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MEV may have opened up and formed a profit redistribution market triggered by transaction transparency. Flashbots is expected to bring order to the dark forest, eliminate free-riding behavior, and enable stakeholders to form a new game balance.
Written by: Cao Yixin, working at HashKey Capital Research
Audit: Zou Chuanwei, Chief Economist of Wanxiang Blockchain
The MEV research organization Flashbots released a March report that its third-party Ethereum client version MEV-geth has attracted 12 mining pools with 58.8% of the hash power of the entire network. The rising popularity of this version is accompanied by a sharp drop in Ethereum Gas fees. Although its causal relationship has not yet been proven, it is enough to attract widespread attention. There are also many debates in the community on the legitimacy of MEV.
This article hopes to clarify the definition of MEV and its impact on the Ethereum ecosystem by analyzing the source of MEV, and to explore a possible future state based on the game relationship between stakeholders under the MEV benefit distribution market order that Flashbots is trying to establish.
Source of MEV
The mature operation of Ethereum for many years has formed a stable pattern from producers (miners) to auction houses (mining pools) to bidders (users). The supply and demand of block space has been adjusted through the priority Gas Auction (PGA) mechanism and block rewards. .
If transactions can be divided into three processes: price discovery, transaction matching, and transaction execution, then at this stage, the core value of the block space is composed of a series of blockchain core components such as hash pointers, consensus mechanisms, and peer-to-peer networks. “Guaranteed decentralized transfer service ( detrusting of transaction execution), and using smart contracts to further replace the credit intermediary that was relied upon before the transaction is reached (detrusting of transaction matching), thereby eliminating the “trust” related to the entire transaction process Friction costs provide a critical infrastructure for the issuance and transaction of digital assets.
“In- depth analysis of the Ethereum block space market: new models will emerge in the mining cycle “
Driven by smart contracts , the Ethereum application layer derives large-scale application innovations for the DeFi business, which makes the block space begin to be filled with a part of complex transaction logic, such as excess mortgage lending, AMM, income mining strategy, derivatives, insurance, DeFi systems built with DeFi Lego blocks such as algorithmic stablecoins have begun to take shape. The wealth effect brought about by its combinable performance has been discussed for a while, and the transparency and openness of block space and unconfirmed transaction pools are the price discovery process The participants brought brand new opportunities and challenges, and MEV is a by-product of this feature.
Price discovery is an indispensable economic function for the self-organized development of decentralized markets. Ordinary trading users, professional arbitrage and liquidation robots, and even hackers who find loopholes in the economic system are all participants in price discovery (hereinafter collectively referred to as searchers). Search for the gap between actual and expected, pay capital costs and transaction fees to obtain potential benefits . The transparency and accessibility of information on the blockchain provides new opportunities for an efficient price discovery system. Innovative lending models such as lightning loans bring a lot of convenience to price discovery.
But these searchers are facing new challenges. On the one hand, they have to compete in PGA competition for more priority trading opportunities; on the other hand, they are faced with snooping and plundering by runners . The competition between searchers highlights and raises the time value of transactions within the block, which is manifested as a higher handling fee cost than ordinary transactions, which is understandable. The discreteness of the block generation time and the transparency of the unconfirmed transaction pool allow the rush runners to have time and easily monitor the unconfirmed transactions in the unconfirmed transaction pool. They can participate in the PGA process together without paying the search cost. The high gas fee is used to close one’s own and rushed transactions in a specific chronological order to achieve the goal of getting something for nothing, so that the searcher’s interests are harmed by this free-riding behavior. Therefore, it is recommended that we distinguish between the nature of these two types of transactions when discussing the legitimacy of MEV.
For example, after a lightning loan attacker manipulated the relative price of AMM assets such as Curve, arbitrageurs quickly flattened the spread and obtained a large amount of considerable arbitrage gains. This is a legitimate gain for them to help the market react quickly; and in the process of their arbitrage The sandwich attack encountered by AMM transactions or the direct copy of their arbitrage trading preemptive transaction is a free-riding behavior; similarly, robots that track market fluctuations and monitor price oracles update the trading competition and clearing opportunities. The responsibility of the keeper , while monitoring the copy of the transaction sent by other clearing robots and preemptively acting as the clearer will rob the labor of the clearing transaction; some alternative trading opportunities require more effort to capture, but they are in front of the rusher All previous efforts were discarded (the hackers of the DODO security vulnerability attack that occurred in March this year were also helplessly intercepted by the rushing robots).
