Overview of the MEV track: Is its importance underestimated?

Author: Yilan

1. Understanding MEV

When Ethereum still uses the PoW mechanism, MEV stands for “value extracted by miners”. Under the POS mechanism, miners have been replaced by verifiers, and MEV stands for “maximum extractable value”. Under PoW, a small number of opaque mining pool operators control transactions Sorting and obtaining benefits are different. Under the PoS mechanism, the right to arbitrage transactions in the block is open to anyone, and the market is opened by playing different roles to participate in block space arbitrage. GP Dan of Paradigm classified MEV into EIP-1559 burn, hedging, rebalance loss, and price changes before and after the transaction. The understanding of breaking the obscure term MEV is that any part or all of the value captured by transaction ordering privileges on any chain can be classified as a certain kind of MEV, **so now the arbitrage behavior on the chain is sometimes collectively referred to as MEV, and MEV is also called Treated as a by-product in the blockchain, permissionless incentives, ** users can withdraw on a first-come, first-served basis.

For example, suppose user A sells 100 ETH in AMM. Due to the AMM algorithm mechanism, every unit of asset sold will lower the price. If a large amount of asset is sold, the price of the asset will be lower than the current market price. Slippage occurs. After discovering such a transaction, MEV searchers will buy ETH at the new price and sell it at the market price, completing arbitrage. In this example, the transaction initiated by the MEV searcher needs to be the first transaction after user A in order to successfully complete the arbitrage. Therefore, it can be seen that MEV searchers face huge competition, and how to be the first transaction before and after a certain transaction usually depends on the priority fee paid to be included in the block first , MEV searchers participate in the gas fee auction market in order to allow miners to package transactions in a timely manner, resulting in fierce competition that pushes the cost of gas fees very high.

A more traditional explanation is that on the Ethereum blockchain, all new transactions must first wait in a public memory pool (or “mempool”) before being put into a block and added to the blockchain. In the past POW mode, miners decide which transactions to put into blocks, and in what order, they just choose the transaction with the highest transaction fee, and don’t care about the order of transactions. But in the huge transaction ecosystem spawned by Ethereum, MEV searchers soon began to realize that by rearranging transactions, censoring transactions, or creating new transactions based on transactions in the mempool, profits can be made, and these profits are MEV. Although Seekers are the initiators of MEV, usually more profits are distributed to the remaining participants in the MEV conduction value chain, such as validators, rather than Seekers themselves.

From the perspective of sustainable development of users and ecology, MEV activities can be roughly divided into two types, arbitrage behaviors that help price discovery, beneficial MEV such as liquidation, and simple front-running transactions, or more complex sandwich attacks (in a legitimate buying Unfavorable MEV activity such as two new orders sandwiched between two new orders that buy the target token at a higher price and sell at a higher price), front-running and sandwich attacks can lead to worse earnings for the average DEX trader s price.

2. MEV track overview

1. Track Features

The MEV track belongs to the underlying basic track. It is strongly related to all tracks related to transactions in the block space. It has the characteristics of high income effect, more and more complex transaction scenarios, which are more conducive to income acquisition, and relatively low risk. It is compatible with the entire market. The multi-L1 ecological expansion is mutually reinforcing.

2. Track Development

(1) Solving the MEV problem is an important part of the Ethereum roadmap. On November 5th last year, Ethereum co-founder Vitalik Buterin (V God) published an updated version of the Ethereum development roadmap, which contains three major changes, including adding a new stage to the roadmap - “The Scourge”, ensuring Reliable and fair and trustworthy neutral transactions and solving MEV problems. This means that the agreement to solve the centralization problem of MEV will attract attention, and the attention of this track will gradually increase.

(2) The future development of MEV should focus on the acquisition of cross-chain MEV, minimize the loss of value, minimize the potential negative impact of MEV on real users of the protocol, and ensure the fair distribution of participants.

3. Track size

The revenue scale of this track is almost in sync with the trading volume of the encryption market. Two main factors affect the scale of MEV. One is that there is a positive correlation between arbitrage frequency and price fluctuations, and the other is that there is also a positive correlation between arbitrage volume and total transaction volume.

Judging from the revenue of Flashbots, the total gross profit is 713.95M. This part is considered a good MEV, which has a positive impact on price discovery, the completion of the core functions of DeFi and the transaction volume of DEX. Sandwich attack income is 1206.11M, this part is considered unfavorable MEV, and most MEV protected DEXs want to control and democratize this part of profit.

