What is Maximal Extractable Value (MEV)?

Introduction

Maximal Extractable Value (MEV) — previously known as Miner Extractable Value — refers to a strategy for including, omitting, or reordering transactions when creating a new block. The objective of MEV is to obtain the greatest possible profit. Block producers are in the best position to do this, as they have the ability to select and order transactions.

However, other network participants (known as "searchers") can also pay fees to place transactions if they identify an MEV opportunity, such as arbitrage, front-running, or liquidation. MEV is most frequent in networks that use smart contracts, where blockchain transactions include more complex information.

What is MEV?

MEV is a cryptocurrency term used to describe the deliberate reordering, inclusion, or exclusion of transactions when producing a new block (to be added to a blockchain) in order to extract the greatest possible profit. It represents the additional value obtained from a block, beyond standard rewards and gas fees, by choosing which transactions to include and in what order.

MEV has been most frequently associated with the Ethereum network due to its significant decentralized finance (DeFi) ecosystem. The more complex the transactions involved in a block — for example, smart contracts related to lending, mortgages, or trading — the greater the opportunities for block producers to obtain extra profits (extract maximum value) by deciding to include, omit, or reorder certain transactions.

When this concept was first introduced, it was primarily associated with Ethereum, which at that time used a Proof of Work (PoW) consensus mechanism. As such, miners had the power to reorder, include, or exclude transactions when producing blocks and could make these choices to gain additional profit.

This led to the term Miner Extractable Value, coined to explain the phenomenon of extracting the greatest possible profit. However, in September 2022, Ethereum completed the Merge, a technical upgrade that changed the network's consensus mechanism from PoW to Proof of Stake (PoS).

Consequently, 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 created, so whoever chooses which transactions to include and in what order can make decisions that will help them extract as much value as possible from a block. Although the old concept of MEV still exists, it is now said to stand for Maximal Extractable Value, since it is no longer exclusive to miners.

How MEV Works

To understand how MEV works, a basic understanding of the role of block producers (whether miners or validators) is necessary. They play a crucial role in the security and maintenance of 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 mining or validation.

In simple terms, block producers ensure the integrity of transactions on the network and guarantee its functioning. Without them, it is impossible to add new data to the chain. Block producers are those who collect transaction data from users and organize it into blocks to be added to the network chain.

The important thing to note is that it is up to block producers to decide which transactions to include in their blocks. Logically, transactions are selected based on profitability, which means those with the highest fees will be selected first. This is why users pay higher gas fees during periods of heavy traffic — to ensure their transactions are selected first. If a block producer selects transactions with the highest fees, they will obtain greater profit. Consequently, transactions with lower fees must wait longer to be included in a block.

However, there is no rule that requires selecting or ordering transactions based on fees. When transactions include more complex information (as occurs in blockchains enabled for smart contract use), block producers can include, exclude, or reorder transactions in a way that allows them to obtain additional profit beyond standard block rewards and fees.

For example, selecting certain transactions over others and ordering them in a particular way can allow for additional profits through arbitrage opportunities that result from on-chain liquidations. This is the essence of MEV: the process of selecting and ordering transactions to obtain additional financial gains.

MEV Searchers

Although it may seem that MEV is a strategy that exclusively benefits block producers, a significant amount of MEV is secured by other participants, known as "searchers." These participants use MEV-specific operations that analyze network data in search of profitable MEV opportunities.

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

Take, for example, arbitrage on a decentralized exchange (DEX), where we know that searchers pay more than 90% of their MEV income in gas fees, because it is the only way to ensure that a profitable arbitrage operation is executed before other similar operations.

Common Examples of MEV

Arbitrage, front-running, and liquidation are all opportunities for searchers and block producers seeking to profit through MEV.

Arbitrage

When the price of an asset is not consistent across various exchanges, an arbitrage opportunity is immediately created. In the cryptocurrency sector, the same token might have a different price on two different DEXs. When this is noticed by someone (engaging in arbitrage), they will move to execute a transaction to profit from this discrepancy. MEV takes place when a searcher's bot identifies the ongoing transaction and inserts its own transaction before it in order to extract the value offered by that arbitrage opportunity.

Front-Running

Searchers and block producers can exploit their ability to order transactions in a block to anticipate a significant purchase order still pending in the transaction pool. MEV occurs when a similar purchase order is placed before that transaction to secure a more favorable price before the large purchase order goes through, causing the price of that digital asset to increase.

A similar MEV strategy is "sandwiching," which consists of placing a purchase order before and a sale order after a specific price-movement operation, thus exploiting price pressure on both sides.

Liquidations

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

There is an MEV opportunity for any searcher or block producer who uses a bot to identify this type of transaction and who is therefore able to insert their own liquidation transaction in the block before anyone else, thus extracting the value of the reward.

Pros and Cons of MEV

MEV is a rational strategy, as those who implement it primarily seek to maximize their profits. Some argue that it is beneficial for the ecosystem in general, as it ensures that inefficiencies are corrected as quickly as possible.

For example, the race among MEV searchers to be the first to capture the value of arbitrage opportunities on DEXs leads to rapid price corrections. Similarly, lending protocols do not want risky loans to remain unchecked in case collateralization levels become imbalanced, so the push toward MEV-driven liquidation ensures that lenders are repaid as soon as possible.

However, MEV also presents a series of problems that must not be ignored. Some implementations, such as front-running and sandwiching, produce negative results for other users, who are forced to pay too much for their trading operations, to suffer greater slippage, or to lose value in what is essentially a zero-sum game.

Furthermore, the activity of MEV searchers can lead to increased gas prices and network congestion, as users compete to insert their transactions into blocks and capture the resulting value.

At a fundamental level, if the value derived from reordering transactions in a previous block is greater than the rewards and fees of the next block, MEV could make it economically rational for a block producer to engage in blockchain reorganization. This would threaten the consensus and integrity of the network.

As the ecosystem continues to evolve rapidly, the search for solutions to these MEV-related problems is now a central area of research and development within the ecosystem.

FAQ

What is MEV (Maximal Extractable Value)? How does it work?

MEV is the maximum profit validators and searchers can extract by reordering, inserting, or censoring transactions within blocks. They exploit transaction ordering to capture additional value, potentially increasing user fees and transaction costs.

What are the negative impacts of MEV on blockchain users and transactions?

MEV causes transaction delays and reordering, harming user experience and market fairness. Front-running and sandwich attacks lead to unfair profits for extractors while users suffer economic losses and reduced transaction predictability.

How do miners and validators profit from MEV?

Miners and validators extract MEV by prioritizing high-value transactions, collecting increased gas fees from traders, and sharing MEV rewards through block production and transaction ordering.

What are front-running and sandwich attacks? How are they related to MEV?

Front-running occurs when MEV searchers identify pending transactions and execute similar trades beforehand to profit from price movements. Sandwich attacks involve placing transactions before and after a target transaction to extract value. Both are direct MEV extraction strategies where searchers capitalize on transaction ordering to generate profits.

How to reduce or prevent the negative impact of MEV? What are the solutions?

Solutions include using Flashbots for private transaction pooling, implementing MEV-resistant consensus mechanisms, utilizing encrypted mempools, and adopting PBS（Proposer-Builder Separation）to minimize front-running and sandwich attacks.

What is the relationship between MEV, gas fees, and slippage?

MEV, gas fees, and slippage are interconnected. Higher gas fees incentivize validators to prioritize transactions, which can lead to increased slippage due to MEV activities like sandwich attacks. MEV activities directly cause users' transaction slippage to increase.