With the proliferation of blockchain applications worldwide, making a profit from transaction ordering has become increasingly complicated. Maximum Extractable Value (MEV) is one of the most overwhelming strategies that influences the way blocks are formed and validated. MEV is a crucial component of the digital finance ecosystem, and it still poses essential questions.
Understanding MEV and Its Rise
MEV is the profit gained by a rearrangement of the sequence of the transactions in a block prior to confirmation. Although it was first applied to miners in proof-of-work protocols, it is also applied to validators and builders in proof-of-stake protocols. This introduction is a pointer of the manner MEV has changed to fit the new network upgrades and consensus systems.
The absence of a forced order of transactions allows block producers to add, delete, and reorder transactions to maximize their profit. With the increase in DeFi activity, bots and searchers began scanning mempools, finding profitable trades, and facilitating high-fee transactions. This led to MEV extraction soon being an organized and lucrative event in numerous blockchain ecosystems.
Common MEV Strategies in Practice
Another common MEV technique employed is known as arbitrage, and it takes advantage of the price disparity between exchanges to generate returns based on the price gap. Frontrunning occurs when bots place a transaction ahead of a significant pending transaction, enabling them to capitalize on price changes. These techniques are combined with backrunning and usually create sandwich attacks on user trades.
In sandwich attacks, bots purchase before a user’s trade and sell immediately afterwards, creating slippage and additional expense for the user. Liquidation MEV occurs when loans drop below the collateral value, and bots compete to trigger the liquidation and receive a bonus. JIT liquidity contributes temporarily to pools before a trade and then withdraws it to generate fee profits.
Priority gas auctions previously determined who received an added transaction; however, private relay systems have mitigated these open gas wars. MEV-Boost has been extended to support privately presenting transaction bundles to validators. This transformation reduces network congestion but increases dependency on off-chain systems.
MEV Infrastructure and Actors
The MEV ecosystem is driven by multiple-purpose actors and tools that collaborate to play their respective roles. These actors play different roles yet relate perfectly to extract or reduce MEV. The priority groups are:
- Searchers: Bots or traders that scan mempools to find arbitrage opportunities, liquidation opportunities, or sandwich opportunities and submit profitable bundles.
- Builders: Organizations that group bundles of transactions into complete blocks and order them most profitably and pass them on to validators.
- Validators: Block producers that decide what blocks to confirm and frequently employ MEV-Boost to get a higher reward.
- Relays: Reliable intermediaries relaying high-value blocks between builders and validators in a secure fashion, preventing DOS attacks, and achieving trust.
- Wallets and Aggregators: End-user applications that send transactions through closed networks to minimize interaction with open bots.
- Flashbots and MEV-Boost: Essential software designed to make MEV extraction standardized, decrease gas wars, and allow submission of private bundles.
These actors create a layered network that not only mitigates MEV but also reduces its most pernicious impacts. While this structure creates efficiency, it also introduces new risks of centralization and trust. This space is now dominated by flashbots and other projects that influence the way MEV is performed across blockchains.
MEV’s Impact and Regulatory Concerns
MEV establishes advantages and issues in the blockchain economy because it increases the reward of validators, but it can harm users. Social malpractices, such as sandwich attacks, discourage trust and increase user expenses in the trades, which is a concern throughout the DeFi arena. The overall effect of this is increased competition among bots, which has also increased the cost of gas for all.
In traditional finance, some experts caution that MEV is an act of illegality, e.g., market manipulation or access imbalances. European regulators have questioned the equity of MEV practices and whether they are in line with financial regulations. Legal researchers are still exploring the possibility of policy intervention and even stricter regulation.
To combat this, applications such as MEV-Share are designed to redistribute part of the gains of users whose transactions were victimized. The idea behind these redistribution systems is that they help safeguard fairness without undermining incentives. Nevertheless, there is still low adoption, and technical shortcomings are being solved.
Future Outlook and Cross-Domain Challenges
Cross-chain MEV is trading across multiple networks, including Ethereum and BNB Chain, to capitalize on price disparities. These measures come with risks such as failed trades due to non-atomic execution and capital lockups. Nevertheless, many traders maintain balances on more than one chain to minimize delays in trade.
Sequencer Extractable Value (SEV) has been introduced on Layer 2 networks, with centralized sequencers determining the ordering of transactions. These risks are now being observed in rollups such as Arbitrum and Optimism, which are similar to Layer-1 MEV. There will be a need to work out a solution to diminish centralization in control and remain fair to the users.
Technologies such as Proposer-Builder Separation and private mempools are being tested to enhance the level of MEV fairness. Such transformations are guaranteed to be more decentralized as long as they are adopted and have reasonable technical justifications. With the current developments of MEV, a balance between efficiency and equity remains a priority for both developers and users.
