Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

Ethereum is getting more and more complex, which is its essence and its curse, because the core of Ethereum is – smart contracts. This new, radical tool enables developers to boldly enter the decentralized finance space, which is rife with explosive growth and volatility. However, the new system also brought unprecedented risks. Maximum/Miner Extractable Value (MEV), which is its by-product.

Overview of the main content

  1. MEV is the total amount of ETH that miners can withdraw from manipulation transactions. There are several forms of this manipulation, but most are reordering and frontrun (front-running).
  2. The three most common examples of MEV are: DEX (decentralized exchange) arbitrage, liquidation, and sandwich trading.
  3. MEV-Geth is a permissionless MEV extraction proof-of-concept, designed and executed by Flashbots to alleviate network congestion caused by frontrun and backrun bots.
  4. MEV-Boost separates the roles of PoS validators: block construction and block proposal. Searchers (independent network participants, named after their search for MEV opportunities on the blockchain) send bundled transactions to block builders, sometimes themselves.
  5. OpenMEV is a platform that facilitates the gathering and communication of block producers and validators, with the goal of giving users a share of the MEV pie.

What is MEV?

At the heart of MEV is the total amount of ETH that miners withdraw from manipulation transactions. There are several forms of this manipulation, but most are reordering of transactions and frontruns. This is determined by the miners’ control over the order of transactions. There are two basic sources of MEV:

  1. Net Income Opportunity from DEX Arbitrage
  2. Optimal Gas Auction (PGA)

The term MEV can be misleading as many people believe that the extracted value belongs to the miners. In fact, most of the MEV goes to carry traders. The popularity of MEVs is based on the fact that no matter how the market environment changes, the value will accumulate.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

As an example, let’s look at the net income arbitrage opportunity and how the PGA achieves MEV. Suppose there is a large trade on the DEX, there is an opportunity for arbitrage. The arbitrage bot then submits a transaction that captures the price difference and pays the Xgwei gas fee. Next, miners copy and censor the arbitrage bot’s trades to profit for themselves. Or other arbitrage robots pay higher gas fees, and then PGA appears. The difference between the final gas fee paid and the MEV is the profit of the arbitrage robot. This is just one example of getting MEV, we will cover other MEV strategies later.

MEV supply chain

To better understand how MEV works, let’s break down its supply chain. Since the inception of MEV in 2017, there have been two main players: miners and MEV Searchers.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

MEV searcher can be understood as “blockchain plumber”. They use different methods, looking for all the extractable value on-chain. Searchers cooperate with miners and are also willing to pay high gas fees because they want their own transactions to close. In some cases, searchers pay miners 90% of their total MEV revenue in gas fees, and sometimes more.

Now, we revisit MEV searchers and miners from a supply chain perspective.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

The “user” mentioned below refers to anyone who wants to participate in the blockchain. The user accesses the wallet UI, which encodes the user’s wishes into transactions for the blockchain to understand. This is the application layer, which brings together all the behaviors to express the user’s intent. The developer makes the decision to deal with the MEV on behalf of the user. For example, developers can send transactions to a public transaction pool, where searchers pick transactions, or to a private routing system like Flashbots Protect RPC, which places restrictions on searchers.

The searcher then aggregates all user transactions, converts them into a transaction type called bundle, and extracts all possible MEVs. A bundle is one or more transactions, grouped and executed in order. In addition to the searcher’s transactions, bundles can also cover other users’ pending transactions in the mempool, and bundles can also be bundled for specific blocks.

This is important because searcher liquidity, arbitrage and liquidation are key to keeping the market functioning, but it is also possible for searchers to extract excessive value above the services they provide. Builders will then bundle the pool together, building blocks.

Finally, validators play a consensus role and validate blocks. Previously, validators and builders were considered to be the same group of people, which is not the case after an Ethereum merger, as a merger would split block proposers and builders. More on this below.

MEV strategy

The three most common examples of MEVs are:

  1. DEX arbitrage 
  2. liquidate
  3. sandwich deal

DEX arbitrage has been covered in the previous example, so let’s talk about liquidation and sandwich trading.

Liquidation is a major MEV opportunity. When a borrower is liquidated, there are often substantial liquidation fees. This is where the MEV opportunity lies. After the searcher determines the liquidated borrower, it strives to be the first to submit a liquidation transaction and collect a liquidation fee.