The opportunity of rush-running brought by transaction transparency prevents searchers themselves from forming technical barriers, and the MEV competition market has become a dark forest of rush-running robots. When this highly capitalized market attracts various preemptive robots, they themselves have to fight in the block space auction mechanism, through more rounds of PGA process to obtain priority transaction sorting, and mines with block sorting rights The pool is given a natural right to rent-seeking opportunities, and the mining pool itself also has an absolute advantage in the race. This reflects an inherent loophole in the existing blockchain mechanism, and promotes the distribution of part of the searcher’s benefits to the runners, and then through the process of distributing the runners to the miners. And I prefer to grab the runners unallocated total value obtained from the searchers called the maximum extractable value (Maximum Extractable Value, MEV), the miners get additional revenue from the PGA called miners can extract value (Miner Extractable Value, mev).
MEV’s negative externalities to the blockchain ecology
The existence of MEV has triggered a new kind of competition between the searcher group and the grab-runner group , and provided miners with a source of income other than miner rewards and ordinary handling fees. The community has discussed whether MEV will affect the decentralization characteristics of the blockchain. One view is that the final link of extracting MEV is restricted by the competition of the computing power of the packaged block, and the mining pool with more computing power succeeds as a pre-runner. The opportunity to package MEV transactions is greater, and a positive cycle will be formed to encourage the mining pool to continue to attract miners to join and expand, resulting in the centralization of computing power and reducing the decentralization and security of the blockchain.
However, another point of view is countered. It is believed that because the mining pool cannot confirm whether it can definitely compete for the next packaged block right, the mining pool will sell the searched MEV trading opportunities to other mining pools under rational drive. Lock in your own extra income, from the probability that MEV will be allocated to the mining pools participating in the MEV competition, increasing its overall income.
From the perspective of the historical trend of continuous division of labor, the skills and production tools required to search for MEV transactions and computing power mining are quite different. It is more likely to form the division of labor between MEV search and computing power mining, which will be described below. The solution proposed by Flashbots also shows that this division of labor is taking shape.
A certain negative externality of MEV to the blockchain ecology is its malignant effect on the gas bidding mechanism . As long as the MEV is large enough, rush runners will be willing to pay gas fees hundreds of times higher than ordinary transactions through vicious competition, and at the same time cause the block space to record many failed transactions with high transaction fees, resulting in such a scarcity of block space. Waste of resources.
MEV has a certain antagonistic effect on ordinary transaction users and searchers. In traditional finance, some regulatory agencies impose legal constraints on behaviors that disrupt market transaction order, such as scramble transactions; in the decentralized financial ecology, currently it mainly relies on the game between stakeholders and the technological upgrade of the decentralized system to promote the market Reform or optimization of the mechanism.
MEV benefit distribution market order
In response to the negative impact of MEV on the blockchain ecology, Flashbots attempts to establish a MEV profit distribution market order for searchers and miners. In fact, it provides a channel for decentralizing part of the PGA process to the chain and allowing mining pools to bid for mev. This can indeed alleviate the problem of block congestion on the chain caused by the MEV snatching battle.
But a new problem is coming, how to avoid all possible evils by the stakeholders of the system under the chain? This returns to how to ensure the privacy of transaction information before the chain, otherwise, the searcher’s transaction information will still be easily snatched away by the miners. Currently Flashbots of MEV-Geth version uses licensing system to constrain the behavior of the participants, and the latest proposal is the use of privacy achieve market-based SGX sealed auction (Sealed-bid Auction) mechanism unlicensed access and transaction process. This is a topic worthy of in-depth study, this article will not start.
Figure 1. Flashbots design goals and MEV-SGX architecture (from Flashbots MEV Roast 13)
The emergence of Flashbots has changed the dark forest law of block space . Searchers can choose to compete for the right of priority in an orderly market. The following analysis speculates through the game of stakeholders, the new order is expected to eliminate the free-riding of runners. Opportunities to enable arbitrage and clearing robots to carry out fair PGA competition, and the mev allocated to miners has gradually evolved into a regular price discovery premium after transaction privacy is protected. And whoever has a better strategy in the bidding process can implement the price discovery process at a relatively lower premium.
Figure 2. Two types of attack methods to obtain MEV
At present, the attack transactions of pre-runners can be divided into two categories:
The transaction order mainly for the AMM market causes the user to suffer a greater slippage loss Cs , which is the MEV obtained by the runner. Users can control Cs by limiting the transaction volume and setting the maximum slippage so that 0≤MEV≤Cs. The runners will allocate a portion of the profit mev to the mining pool in the PGA.
Mainly aimed at arbitrage, clearing transactions, flash loan attacks and other transactions that profit from system vulnerabilities can also be classified into this category. The MEV that the attacker obtains first is equal to the expected return Re of the looted transaction, which makes the looted transaction fail or invalid, not only loses the expected profit, but even pays the handling fee in vain and in some cases incurs additional losses.
