What Is Miner Extractable Value (MEV) And How Does It Affect The Ethereum Network?

2021/08/10 09:46:19

Miner Extractable Value (MEV) has been a topic of debate for quite a while now, especially after the announcement of EIP-1559. MEV is the value that miners extract permissionlessly from a block being produced by reordering, insertion, or censorship of transactions within that block.

The MEV came into the limelight just a few months ago after a research paper published by Flash Bots, a research and development organization working on exploring the adverse effects of current MEV extraction techniques. MEV is also called the Maximal Extractable Value since Ethereum 2.0 won't be having any miners, but the MEV phenomenon will stay intact.

Have you ever encountered a situation where your swap transaction on a DEX such as Uniswap or SushiSwap got delayed and executed with a higher slippage? Have you ever noticed a profitable arbitrage opportunity and quickly initiated the transaction, only to realize later that the opportunity was seized by another transaction that bid a higher gas price to take the arbitrage profits? If the answer is positive, there is a higher chance that you were a victim of a malicious MEV attack.

Let's dig a little deeper into the Ethereum dark forest of MEV to understand how miners steal your opportunity to make a profit on certain trades across the Ethereum ecosystem.

What is MEV

MEV, the Miner Extractable Value or the Maximal Extractable Value, is the value that miners extract from reordering, insertion, or censorship of transactions when they are constructing a block. When you send a transaction on the Ethereum network, your transaction goes into the global mempool (a pool with all the unconfirmed transactions).

Miners pick up a subset of the transactions, reorder it based on higher gas fees, mine the block, and then propagate that block to make it a part of the Ethereum blockchain. Miners collect the block reward (2 ETH) and all the transaction fees in that block. This accumulation of the transaction fees is the simplest form of MEV, where miners are incentivized for including those transactions that are bidding higher gas fees.

Over the last few months, 30-40% of miners' revenue comes from transaction fees alone. This distribution is constantly changing based on the network behavior, but a major portion of the revenue comes from the accumulation of transaction fees within a block. After the EIP-1559 update, miners are expected to get a hit as the base fees (mandatory fee) will be burned while only the inclusion fees (optional tip) will go to the miners.

Ethereum Miner Revenue (block rewards + transaction fees) | Source: The Block

However, MEV gets more complex, and there is a darker side to it. When miners scan the global Ethereum mempool, they pick up specific transactions that are targeting profitable arbitrage or liquidation opportunities and replace them by creating a new transaction with higher gas fees so they can profit from this opportunity. Then, they reorder it and put it on the top, so their transaction gets processed first.

This value extraction from transaction reordering and insertion is the second form of MEV. Miners get the profit, and you are only left with a transaction with higher slippage or not getting the profit altogether since the miners have already banked on the arbitrage or liquidation opportunity.

We discussed previously that 30-40% of the miners' revenue comes from transaction fees alone. However, according to a research done by Paradigm Research, an additional 40-50% of the miners' revenue comes from these malicious MEV opportunities where miners take the profit from arbitrage or liquidation opportunities from various DEX transactions.

Miner revenue coming from block rewards, Tx fees, and MEV | Source: Paradigm Research

This leads us to a second question, will miners really be affected by EIP-1559? The answer is tricky, but since the miners are increasingly targeting the profit-making opportunities in the mempool, the MEV will only increase despite the EIP-1559 upgrade. To give a perspective, $761.3 million is the total MEV extracted since Jan 1 2020, and is growing rapidly.

Total MEV extracted since Jan 1 2020 | Source: Flash Bots

Closing Thoughts

Miners are in complete control to choose the pending transactions from the global Ethereum mempool, reorder them, or add their own transactions in the block. MEV represents a darker side of miners where they profit from arbitrage or liquidation opportunities across various DEX platforms. EIP-1559 will push the miners even further to maximize their revenue, and MEV is the last resort for them.

Even after Ethereum 2.0 goes live, the validators will do the same since they are in complete control when it comes to constructing a block and choosing which transactions are included in the block and in which order. The MEV problem has been identified quite recently, and we are yet to see how the Ethereum community will come up with a solution to democratize the network.

What do you think of the implications of the MEV in the long run?

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