Understanding the Negative Effects of MEV Withdrawals: An Invisible Tax for Ethereum Users
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MEV, an invisible tax for Ethereum users
MEV is an abbreviation for "Miner Extractable Value" or "Maximal Extractable Value". It refers to the profit earned from extracting value from Ethereum users by reordering, inserting, or censoring transactions within blocks being produced. It often affects how DeFi users interact with automated market makers and other applications.
Interestingly, the MEV issue in Ethereum was first discovered in 2014, a year before Ethereum was launched, by an analyst and veteran algorithmic trader who goes by the pseudonym Pmcgoohan.
Shocked by what happened in 2008 and the onset of the global financial crisis, when Pmcgoohan first heard about Ethereum and the idea of a programmable blockchain, he became fascinated by blockchain's promise of distributed and fair markets. But when he looked at the pre-genesis draft documents of ethereum, he was surprised to find a key flaw. Pcgoohan recognizes that miners have complete control over the inclusion and ordering process of transactions, which means they can use this power to unquestionably extract value from users as soon as the protocol goes live.
While some immediately recognized the inadequacies of Ethereum’s design, Pmcgoohan was ahead of his time and his warnings were largely heeded. Until 2019, a group of researchers published a paper called Flash Boys 2.0 that highlighted this problem. In the paper, the term "MEV" was coined for the first time to describe the problem that Pmcgoohan posed many years ago.
Subsequently, Georgios Konstantopoulos and Dan Robinson's "Ethereum is a Dark Forest" and Samczsun's "Escaping the Dark Forest" articles were published in August and September 2020 respectively, solidifying MEV as a fundamental concept of cryptoeconomics and emphasizing Its importance as one of the most challenging and pressing questions facing the Ethereum research community today.
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Why do MEVs happen?
In Ethereum, miners are responsible for selecting and aggregating transactions into blocks. Crucially, they have full autonomy over which transactions to include in the blocks they mine from the mempool (an off-chain space where pending transactions await confirmation).
When miners, validators, and orderers optimize for profit, they tend to select and order transactions based on the highest gas price or transaction fee. However, the protocol does not require transactions to be ordered by fees. Miners can use their discretion to rearrange transactions to extract additional profits from users. This "irregular" income stream is MEV.
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Learn about MEV games
The best way to understand the MEV game is to look at it through the lens of the key players, including miners, searchers, users, dapps, and protocol developers.
Miners, or block producers, are responsible for ordering transactions and deciding which transactions are included in a block and in which order. Miners can profit from the MEV game in two ways: first, through the so-called Prioritized Gas Auction (PGA), which sells scarce block space to non-miner MEV miners in exchange for high transaction fees, and through reordering , including or reviewing transactions to acquire MEV directly to profit from on-chain liquidation or arbitrage opportunities.
MEV also involves end users, such as people taking out loans on-chain or trading on decentralized exchanges. Users are the most exploited party in this game, as some of the value they unlock can be captured by miners and non-miner MEV miners.
Decentralized application and protocol developers play a supporting role. The former creates MEV opportunities through design and incentive mechanisms, while the latter establishes the basic rules of the game, such as giving block producers the power to sort transactions, which makes MEV possible.
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Typical MEV extraction process for a Seeker
Seekers begin their MEV journey by monitoring the Ethereum blockchain using bots and automated tools, looking for potential profit extraction opportunities.
When they spot an opportunity, Seekers analyze the logic behind the transaction, conceptualize the attack vector, and create a bundle - one or more transactions grouped and executed in the order provided - designed to achieve the MEV extraction goals when mining . Seekers' transaction packages can reference other users' pending transactions in the mempool and include them for specific blocks.
Once a bundle is created, the Seeker typically sends it to the miner using an off-chain network such as Flashbots' MEV-Geth. This allows them to bypass public transaction pools and express their transaction ordering preferences directly to miners quickly and risk-free (saving them gas fees when their transactions get rejected).
Due to the huge number of bundles submitted by Seekers and the limited block space, miners auction block space through Flashbots auction - an off-chain price-sealed bid auction, where Seekers can privately communicate their bids and particle transactions directly with miners order without paying fees for losing bids - only including the most profitable transactions in their block.
