurrency and blockchain-based assets, like NFTs. Most of the on-chain interactions for regular users are achieved through wallets.

Searchers

Searchers are individuals who interact with the mempool to monitor unconfirmed transactions and gain insight into imminent transactions before they are permanently recorded on the blockchain. Searchers implement algorithms that identify MEV opportunities from the pending transactions and generate transactions that extract value from found opportunities, such as front-running.

Validators