If we use Uniswap, Pancakeswap, and Sushi, which are the top three in cumulative fee income, as anchors, the cumulative fee of the three DEXs is (3.24+1.2+0.77) billion, or 5.21 billion. It is roughly estimated that the MEV revenue obtained through Flashbots accounts for 37% , and in fact, in addition to the main DEX, other dapps, alt L1 and L2 on Ethereum will also generate considerable MEV revenue. To estimate the transmission of these costs in the entire value chain to form the scale of each segment, it is necessary to analyze how MEV profits are distributed among different participants.

According to Eigenphi, in January and February 2023, MEV seekers earned $48.3 million from all user transactions via wallets and RPC, with $34.7 million going to builders. The builder then sent $30.3 million to the validators.

Profit distribution: Searchers — $7.3 million (17.4%); Builders — $4.4 million (10.5%); Validators — $30.3 million (72.1%). (The functions of these participants playing specific roles will be introduced below.) It is not difficult to see that most of the profits (72%) are still captured by the downstream validators.

Of the $48.3 million, $6.3 million was spent on EIP 1559 burns. The priority fee for ordinary transactions transferred from wallets and RPCs to builders and then to validators is $32.554 million. Ordinary transactions from wallets and RPCs burned $227.2 million for EIP 1559.

In the bull market in 2021, the overall revenue ceiling is 476 million US dollars. Calculated with a lower 10 times PS, the overall track size is nearly 5 billion US dollars. As for the track size of each subdivided track, it can be estimated based on the proportion that the Searcher is more than 1 billion US dollars, and the verifier is more than 3.5 billion US dollars. This is only a rough estimate.

However, those bots that profit from on-chain transactions may still bear the cost of many failed transactions, as well as the impact of other off-chain hedging costs, which are not included in the calculation. And this is only the calculation of the income obtained by the direct participants, and does not calculate the indirect participant market. In fact, the size of the entire track will far exceed the above figures.

4. Two angles of MEV track layout

(1) Value chain

• **Upstream (RPC provider): **Upstream refers to a service provider that provides on-chain transaction information and data, usually an Ethereum node operator or an RPC (Remote Procedure Call) service provider. These service providers provide the necessary data interfaces for midstream and downstream participants, enabling them to obtain information about transactions and blocks, so as to better participate in MEV-related activities. **For example, Uniswap will transfer transactions initiated by users (TX) is sent out through RPC (remote procedure call), and these transactions will enter the Ethereum memory pool (mempool). **
• **Midstream (Tools and Infrastructure): **Midstream includes various tools, platforms, and infrastructure to help connect upstream and downstream participants, thereby realizing the distribution of MEV value. These midstream tools may include search engines, transaction builders, transaction relayers, etc., which enable searchers, builders, block producers, etc. to more efficiently discover, execute, and distribute MEV opportunity.
• **Downstream (MEV Profit Acquirer): **Downstream covers participants who really benefit from the value of MEV, including validators and other individuals or entities that actually obtain MEV profits. Validators are nodes that participate in block verification in the Proof of Stake (PoS) network, and they can earn rewards from transaction fees and base interest on the network, which are facilitated by midstream and upstream activities. Downstream validators include crypto exchanges (CEX), liquid staking platforms (Liquid staking), institutional stakers and individual stakers, etc.

(2) Direct and indirect parties

MEV value chain conduction process

Direct participants include Searchers, Builders, Relayers and block producers (block producers/validators). These types of participants also form MEV supply chain structure. Tools to better serve these direct participants, such as infrastructure designed to address MEV-related challenges including Flashbots, which just raised $60 million at a valuation of $1 billion this month, intends to use the financing to develop its platform SUAVE .

SUAVE** (Single Unified Auction for Value Expression) is an infrastructure designed to solve MEV-related challenges, and its vision is to become a common ordering layer for different chains. **SUAVE focuses on separating the role of mempool and block generation from the existing blockchain to form an independent network (ordering layer) that can be used as a plug-and-play mempool and go to any blockchain Centralized block builder, which acts as a Mempool and builder for other chains. The main purpose of SUAVE is to provide a more decentralized and fair ecosystem for MEV-related participants such as users, block builders, and validators. Separate the Mempool and builder of all chains from other roles to achieve professional management, so as to improve the efficiency of the whole chain and achieve a win-win situation, that is, the blockchain itself is more decentralized, the income of the validator is increased, and the searcher/builder can set preferences and Potential income increases, and users can also conduct private transactions at the cheapest price.

· Seekers write code, often powered by proprietary complex algorithms, to identify MEV opportunities in mempools, and are responsible for listening to public transaction pools and Flashbots private transaction pools. They compete to submit response “packages” to builders, and bid a gas, expressing the maximum cost (priority fee) they are willing to pay.