The back-running attack against oracle updates and large transactions is actually a clever search behavior that does no harm to the trailed transaction. The searcher just seizes the profit opportunity before the other trailers.
The sender of the ransack transaction seems to be the most innocent victim in the ransack attack. He puts effort into searching for profit opportunities. Once posted on the Internet, he will be free-ridden by other competitors. This is a free-riding phenomenon. This makes a mismatch between labor and income in the price discovery process.
Flashbots provide stakeholders with new options.
AMM trading users and searchers are extremely passive in the transparent and open mode of unconfirmed transactions. Their expected profit can be expressed as:
Among them, Re is the expected return in the price discovery process (deducting the acceptable slippage cost), Cgas represents the ordinary transaction fee , and MEV is the profit expected to be grabbed by the runners .
For the early runners, their expected profit is expressed as:
Among them, mev is the profit allocated to the mining pool during the PGA process .
The lower limit of the MEV expected by the rush runners is mev. For AMM trading users, their strategy is to reduce the transaction volume and set the upper limit of slippage to constrain the MEV.
In fact, when the Flashbots model becomes non-licensed, users can choose to directly participate in the MEV-geth bidding process, bidding at the (mev, MEV) range of bid prices. The biggest loss is just paying the same amount of cost as before. , Or the bid fails to complete the transaction immediately, and the sandwich robot will lose many goals. If another auction market can be created where transaction privacy is protected, the problem of sandwich attacks can also be effectively alleviated.
For arbitrage and clearing transactions that are being snatched away, the MEV that a snatcher can grab is often larger. The searcher sends these transactions directly to the MEV-geth node while protecting the privacy of their transactions, while also gaining an advantage in the auction (excluding In order to avoid the competition of the pre-runners, it only competes with similar searchers, and the failure of the bidding will not lose the handling fee).
For start-up runners, they can still find unconfirmed transactions in the transaction pool and have the motivation to send transaction bundles to the MEV-geth node. The reason is that the MEV-geth node can protect it from being further rushed by the mining pool. During the off-chain auction process, even if the transaction fails, it will not be packaged on the chain and will lose handling fees or more additional losses. For stakeholders with dual identities as a runner and a mining pool, as the computing power of MEV-geth nodes increases, it is difficult for them to have an advantage in free-riding. Imagine that for the same rush-running transaction, an ordinary rush-running robot sends it to the MEV-geth node with close to 60% of the computing power for packaging, and its winning rate can finally compete with a single mining pool. And when more and more searchers send arbitrage and clearing transactions to MEV-geth nodes in the form of privacy protection, free-riding opportunities for runners will continue to decrease.
Eventually , the profit distribution order established by Flashbots may form an auction market dominated by arbitrage and liquidation robots, eliminating free-riding behavior. And the mev nature of these robot bids becomes the price discovery premium paid to obtain transaction privacy and resist preemption attacks.
For mining pools, theoretically there is a preference for risk aversion . After all, the official Ethereum client version has been running for many years and its security has been verified. However, close to 60% of the computing power is still switched to the third-party version, which is indeed worthy of attention. Part of the reason for this may be that driven by EIP-1559 , mining pools gradually stepped into the MEV market and faced a choice -to participate in MEV competition or to adopt the MEV-geth version and follow the market order established by Flashbots. For mining pools that do not themselves act as searchers, the use of MEV-geth can simply increase the income of miners and avoid the loss of miners; for mining pools with search capabilities, it depends on the opportunity cost given up after the use of MEV-geth, for example, MEV- Geth currently stipulates that only one MEV transaction can be inserted into a block, and the mining pool may configure its own block containing one or more MEV transactions to obtain greater benefits. However, searching for MEV requires mining pools to have relevant skills and consume more resources, reducing their net income.
Summary and reflection
We are pleased to find that the blockchain infrastructure has built wheels for the decentralized market, and the ecology has begun to iteratively develop in various subdivisions, and we are fortunate to pay attention to interesting new markets such as MEV.
MEV allows us to pay attention to the value of transaction data and the importance of block space ordering , and it also allows us to think about some new roles besides miners, mining pools, and users. Although Flashbots has many improvements, it gives us a good example of how to provide order for this emerging trading market to eliminate some factors that are not friendly to the overall economic development and build a civilization in the cyberspace. Under its impetus, the extractable value of miners is expected to gradually evolve into a regular price discovery premium after transaction privacy is protected.
And just as Flashbots is trying to bifurcate the unconfirmed transaction pool module of the blockchain system, there is still room for optimization in the mechanism design of the decentralized system, which deserves more consideration.