What is MEV? Maximum Extractable Value Explained
Key Takeaways
- Maximal Extractable Value measures the maximum profit miners and validators can extract by ordering, including, or excluding transactions within a block.
- There are two main types of MEV, DEX Arbitrage and Liquidations.
- MEV Attacks can cause unfair transaction ordering, slippage, and increased user costs.
- Avoiding MEV attacks involves using MEV-blocking RPC endpoints, setting lower slippage, paying priority gas fees, and opting for DEX-native MEV protection.
The crypto mining world is expanding with the lure of profitability drawing more people to get involved. But with the difficulty of BTC mining on the rise miners need to optimize every aspect of their operation to remain viable. One way this is done is through MEV (Maximal Extractable Value). By understanding and utilizing MEV, miners can extract additional value from transactions on the blockchain.
In this article, we’ll explore MEV, how it works, the different types, and potential attacks, and how you can protect yourself from MEV-related issues.
What Is MEV (Maximal Extractable Value) in Crypto?
MEV originally stood for Miner Extractable Value. However, the term evolved as blockchain systems incorporated Proof-of-Stake (PoS) networks, which replaced miners with validators. Since the principle still applies, the acronym became Maximal Extractable Value, allowing it to apply to validator nodes too.
Maximal Extractable Value is essentially extra profit that can be extracted by miners, beyond the standard block rewards and transaction fees. They are able to do this by reordering, inserting, or excluding transactions within new blocks according to the price fluctuations those transactions will cause.
How Does MEV Work?
Cryptocurrency miners can see crypto transactions before the rest of the market, as they sit in the mempool waiting to be added to a block. MEV sees miners use this knowledge to their advantage in order to maximise their profits. Let’s see how that works, using an example:
Let’s say a cryptocurrency has a circulating supply of 10, 000 tokens, and a buyer purchases 1000. The purchase would cause the supply to become more scarce and the price of the asset would spike following the sale. For the mining operation, knowing about this transaction before the rest of the market offers a huge advantage.
The miner can insert a transaction of their own before the large trade (front-running), buying a large amount of that same crypto before the known price increase. The miner can then insert a second transaction to sell their crypto just after the large purchase order (back-running), profiting from the inevitable price increase.
MEV is possible because miners and validators can control the order of transactions within a block they’re mining. Since they decide the order, they can prioritize or delay transactions, and also insert their own transactions at will, to take advantage of price differences. While MEV can provide additional revenue for miners, it can also disrupt the fair execution of transactions and create an uneven playing field for regular users.
Different Types of MEV
There are two main types of MEV. These include DEX arbitrage and liquidations. Let’s have a look at the specifics for each one.
DEX Arbitrage
DEX arbitrage is one of the most straightforward forms of MEV. Arbitrage opportunities arise when the same asset is priced differently across various decentralized exchanges. Miners can exploit these differences by buying an asset on one exchange where the price is low and selling it on another where it is higher. By placing their transactions within the block, miners can ensure they capture the price difference before anyone else.
Liquidations
Liquidations occur in lending platforms when the value of a user’s collateral falls below a certain threshold, triggering the automatic sale of their assets to cover their debt. Miners can extract value by prioritizing liquidation transactions and earning fees or rewards for participating in the liquidation process. They may also capitalize on price fluctuations caused by the liquidation itself.
MEV Attacks
While profitable for miners, MEV can be harmful to regular users. MEV attacks, such as front-running, back-running, and sandwich attacks, are all methods miners use to exploit the transaction order. They do so for their financial benefit at the cost of regular users.
- Front-Running: This occurs when a miner or validator sees a pending transaction that is likely to affect the price of a token. The miner/validator then inserts their transaction before it to benefit from the price movement.
- Back-Running: In this attack, the miner waits for a large trade to be executed and then immediately places their transaction. After the price change, they profit from the new price.
- Sandwich Attack: This occurs when a miner places one transaction before and one after a pending transaction, effectively “sandwiching” it between their two transactions. The idea is to capture value from price changes.
These tactics can result in higher transaction fees for regular users or worse execution prices on trades. As a result, MEV can be a significant challenge in DeFi systems.
How to Avoid MEV Attacks
Fortunately, there are strategies and tools available that can help users avoid falling victim to MEV attacks.
RPC Endpoints (MEV Blockers)
One of the best defenses against MEV attacks is using MEV-blocking RPC endpoints. These specialized endpoints encrypt transaction data until it reaches the blockchain preventing anyone from seeing it in advance. This makes it harder for miners to interfere with the transaction.
Lower Slippage Tolerance
Slippage tolerance refers to the maximum price change a user is willing to accept when executing a trade on a decentralized exchange. By lowering slippage tolerance, users can reduce the chances of MEV attacks.
Priority Gas Fees
Another way to avoid MEV attacks is by using priority gas fees, which allow users to pay a higher fee to ensure their transactions get priority. This minimizes the time that a transaction is pending, reducing the chances of being front-run or back-run by a miner.
DEX-Native MEV Protection
Some decentralized exchanges (DEXs) have a built-in MEV protection mechanism. These platforms include features like randomized transaction ordering, encrypted mempools, or other solutions to make it more difficult for miners to exploit MEV.
Closing Thoughts
MEV plays a significant role in the economics of blockchain networks, particularly within DeFi. It provides additional incentives for miners and validators but it also introduces risks to users through front-running and sandwich attacks. Understanding how MEV works and adopting strategies to mitigate its impact can help users protect their investments in the crypto space.
