Maximal extractable value is a concept in blockchain that effect participants who transact on public blockchain network like Ethereum, Solana and more. All network participants must be aware of the risks and different opportunity a particular transaction creates for MEV while transacting on a network.
Maximal extractable value or MEV can simply said to be the invisible tax collected by miners or validators from users who are submitting transactions on a blockchain. MEV is like a double-edged sword because it can benefit and harm the network. MEV enhance network efficiency and a additional reward to validators but it also badly effect user experience, network congestion due to increased gas costs, and slippage.
In this article, we will look into Maximal Extractable value, how it works, examples and its impact on crypto market.
What is the Maximal Extractable Value – MEV
Maximal Extractable Value or MEV is the additional value that can be extracted by miners or validators during the process of Block production by including, excluding or rearranging the order of transactions in a block.
MEV was introduced in the Proof of Work consensus and was known as Miner Extractable Value. In POW, miners are responsible for the creation of a block by solving cryptographic puzzle controlling transaction inclusion, exclusion, and ordering. The MEV is considered as an additional reward for miners apart from standard block reward and gas fee. Transition from Proof of Work (POW) to Proof of Stake(POS), validators take charge of these roles in block production. Therefore MEV is now referred to as Maximal Extractable Value.
How Does MEV Work?
How does reordering, inclusion, or exclusion of transactions in a block maximize profit? Before that, you must understand how a block is created.
Below are the steps involved in creating a block from users transactions:
- A transaction is submitted by a user on a blockchain network
- Transaction is forwarded temporarily stored into a mempool waiting for confirmation.
- Miners or validators choose and order transaction from the pool to create block
- Miners or Validators verify the block and add to the blockchain
Now the question is on what basis miners/validators select transactions from the public mempool? Basically they should prioritize processing transactions by gas fee, the higher gas offered the higher chance to get transactions to be included on the block. Due to the transparency nature of mempool, they get necessary information about the transaction to extract MEV through more profitable opportunities like arbitrage, sandwich, and liquidations.
Miners and validators are the major players in the MEV sector however a large portion of MEV is extracted by network participants also known as searchers. Searchers find MEV opportunities with the help of bots and submits profitable transactions automatically to the network. Even though searches are experts in finding good MEV, validators are required to validate and include transactions in a block. SErachers are compelled to pay a large portion of MEV profit to validators in the form of gas fees. Gas golfing techniques are used by searchers to reduce gas consumption so that they can balance the total gas fees in transactions.
Different Types of MEV
Arbitrage
Decentralized exchange(DEX) arbitrage is the simplest example of MEV. Like any arbitrage, it is the method of buying and selling assets in different markets or DEX, to gain profit on any price differences.
For example, consider two DEX offering the same token at two different prices, one can buy that token from the DEX that offers in lower price and sell it to the DEX that offers a high price in a single transaction.
Front running
Front running transactions are another simplest form of MEV. Here searchers continuosly watch public mempool. When a profitable transaction like large trade ot tokenswaps is found either using bots or manually, they can replace the original users address with front runners address and submit transaction with higher gas price getting MEV.
Liquidation
Lending protocols like Aave let users deposit collaterals to borrow other assets. Borrower’s collateral value may change due to market fluctuation. Liquidation happens when borrower’s collateral value falls too much and searcher’s find this as a MEV opportunity to get profit of liquidation fee by acting as liquidators.
Sandwich Attack
Trading is a riskier and malicious approach in MEV extraction where searcher submit transaction (as in front running) and submit another transaction after the orginal transaction from the user(back running) similar to layers in sandwich. This method is often implemented in large trade to cause the price fluctuation.
Example, a searcher buys large order increasing the asset price. Any user purchase the asset at high price. The searcher now will sell all the orders at the higher price, to gain profit from the price difference.
Impact of MEV in Blockchain Ecosystem
There is a good and bad side to things right? MEV can be good and bad for a network.
The good side is that it is an extra income source for validators and searchers. Additionally, they improve pricing inefficiencies in several DeFi protocols and balance liquidation.
Now coming to drawbacks, some MEV strategy like Sandwich trade bring worse user experience, increase slippage and transaction cost. Also causes network congestion due to sudden rise in gas cost, and consensus risks.
Conclusion
Maximal extractable value -MEV is complicated yet unavoidable in crypto space. While MEV brings opportunities to increase the efficiency of the network and new revenue stream there exist risks to user experience and network stability. Awareness and clear understanding of MEV is essential for network participant or user transacting on public blockchain.
