<p>Along with scaling and hacks, <strong>Maximal Extractable Value (MEV)</strong> is likely the most critical issue confronting Ethereum and other smart contract blockchains today. Miners and third parties can extract revenue from decentralized application users on Ethereum by utilizing their discretionary authority to sequence transactions within blocks, substantially reducing the user experience and endangering the network's stability.</p><h2>The two aspects that a miner/third-party can take advantage of</h2><h3>Information Asymmetry</h3><p dir="ltr">To understand <strong>MEV</strong>, we must first understand how transactions are verified on the network. Currently, the majority of PoW or PoS chains require a user to pay a gas cost in order for their transaction to be finalized on the chain. This transaction processing fee is essential to verify that the user sends a valid transaction because the fee is forfeited if the transaction is harmful. This cost becomes interesting because each new block on the blockchain has a restricted amount of space toward which transactions can be inserted. Simply put, the network can only process a finite amount of transactions and must prioritize them.</p><p dir="ltr">Miners are responsible for proposing new blocks in addition to validating new blocks, and this is where things become complicated. In a typical case, a user expresses their desire for faster transaction confirmation speeds by increasing the gas fee they are ready to pay. Miners, on the other hand, would choose the transaction with the highest gas fee from the transaction queue in order to maximize their income. Simply put, this ensures that the miner is unconcerned about the transaction's contents and prioritizes based solely on the fee. The problem stems from the existence of a publicly accessible transaction queue.</p><p dir="ltr">To be picked up by miners on such networks, all transactions must first be added to a queue. Given the openness that public blockchains provide, this queue is unavoidably public. When the specifics of a user's transaction are used against them before it is finalized on the network, an unknowing user may be caught off guard. Bear in mind that it takes time for a transaction to be finished (ie included in a block), and this information may be capitalized on during that time because it had already been signed by the user. It is worth noting that this is not limited to miners; third parties that access such information can offer transactions with a greater gas charge in order to have their transactions prioritized.</p><h3>Time premium</h3><p dir="ltr">Only while the transaction is still in progress is the information above useful. Since the information is practically useless to the <strong>MEV strategy</strong> beyond the transaction confirmation period, it establishes an upper bound on the time value of such information. There isn't much time for the MEV approach to be implemented given that ETH block durations are roughly 13 seconds. As a result, MEV is typically performed by bots, which typically execute the following:</p><ul><li><p dir="ltr">Pay attention to the transaction queue for transactions that fulfill their unique requirements.</p></li><li><p dir="ltr">Compute the profitability based on the facts supplied. This will also have to account for the cost of gas.</p></li><li><p dir="ltr">Form a transaction based on the computed parameters if there is a profit to be made.</p></li><li><p dir="ltr">Create the transaction with a greater gas fee to front-run the desired transaction,</p></li><li><p dir="ltr">Track the sequence of transaction confirmations because the target transaction could still be verified first. If this is the case, cancel the MEV transaction.</p></li></ul><p dir="ltr">Efficiency is critical here since every second the <strong>MEV transaction</strong> is delayed means the bot is one step closer to being excluded from that block. The above assumes a single bot, but in reality, there will be many bots competing for a piece of the pie. As a result, in addition to being as efficient as the competitors, network latency is important to the strategy's success. This means that lower latency gives such techniques a competitive advantage.</p><h2>How they capitalize on network</h2><p dir="ltr">Given the preceding context, there are several approaches to extracting profits by reordering, including, or excluding transactions within a block. Keep in mind that all of the tactics below strive to have their <strong>MEV transaction</strong> included in the same block or prior to the target transaction confirmation.</p><h3>Sandwich Attack</h3><p dir="ltr">A bot monitors the queue for a major impending trade. Slippage is the gap between the quoted price at the moment the user confirmed the deal and the actual price when the transaction was confirmed for large trades.</p><p dir="ltr">When a target trade is identified, for example, a trader swapping 1000ETH to SOL, the bot will purchase SOL before the target trade is allowed. This raises the effective price of SOL, which is subsequently sold back to the trader by the bot. From the trader's standpoint, this raises slippage and, as a result, the cost price of the comparable SOL received.</p><h3>Arbitrage</h3><p dir="ltr">A bot observes the queue for a major impending trade. The bot determines the implied price movement on the exact exchange where the transaction is placed after identifying the target deal. The bot searches for prices on various exchanges (decentralized but even centralized if sufficient cash is available) and analyzes the price impact above to assess profitability.