Why is MEV bound to develop together with cryptocurrency?

Imagine you are shopping for a heavily discounted item, and when you check out, customers behind you are also competing for this item. The customer gives the merchant a little extra money in front of you, and the merchant sells the goods to other customers. How would you feel in this situation?

The above example represents MEV, the dilemma in the crypto market. Since January 2020, Ethereum alone has gained nearly $700 million from MEV. The pie will get bigger and bigger, attracting more people to join. So what is MEV?

The inevitable result of system design

Not only can miners or objects such as validators and stakers benefit from the consensus mechanism (mining tokens, staking tokens, etc.), the design of most blockchains also allows these entities to benefit from the ordering of transactions. Transactions that pay higher fees will be prioritized.

Participants will be attracted if the financial benefits of executing the transaction are greater than the fees that need to be paid. The value extracted during this process is called MEV (Miner Extractable Value or Maximum Extractable Value).

Blockchains that can only send and receive cryptocurrencies like Bitcoin make it nearly impossible to mine MEV (A sends funds to B, and the funds eventually return to B even if other transactions interfere). Blockchains that support smart contracts (the basis of DeFi and NFTFi) have more ways to mine MEV. Ethereum, which currently attracts most of the value, is the blockchain with the most MEV mined.

MEV on Ethereum and other smart contract platforms is an inevitable consequence of the economic benefits they bring. Miners who prioritize fees also help filter and eliminate spam transactions.

Zero-fee blockchains like EOS have a lot of spam transactions. Transactions on low-fee blockchains like Solana or Polygon often fail due to too many spam transactions on the network.

Are all MEV harmful?

There are three basic types of MEV, including arbitrage, clearing, and sandwich trading. The other current MEV types are just variations of the above types. With the development of smart contract platforms, many new MEV types may gradually appear in the future.

Arbitrage: Make profitable trades based on the price difference of tokens on two different DEXs.

According to Eigenphi’s report, arbitrage MEV will account for more than 68% of all MEV transactions in 2022. Due to its lower cost, this is also the most profitable type of MEV. This process is called MEV (Miner Extractable Value or Maximum Extractable Value).

Liquidation: MEV becomes the first buyer to purchase collateral assets at a discount and sell them at market price when a liquidation event occurs on a lending protocol or derivatives trading platform.

Sandwiching: When a liquidation event occurs on a lending protocol or derivatives platform, MEV becomes the first party to purchase the collateral at a discount and then sell it at the market price.

Of the three types, arbitrage and liquidation are beneficial as they help overcome market price differences. Mezzanine trading is harmful because it can cause significant slippage, causing a user’s trade to be executed at a higher price than the original price. By the end of 2022, there were more than 1.5 million mezzanine attacks on Ethereum, the majority of which were carried out on Uniswap, the most liquid exchange.

The future of MEV

As branches such as DeFi grow, the MEV market will grow due to the benefits it brings. We can't stop others from profiting from the system. As currently designed, MEV has been, is, and will continue to be a problem for the crypto market.

The pros and cons of MEV depend on how it is utilized. They incentivize market-balancing activities and enable branches such as DeFi to run smoothly. On the other hand, they can disrupt the network and interfere with the user experience.

Rather than trying to eliminate them entirely, what is needed now is to minimize the negative impacts of MEVs and distribute them more equitably. There are already solutions to address MEV to achieve the above. Currently the most well-known and used platform solution is MEV-Boost.

In addition to MEV-Boost solutions, there are also application-level solutions that help limit the impact of MEV, such as CowSwap, which allows users to trade directly without going through a pool. Additionally, users need to remember tips for reducing harm from MEV, such as splitting trades and adjusting for low slippage.

MEV will exist and develop in parallel with the smart contract platform. If well controlled, MEV can be both beneficial and harmful, creating a boost for ecosystems. Solutions that serve this will be well positioned for this trend.

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