Understanding MEV: How It Affects Your Blockchain Transactions and Strategies to Mitigate Risks

MEV (Maximal Extractable Value) enables block producers to reorder transactions for profit, impacting blockchain users. Learn how MEV works and ways to protect yourself from its effects.

In the early days of Bitcoin, miners earned rewards by either mining blocks or receiving commissions based on the highest gas price transactions. The process of forming a block was straightforward—collect all valid unmined transactions from the mempool, sort them by gas price, form a block, and begin mining.

As blockchain technology evolved, particularly with the advent of Turing-complete smart contracts on Ethereum and the explosive growth of DeFi, block producers discovered new ways to increase their profits. By selectively including, excluding, or rearranging the order of transactions, they could extract additional value. This practice, known as Maximal Extractable Value (MEV), represents the maximum profit that block producers can extract from transaction manipulation.

The History of MEV

Even before Ethereum’s mainnet launch, discussions around extracting additional profits from blockchain transactions began circulating online. It was discovered that the decentralized and public nature of blockchains allowed opportunistic users to ‘sneak’ smaller transactions in front of larger ones, enabling them to purchase assets at lower prices before a larger transaction drove up the asset’s value on decentralized exchanges.

The term ‘MEV’ was coined in 2019 following the publication of the Flash Boys 2.0 research, the first comprehensive study on the topic. This research provided a detailed examination of MEV and its implications for blockchain transactions.

How MEV Works

Typically, miners, validators, or block producers have the authority to include, exclude, or reorder transactions within a block. Imagine you spot an opportunity to profit from a protocol. You prepare and submit a transaction, eagerly awaiting its inclusion in the blockchain. However, just before your transaction is mined, someone else submits a similar transaction, effectively capturing the reward you were aiming for.

It’s natural to wonder how two people could find the same opportunity simultaneously. The truth is, they didn’t. Automated programs and tools continuously analyze submitted transactions, identifying profitable opportunities and modifying them for the benefit of their owners. These modified transactions are then sent ahead using a technique called frontrunning.

Types of MEV

• Arbitrage: Arbitrage involves exploiting price discrepancies across different platforms. Miners who detect these gaps can be the first to submit transactions that take advantage of them. This can have a positive market effect by aligning asset prices across platforms.
• Frontrunning: A frontrunning MEV transaction is placed ahead of the original one, allowing the attacker to profit by buying assets before a larger transaction raises their value.
• Backrunning: Backrunning is similar to frontrunning, but the transaction is placed immediately after the original one. An example is buying a token right after it launches on a DEX.
• Sandwich Attack: This involves sending two transactions—one before and one after the original transaction. This technique allows the attacker to profit by controlling both ends of the price movement.
• Liquidation: In lending protocols, liquidations are often open to any user, enabling them to earn extra funds. Users compete to submit the liquidation transaction first to capture the profit.

MEV Prevention

The existence of MEV introduces additional costs and risks for users. To combat MEV, the Flashbots system was developed. Flashbots create an open transaction auction, attempting to regulate MEV by making it more transparent and less harmful.

Conclusion

MEV is a byproduct of the open and decentralized nature of blockchains, with both positive and negative consequences. It’s crucial for blockchain users and developers to understand how this technology works to minimize the risks of falling victim to unexpected attacks.

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