What is Maximal Extractable Value (MEV)? The Complete Guide

What is Maximal Extractable Value (MEV)? The Complete Guide

Did you know that competition between block producers can increase the security of a network? The concept of MEV is common in the Ethereum blockchain, and it is an approach used by validators to leverage arbitrage opportunities in different blockchains through public mempools or algorithms.

If you are just hearing this term for the first time, this article is an introduction to maximal extractable value, offering everything you need to know about how users use various MEV extraction techniques to gain block rewards. Furthermore, we will be discussing areas like:

• What is the term maximal extractable value?
• How MEV works in crypto 
• Common examples of MEV in DeFi protocols
• Impact of MEV in areas like transaction fees and consensus instability
• The concept of MEV extraction and mitigation
• YouTube videos to show you how to make a profit from MEV opportunities

As a DeFi investor who is willing to pay, knowing the negative externalities of MEV and value extraction can help you protect your crypto assets from well-known MEV attacks during large trades. 

What Is Maximal Extractable Value (MEV)?

Maximal Extractable Value (MEV) is the maximum amount of value that can be extracted from validators or miners during block production by changing the order of transactions within a block. Initially, it was called Miner Extractable Value, and it has grown beyond validators in a Proof-of-Work network. 

MEV emerges because of how transparent blockchain mempools are, where transactions that are pending can be seen by everyone. This visibility entices malicious actors to take advantage of transaction ordering for profit.    

How Does MEV Work?

Transactions in blockchain networks are broadcast to a mempool before they are added to a block, and a validator chooses a transaction to be included in the next block. Although the normal process of MEV participants is to select transactions with higher fees, some users can change transaction settings for their own profit.  

For example, if a trader on a decentralized exchange (DEX) submits a large buy order, a validator can decide to place their buy order before and a sell order after the transaction is concluded, thereby making profits from the price swings (Sandwich Attacks).

Common MEV Examples

Validators in the network prioritize transactions based on the transaction fees before adding them to a new block. Here are common examples associated with MEV:  

1. Front-Running

In the MEV landscape, front running is adding a transaction before a pending transaction to make profits from the anticipated price fluctuations. For instance, if a front-runner detects a large purchase, he can buy the asset first and make a profit from the subsequent price increase.  

2. Back-Running

In back-running, a transaction is added after a major transaction to make profits from the resulting price movement. An example of this is when an asset is sold after a large buy order is made to exploit the spike in price.   

3. Sandwich Attacks

Sandwich attack is one of the forms of MEV examples, and it occurs when a buy and sell is placed during the transaction of a victim to alter the price and gain profit from the transaction.  

4. Arbitrage

Arbitrage is simply leveraging the different prices of an asset across several exchanges. In this attack, bots are used to instantly purchase low on an exchange and sell high on another, thereby allowing the trader to make a profit from the price difference.  

How MEV Extraction Occurs

We earlier stated that the maximal value is the value extracted by a miner or validator when they alter the transaction order. The presence of MEV extraction cannot be found in regular block rewards because it involves having an additional value, and it can only be obtained from attacks like sandwich, arbitrage, and front-running. Here is how the maximum value works:   

1. Monitoring the Mempool: MEV bots go through the mempool to locate different opportunities for making MEV profits.  

2. Transaction Reordering: The bot compiles a bundle of transactions and submits them to the block producer through Flashbots to ask for a specific order to make a profit.   

3. Inclusion in a Block: If the profit in the bundle is enough, the miner or validator will add it to the next block.   

Effects of MEV on DeFi Users

The consequences of MEV on regular users can be seen in the following areas:   

1. Increased Transaction Costs: The activities of MEV can result in high transaction costs because bots are competing with each other to add their transactions in a block. 

2. Unfair Trade Execution: Another implication of MEV is unfair trade execution, where users get worse prices because of attacks like sandwich or front-running.    

3. Network Congestion: Congestion in the network usually results from too much competition among bots. This can result in slower transaction times for users and borrowers.  

4. Centralization Risks: MEV can also encourage centralization because larger validators have more tools to take advantage of opportunities.   

Mitigating MEV Risks in Crypto

1. Flashbots: This is a development company with the sole aim of reducing negative externalities and bringing transparency when MEV is extracted.   

2. MEV-Blocking RPC Endpoints: These endpoints protect the data of transactions from attacks like front-running until they are added to a block. 

3. Lower Slippage Tolerance: Having a lower acceptable slippage can reduce the profits gained from sandwich attacks.  

4. Priority Gas Fees: Paying higher fees can entice miners to instantly add your transaction to a block, thereby lowering the risk of exposing MEV.  

5. MEV-Resistant Protocols: Platforms such as UniswapX are resistant protocols developed to reduce the exploitation of MEV value from users.   

YouTube videos on leveraging MEV opportunities for network participants

• What is MEV (Maximal Extractable Value)?

• How MEV Bots Work in DeFi

• Strategies to Protect Against MEV

Conclusion on MEV in Blockchain Technology

Maximal Extractable Value (MEV) is a complex and evolving aspect of blockchain technology that presents both challenges and opportunities. While it can lead to increased profits for miners and validators, it often comes at the expense of regular users. Understanding MEV, its mechanisms, and mitigation strategies is essential for anyone participating in the DeFi ecosystem. By staying informed and utilizing available tools, users can better protect themselves and contribute to a more equitable blockchain environment.

Also, check out this article on the Ethereum DAO Hack to learn how to protect your assets from hackers

FAQs

Q1: How does MEV specifically impact DEX users?

MEV can lead to unfavorable trade executions and higher fees for DEX users, as bots exploit transaction ordering to their advantage

Q2: Are there ways to completely avoid MEV?

While it's challenging to eliminate MEV, using MEV-resistant tools and strategies can significantly reduce its impact.

Q3: What are the ethical considerations surrounding MEV?

MEV raises concerns about fairness and decentralization, as it can disproportionately benefit those with more resources and technical knowledge.

Q4: How does MEV affect the overall blockchain ecosystem?

MEV can lead to network inefficiencies, increased centralization, and reduced trust among users if not properly managed.