A Preliminary Look at the LSD MEV Track: What Will Marketization and Fairness of the MEV Bring to LSD?

Author: Morty, Deep Tide TechFlow

MEV (Maximal Extractable Value) is one of the most important topics in the crypto world. It refers to the maximum value that validators can extract from block production beyond standard block rewards and gas fees by adding, removing, and changing the order of transactions within a block.

What kind of combination will occur when MEV meets the hot LSD trend?

MEV Concept Review

MEV is not a new concept; it involves three stakeholders: blockchain users, validators, and searchers.

Essentially, MEV has led all blockchain users to compete for the rights to use block space. Therefore, in the current warming trend on-chain, MEV has become a "cash machine" for many searchers. For example, during the Memecoin craze, as of April 19, the profits generated by MEV in just seven days have exceeded three million dollars.

An counterintuitive phenomenon here is that the value of MEV is not captured by the validators of the blockchain, but by the searchers, who are often referred to as "scientists" in the Chinese crypto community.

MEV can be simply understood as on-chain arbitrage conducted in the form of front-running trades, with sandwich attacks being a common example, colloquially known as "clipper bots."

For instance, when you buy $10,000 worth of token X on Uniswap, a bot sniffs out this transaction and rushes to buy X with a higher gas fee before the block is packed, thus the bot's transaction is executed first.

Due to Uniswap's automated market-making mechanism, the price of token X will be driven up. After your transaction is executed, the price of token X will continue to rise. At this point, the bot generates another transaction to sell the X it bought at the lower price in the previous transaction, just making a profit from the price difference.

The two transactions generated by the bot perfectly sandwich our transaction, resembling a sandwich.

MEV Protocols and Practices

To regulate the unchecked extraction brought by MEV, the crypto industry has seen the emergence of several MEV-related protocols, such as Flashbots, CowSwap, and Manifold Finance.

CowSwap and Flashbots essentially represent two directions of application in the MEV track.

• CowSwap stands on the opposite side of MEV searchers; it uses a batch auction mechanism to apply a uniform clearing price to all transactions in the same batch, so these transactions do not need to be ordered, and everyone receives the same asset price.
• Flashbots concentrates potential searchers for standardized management, establishing a private mempool to provide ordinary users using Flashbots RPC with opportunities to avoid harmful MEV, and offers harmless MEV opportunities to searchers through Flashbots Bundle. Flashbots MEV-Boost has established a channel that helps protocols communicate effectively with validators, allowing validators to earn additional rewards through MEV-Boost.

The new product MEV-Share built on MEV-Boost aims to equalize the depth of the MEV market, allowing both block space users and searchers to pay fees and extract value within the rules, ultimately achieving fairness in transaction ordering. MEV is essentially a three-party game among validators (Builders), searchers, and block space users, where validators can gain economic incentives through their power, searchers can earn arbitrage fees, and block space users seem to only play the role of the victim.

The ultimate outcome of MEV-Share is that, while ensuring the transaction privacy of block space users, validators receive their compensation, searchers obtain a small portion of MEV rewards, and block space users receive the majority of MEV rewards, promoting the marketization, standardization, trustworthiness, privacy, and decentralization of MEV behavior.

Implementing MEV-Share will have a direct impact on block space users and validators, thus the LSD sector that gathers validators will also be directly affected. Unlike the nested structure of LSDFi, MEV is actually another direction of LSD expansion—it will also bring more real benefits to LSD protocols. Ultimately, the growth curve of the MEV track in the future is likely to resonate with LSD.

Manifold Finance, mentioned earlier, is also a protocol that can bring additional MEV rewards to Ethereum stakers. It has created a new asset called mevETH and expanded mevETH across the entire chain through LayerZero. mevETH will benefit stakers by capturing non-extractive MEV rewards. Additionally, Manifold Finance has established partnerships with many DeFi OG protocols like SushiSwap to provide MEV protection for protocol users.

Initial Exploration of MEV's Impact on the LSD Track

Let’s imagine how LSD protocols might develop under the promotion of MEV-Share.

The fairness and marketization of MEV provide predictable returns for LSD protocols and Ethereum stakers, and higher returns will promote the growth of Ethereum staking and the adoption of MEV-Boost or other MEV solutions by LSD protocols.

In the future, LSD protocols may determine which MEV solution to use for higher incentives through native token governance. This also empowers the native tokens of LSD protocols.

The growth of Ethereum staking will drive the market share growth of the LSDFi track, and the rise of LSDFi will further promote the increase in Ethereum staking, thus forming a flywheel. Fair and marketized MEV products will serve as the lubricant for this flywheel.

From another perspective, the fairness and marketization of MEV will promote an increase in on-chain activity. The rationalization of gas fees and maximization of block space utilization it facilitates are secret weapons for enhancing the on-chain user experience. The increase in on-chain activity will drive the demand for block space, which in turn will promote the adoption of MEV products, ultimately driving users' demand for public chain security, which is the demand for Ethereum staking. This is also a flywheel.

Conclusion

I really like a term mentioned by Manifold Finance: "non-extractive." Most current MEV protocols are designed to address the issue of extractive MEV, aiming to establish a marketized and fair MEV market. However, the problems they ultimately solve will not only be about extractive MEV; the distribution of interests among block space users, validators, and searchers will also be better allocated, thus promoting the overall growth of the Ethereum ecosystem.