A Brief Analysis of the Current Status and Trends of MEV

Author: 0xCousin IOBC Capital

1. Definition and Background of MEV

MEV (Maximum Extractable Value) refers to the value extracted from users by reordering, inserting, and censoring transactions within a block, such as through arbitrage and liquidation. It can fundamentally be understood as "the additional profit gained by adjusting the order of transactions when creating a new block."

The concept of MEV was first introduced by Phil Daian in "Flash Boys 2.0." Before the Ethereum merge, MEV was primarily captured by miners, and was therefore also referred to as "Miner Extractable Value." MEV arises when a user submits a transaction on the blockchain; this transaction typically enters the Mempool, a publicly accessible pool of pending transactions. Arbitrageurs and miners can retrieve the Mempool and find opportunities to capture MEV.

After the Ethereum merge, the roles in the MEV supply chain changed due to the alteration of the mining mechanism. Before Danksharding was implemented, Flashbots proposed MEV-Boost as an off-protocol practice of PBS. Builders focus on constructing blocks and maximizing the benefits of each block as much as possible, and then the most profitable block is submitted to the Proposer.

The implementation of the PBS mechanism has altered the interests within the blockchain block production industry, while also promoting the specialization and commercialization of related institutions in the supply chain, resulting in a new landscape for the MEV supply chain.

2. MEV Supply Chain

The Tx on-chain process based on MEV-Boost is illustrated in the following diagram (light green represents the conventional Tx on-chain process, while the white modules represent the MEV Tx on-chain process):

Source: Flashbots

Compared to the conventional Tx on-chain process, the MEV Tx on-chain process achieves off-protocol practice of PBS through Flashbots' MEV-Boost, allowing MEV to be captured by roles such as Searcher, Builder, and Validator.

Searcher: Generally includes roles such as arbitrage and liquidation bots, DeFi traders, and Ethereum Dapps with advanced use cases. They find all extractable value on-chain through various methods and bundle transactions together to provide to Builders;

Builder: Builders are typically specialized institutions (there have been 36 active Builders in the past 14 days, with the top 6 monopolizing over 88% of the market share). They select the most profitable bundles sent by Searchers to package into a Full Block, which is then sent to Validators via Relay. Several bundles can be combined to form a block, which may also include pending transactions from other users in the Mempool;

Data Source: MEVBoost.pics

Relay: Relay connects Builders and Proposers, verifying the validity and bids of blocks submitted by Builders, and submitting the highest valid bid to the Proposer. Currently, there is an oligopoly with only 11 active Relays, but Relays do not participate in the division of MEV profits and serve as neutral infrastructure;

Data Source: MEVBoost.pics

Validator: Validators are the miners of ETH2.0. Validators (the Proposers among Validators) are responsible for proposing blocks to the network and adding blocks to the chain. The competitive landscape among Validators is becoming more stable, with Lido holding the largest market share. Validators can earn consensus rewards (block rewards) as well as execution rewards (MEV + Tips).

Data Source: MEVBoost.pics

Currently, various projects are active in each segment of the MEV supply chain. In the Searcher segment, there are many arbitrage and liquidation bots, DeFi traders, market makers, and projects serving these Searchers.

For example, data platforms like EigenPhi that showcase on-chain arbitrage cases; in the Builder segment, there are specialized institutions like Flashbots, BloXroute, and Blocknative; Relay serves as a neutral infrastructure in the MEV Supply Chain, requiring trust, with only 11 active Relays; there are also many projects in the Validator space, which has shown a certain robustness in its network, and recent funding situations indicate that new teams are still looking to start ventures in this field.

3. Classification of MEV

Based on the methods of obtaining MEV, it can be mainly classified into the following categories:

Front Running: The act of executing a transaction ahead of a target transaction in the Mempool by paying a higher Gas Fee. For example, if there is a transaction in the Mempool that will cause significant price fluctuations for a token, one could insert a transaction before it; or during the launch of a new NFT project, one could front-run the Mint NFT transaction. Currently, preventing front-running is relatively simple; one just needs to connect to a Private Transaction Pool like Flashbots Auction to achieve Front Running Protection;

Back Running: Refers to the act of inserting a transaction after a transaction that will cause significant price fluctuations, which could be for arbitrage, liquidation, etc. For instance, if a large transaction occurs on-chain, causing price fluctuations for a trading pair, one could insert a transaction afterward to stabilize the DEX price while the arbitrageur also profits; or if a liquidation line is triggered after a collateral loan, one could insert a liquidation order afterward;

Sandwich Attack: A sandwich attack is essentially a combination of Front Running and Back Running. The Searcher looks for potential large transactions in the Mempool, buys the asset that will appreciate before the transaction occurs, and then immediately sells these assets after the large transaction is executed to profit from the price difference;

Time Bandit Attack: This type of MEV mainly occurs in blockchain networks that follow the longest chain principle (such as Bitcoin with Satoshi's consensus).