</p><p dir="ltr">Using the same example as before, the bot purchases SOL from other exchanges and quickly sells it to the exchange hosting the target trade. This raises the trader's effective price of SOL.</p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed398153504a82a8e6023f659fee92.jpg" alt="Arbitrage Bot" title="Arbitrage Bot" width="600" height="600" class="lykafe0"></p><h3>Sniping</h3><p dir="ltr">A bot scans the queue for transactions intended to purchase newly released tokens/NFTs. Because there is usually a rush of users attempting to obtain the new token, the price of the token tends to rise immediately following its debut. The bot can evaluate if it is able to gain the token by front-running the user and then reselling it to them at a considerably higher price based on the purchase transactions performed by the users.</p><h3>Liquidation</h3><p dir="ltr">A bot observes the queue for liquidation transactions. When a target transaction is identified, the bot creates a liquidation transaction and submits it to the network at a larger cost. As a result, the bot did not truly identify the triggered liquidation event but instead capitalized on the liquidators' sluggish transaction.</p><h2>How do MEV strategies affect users and protocols?</h2><h3>Users</h3><p dir="ltr">The above techniques could be utilized by <strong>both miners and MEV parties</strong>, but in either case, the miner stands to earn the most from them. This is especially true if the miner is also the MEV party, as block producers are not required to add a transaction fee to encourage transactions to be included in a block.</p><p dir="ltr">The <strong>MEV party</strong> stands to profit from the greater slippage in transactions or from the forerunner status in critical token events. The miner gains from higher gas prices as a result of MEV bots outbidding one other. All of this comes at the expense of a poor user experience, as trades are always completed at the highest possible price, fees are continually high, and any profit chances detected are effectively stolen away. Furthermore, these <strong>MEV techniques</strong> frequently result in negative externalities like network congestion (i.e. peer-to-peer network burden) and chain congestion (i.e. block space usage).</p><h3>Protocols</h3><p dir="ltr">While it may be claimed that MEV is part of market efficiency in order to remove information gaps, the distinction is blurred when it comes to access to MEV tooling. Many of the MEV strategies described above necessitate a certain level of expertise in order to be implemented. Furthermore, the initial money required may be rather large for the normal person, especially if the gas fees are high, as is anticipated with all MEV bots. This means that skilled parties with adequate wealth receive the benefits of MEV, but this may come at the expense of protocol security.</p><p dir="ltr">To begin, if the worsened user experience outweighs the benefits of using the network, members of the community may opt to leave the network. This must be considered in the DeFi space within the framework of centralized exchanges, which do not suffer such issues technically. Users may shift their trades to centralized exchanges, reducing the decentralization guarantees.</p><p dir="ltr">A more vital concern is what occurs when the MEV/block rewards ratio begins to favor MEV. In this scenario, it is more advantageous for miners (who are presumed to be motivated solely by profit) to begin employing MEV strategies than safeguarding the network. Of course, MEV strategies would not exist unless the blocks were created. However, as a whole, the network will be unable to provide adequate guarantees that a transaction will be included only on the basis of the gas fee.</p><p dir="ltr">Miners might even modify blockchain history in what is known as a time-bandit attack, taking this a step further. All MEVs extracted in earlier blocks could be used to underwrite the attack by re-mining previous blocks. This makes logical sense when the MEV/block reward ratio increases.</p><h2>The solution?</h2><p dir="ltr">Many smart brains are now working on reducing the negative externalities caused by MEV techniques. The team at Flashbots, whose name is an imaginative play on the books Flashboys and bots, both of which are important foundations of MEV, is a key member of this group. If you're interested in learning more, I highly recommend checking out their documents. Flashbots is dedicated to increasing transparency in the MEV ecosystem while also democratizing MEV extraction.</p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed398153505251a8e6023f659fee92.jpg" alt="flash bots team" title="flash bots team" width="600" height="331" class="lykafe1"></p><p dir="ltr">While Flashbots works within the technical constraints of transaction queue implementation, ChainLink labs is directly redefining the rules of the game with its Fair Sequencing Services. This entails encrypting transaction data before it is sorted by a decentralized oracle network. Transaction details are effectively only viewable on-chain at the point of execution, whereas block proposal is no longer restricted to a single proposer.</p><p dir="ltr">All of this bodes well for the future of public blockchains because so many talented individuals are coming together; each focused on a very specific component of the network but all contributing to the network's security in a decentralized manner.</p><div class="pr-block-special"><strong>Disclaimer:</strong><br>This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

Beside scaling and hacks, Maximal Extractable Value (MEV) is likely the most critical issue confronting Ethereum and other smart contract blockchains

MEV (Maximal Extractable Value): How miners and third parties exploit the networks