· Block Builders are specialized providers who compete in a real-time market to perform block building on behalf of validators. Any user who downloads MEV-Boost can become a Block Builder. Builder accepts transactions from searcher, and further selects profitable blocks from them, and then sends the blocks to relayers through MEV-Boost.

·Relayers are intermediaries between block builders and block proposers, allowing validators to offer their block space to block builders. Some relayers include transactions of ETH that have passed through the Tornado Cash protocol in the past, while some exclude or “censor” these transactions. MEV repeaters are controversial due to censorship issues. In August 2022, Tornado Cash was blacklisted by the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC), making it illegal for U.S. citizens, residents, and companies to receive or send funds through the protocol. Since then, validators must carefully consider the relayers they use to generate MEV revenue, deciding whether to exclude such relayers that are considered “OFAC compliant”. Given the high number of Ethereum nodes in the US, it is likely that many US-based validators will want to choose to cooperate with the safety aspects of regulatory scrutiny and not risk non-compliance. And that runs counter to the principles of censorship resistance. Flashbots’ own relayer was the first MEV-Boost relayer and chose to review non-compliant transactions, which explains the initial dominance of OFAC-compliant block offerings on Ethereum. This trend has reversed as more relayers became available, including uncensored ones, and less than half of all blocks are now OFAC compliant. It can be seen that the market share of Flashbots repeaters has declined, and it is currently 23%.

MEV Boost Relay Market Share

** · Block Producers/Validators** are entities responsible for validating and proposing blocks to be added to the blockchain under PoS. They are often the biggest capturers of MEV revenue. Any user under POS can pledge 32ETH to become a Validator. Currently Lido is the largest Validator. As long as the Validator uses MEV-Boost, it can select the most profitable block from the proposals of multiple relayers and receive a priority fee. Then one of the many Validators is randomly selected as the Proposer to submit the final transaction (block).

Indirect participants include almost all underlying L1, L2, and Application-level projects that generate transactions. The Application level is divided into DEX, Lending, and LSD (MEV activities run through the entire DeFi ecosystem, including increasing handling fees and helping liquidation. Help verifiers improve the APY of the execution layer, etc.), and then derive to protocols (including tool providers and beneficiary protocols) that help users avoid MEV in specific transaction scenarios, such as Unibot and other TGbot protocols.

Leading projects from different parties

• Lido

MEV is still very important to the Ethereum economy, accounting for more than 15% of all Ethereum transactions, and increasing the reward rate of stakers and validators by 25%. 31.7% of all verifiers, 19.86mln (two-month data from January to February this year). Taking the executive layer APR of Lido DAO as an example, the main income is MEV, which accounts for about 1/3 of the total income of stETH. When the transaction heat on the chain is high, it accounts for nearly 70%; therefore, it is speculated that when the bull market comes, MEV revenue will still account for 70% of Stake’s total revenue. It can be considered that the development of the MEV track and the LSD track are positively correlated. high.

• Uniswap

Different DEX protocols extract MEV shares

The relevant MEV transaction on Uniswap obtained a profit of 252mln. In 2022 alone, arbitrage bots have withdrawn at least $85 million from market price asymmetries involving Uniswap V3 liquidity pools; sandwich bots have withdrawn at least $47 million from exchange users of Uniswap V3 liquidity pools; $6 million was withdrawn from interchange fee income.

The total extraction value of these three types already exceeds 25% of supply-side revenue, or $540 million.

For the real users of Uniswap, after UniswapX built-in MEV income in the future, it can significantly improve the interests of swappers. UniswapX’s aggregator and RFQ off-chain order matching mechanism will be a huge improvement for preventing MEV ( Although at the expense of decentralization). For MEV cross-chain acquisition, the cross-chain technology planned by UniswapX is the key infrastructure.

Unibot

At present, the total market value of the TG Bot track is less than 200 million US dollars, of which the leading Unibot occupies about 75% of the market share.

Judging from the 800 million users of Telegram, Unibot is trying to open a huge traffic portal through functional integration. Although the robot function is still in the early stage, doing one-stop transactions in the traffic pool is obviously different from most DeFi Apply the method of customer acquisition, although in the end most transactions are still conducted on Uniswap.

At present, the daily active users of Unibot have surged from about 400 to 1,700 at the peak within two weeks in July. Objectively speaking, there is still a lot of room for growth, but this track user group is quite special, usually when the meme market is prevalent The popularity of users continues, the overall market value is still small, the business logic is established, the token has a relatively reasonable dividend mechanism (40% revenue sharing to holder), and the growth ceiling is also high. In the long run, only users who are not price-sensitive will use Unibot, which costs 5% more tax than trading directly on Uniswap. This type of protocol also has obvious shortcomings, as bots have different settings, but usually allow users to create dedicated wallets or connect existing wallets. In both cases, bots will have access to private keys, which may add an additional layer of risk to users.