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Front-Running
sandwich attack
sandwich attack
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Back-Running
to liquidate
to liquidate
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Time-Bandit attack
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How bad is MEV?
According to Flashbots data, which only measures the downline of total MEV withdrawn and tracks only 8 DeFi protocols, since January 1, 2021, more than $689 million has been withdrawn from Ethereum network users.
Besides scaling and attacks, MEV is one of the biggest problems facing Ethereum and similar smart contract blockchains right now. Pmcgoohan believes that the MEV auction will kill the Ethereum network. Despite Pmcgoohan's pessimistic view, the downside of MEV extraction is manifold. The biggest one is that MEV represents an invisible tax that miners and seekers collect from users. Every dollar withdrawn through MEV is a lost dollar for the user. Some even describe it as theft.
MEV also causes network congestion and puts upward pressure on gas fees. The game theory involved creates a self-reinforcing loop of circular dependencies: arbitrage and liquidation opportunities create MEV opportunities, MEV extraction bots compete for the opportunity through gas price bidding wars, and fee estimates use these bots' inflated gas prices as a reference, leading users to Overpaying for a transaction.
MEV also destabilizes Ethereum at the protocol level, as it questions the finality and immutability of transactions. If the MEV is greater than the block reward, miners have an incentive to break consensus. If miners can reschedule transactions from previous blocks for profit, then the entire premise of the blockchain as a secure, predictable, and permissionless ledger falls apart.
MEV erodes the usability, neutrality, transparency, decentralization and security of Ethereum. It creates an environment where miners better at extracting MEV grow at the expense of honest miners, effectively tilting the core incentive structure of Ethereum security in the wrong direction.
Ethereum recently rolled out EIP-1559 and plans to move to proof-of-stake, but neither update will fix the MEV issue. In fact, some MEV researchers worry that the upgrade could exacerbate the problem.
While the main purpose of EIP-1559 is to improve the predictability of transaction fees, the upgrade also features fee burning, which will negatively impact miner profitability, which in turn may lead miners to increase MEV withdrawals to compensate for the reduction in rewards. In response to EIP-1559, Ethermine — a mining pool that accounts for roughly 20% of Ethereum’s hashrate — has introduced a MEV withdrawal procedure that redistributes profits extracted via MEV among all miners in the pool.
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Is MEV inevitable?
Some have concluded that MEV is inevitable. There are two views on this topic. The first school of thought argues that MEV is inevitable, and thus the crypto community should work to mitigate and suppress negative externalities. Another school of thought argues that the MEV problem is solvable, so the community should focus efforts on prevention.
Flashbots, a leading research and development organization in this field, belongs to the first camp. It’s focused on building tools like MEV-geth that “democratize access to MEV revenue and bring transparency to MEV.” In this regard, MEV-geth is actually a frontier-as-a-service (FaaS) for miners and MEV extractors. FaaS) products.
Proponents of the first school of thought argue that, given the inevitability of MEV, FaaS is entirely beneficial as it removes negative externalities such as high transaction fees and network congestion while compensating for Ethereum’s EIP-1559 fee-burn update resulting loss of income. Thus, it indirectly funds the security of Ethereum as miners compete for MEV with higher hash power.
On the other hand, some see FaaS as theft. Researchers at Cornell University have been advocating an alternative solution, while computer science professor Edward Felten claims MEV auctions increase centralization and exacerbate problems for ethereum users . Pmcgoohan agrees with the second camp, arguing that MEV is avoidable. Pmcgoohan was critical of Flashbots' approach, arguing that MEV is solvable if the community "comes to a consensus on mempool chronological ordering."
In the second camp, researchers have made progress in minimizing or eliminating MEV by designing protocols for ordering transactions fairly. Current application-level solutions include ChainLink's Fair Sequencing Service, Offchain Labs' Aritrum, and Automata Network's Conveyor. While all of these protocols address MEV in different ways, they rely on DeFi applications to implement them on a case-by-case basis. The ultimate protocol-level panacea has yet to be found, let alone realized.
Source：https://cryptobriefing.com/what-is-mev-ethereums-invisible-tax-explained/
