Opinion by Pavel Nikienkov, co-founder of Zano.
Satoshi Nakamoto is a genius, but when it comes to privacy, he left the door wide open. Now, the vultures are feasting. The original blockchain and its many descendants are transparent, immutable, and decentralized. That might sound like everything you ever wanted from a financial system, but you’re wrong.
Privacy is a vital component of any secure financial system. There’s an inherent contradiction between blockchain technology and privacy. The desire for privacy is essential, and the right to be forgotten is enshrined in law. Still, blockchain technology violates this principle with its very existence because it’s an infusible, yet permanent and public, data ledger.
Maybe you don’t care because the only information that anyone can see is a string of random letters and numbers, however, this has real-life implications for transactions on the chain.
Consider a potential example: You go to Uniswap to buy a token, place your order, execute…and receive significantly less of the token than you expected. You check the pair’s order history and find that a large buy was made just before yours, pushing the price up, with a hefty sell following after your order went through. You’ve just been “front-run,” and probably not for the first time.
Front-run? You might think: “I was an ace runner in school; no one’s beating me!” Let’s take a step back and explain what front-running is.
What is MEV?
Maximal extractable value (MEV) refers to the maximum value a blockchain miner or validator can make by including, excluding or changing the order of transactions during the block production process.
Blockchain networks are immutable ledgers secured by a decentralized network of nodes known as “block producers.” In proof-of-work blockchains, this means miners. For proof-of-stake networks, this refers to validators. The block producers are responsible for regularly aggregating pending transactions into blocks, which are then validated by the entire network and appended to the global ledger. While blockchain networks ensure all transactions are valid (e.g. no double-spends) and new blocks of transactions are continually produced, there isn’t a guarantee that transactions will be ordered as they were submitted to the blockchain.
As each block can only contain a limited number of transactions, block producers have complete autonomy in selecting which pending transactions are in the mempool. In this memory pool, block producers store unconfirmed transactions offchain, which they will include in their block. As a result, block producers have full autonomy to engage in rent-seeking behavior by extracting MEV with impunity. For instance, the cumulative value of MEV extracted on Ethereum reached $78 million in early 2021, which then shot up to $554 million by the end of the year. MEV extracted on Ethereum now stands at over $600 million.
Problems and solutions around MEV
Thankfully, the last few years have seen the development of various methods to mitigate the problem of MEV. These fall into two buckets: new transaction ordering protocols and modifications to existing protocols that reduce the scope for manipulation.
One solution that takes the former approach is Fair Sequencing Services (FSS), which ensures that transactions are ordered relatively to reduce opportunities for front-running or reordering by miners and validators. One example is Chainlink’s Fair Sequencing Service, which uses decentralized oracles to maintain fair transaction ordering. Another such protocol is First-In-First-Out (FIFO), which processes transactions as they arrive at the mempool. This method offers a straightforward solution to maintain order integrity, minimizing the chance for miners to manipulate transaction sequences for MEV.
Recent: ‘Unlucky’ MEV bot takes out huge $12M loan just to make $20 in profit
These approaches have a common goal: to create a fairer and more secure transaction ordering system and reduce the potential for manipulation. This objective is essential for building the trust necessary for decentralized ecosystems to go mainstream.
MEV mitigation approach
The block producers rely on visible transaction data to manipulate transactions for profit. Privacy protocols solve the issue, although the primary function has never been eliminating MEV.
Ring Confidential Transactions (RingCT) obfuscates vital transaction details, including the transaction amount, sender and recipient. RingCT prevents miners from determining which transactions might be lucrative to manipulate, reorder or front-run. If specific details of individual transactions are made invisible, MEV extraction becomes virtually impossible, as miners are left blind to potential arbitrage or front-running opportunities.
Likewise, stealth addresses are another powerful privacy tool to mitigate MEV. They generate unique, one-time addresses for each transaction, hiding the recipient’s identity. Since the addresses are untraceable, miners cannot focus on high-value transactions, removing the incentive to prioritize or reorder them for personal gain.
MEV relies on the ability of miners or validators to see transaction data to manipulate transaction order or inclusion. Privacy-centric design targets miners’ ability to view specific transaction details, making it exceedingly difficult to target transactions that might yield profitable outcomes.
The primary function of privacy tech is to protect our privacy in the state’s growing ecosystem. According to a Bank for International Settlements (BIS) survey, 94% of the 86 participating banks were looking at a digital version of their national currencies. That’s up from 90% of 81 respondents in a 2021 survey conducted by the BIS, an umbrella organization for the world’s central banks.
Still, the second function that has been overlooked is that it also helps combat predatory MEV arbitrage practices in blockchain ecosystems by making your footprint on the blockchain invisible.
Pavel Nikienkov is a co-founder at Zano. He is an expert in launching privacy-focused software products and has worked as a project manager. He joined the blockchain privacy ecosystem over five years ago and has been an effective member ever since.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