• Valuation aspect
• Unibot peak Vol/FDV = 12mln/182mln = 0.06
• Uniswap: Vol/FDV = 429mln/6193mln=0.069
• Velo: Vol/FDV 7.5mln/100mln=0.075

Judging from the Vol/FDV indicator, the market has pushed the price of Unibot to a reasonable valuation range, but as the popularity of meme fades, the trading volume of Unibot will obviously decrease accordingly.

In addition to the Ethereum ecosystem, MEV track opportunities also exist in other ecosystems. And more complex cross-chain transaction scenarios in the future will significantly amplify MEV activities.

3. The dynamic balance of MEV and DEX ecology

There is a positive correlation between MEV transaction volume and total transaction volume. Eigenphi data shows that the correlation coefficient between trading volume (excluding arbitrage trading volume) and arbitrage trading volume is 0.6, and the correlation coefficient between trading volume (excluding clip trading volume) and clip trading volume is 0.62. Therefore, the larger the total transaction volume, the larger the MEV transaction volume. As more and more DEXs increase their Total Value Locked (TVL) on multiple chains, liquidity pools of the same asset pair will be formed on multiple channels, but their transaction volume and depth vary, which is also an important factor for transactions and MEV Created new opportunities.

Other factors that can affect MEV activity include high or low gas fees (lower is potentially more profitable, but searchers may still bid up gas across the network for a larger transaction) and market volatility (more market volatility more arbitrage trading opportunities)

AMM is where most MEVs are extracted. After the emergence of Uni V3, the concept of centralized liquidity range was introduced, which allowed traders to trade in a smaller price range, thereby reducing some price differences, which in turn reduced the profitability of certain MEV activities. In addition, due to the more granular price setting mechanism adopted by Uni v3, the slippage will generally be smaller than the previous version, which theoretically reduces some possible MEV profit opportunities and also helps to reduce some MEV activities. To put it simply, as the centralized liquidity at a certain price becomes deeper, the user’s refined price setting leads to smaller slippage, and the profit that MEV can arbitrage also drops significantly.

The further emerging anti-MEV dex achieves the purpose of protecting ordinary users through the following mechanisms:

(1) Order openness and predictability-DEX can disclose the details of the order before the order is submitted, adopt mechanisms such as auctions, and use an off-chain matching mechanism similar to the order book to reduce transaction front-running attacks Opportunity. By disclosing information in advance, traders can better predict market behavior, thereby reducing the probability of an attack.

(2) **Time-locked transactions-**Implement time-locked, restricting transactions to be executed after a specific block. This reduces the impact of types of attacks such as flash loans, since an attacker cannot execute multiple transactions within the same block.

(3) Batch Transactions - DEX can allow traders to submit multiple transactions and process them as a batch. This can increase the privacy of transactions and reduce the ability of attackers to analyze transactions.

So how to understand the impact of this MEV-proof approach on transaction volume? For the anti-MEV dex, this part of the benefits is transferred to its own users. Although the reduction of clipping behavior or conversion to no direct transaction fees will be the reason for the decrease in transaction volume, in fact, maintaining a good transaction environment is beneficial to The sustainable development of any trading system is beneficial.

MEV also has different impacts on traders, liquidity providers and miners. For traders, it is obvious that MEV, especially unfavorable MEV, leads to increased transaction costs, and traders need to pay higher transaction fees to ensure that their transactions are prioritized in the blockchain. This increases costs for traders, especially during times of high network congestion.

The second is information asymmetry. MEV causes some interested parties to use their ability to control the order of transactions to obtain market information, thereby gaining an unfair advantage. This exposes other traders to the risk of information asymmetry.

For LP, the risk of providing liquidity increases. Liquidity providers may face the risk of flanking transactions, that is, the liquidity they provide may be used by other traders during transactions, resulting in losses. In addition, LPs also face the problem of cost-effectiveness damage. LPs need to consider higher gas fees and risks to balance their profits and risks.

For miners/validators, MEV may lead miners to optimize their mining strategies to obtain more transaction fees and rewards. But it also means increased competition, with miners/validators competing to earn MEV, leading to gas inflation and network congestion.

4. Solutions to prevent unfavorable MEV

There are some solutions to prevent unfavorable MEV from the consensus layer, execution layer, app layer, L2, MEV tools, etc.

