Summary

Maximal Extractable Value (MEV) — previously called Miner Extractable Value — is a strategy that includes, omits, or reorders transactions when creating a new block. MEV's goal is to make as much additional profit as possible. Block producers are best positioned to do this because they are able to select and sequence transactions.

However, other network participants (called seekers) may also pay fees to place transactions when spotting MEV opportunities, such as arbitrage, front-running, or liquidation. MEV is often found in smart contract-based networks with blockchain transactions that include more complex information.

Introduction

MEV is a crypto term used to describe the deliberate reordering, inclusion, or exclusion of transactions when generating a new block (to be added to a blockchain) in order to extract the largest possible profit. Think of it as extra value squeezed from a block over and above the standard reward and gas fees by choosing which transactions to include along with their order.

MEV is often associated with the Ethereum network because it has a significant decentralized finance (DeFi) ecosystem. The more complex the transactions included in a block — for example, smart contracts connected to lending, taking out loans, or trading — the more opportunities there are for block producers to generate additional profits (extract maximum value) by deciding to include, omit, or reorder certain transactions.

What is MEV?

When introduced for the first time, this concept was associated mostly with the Ethereum network which used a proof-of-work (PoW) consensus mechanism at the time. Thus, miners are parties who are able to reorder, include, or exclude transactions when producing blocks and can make such choices to gain additional value.

This led to the emergence of the term Miner Extractable Value to explain this phenomenon of extracting as much profit as possible. However, in November 2022, Ethereum completed The Merge, a technical upgrade that switched the network's consensus mechanism from PoW to proof-of-stake (PoS).

That way, new blocks on the Ethereum network are no longer created by miners but by validators. However, PoS systems are not immune to MEV. Blocks are still being created, so whoever chooses which transactions to include along with their order can make decisions that will help him extract as much money as possible from a block. Even though the old MEV concept still exists, the abbreviation has changed to Maximal Extractable Value because it is no longer exclusive to miners.

How Does MEV Work?

To understand how MEV works, you must have a basic understanding of the role of block producers (both miners and validators). They play an important role in securing and managing the blockchain network, and are responsible for verifying transactions and adding them to the network in the form of blocks. Depending on the chain, this process is referred to as mining or validation.

Simply put, block producers guarantee the integrity of transactions on the network and ensure it continues to function. Without them, no new data can be added to the chain. Block producers are parties who collect user transaction data and organize it into blocks that will be added to the network chain.

An important thing to note is that block producers have the right to determine which transactions will be included in their blocks. Logically, transactions are selected based on profitability. This means that transactions with the highest fees will be selected first. This is why users pay higher gas fees (or transaction fees) during busy times — to ensure that their transactions are selected first. If a block producer chooses the transaction with the highest fees, then he will make a greater profit. As a result, transactions with lower fees have to wait longer to be included in a block.

However, there are no rules that dictate that transactions must be selected or ordered based on cost. When transactions contain more complex information (such as in smart contract-based blockchains), block producers can include, exclude, or reorder transactions to earn additional profits beyond standard block rewards and fees.

For example, by selecting certain transactions over others and ordering them in such a way, block producers can generate additional profits due to on-chain arbitrage or liquidation opportunities. The essence of MEV: The process of selecting and sequencing transactions for greater financial gain.

MEV Finder

Although MEV appears to be a strategy that only benefits block producers, large amounts of MEV are secured by other participants called “searchers”. These participants use special MEV operations that analyze network data to search for profitable MEV opportunities.

Searchers typically pay very high gas fees to block producers to ensure profitable execution of their MEV transactions and strategies. Rationally, depending on the competition for an MEV opportunity, a block producer could receive gas fees of up to 99.99% of the prospector's potential profit.

For example, in decentralized exchanges (DEX), seekers have been known to pay over 90% of their MEV earnings in gas fees. They do so because it is the only way to ensure that profitable arbitrage trades are executed before similar trades.

Common Examples of MEV

Arbitrage, front-running, and liquidation offer block seekers and producers the opportunity to profit through MEV. Below, we'll dive into these examples to gain a more detailed understanding of MEV and how it works.

Arbitrage

When the price of an asset is inconsistent across exchanges, arbitrage opportunities immediately arise. In the crypto space, the same token can have different prices on two DEXs. When this condition is known to someone (the arbitrageur), he will make a trade in order to profit from the difference. MEV occurs when a search bot identifies a pending transaction and then enters its own transaction ahead of it to extract the value offered by that arbitrage opportunity.

Front-running

Block seekers and producers can leverage their ability to sequence transactions within a block to front-run large buy orders that are still pending in the transaction pool. MEV occurs when a similar buy order is entered ahead of the trade to secure a more favorable price before the large buy order is successful which could cause the price of the digital asset to rise.

A similar MEV strategy is “sandwiching” which involves placing buy orders and sell orders after certain transactions that move prices to take advantage of price pressure from both sides.

Liquidation

DeFi allows users to take out loans collateralized by deposited digital assets. If the market moves and the value of the collateral falls below a certain price, the position will be liquidated. The smart contracts involved often provide rewards or fees for transactions that trigger liquidation.

The MEV opportunity arises here for block finders or producers who run bots to track these types of transactions who are then able to include their own liquidation transactions in the block ahead of others and so can extract reward value.

Wrapping Up: Pros and Cons of MEV

MEV is a rational strategy, because the parties involved are primarily trying to maximize profits. Some argue that this strategy benefits the ecosystem in general by ensuring that inefficiencies are corrected as quickly as possible.

For example, MEV seekers race to be the first to capture value from arbitrage opportunities, thereby causing rapid price corrections on various DEXs. Likewise, lending protocols do not want to allow loans to become risky if collateral levels become unbalanced, so MEV's liquidation drive encourages lenders to get repayment as quickly as possible.

However, MEVs also pose a number of problems that cannot be ignored. Some implementations, such as front-running and sandwiching, provide poor outcomes for other users who are forced to pay too much for their trades, experience greater slippage, or lose value in what is essentially a zero-sum game.

Additionally, the activity of MEV seekers can lead to higher gas prices and network congestion, as they scramble to include their transactions in blocks to capture the resulting value.

Essentially, if the value of reordering transactions in a previous block is greater than the rewards and costs of the next block, then MEV can make blockchain reordering a rational thing for block producers to do from an economic standpoint. This would then threaten the consensus and integrity of the network.

As this ecosystem continues to rapidly develop, finding solutions to MEV-related problems is now a focus of research and development in the field.

Further Reading

• The Ethereum Merge Upgrade: Everything You Need to Know

• What Is a Decentralized Exchange (DEX)?

• Proof of Work (PoW) vs. Proof of Stake (PoS)