What is MEV in Ethereum and how it will change after the transition to POS

As you know, blocks recorded in the blockchain are unchanged information and cannot be rewritten. However, miners or validators can include, exclude and change the transaction order in the future block at their discretion before it is confirmed.

Each unconfirmed transaction first falls into a publicly accessible membrane. Further, miners choose which transactions they will add to the Mempool unit. So miners form for themselves the most profitable combination of user transactions.

This leads to abuse. Miners (and after the EThereum transition to POS – validators) prefer the transaction of the largest size, building priority from larger to smaller, and add them to the future block, which will be recorded in the blockchain.

This feature led to the creation of a mechanism for extracting benefits by substituting transactions in the right order. This practice is called the maximum extracted cost, or MEV.

The MEV strategy is to search for speculative operations on the basis of existing unconfirmed transactions and increase the actual commissions for their implementation.

We will analyze the example when the Ethereum user decided to exchange 10,000 USDC for ETH at a price of $ 2,000 for a DEX coin in the USDC/ETH liquidity bullet. This is what happens after placing an exchange application:

1. Special bots work in the mempule, which track unconfirmed transactions and collect various data from Defi applications, including the price and liquidity volume.
2. Having noticed the user’s intention about buying ETH, the bots initiate an operation that will increase the price right before the user transaction execution. For example, the bot can add more USDC to the USDC/ETH liquidity pool to increase the price of ETH.
3. Thus, the expected price of $ 2000 for the ETH coin https://gagarin.news/news/the-u-s-has-decided-when-it-will-pass-a-law-to-regulate-cryptocurrencies/, which the user was counting on, will change on conditional $ 2500 per ETH coin. The transaction will be made: instead of 5 ETH, the user will receive only 4 ETH. The profit of the initiator of this MEV operation will be 1 ETH minus the expenses for the commission.

Since MEV leads to an increase in commissions for the user, it is also called an “invisible tax”, which is characteristic not only for Ethereum.

When the “Invisible Tax” MEV appeared

For the first time, the problem of “substitutions” of user transactions called MEV raised an algorithmic trader and analyst at PMCGOOHAN in 2014, even before the launch of the Ethereum maintenance. He suggested that miners, without violating any consensus rules, can manipulate user transactions for their selfish purposes.

The term MEV was put forward only in 2019 in the work “Flash Boys 2.0 “, which was the first public publication to study the seriousness of the problem described by PMCGOOHAN.

The problem was spoke about the scale and seriousness of the problem only in 2020 in such articles as “Ethereum is a Dark Forest” and “Escaping the Dark Forest”, written by Dan Robinson, the St. George Constantopulos and the Samczsun crypto investor. These publications were aimed at informing Ethereum users about an “invisible tax” assembled from users.

Varieties of MEV

The development of the decentralized finance sector (Defi) and individual Ethereum ecosystem elements, in particular price oracles, liquid tokens and cross-bridges, led to various MEV strategies.

Frontranding

The most common strategy where MEV transaction is trying to put in front of an original transaction. Special bots can monitor potentially profitable operations, simply copying user transactions, acting ahead of schedule.

Bacranning

Exposing the transaction due to any event. For example, immediately after the appearance of a new pool on the Uniswap, the exploiter can redeem a significant part of the tokens and take first place in line, devastating the bullet. After that, it allows the rest of the participants to sell and sells itself at a more profitable price.

Sandwich Atak

Combination of the two previous schemes. If the bot finds a large order for the purchase in the mempoule, then puts up before him to purchase tokens at a lower price using front -line. A large order is executed, moving the price up. Then, using backranning, coins are sold with a profit earlier than other users.

Liquidation

The strategy aimed at receiving the profiter by the redemption of a collateral position in the lending protocol immediately after its liquidation. The user sees that in the next block the position can be eliminated and sends a transaction for the purchase of a pledge.

“Uncle Bandit Attack)

A complex type of meV strategy based on a speculative chain of transactions found in a competing block. There are times when miners find two blocks at the same time. At this point, miners can use data from the “neighboring” block in their interests.

“Time Bandit Attack)

Involves the process of reorganization of previous blocks, where miners specifically offer competing blocks containing other transactions. Leads to the disappearance of transactions and their inclusion in a completely different block.

Methods of protection against MEV and flash bots (Flashbots)

MEV is characteristic not only for Ethereum. As the Defi Applications sector and toughening, the bots have moved to EVM-compatible blockchains, such as Polygon and BNB Chain. However, it was Ethereum that became the most advanced network in terms of combating this problem.

According to data for 2021, Ethereum major earned $ 730 million in the form of awards for MEV extraction-4.3% of national revenue. This indicates the growth of “dishonest markets” and leads to a deterioration in user experience due to the growth of commissions and the lack of predictability in the process of execution of transactions.

A centralized Flashbots system financed by Paradigm Venture Companies appeared as a solution in 2020. She does not seek to eliminate the problem, but rather take control of it by creating an open market through the incorporation of the public auction of etH transactions.

The solution quickly gained popularity. According to the research unit of the Bitmex crypto -tank, in May 2022 more than 90% of miners on the Ethereum network were connected to the Flashbots server. Researchers noted that 63% of remuneration for MEV transactions were received by operators, and the remaining 37% moved away to miners.

What will change after Ethereum transition to POS

Experts believe that the change of consensus algorithm in Ethereum will not change the basic principles of creating blocks in the network. As in the case of mining, the validators have the ability to “lay” blocks from transactions at their discretion.

At the same time, according to Blocknative, many unprofessional NOD operators will appear in Ethereum. This can lead to the emergence of a separate category of participants from among the validators called “Block Builders” (Block Builders). They will provide the service of the most profitable group of blocks, contributing to maximizing profit and network optimization.

As a result, different types of blocks will appear in Ethereum depending on the needs of the validators:

• Blocks with the maximum number of MEV transactions;
• Blocks with MEV only for charitable purposes;
• Blocks with certain gas prices;
• Blocks ordered in time;
• Blocks put up for auction;
• Censorship blocks;
• Uniaberm blocks.

It is also expected that due to the specifics of the “era” (the procedures for selecting validators and the creation of a new block), MEV operators will know in advance which validators will offer the next block. This can lead to the creation of completely new, long-term MEV strategies.

The developer Elias Simmos, who studied the first 24,500 blocks after The Merge, came to the conclusion that 18% of them were mined using a modified mechanism called MEV-BOOST. As a result, POS-vodants were able to get 122% more profits, and the blocks formed by them contained 41.4% more transactions.

Despite the results of the use of MEV validators, it is still difficult to evaluate the economic and other possible consequences of using MEV strategies regarding ordinary users.