Maximum Extractable Value (MEV): What Is It?Table of Contents
Maximum Extractable Value (MEV): What Is It?
By CoinUnited
28 Jan 2023
The term "Maximum Extractable Value" (MEV), formerly "Miner Extractable Value," describes a method for deciding which transactions to include, exclude, or rearrange in a new block. Since block producers may choose and rank transactions, they are in the greatest position to accomplish this. However, other members of the network (known as searchers) can pay fees to place trades if they discover a MEV opportunity (such as arbitrage, front-running, or liquidation).
This idea originally gained widespread attention in relation to the Ethereum network, which at the time relied on a proof-of-work (PoW) consensus method. When creating new blocks, miners might reshuffle the sequence of transactions, choose which ones to include, and even choose which ones to leave out altogether, all in an effort to maximize their reward. To describe the situation of miners trying to squeeze out every last bit of profit, the phrase Miner Extractable Value was created. Ethereum, however, completed The Merge, a technological update in September 2022 that replaced PoW with proof-of-stake as the network's consensus method (PoS). In light of this change, validators, rather than miners, are responsible for adding new blocks to the Ethereum network. However, MEV can also affect PoS systems. For as long as blocks are being generated, whomever decides which transactions to include and in what sequence may maximize their money each block. In spite of the fact that the previous MEV idea is still around, it has been rebranded as MEV: Maximal Extractable Value to reflect the fact that it is no longer exclusive to the mining industry.
To fully grasp how MEV functions, one must have a fundamental comprehension of the function of block producers (be they miners or validators). They are essential to the safety and upkeep of blockchain networks because they check and add new transactions (in the form of blocks) to the network. Mining or validation, depending on the chain, describes this step. Simply said, block producers are responsible for maintaining the network and ensuring that all transactions are secure. They are necessary because without them, no further information can be added to the chain. Users' transaction records are compiled by "block producers," who then add these blocks to the distributed ledger. Bear in mind that it is up to individual block producers to decide which transactions to include in their blocks. Given that the most lucrative transactions are the ones that carry the greatest costs, it stands to reason that they will be prioritized. To guarantee their transactions are prioritized, consumers are willing to pay higher gas prices (or transaction fees) at peak times. To maximize their earnings, block producers may choose to prioritize transactions that generate the highest fees. For this reason, low-fee transactions must wait longer to be included in a block. While costs may play a role in determining the order in which transactions are processed, this is not a hard and fast rule. It's possible for block producers to earn more money than just the regular block rewards and fees when transactions contain more complicated information (as they do in smart contract-enabled blockchains). Arbitrage possibilities and on-chain liquidation are two examples of how choosing and arranging transactions may increase profitability. Selecting and prioritizing transactions for further financial advantage is the crux of MEV.
Although it may appear that block makers are the only ones who gain from MEV, other players, known as "searchers," really obtain a large portion of MEV. In order to conduct their successful MEV transactions and tactics, searchers generally pay block producers high gas costs. A block producer can collect gas fees equal to 99.99% of a searcher's prospective profit, which is reasonable given the level of competition for a MEV opportunity. Consider the case of decentralized exchange (DEX) arbitrage, where searchers have been known to shell out more than 90% of their MEV revenue in gas costs since that's the only way to guarantee that a successful arbitrage deal is made ahead of comparable trades.
Opportunity abounds for searchers and block makers to make money with MEV through arbitrage, front-running, and liquidation. Below, we examine these cases in further depth to explain what MEV is and how it operates.
Arbitrage opportunities arise whenever there is a pricing discrepancy across markets for the same asset. In the crypto market, two separate DEXs may list the same token at different prices. The moment someone (an arbitrageur) notices this, they will act to take advantage of the difference by making a deal. When a searcher's bot sees an arbitrage opportunity, it will put its own transaction in front of the pending one to take advantage of the price difference. This is known as a "multi-exchange transaction" (MEV).
If a large buy order is still outstanding in the transaction pool, a searcher or block producer can use their abilities to order transactions in a block to get in front of the order. As the price of a digital asset is expected to rise in response to a large buy order, market makers may employ MEV to get a better price for themselves before the larger buy order is executed. Sandwiching is another MEV approach that involves placing a purchase order before and a sell order after a certain price-moving transaction to benefit from the upward and downward pressure on the price.
The trade is closed if the value of the collateral falls below a certain level due to market fluctuations. Any searcher or block producer using bots to spot this type of transaction has a MEV opportunity to insert their own liquidation transaction into the block ahead of anybody else and get the reward value.
In order to quickly capitalize on arbitrage possibilities, MEV seekers often race to be the first to buy or sell on various DEXs. As a result, the MEV liquidation drive results in lenders getting repaid as fast as possible, which is consistent with lending protocols that don't want dangerous loans continuing unchecked should collateralization levels become uneven. It's important to recognize the challenges posed by MEV, though. Front-running and sandwiching are two examples of implementations that lead to unfavorable results for other users, who must pay more for their trades, have more slippage, or otherwise lose out in a value-neutral scenario. As MEV searchers race to insert their transactions into blocks and seize the associated value, they can drive up gas costs and strain networks. It may be economically advantageous for a block producer to commit to blockchain reformation if the MEV of rearranging transactions in a prior block is higher than the rewards and fees of the future block.
