Below is an explanation of what exactly MEV is, how it works, and what are some of its possible impacts on cryptographic ecosystems.
One of the hot spots for cryptominers and validators in recent months has been MEV, or “maximum mineable value” (the term can also mean “mining mineable value”). MEV is sometimes referred to as the “invisible tax” that miners collect from participants in a cryptoeconomy by reordering and manipulating transactions in the validation process.
Benefit in Handling Transactions
In a cryptocurrency system, regardless of the type of consensus mechanism used to confirm transactions, pending transactions are held in what is known as a “mempool,” a holding area that is visible to the public. The miners or validators in the system then select the transactions, order them, and create a block, which is then validated and added to the blockchain.
In 2014, an algorithmic trader using the Pmcgoohan identifier predicted that miners could manipulate transactions in a mempool to make a profit. They wrote that “miners can see all the contract code they execute…and the order in which transactions are executed depends on individual miners…what should stop a miner in any marketplace implementation?”
How Does MEV Extraction Work?
In theory, network miners or validators should receive the entire MEV available for a given transaction. However, these days, bots have been increasingly used by independent members of the network known as “seekers” to spot MEV opportunities and automate the mining process. This is not entirely a negative for miners, who tend to receive gas fees from prospectors eager to have their transactions included in a block for validation.
Some Techniques Used to Extract MEV
Settlement: In a DeFi lending space, users must deposit cryptocurrency to use as collateral. If a user is unable to repay their loans, the protocols often allow other participants to liquidate the collateral and obtain a liquidation fee from the borrower. Those looking for MEV opportunities can compete to find payoff-ready borrowers so they can get the payoff fee for themselves.
Running front: A bot known as a “general favorite top” can search the mempool for transactions that could be profitable for a finder. Upon discovering a candidate, the bot replicates the original transaction but with a higher gas price, leading miners to choose that transaction over the first.
DEX arbitrage: Decentralized exchanges may list different prices for the same tokens as a result of different levels of demand. A large price discrepancy can be an opportunity for MEV mining. Bots can exploit these situations by buying tokens at a lower price on one exchange, turning around, and selling them on a second exchange at a higher rate.
Sandwich attack: This is a technique that involves a seeker, who finds a large trade pending on a DEX may try to “wall” that trade among their own. Meanwhile, the finder increases the token price for the unwitting trader, who ends up paying a higher rate, and then sells tokens in the pool at that higher price to make a profit on the difference.
In short, mining MEV can be a complicated process that has an equally complex impact on the broader crypto market. MEV mining can obstruct the validation process for other users and force users to pay higher prices on transactions, but it can also help to even out token price discrepancies on decentralized exchanges.
By Audy Castaneda
