By Larry Wright
Cryptocurrencies are driven by blockchain technology which allows decentralized transactions between parties. Different consensus mechanisms are used by blockchain to validate transactions on the network, such as Proof of Work (PoW) and Proof of Stake (PoS).
In both consensus mechanisms, transactions remain pending in a ‘mempool’ until a miner selects to validate the transaction. ‘Mempool’ is like a waiting area for the pending transaction.
While the pending transactions are in the mempool, validators and miners, have discovered methods for profiting from pending transactions. MEV, or maximum extractable value, is used in this technique.
This guide will give a tour of MEV and all the related information one needs to know.
What is MEV?
MEV, aka Miner Extractable Value, is now called Maximal Extractable Value. It refers to the profit a miner can earn by including, reordering or censoring transactions in a block. The ability of miners to choose the sequence in which transactions are included in a block gives rise to MEV. By doing this, they can profit more by foregoing or backtracking some transactions.
MEV: How Does It Work?
MEV is a complicated concept that takes into account a variety of elements. Firstly, a miner must decide which transaction to include in a block. Miners often give the highest-value transactions top priority to maximize their potential MEV. That’s why users pay high transaction costs to guarantee their transactions are chosen first.
Once the miner has chosen the most valuable transaction, miners will typically attempt to extract MEV from those transactions. This may entail initiating trades ahead of schedule, rearranging trades to create fresh trading opportunities, or reaping the benefits of other market imperfections.
Lastly, when the miner has extracted all the MEV, the block will be added to the blockchain, and the miner will get paid the customary block rewards and transaction fees.
While MEV may appear to be a mechanism that only helps block makers, a sizeable portion of MEV is acquired by other parties, referred to as “searchers.” These players look for lucrative MEV chances using MEV-specific algorithms that examine network data
MEV Extraction Strategies
Sandwich Attack
It is a malicious form of trading. In this tactic, the miner places their transaction ahead of or before high-value transactions in the queue by using their position to do so. This allows the miner to profit from price changes or market inefficiencies and extract more value from the transaction.
Liquidation
Miners can also obtain MEV by prioritizing transactions in decentralized finance (DeFi) protocols that culminate in the liquidation of leveraged positions. Miners may benefit from price changes brought on by these liquidations by making these trades ahead of time.
Arbitrage Opportunities
One typical method by which miners can derive MEV is by reaping the benefits of chances for arbitrage between several cryptocurrency exchanges. Miners may benefit from market imperfections and produce value beyond block rewards and transaction costs by giving preference to transactions that let them buy cheaper and sell more expensively.
Pros and Cons of MEV
MEVs have both positive and negative effects on the crypto ecosystem. Let’s learn about the positive impacts first. MEV allows miners to make more money than just the regular transaction fees and block incentives, which may encourage them to keep using the network and maintaining its security.
Additionally, the sequence in which transactions are completed can be optimized with the aid of MEV extraction techniques, such as transaction reordering and prioritizing, potentially enhancing the network’s overall efficiency.
On the other hand, MEV extraction techniques call for specialized technical expertise and resources, which might be prohibitive for smaller miners and could result in the concentration of mining power. MEV might also skew market incentives by enabling miners to make money through unethical or deceptive techniques.
Moreover, MEV extraction tactics may influence network security by incentivizing miners to put their interests ahead of the system.