Sandwich trading is another common form of MEV extraction and is also considered the most evil. This strategy is a bit like high-frequency trading in traditional finance. The core of the sandwich is to use the mempool to scan large DEX transactions. The two main components of a sandwich attack are:

  1. AMM (Automated Market Maker)
  2. slippage

For example, if an MEV extractor sees a pending ETH transaction on Uniswap worth 100,000 USDC, then the conclusion is clear that the price of ETH will rise after the transaction is executed. It makes sense to buy ETH immediately before the trade executes and sell it immediately after the trade executes.

In this way one can calculate the approximate price effect of any given transaction, which has advantages over front-running in traditional finance. Every transaction on a DEX has specific properties, and one can calculate an optimized transaction size to buy ahead.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

post-merger era

In 2021, MEV mining has exploded and gas fees have been ridiculously high for a few months. After the emergence of an altruistic group called Flashbots, people started talking about creating a permissionless, transparent and fair ecosystem for MEV extraction. Therefore, the general frontrun transaction is no longer valid, and the PGA is done off-chain with lower gas fees.

MEV-Geth is a proof-of-concept for permissionless MEV extraction, designed and executed by Flashbots to alleviate network congestion caused by frontrun and backrun bots.

The idea is that permissionless MEV extraction with a neutral, public, open source infrastructure eliminates the risk of MEV insider trading. At the same time, MEV-Geth also attempts to create an ecosystem for MEV extraction, preserving the properties of Ethereum. In fact, Ethereum’s concept of “searcher” and “bundle” was introduced by MEV-Geth.

Note that MEV-Geth is a proof-of-concept, and while it is compatible with regular Ethereum clients, it is still a work in progress.

future

MEV is not limited to Ethereum, but MEV on Ethereum is the largest. Therefore, it is necessary to discuss the combined MEV.

We talked about Block Proposer-Builder Separation (PBS), but why is PBS important to MEV and Ethereum? MEV brings risks to the decentralization of the consensus network, and also problems when encountering economies of scale. For example, in a 10 times larger trading pool, the chance of extracting MEV is also 10 times larger. Additionally, MEV complicates decentralized exchange pools because there is still only one entity responsible for building blocks and making proposals. They can then easily and discreetly withdraw MEV without sharing the revenue with the trading pool.

PBS solves this problem by splitting proposers and builders. Block proposers do not produce blocks with the highest revenue by themselves, but cooperate with third-party marketplaces, namely block builders. Block builders produce bundled transactions that contain block content and charge proposers a fee. The proposer chooses the bundle with the highest fee.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

After merging, the block time will be fixed at 12 seconds instead of the current Poisson distribution. Additionally, block proposers are notified in advance. Fixed block time and advance notification of block proposers allows searchers to submit bundled transactions before blocks are proposed. Searchers will be concentrated next to large validators and optimal block builders. In fact, some block builders offer colocation services (such as AWS data centers) to searchers.

Currently, Flashbots is developing a PBS tool called MEV-Boost for merged Ethereum validators. Validators running MEV-Boost can sell block space to the open market, amplifying their staking returns (up to 60%!) while preserving the decentralization of Ethereum.

So, how does it work? A PoS node operator must run three pieces of software: a validating client, a consensus client, and an enforcement client. MEV-boost can be regarded as the “motorcycle sidecar” of the consensus client, outsourcing block construction to other network builders. Block builders prepare complete blocks, optimizing MEV extraction and fair distribution of rewards. Then they submit the block to the relay server. The relay server aggregates blocks from multiple builders and selects the block with the highest fee. Finally, the most profitable block in MEV-boost is proposed by the validator’s consensus layer to the Ethereum network for authentication and packaging.

Explain MEV principles and strategies in detail: How about the democratization of MEV after the merger of Ethereum?

Democratizing MEVs

In addition to Flashbots, Manifold Finance launched OpenMEV, a platform that facilitates the aggregation and direct communication of block producers and validators. Protocols can use MEV to their advantage. For example, a user can propose a desired order of block transactions. The core strength of OpenMEV is its reliable neutrality. That is, there is a mechanism or rule that regulates off-chain behavior and activities.

The goal of OpenMEV is to make the protocol more efficient in capturing and distributing value, as the barriers to becoming an MEV extractor are currently a bit high. With OpenMEV, anyone can earn OpenMEV “rewards” through SushiSwap.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/explain-mev-principles-and-strategies-in-detail-how-about-the-democratization-of-mev-after-the-merger-of-ethereum/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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