- Key Takeaways
- What Is a МEV Bot (Arbitrage Bot)?
- How Do MEV Bots Work?
- Different Types of MEV Bots
- Other Types of Crypto Trading Bots
- Common Features of MEV Bots
- How Are MEV Bots Changing Crypto Trading?
- Advantages of MEV Bots
- Risks of MEV Bots
- MEV Bot in Action – An Example
- Who Can Use a Mev Bot?
- Closing Thoughts
Key Takeaways
- MEV bots allow miners to analyze pending mempool transactions for arbitrage opportunities, and order the transactions to their advantage.
- These bots track mempool activity, reorder transactions, and extract value by exploiting price changes caused by slippage.
- MEV bots push the boundaries of on-chain data usage, going beyond simply “spotting” arbitrage opportunities to allow miners to actively c
- While miners traditionally had exclusive access to mempool data, developers and traders now deploy MEV bots to capitalize on decentralized finance opportunities.
Crypto arbitrage is a popular trading strategy in which traders look for price discrepancies between different platforms to make a profit. But did you know that you don’t always need to wait for arbitrage opportunities to arise – you can actively create them? This is where MEV bots (Maximum Extractable Value) come into play.
MEV bots are an unusual crypto trading tool because they focus on manipulating transactions in the mempool, before they’ve even reached the blockchain. In this article, we’ll explore what MEV bots are, how they work, and the impact they have on crypto trading.
What Is a МEV Bot (Arbitrage Bot)?
MEV bots are algorithms that monitor pending transactions in the mempool, manipulating the order in which they are processed. Their objective is to maximize your profits by creating arbitrage opportunities – either enabling you to buy low, or sell high.
The name “MEV” – short for Maximal Extractable Value – refers to maximizing the profit generated extracted from a block of transactions. In the past, it was only miners themselves who could innlfuence this by looking at their own mempool activity—this is why it was previoously called Miner Extractable Value. However, with mempool data now available to anyone, more or less any trader can use this data to influence how new blocks are put together.
MEV bots are distinct from typical trading bots in two ways:
- Instead of looking at transaction data already published on the blockchain, they focus on unconfirmed transactions in the mempool.
- Beyond simply analyzing data to find opportunities, MEV algorithms can actively create profitable opportunities by manipulating the way transactions are processed.
How Do MEV Bots Work?
Crypto trading suffers from a problem known as slippage, which refers to the price of an asset changing rapidly after a large transaction.
For example, let’s say you wanted to sell 1000 Kittycoin in one single transaction, and liquidity for Kittycoin is relatively low. By flooding the market with new Kittycoin, this one very large sell order would likely drive down the price of the asset. This presents an opportunity for another trader to buy Kittycoin at a low price directly after the large sell order.
This is where MEV bots come in. They allow miner nodes to see large pending transactions like the one above, and insert their own buy or sell order directly after it to take advantage of the momentary price difference; this is known as front running, or sandwiching. The buyer can then sell that asset for a profit.
Now that you have a rough overview of what these bots can do, let’s take a closer look at how they achieve it:
1. Mempool Tracking
The mempool is a temporary storage area for transactions awaiting confirmation by miners or validators. Think of it as transaction limbo.
MEV bots monitor the mempool in real time looking for arbitrage opportinities. This might include large transactions like the one above that cause the price of an asset to change. By doing so, they identify potentially profitable scenarios, such as price discrepancies across decentralized exchanges or opportunities to front-run large trades.
2. Transaction Creation
Once a MEV bot identifies a profitable opportunity, it will calculate the optimal buy or sell transaction that would allow you to maximize your profits. It will also determine what type of transaction to deploy: sandwiching, front running or back running. We’ll unpack those below.
3. Gas Fee Optimization
Next, the MEV bot will make sure your transactions enter the new block at the right point to ensure only you can take advantage of this opportunity. MEV bots do this by calculating exactmy how much gas you should pay for the transaction. For example, the bot may submit its own transaction with a higher gas fee to ensure it is processed before or after the target transaction. By influencing the transaction order within a block, MEV bot users maximize profits.
4. Profit Extraction
After reordering or inserting transactions, the MEV bot executes its strategy to extract value. This generally involves arbitrage, which means selling the assets elsewhere at a higher price.
Different Types of MEV Bots
MEV bots can extract value in different ways. Depending on the mechanism they utilize, we can classify them into:
Front Running MEV Bots
Front-running MEV bots capitalize on their ability to prioritize transactions. They monitor the blockchain mempool and identify opportunities. Once a profitable transaction is detected, these bots submit their own transaction with a higher gas fee, ensuring it gets priority.
For example, if a large buy order is detected, the bot places a buy order ahead of it to benefit from the price increase that will result from the initial transaction.
Sandwiching MEV Bots
Sandwiching MEV bots take advantage of slippage and price movement caused by large trades. They execute two transactions: one before and one after a targeted transaction. This effectively sandwiches the target transaction between the bot’s trades, extracting value at the trader’s expense.
Sandwiching can be particularly harmful in DeFi markets, as it exploits traders by increasing costs and reducing returns.
Other Types of Crypto Trading Bots
Beyond front-running and sandwiching MEV bots, the crypto ecosystem hosts a variety of trading bots that leverage different strategies to maximize profitability. These bots often operate in niche areas such as decentralized finance (DeFi) protocols. Some of the most notable types include:
MEV Arbitrage Bots
MEV arbitrage bots capitalize on price discrepancies across exchanges. These bots monitor the blockchain for instances where an asset is priced differently on multiple platforms and execute transactions to profit from these differences. By buying the asset on one exchange and, at the same time, selling it on another at a higher price, they extract value from the inefficiency.
