What is Maximum Extractable Value?

Introduction

The term MEV, which stands for Maximum Extractable Value, has grown in popularity in recent times among crypto natives. MEV basically refers to the additional value that is produced — and can be extracted — from a blockchain as a consequence of protocols’ design and interactions. Strategies commonly comprise including, omitting, or reordering transactions when making a new block. The goal of the MEV is to make as much additional value as possible.

History of MEV

The emergence of MEV, known as Miner Extractable Value previously, was mostly associated with the Ethereum network back when it was still running on a Proof-of-Work consensus mechanism, miners were able to reorder, omit, or include transactions as they were the ones responsible for producing blocks. With its consensus upgrade to Proof-of-Stake, the power to manipulate transactions shifted to the slot leaders — who are responsible for producing blocks. The term Maximum Extractable Value came about later on as MEV is no longer exclusive to miners.

Who else benefits from MEV?

It may seem like MEV solely benefits block producers, but in reality, a significant amount of MEV is capitalised by other participants, known as “searchers”. These participants use MEV-specific operations that analyse network data in search of profitable MEV opportunities.

Apart from MEV searchers, day-to-day users who delegate their native tokens to validator nodes that run MEV clients get rewarded. The MEV clients enable validator nodes to search for MEV opportunities and secure the MEV when it is their time to be the block producer. The MEV is then redistributed back to the delegators in the form of rewards. One such example is Jito Network on the Solana network.

MEV also encourage the addition of liquidity to decentralised exchanges by arbitraging price discrepancies across different exchanges. This can increase liquidity and reduce price slippage for users. This means the users making trades on the exchanges would enjoy asset prices closer to their true value.

Common examples of MEV

There are many common examples of MEV, and today we will zoom into three examples — arbitrage, sandwich attack, and liquidation which all offer opportunities to searchers and block producers seeking to profit through MEV.

Arbitrage

A common example of arbitrage is the inefficiency created by a transaction that executes a swap against a particular AMM. It creates a price difference between that particular liquidity pool and other venues where the same token can be traded. The first party to act on it can make a profit. Imagine ETH is trading at $1000 on platform A and $1200 on platform B; one could simply purchase ETH on platform B and sell it on platform A to make a $200 profit.

Sandwich Attack

Let’s start with the basic definition of a sandwich attack. Let’s assume Alice wants to buy a large amount of token X on a DEX that uses an automated market maker (AMM) model. Let’s now assume that an adversary sees Alice’s transaction (let’s say Bob) and can create two of its own transactions, which it inserts before and after Alice’s transaction (sandwiching it). In this configuration, Bob first buys the same token X, then Alice buys a large amount of token X which would drive its price up, and then the third transaction is the adversary’s transaction, where Bob will sell token X (now at a higher price) at a profit.

Liquidations

DeFi allows users to take out loans against deposited digital assets as collateral. If the market moves and the value of the collateral drop below a certain price, that position is liquidated. The smart contracts involved often pay a reward or fee to the transaction that triggers the liquidation.

An MEV opportunity exists here for any searcher or block producer running bots to spot this kind of transaction, and who are then able to insert their own liquidation transaction in the block ahead of anyone else, thereby extracting the reward value.

Conclusion

Even though we have covered the common MEV examples in this article, note that the implementation of MEV extraction techniques varies on different blockchain protocols. For example, MEV searchers compete on gas prices to prioritise their transactions due to its high latency, on the other hand, Solana competes on speed. This can translate to negative externalities, such as high gas fees on Ethereum and a congested network on Solana. As the ecosystem continues to evolve rapidly, finding solutions to these MEV-related problems is now a core area of research and development within the space