Multicoin: Value Flow in the MEV Ecosystem

Original Title: “Value Flows in the MEV Ecosystem”

Written by: Shayon Sengupta, Tushar Jain, Investment Partner and Managing Partner at Multicoin Capital respectively

Translated by: aididiaojp.eth, Foresight News

Miner Extractable Value (MEV) is fundamental to permissionless distributed systems, whether Proof of Work (PoW) or Proof of Stake (PoS), MEV is indispensable.

The market structure of MEV is dynamic and complex, but it is clear that the participants profiting in the Ethereum 1.0 PoW network are solely miners and seekers.

Historically, MEV has required some balance between miners and seekers. For any given opportunity, the task for seekers is to technically optimize a set of transactions and select the miner that offers the optimal potential profit percentage from the chosen transaction based on game theory principles. The profits paid to miners and the profits extracted by seekers are classified as MEV.

However, in PoS systems, the market structure of MEV becomes entirely different for two key reasons. First, the staking pools participating in consensus allow the profits generated by seekers' activities to be redistributed to individual stakers. Second, miners serve two distinct roles: validators (or block proposers) and block builders.

Integrated vs. Modular MEV Infrastructure

In PoS networks, there are four important participants in MEV:

• Staking Pools: Staking pools aggregate L1 tokens from various stakers and delegate them to validators participating in block production (e.g., Lido, Jito, Marinade, and Coinbase staking pools)
• Seekers: Bots or individuals that identify and attempt to capture on-chain profit opportunities (e.g., transactions displayed on Solana and Ethereum dashboards)
• Block Builders: Entities that build and order transactions in blocks (e.g., Jito Block Engine, Flashbots MEV-Boost)
• Validators (Block Proposers): Validators or full nodes that propose a block for validation by other nodes in the network based on their staked shares. Validators include Staked, Figment, Chorus One, Staking Facilities, etc.

In this participant ecosystem, the leverage point is the staking pool, or more accurately, the individual staker participating in staking, as the staking pool has the ultimate authority to grant validators the right to produce blocks. Validators need to stake to maximize income, and competition in the aggregated staking market becomes fierce.

To effectively aggregate, staking pools must offer competitive rewards to stakers. Historically, staking income has been fixed as a function of protocol releases, and validators compete with each other on fees. With the increase in on-chain activity, the differentiation opportunities among staking pools have also increased. Staking pools can now compete through several main avenues:

• Base emissions for block production
• Fees or no fees
• Shares of extracted MEV

To provide competitive returns, staking pools must delegate to validators building the most profitable blocks and ensure that these profits are shared with their stakers. If validators are inefficient in extracting MEV or choose to retain the MEV they extract, staking pools will quickly reallocate their stakes elsewhere.

Seekers have been looking for opportunities on-chain or interacting with decentralized order flow markets (e.g., DFLow). When seekers identify MEV opportunities they want to win, they use relayers supported by block builders to submit optimized transaction requests. This also includes tips from validators, which are a small portion of the expected profits, thereby increasing the success rate. In a world where staking pools have the most influence, these tip rewards must at least partially flow back to the staking pools so they can distribute competitive rewards to stakers.

To maximize the income of stakers in staking pools, the pools effectively require validators to obtain blocks from the most efficient block builders. Block builders are also incentivized to build the most profitable blocks, as they want more validators to include the blocks they build, increasing their success rate and potential MEV income.

The main staking pools in PoS networks provide liquid staking derivatives (e.g., Jito's jitoSOL, Lido's stETH, Coinbase's cbETH), which represent a 1:1 claim on the original staked assets and can accumulate all staking rewards. The role of staking derivatives is to enhance capital efficiency and equity distribution.

Until recently, these ecosystem participants have collaborated as modular MEV infrastructure providers. As opportunities to capture MEV increase, we expect MEV infrastructure to be integrated to improve value capture at every touchpoint in the value chain.

Jito Labs is building the first complete instance on Solana, in which we invested in August 2021. The Jito Foundation is set to launch a staking pool, making them the first MEV infrastructure with integrated block builders and staking pools. They have also open-sourced their validator client Jito-Solana to facilitate easier participation of validators in the system.

The Jito Block Engine also supports off-chain block auctions, and the Jito staking pool and liquid staking derivatives (JITO-SOL) create an integrated system that enhances efficiency and rewards returning stakers.

MEV Value Accumulation

The market structure of MEV in PoS mechanisms indicates that value will accumulate in two layers: first through staking pools with stakers, and second through infrastructure providers that facilitate MEV extraction and redistribution. The tighter the integration of each component of MEV infrastructure, the more effective the mechanism is in value capture.

In “Protocols Don't Capture Value, DAOs Manage Risk”, we argue that the state of applications and risk management are necessary to drive sustainable value for any protocol. Integrated MEV systems need to manage risks at every layer between seekers, staking pools, validators, and block builders.

For stakers, they manage risk by offering above-market staking returns; for seekers, by providing high-probability transaction confirmations; for validators, by providing incremental income for block proposals through stake delegation; for block builders, by providing incremental income through higher block inclusion probabilities.

Integrated MEV systems improve the conditions for all participants in the value chain, giving them a stronger position than any modular participant in the system, thus yielding substantial scale returns.