MEV Explained: How Miners and Validators Extract Extra Value from Blockchain Transactions

Have you ever wondered how some people can make money by manipulating the order of transactions on a blockchain? Or how some transactions can be delayed or altered by the network participants? If so, you might be interested in learning about MEV or Maximal Extractable Value.

MEV arises from the fact that transactions on a blockchain are not executed instantly but in batches called blocks. The order of transactions within a block can significantly affect the outcome of the transactions and the state of the blockchain.

You see, it is a simple demand and supply scenario; when someone buys something, the price goes up. So, in this case, when Bob buys 100 ETH, the price of ETH goes up (say to 101 USD). But since Alice also wants to buy 100 ETH, she has to pay 101 USD now. If Alice buys 100 ETH at 101 USD, the price of ETH again will increase, let’s say, to 105 USD. Now, Bob can sell his 100 ETH that he bought for 100 USD at 105 USD and make a profit of 5 USD.

MEV is a critical concept to understand because it has implications for users and network security. On the one hand, MEV can incentivize miners and validators to secure the network and promote market efficiency. On the other hand, MEV can also lead to centralization risks, user exploitation, network congestion, and transaction unpredictability.

In this article, we will explore the benefits and detriments of MEV and some of the solutions that Ethereum is implementing to address the MEV issue. We will also explain how MEV works and how it affects the users and the network. By the end of this blog, you will have a better understanding of MEV and its role in blockchain transactions.

Understanding Maximum Extractable Value (MEV) and its implications requires us to look at its possible benefits as well as its potential drawbacks.

Benefits:

• Market Efficiency: MEV extraction through arbitrage promotes market efficiency. For instance, if Bitcoin is priced at $30,000 on exchange A and $30,100 on exchange B, an MEV miner could buy Bitcoin on A and simultaneously sell it on B, profiting from the price discrepancy and contributing to price equilibrium across exchanges.
• Network Security: By providing an additional income source, MEV can instigate miners to participate in mining activities to secure the network. Miners validate transactions and maintain the blockchain ledger — activities vital for the blockchain's functionality and security.
• Liquidity Management: In the case of decentralized finance (DeFi) applications, rapid market movements might render a DeFi loan under-collateralized. An MEV mining algorithm could identify such situations and swiftly execute the needed liquidations, ensuring the overall health of the DeFi ecosystem.

Detriments:

• Centralization Risks: Powerful miners exploiting MEV could influence the network disproportionately. For example, if a miner controls a significant percentage of the mining power, they could reorder, include, or exclude transactions within a block to maximize their MEV, undermining the premise of decentralization.
• User Exploitation: MEV may lead to practices like 'front-running' where parties use their power to manipulate transaction orders. For instance, if a user submits a transaction to buy a large amount of a particular cryptocurrency, a miner could put their transaction first, causing the user's transaction to execute at a higher price due to increased demand.
• Network Congestion: If a miner opts to include transactions with higher MEV potential first, usual transactions might be delayed, causing network congestion. This would lengthen confirmation times for regular transactions.
• What You See Is Not What You Get: Miners using MEV could alter the transaction from its initial state. Suppose a user broadcasts a transaction to buy an asset in a decentralized exchange. An MEV miner could rearrange the transaction order in such a way that the price of the asset increases before the user's transaction executes, resulting in the user paying more than initially intended.

What steps is Ethereum taking to address the downsides of MEV?

Ethereum's primary solution to the MEV issue lies in its transition from Proof of Work (PoW) to Proof of Stake (PoS) mechanism through Ethereum 2.0, also known as Serenity.

In the PoW mechanism, miners with more computational power have higher chances of adding the next block and, thus, the ability to decide the block's transaction order, leading to potential MEV exploitation. However, with the PoS mechanism, 'validators' are chosen algorithmically to propose the next block, making it harder for a single entity to control transaction ordering consistently.

However, PoS and EIP-1559 alone won't eliminate all MEV opportunities; instead, they reduce the instances where these can be exploited.

In addition, a prominent project to tackle MEV directly on Ethereum is the Flashbots project . Flashbots provides a 'fair' marketplace for MEV extraction. It provides an infrastructure where bots compete with each other to offer the best price to validators for including transactions. This brings transparency to MEV activities and mitigates concerns like network congestion, as these transactions are not broadcast to the entire network.

Conclusion

MEV is a fascinating and complex phenomenon that arises from the nature of blockchain transactions and smart contracts. It has both positive and negative effects on the users and the network security of Ethereum and other blockchains. While MEV can incentivize network participation, market efficiency, and liquidity management, it can pose challenges such as centralization risks, user exploitation, network congestion, and transaction unpredictability.

Ethereum is taking several steps to address the MEV issue and reduce its detrimental impacts. Some of these steps include transitioning from PoW to PoS mechanism through Ethereum 2.0, implementing EIP-1559 to overhaul the fee structure, and supporting projects like Flashbots that provide a fair and transparent marketplace for MEV extraction.

However, MEV cannot be eliminated entirely, as it is inherent to blockchains with smart contract capability and transaction competition. As Ethereum continues to evolve and grow, more solutions will likely emerge from the thriving developer ecosystem. The challenge is to find a balance between harnessing the benefits of MEV and mitigating its drawbacks.

I hope this article has helped you understand what MEV is and how it affects blockchain transactions. If you want to learn more about MEV, you can check out some of the links I have provided at the end. Thank you for reading!