For example, if Token X is priced at $100 on Exchange A and $101 on Exchange B, the bot would buy the token on Exchange A and sell it on Exchange B, securing a $1 profit per token. These bots can enhance market efficiency by reducing price discrepancies but they also drive up gas fees during periods of intense activity.
Flash Loan Bots
Flash loan bots utilize the concept of flash loans, unsecured loans that must be repaid within a single blockchain transaction. These bots perform complex operations that would typically require significant capital, but the flash loan allows them to execute trades without upfront funds.
A flash loan bot might borrow funds to execute an arbitrage trade across several exchanges, profiting from price differences. Flash loan bots are powerful tools that require sophisticated programming and strategic planning, making them popular among advanced traders and developers.
Liquidation Bots
This type of bot targets undercollateralized loans on DeFi lending platforms. When a borrower’s collateral falls below the required threshold due to price fluctuations, these bots step in to liquidate the position. By doing so, they earn a reward or a percentage of the liquidated collateral, as incentivized by the protocol.
For example, if a borrower’s collateralized debt position on a platform like Aave or MakerDAO becomes undercollateralized, a liquidation bot will execute a transaction to seize and sell the collateral. This helps maintain the health of lending protocols. On the other hand, it puts price pressure during market downturns.
Common Features of MEV Bots
It’s worth understanding the key features of MEV bots that enable them to extract profit. Here are some common features:
Front-running (Sandwiching)
Front-running is a practice where traders execute a transaction in anticipation of another trade, capitalizing on its expected price impact. MEV algorithms excel in front-running because they analyze pending transactions and submit their own trades ahead of large orders.
For example, if a large buy order is detected in the mempool, the bot can purchase the asset beforehand, benefiting from the price increase when the original transaction is executed.
Gas Optimization
MEV bots carefully manage gas fees to ensure their transactions are prioritized by miners. By offering higher fees than competing transactions, they secure a better position within a block. At the same time, these bots aim to minimize unnecessary gas expenditure to preserve profits. This delicate balance between offering competitive fees and maintaining profitability is a sign of successful MEV algorithms.
Smart Contract Analysis
To identify profitable opportunities, MEV bots analyze smart contracts for vulnerabilities. This includes identifying vulnerable liquidity pools with low liquidity, where MEV bots can craft transactions that capitalize on slippage.
How Are MEV Bots Changing Crypto Trading?
MEV bots push the boundaries of on-chain analysis, utilizing mempool data to anticipate market movements before they are publicly visible. This enables the user to proactively influence how transactions in the mempool are processed. As a result, the mempool turns into a new battleground for the most knowledgeable traders.
Furthermore, by exploiting blockchain-specific dynamics like slippage, they create opportunities that benefit their operators while influencing market behavior. While this innovation has advanced the field of blockchain technology, it also raises questions about fairness and transparency in decentralized markets.
Advantages of MEV Bots
MEV bots offer certain advantages that can enhance blockchain operations and improve overall market efficiency. They play a significant role in the DeFi ecosystem, leveraging automation and rapid transaction execution. MEV bots offer:
- Market Efficiency: By identifying and exploiting arbitrage opportunities, MEV bots help reduce price discrepancies across exchanges, leading to better market prices.
- Increased Liquidity: At the same time, MEV bots provide additional liquidity in trading pools, ensuring trades can occur even during volatile periods.
- Automation of Complex Strategies: These bots execute complex strategies, such as arbitrage or liquidation, that would be challenging for humans to perform manually at scale.
- Support for DeFi Protocols: MEV bots contribute to the health of lending platforms by liquidating undercollateralized loans, ensuring solvency and stability.
Risks of MEV Bots
Despite their advantages, MEV bots introduce significant risks that can undermine the fairness and stability of blockchain ecosystems. Their operation often prioritizes profits over user experience or network health:
- User Exploitation: Strategies like front-running and sandwiching directly harm traders by increasing costs and reducing returns.
- Network Congestion: MEV bots often bid up gas fees to prioritize their transactions. Consequently, this leads to congestion and higher costs for everyone.
- Centralization Concerns: The dominance of MEV bots in transaction ordering can create centralization risks.
- Volatility Amplification: Bots that engage in liquidation or flash loans can worsen market volatility.
MEV Bot in Action – An Example
We’ve covered how MEV bots work, now let’s look at a specific example. Consider a scenario involving a decentralized exchange (DEX). Suppose a trader submits a large buy order for a token, which will likely increase its price.
The MEV bot detects this pending transaction in the mempool and places a buy order with a higher gas fee for the same token. Since it uses a higher gas fee, the MEV bot transaction receives priority. After the original transaction pushes the token price higher, the bot immediately sells its tokens for a profit.
This strategy, known as a sandwich attack, allows MEV bots can exploit mempool data to extract value. While profitable for the bot operator, such practices can increase costs for other traders and disrupt market dynamics.
Who Can Use a Mev Bot?
Although the term “Miner Extractable Value” suggests that miners or validators are the primary users, MEV bots are accessible to a broader range of participants. Developers and experienced traders can deploy these bots by leveraging open-source tools and blockchain knowledge.
Creating and running an effective MEV bot requires technical expertise, including familiarity with blockchain mechanics, programming, and market dynamics. Even with AI tools accelerating the coding process, knowledge of the market and blockchain mechanics is still crucial.
Lastly, having the knowledge and the right code won’t do anything without the right API. Creating a MEV bot is a complex task that could cost you countless hours. In the end, it might not even be worth it.
Closing Thoughts
MEV bots represent a fascinating combination of blockchain transparency, technical innovation, and financial strategy. They use mempool data and advanced algorithms, transforming transaction processing and profit extraction in crypto markets.
On the downside, MEV bots also introduce new market stability challenges. In conclusion, if you’re considering trading crypto, a basic understanding of MEV bots is a must.
