Summary

Maximum extractable value (MEV) — formerly known as miner extractable value — refers to a strategy for including, deleting, or reordering transactions when creating a new block. The goal of maximum extractable value is to achieve as much additional profit as possible. Block producers are best placed to do this because they have the ability to identify and arrange transactions.

However, other participants in the network (known as “seekers”) can also pay fees to conduct transactions if they see an opportunity to obtain maximum extractable value, such as arbitrage, insider trading, or liquidation. Maximum extractable value is often found in networks that support smart contracts where blockchain transactions involve more complex information.

the introduction

Maximum Extractable Value (MEV) is a cryptocurrency-specific term used to describe the deliberate re-arrangement, inclusion or exclusion of transactions when producing a new block (added to the blockchain) in order to extract as much profit as possible. You can consider it as additional value being taken out of the block beyond the standard reward and transfer fees on the network by choosing which transactions to include and in what order.

Maximum extractable value is often associated with the Ethereum network due to its large decentralized finance (DeFi) blockchain ecosystem. The more complex the transactions involved in a block — for example, smart contracts associated with lending, borrowing, or trading — the more opportunities there are for block producers to make additional profits (extract maximum value) by deciding to include, delete, or reorder certain transactions.

What is Maximum Extractable Value (MEV)?

When this concept was first introduced, it was mostly associated with the Ethereum network which was using the Proof of Work (PoW) consensus mechanism at the time. As such, miners were the ones who had the ability to reorder, include or exclude transactions when producing blocks, and they could make these choices to gain additional value.

This led to the coining of the term “extractable value to the miner” to explain the phenomenon of this extraction of as much additional profit as possible. However, in September 2022, Ethereum completed the merge, a technical upgrade that transformed the network's consensus mechanism from Proof of Work (PoW) to Proof of Stake (PoS).

Therefore, new blocks on the Ethereum network are no longer created by miners but by validators. However, proof of stake systems are not immune to maximum extractable value. The process of creating blocks is still an ongoing process, so whoever chooses which transactions to include, and in what order, can make decisions that help them extract as much money as possible from the block. While the old concept of maximum extractable value still exists, it is now said to represent maximum extractable value, because it is no longer limited to miners.

How does maximum extractable value work?

Understanding how extractable maximum value works requires a basic understanding of the role of block producers (be they miners or validators), as they play an important role in securing and maintaining blockchain networks, and are responsible for verifying transactions and adding them to the network in the form of blocks. Depending on the specific chain, this process is known as either mining or auditing.

Simply put, block producers ensure the integrity of transactions on the network and ensure their continuity, and without them, new data cannot be added to the chain. Block producers are the ones who collect users' transaction data and organize it into blocks to add to the network chain.

The important thing to note is that it is up to the block producers which transactions to include in their blocks. Logically, transactions are selected based on profitability, which means that transactions with the highest fees will be selected first. This is why users pay higher on-net transfer fees (or transaction fees) during busy periods — to ensure their transactions are picked up first. If the block producer chooses transactions with higher fees, he or she will make a greater profit, and therefore, transactions with lower fees will have to wait longer to be included in the block.

However, there is no rule dictating the selection or ordering of transactions based on fees. When transactions involve more complex information (such as in blockchains that support smart contracts), block producers can include, exclude, or reorder transactions to generate additional profits beyond standard block fees and rewards.

For example, choosing certain transactions over others and arranging them in a certain way may generate additional profits due to the resulting arbitrage or on-chain liquidation opportunities. This is the essence of maximum extractable value: the process of selecting and arranging transactions to achieve greater financial gain.

Searchers for maximum extractable value

While maximum extractable value appears to be a strategy that only benefits block producers, a significant amount of maximum extractable value is secured by other participants known as “seekers.” These participants use proprietary Extractable Value processes that analyze network data for profitable Extractable Value opportunities.

Block producers typically pay very high on-chain transfer fees to ensure that their transactions and strategies execute at the maximum profitable extractable value. Logically, depending on the competition for the opportunity to obtain the maximum extractable value, the block producer can receive on-chain transfer fees of up to 99.99% of the finder's potential profit.

Take decentralized trading platform (DEX) arbitrage as an example, where researchers have been known to pay more than 90% of their maximum extractable value income as transfer fees on the network — and they do so because it is the only way to guarantee a profitable arbitrage trade is executed before similar trades.

Common examples of maximum extractable value

Arbitrage, insider trading, and liquidation provide opportunities for researchers and block producers who seek to profit by capturing maximum extractable value. Below we will examine these examples to provide a more detailed understanding of what maximum extractable value is and how it works.

Budget

When the price of an asset is not fixed across trading platforms, there is an opportunity to arbitrage immediately. In cryptocurrency, the same token can be priced differently on two different decentralized trading platforms. When someone (the arbitrageur) discovers this, they will move to place a trade to take advantage of this discrepancy. The maximum extractable value can be obtained when the finder bot identifies a pending transaction and inserts its own transaction before it in order to extract the value provided by this arbitrage opportunity.

Insider trading

Block researchers and producers can leverage their ability to arrange transactions in a block for trading based on insider information for an important buy order that is still pending in the transaction pool. The maximum extractable value can be obtained when a similar buy order is placed before this trade to secure a more favorable price before the large buy order is executed, which will increase the price of this digital asset.

A similar maximum extractable value strategy is 'trapping', which entails placing a buy order before a particular transaction to move prices and a sell order after it, thus taking advantage of price pressure from both sides.

Liquidations

DeFi allows users to obtain loans against digital assets deposited as collateral. If the market moves and the value of the security falls below a certain price, the trade will be liquidated. The smart contracts in question often pay a reward or fee for the transaction that triggers the liquidation.

The opportunity for maximum extractable value exists here for any researcher or block producer running bots to discover this type of transaction, who can then insert their clearing transaction into the block before anyone else, thus extracting the reward value.

Concluding thoughts: Advantages and disadvantages of maximum extractable value

Maximum Extractable Value is a rational strategy, in which participants are essentially trying to maximize their profits. Some might argue that this benefits the broader blockchain ecosystem by ensuring that shortcomings are corrected as quickly as possible.

For example, seekers of maximum extractable value race to be the first to capture value from arbitrage opportunities leading to rapid price corrections across decentralized trading platforms. Likewise, lending protocols do not want risky loans to go unchecked in the event that collateral provision levels are disrupted, so pushing liquidation of maximum extractable value results in repayment to lenders as quickly as possible.

However, the maximum extractable value also suffers from problems that should not be ignored. Some application systems, such as insider trading and trapping, lead to poor outcomes for other users who are forced to overpay on their trades, suffer greater slippage, or lose value in what is essentially a win-win game.

Additionally, the activity of those seeking maximum extractable value can lead to high transfer prices and network congestion as they compete to insert their transactions into blocks to obtain the resulting value.

At the most basic level, if the value from reordering transactions in a previous block is greater than the fees and rewards of the next block, the maximum extractable value can make it economically rational for the block producer to commit to reordering the blockchain. Hence, this would threaten the compatibility and integrity of the network.

As the blockchain ecosystem continues to evolve rapidly, finding solutions to these issues of maximum extractable value has now become a core area of ​​research and development in this area.

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