This idea originally gained widespread attention in relation to the Ethereum network, which at the time relied on a proof-of-work (PoW) consensus method. When creating new blocks, miners might reshuffle the sequence of transactions, choose which ones to include, and even choose which ones to leave out altogether, all in an effort to maximize their reward. To describe the situation of miners trying to squeeze out every last bit of profit, the phrase Miner Extractable Value was created. Ethereum, however, completed The Merge, a technological update in September 2022 that replaced PoW with proof-of-stake as the network's consensus method (PoS). In light of this change, validators, rather than miners, are responsible for adding new blocks to the Ethereum network. However, MEV can also affect PoS systems. For as long as blocks are being generated, whomever decides which transactions to include and in what sequence may maximize their money each block. In spite of the fact that the previous MEV idea is still around, it has been rebranded as MEV: Maximal Extractable Value to reflect the fact that it is no longer exclusive to the mining industry.
To fully grasp how MEV functions, one must have a fundamental comprehension of the function of block producers (be they miners or validators). They are essential to the safety and upkeep of blockchain networks because they check and add new transactions (in the form of blocks) to the network. Mining or validation, depending on the chain, describes this step. Simply said, block producers are responsible for maintaining the network and ensuring that all transactions are secure. They are necessary because without them, no further information can be added to the chain. Users' transaction records are compiled by "block producers," who then add these blocks to the distributed ledger. Bear in mind that it is up to individual block producers to decide which transactions to include in their blocks. Given that the most lucrative transactions are the ones that carry the greatest costs, it stands to reason that they will be prioritized. To guarantee their transactions are prioritized, consumers are willing to pay higher gas prices (or transaction fees) at peak times. To maximize their earnings, block producers may choose to prioritize transactions that generate the highest fees. For this reason, low-fee transactions must wait longer to be included in a block. While costs may play a role in determining the order in which transactions are processed, this is not a hard and fast rule. It's possible for block producers to earn more money than just the regular block rewards and fees when transactions contain more complicated information (as they do in smart contract-enabled blockchains). Arbitrage possibilities and on-chain liquidation are two examples of how choosing and arranging transactions may increase profitability. Selecting and prioritizing transactions for further financial advantage is the crux of MEV.
Although it may appear that block makers are the only ones who gain from MEV, other players, known as "searchers," really obtain a large portion of MEV. In order to conduct their successful MEV transactions and tactics, searchers generally pay block producers high gas costs. A block producer can collect gas fees equal to 99.99% of a searcher's prospective profit, which is reasonable given the level of competition for a MEV opportunity. Consider the case of decentralized exchange (DEX) arbitrage, where searchers have been known to shell out more than 90% of their MEV revenue in gas costs since that's the only way to guarantee that a successful arbitrage deal is made ahead of comparable trades.
Opportunity abounds for searchers and block makers to make money with MEV through arbitrage, front-running, and liquidation. Below, we examine these cases in further depth to explain what MEV is and how it operates.
Arbitrage opportunities arise whenever there is a pricing discrepancy across markets for the same asset. In the crypto market, two separate DEXs may list the same token at different prices. The moment someone (an arbitrageur) notices this, they will act to take advantage of the difference by making a deal. When a searcher's bot sees an arbitrage opportunity, it will put its own transaction in front of the pending one to take advantage of the price difference. This is known as a "multi-exchange transaction" (MEV).
If a large buy order is still outstanding in the transaction pool, a searcher or block producer can use their abilities to order transactions in a block to get in front of the order. As the price of a digital asset is expected to rise in response to a large buy order, market makers may employ MEV to get a better price for themselves before the larger buy order is executed. Sandwiching is another MEV approach that involves placing a purchase order before and a sell order after a certain price-moving transaction to benefit from the upward and downward pressure on the price.
The trade is closed if the value of the collateral falls below a certain level due to market fluctuations. Any searcher or block producer using bots to spot this type of transaction has a MEV opportunity to insert their own liquidation transaction into the block ahead of anybody else and get the reward value.
In order to quickly capitalize on arbitrage possibilities, MEV seekers often race to be the first to buy or sell on various DEXs. As a result, the MEV liquidation drive results in lenders getting repaid as fast as possible, which is consistent with lending protocols that don't want dangerous loans continuing unchecked should collateralization levels become uneven. It's important to recognize the challenges posed by MEV, though. Front-running and sandwiching are two examples of implementations that lead to unfavorable results for other users, who must pay more for their trades, have more slippage, or otherwise lose out in a value-neutral scenario. As MEV searchers race to insert their transactions into blocks and seize the associated value, they can drive up gas costs and strain networks. It may be economically advantageous for a block producer to commit to blockchain reformation if the MEV of rearranging transactions in a prior block is higher than the rewards and fees of the future block.
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