Ethereum
Miner Extractable Value (MEV) on Bitcoin and Ethereum
“Miner-extractable value” seems innocuous enough. Miners, the participants who keep bitcoin and ethereum safe, should be paid. The main question is how much should they be paid. The answer, a mining reward for creating the block as well as any transaction fees associated with transactions on the block. As transactions that join a block are the only valid transactions. The existence of the equivalent of an open order book in the form of a public mempool has created several opportunities that are not available in traditional financial contexts. Such an open order book attracts arbitrageurs. Arbitrators typically buy an asset at a low price and resell it at a higher value, simultaneously making an assured profit. This can happen when the same asset is available on multiple exchanges at different prices. The function of arbitrageurs is to smooth market prices. However, MEV is generally not a simple arbitrage. We examine the MEV in depth, to separate the malignant and benign aspects.
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MEV refers to the value that can be extracted by miners or validators from creating blocks beyond the standard block reward and transaction fees by managing the content and order of transactions in blocks. In proof-of-work blockchains such as pre-merger Bitcoin and Ethereum, this acronym is derived from Miner Extracted Value. In post-merger Ethereum, where proof of stake has replaced proof of work, the acronym exists, but it is now the maximum extractable value.
With the arrival of DeFi, the different ways of mining MEV have changed. Since the launch of DeFi protocols in Ethereum, MEV in Ethereum has been the most studied. In this text, the term miner is used for all activities, including in post-merge Ethereum where this role is played by block builders. Satoshi Nakomoto created a section on incentives (#6) in the newspaper that launched Bitcoin. This section is one of the first on the crypto-economy. The argument is that if the minor cheated, he would lose more by cheating than by remaining honest. Such an argument was based on only one protocol, bitcoin. “He (the miner) should find it more profitable to play by the rules, rules that favor him with more new coins than everyone else combined, rather than undermining the system and the validity of his own wealth.”
In most public blockchains, the miner chooses transactions from the mempool to assemble a new block. The mempool is a set of transactions that users have typically created through their wallets and constitutes the set of transactions that miners or their proxies can choose to be included in the block. All transactions must go through the mempool, with rare exceptions like the coinbase to bitcoin transaction. The Coinbase transaction is where the miner issues new bitcoins to create the block and pay themselves for it.
Until the transaction is included in a block, user transactions in the memory pool are not confirmed and are not finalized. They can be replaced. Miners choose which memory pool transactions to include in a block based on a complex set of criteria. The most important is the fees attached to the transaction. Items in the memory pool are NOT added in the order they are received, miners convert the memory pool into a priority queue, with those paying the most transaction fees placed at the top of the queue. queue.
Unlike traditional marketplaces, all participants can see the contents of the mempool. Such transparency creates an opportunity for participants called researchers. Researchers look for arbitrage or other opportunities to profit from potentially dynamic market transactions observed in a mempool, or sudden price movements discovered through a standard oracle. Researchers then introduce their own transactions for a high fee into the memory pool. Additionally, what is illegal in traditional markets due to limited visibility of the order book to brokers alone may be legal in a world where the entire memory is visible to everyone.
Broker precedence is illegal in traditional markets. Researchers are creating this capability using robots. DeFi, where leverage amplifies returns, is a natural multi-site for a source of value for miners. This is influenced by the cryptoeconomics of the entire system, not a single protocol. The system includes all DeFi protocols based on the price of an on-chain asset. DeFi has since expanded to many other chains as a way for ordinary cryptocurrency holders to generate income through yield farming, providing liquidity in AMMs as well as participating in public services such as L2, Blockchain Bridges or Oracles. Arbitrage opportunities are created due to price differences for the same token in different DeFi AMM protocols. The robot researcher having discovered this difference can buy the token from the DeFi pool with the lowest price and sell the same token in a pool with the highest price to be atomically settled in the same block. To ensure that both transactions are completed, transaction fees are set higher than most other transactions in the memory pool. These excess transaction fees are collected by miners, leading to maximum extractable value. Such opportunities are also available wherever such price differences can be arbitraged, including front-end attacks, sandwich attacks, and other sources of value extraction. Community leaders and creators alike feel that such activity is legitimate and the price to pay for decentralization and transparency. The MEV-Boost site digs into the details, including ways to use MEV-Boost by different types of participants.
This type of attacks increases costs for ordinary users.