At the consensus level, Ethereum’s “The Scourge” phase is dedicated to ensuring reliable, fair and credible neutral transactions and solving the MEV problem. At the transaction execution level, peer-to-peer and gas-free transactions can prevent unfavorable MEV. Peer-to-peer transactions mean that transactions take place directly between the two parties, reducing the possibility of intermediary intervention and malicious behavior. Gas-free transactions and separation from the mempool reduce the chance for malicious actors to gain an advantage by raising gas fees. In addition, some innovative attempts also provide ideas for preventing unfavorable MEVs. For example, EigenLayer tried to introduce MEV-boost and some block auction mechanisms in some blocks, which provided new ideas and methods for modular MEV stack design.

At Layer 2, the Taiko project takes a very different approach — outsourcing block creation to L1, offering a potential solution to leverage the capabilities of the Ethereum base layer to address the complexity of L2 MEV.

At the app layer, through the Dex aggregator (in fact, the work done by the Dex aggregator in preventing MEV has not been taken seriously, it reduces the impact of slippage on the price at the time point by placing orders through different routing channels, thereby preventing being unfavorable to MEV Looking for trading opportunities), backrunning service and off-chain matching orders, auctions or batch processing orders (unified pricing within batch processing orders fundamentally solves the problem of MEV pinching. Since the trading interface directly matches between peers, there is no transaction order) and other methods to minimize the harm of MEV to users.

In terms of MEV tools, Flashbots aims to alleviate situations caused by MEV that have a negative impact on different participants in the entire ecosystem, such as on-chain congestion. Flashbots has launched several products, Flashbots Auction (including Flashbots Relay), the Flashbots Protect RPC, MEV-Inspect, MEV-Explore and MEV-Boost, etc. The upcoming SUAVE will serve as a sorting layer for different chains, turning the focus to user preferences and optimizing transaction paths, creating the most efficient routes based on searchers’ search desires.

5. Conclusion

From the perspective of the importance of the track, MEV is a by-product of block generation, and it can even be said that the future of MEV is the future of the encrypted world. The characteristics of strong cash flow make the roles of Searcher, Builder, Relayer, and Validator and the tool products that serve and optimize these roles still have a strong income effect. However, since there are not many Searchers and Validators that really capture MEV revenues, there are not many agreements to issue coins, and there are few secondary investment opportunities. However, some application-level applications will obtain additional edges by cutting into the MEV track, and tool projects are in the primary market. There are also good investment opportunities, but such tool projects need to think about how to capture value for their own agreements rather than just enhancing the profitability of participants who already have profitability.

Although unfavorable MEV has a certain negative impact on users, the reasonable use and existence of MEV can also bring many positive factors. For example, arbitrage traders ensure the consistency of the token pricing of each AMM and satisfy the anchoring mechanism of stable coins , ensuring the smooth liquidation of DeFi loans, maintaining incentives for block proposers to increase the security of the blockchain (by providing higher execution layer rewards), etc.

**In general, the development direction of the MEV track is focused on several key areas: cross-chain MEV acquisition, minimizing value loss, mitigating the potential negative impact of MEV on real users of the protocol, democratizing revenue, and promoting sequencers decentralization and ensure fair distribution among participants. **Currently, we can observe that UniswapX’s cross-chain technology plays a key infrastructure role in realizing MEV cross-chain acquisition. On the whole, the value of the MEV market is related to more complex trading scenarios and market fluctuations in the future, which will bring more opportunities for traders. For the potential negative impact that MEV may have on real users of the protocol, it can be alleviated by adopting fair distribution and privacy protection methods at the consensus level, and implementing mechanisms such as off-chain order matching and reducing time-point price slippage at the protocol level. In addition, the stacking and decentralization of MEV participants is also a crucial part of the Ethereum roadmap, which will help build a more robust and secure MEV ecosystem.

In terms of democratizing the benefits of MEVs, there are still many areas worthy of further exploration. For MEV-proof de-pinch attack (MEV) DEX, a part of the revenue originally obtained by the searcher is transferred to its transacting users. While anti-MEV design may reduce or change pinching behavior, which may lead to reduced trading volume due to unfavorable MEV, maintaining a good trading environment is crucial for the sustainable development of any trading system. Such positive MEV benefits gradually contribute to the healthy development of the entire on-chain transaction ecosystem.

A fair market competition environment provides the breeding ground for innovation, and a more efficient benefit distribution mechanism and decentralized architecture are the cornerstones to achieve this goal. Seekers and block-building techniques are inherently neutral, and their impact on the entire transactional environment depends on how people use them.