From the results of these MEV occurrences, Back Running MEV is generally beneficial to the blockchain network, such as risk-free arbitrage achieved by arbitrageurs utilizing price differences between two DEXs + flash loans, and liquidators maintaining the healthy operation of lending protocols. In contrast, Front Running and Sandwich Attacks may harm the interests of other users.

4. Current Status and Future of MEV

MEV is indeed controversial because the existence of non-beneficial MEV appears to be unethical. For example, Front Running, Sandwich Attacks, and Time Bandit Attacks can disrupt the trading experience and harm the interests of ordinary users on the blockchain. Therefore, I have long hoped that the industry could introduce a solution/product/protocol to prevent the occurrence of these non-beneficial MEVs.

However, the public visibility of transactions in the Mempool and the bidding rules for Tx on-chain ordering determine that MEV is inevitable. As a compromise, if your transaction cannot avoid being extracted for MEV, it is better to use products/protocols that can return profits to you.

In response to the negative externalities that MEV (especially non-beneficial MEV) may bring to stateful blockchains (such as Ethereum), there are currently some products in the industry that can mitigate these impacts. For example, the Flashbots series of products:

Flashbots Auction: Flashbots Auction provides a private communication channel between Ethereum users and Validators to effectively communicate preferred transaction order within a block. Through such products, on-chain transaction users can achieve Pre-trade Privacy, Failed trade privacy, Finality protection, etc.

Flashbots Protect RPC: This is an RPC endpoint product that allows users to achieve Front Running Protection. Users can add it to their wallets, allowing their transactions to be submitted to Flashbots Auction. For users, there is no perceptible difference from ordinary transactions, but it can achieve Front Running Protection, Failed trade Privacy, etc.

MEV-Boost: During the PoS era, Validators can sort transactions from the Mempool themselves and package them, or they can choose blocks with higher MEV income that have been sorted by Builders and pushed through MEV-Boost. Through MEV-Boost, Validators can significantly increase their income, so most Validators will choose to connect to MEV-Boost rather than sort themselves.

Image Source: IOSG Ventures Jiawei

From the perspective of the MEV Supply Chain, these three products play roles in various segments of the MEV Supply Chain.

Regarding the future of the MEV field, based on the current development status in the MEV domain, we believe there may be several major trends:

1. The Head Effect Will Be Severe: Over 90% of the past 500 epochs were served by MEV-Boost, and Flashbots' series of products hold a leading position in almost every aspect of block production during the PoS era. With Flashbots as the first mover, new entrants looking to break into the MEV field will need some core competitiveness to capture more market share;

2. He Who Controls Orderflow Controls the Market: To gain more MEV opportunities, having sufficient order flow is crucial. For ordinary trading users, it is actually impossible to completely eliminate MEV. Even if users adopt Flashbots Protect RPC, it can only prevent Searchers in the Public Mempool from capturing potential MEV from their transactions; Builders in the Flashbots Auction network still have the opportunity to extract MEV from their transactions. Therefore, for ordinary users, since it is impossible to completely avoid being extracted for MEV, it is better to choose wallets, DEXs, or other Dapps that will return MEV profits to users;

3. There Is Still Growth Potential for Multichain MEV: The MEV within the Ethereum chain may have been largely captured. However, the blockchain is a multichain ecosystem, and MEV opportunities between Layer 1 and Layer 1, as well as between Layer 1 and Layer 2, are still relatively difficult to capture, indicating some growth potential for MEV in this area;

4. The Demand for On-Chain Transactions Resistant to Censorship Will Always Be Met: According to MEVwatch data, 57.49% of the blocks on the Ethereum blockchain after the Merge complied with OFAC requirements, and only 35 out of the last 100 blocks executed OFAC compliance. The impact of on-chain transactions resistant to censorship is minimal. Although after the Merge, most leading staking platforms are centralized, these centralized entities inevitably face legal regulations, posing challenges to the Ethereum blockchain's censorship resistance. However, even if over 90% of Validators route transactions through MEV censorship, those resistant transactions can still be on-chain within an hour.