4D Long Article: Take you to discuss the future of MEV in detail

Author: fbifemboy

Source: 0xfbifemboy's thoughts

Over the past year, Maximum Extractable Value (MEV, formerly known as Miner's Minable Value) has come to the public's attention, partly because of the apparent high level of skill required to extract MEV, and partly because of the successful extraction of MEV Huge profits can be obtained. However, despite MEV's growing role in the blockchain ecosystem, discussions about MEV are often confusing and imprecise. Since the total MEV withdrawn could be in the billions ($600 million in MEV tracked on the Ethereum mainnet via MEV-Explore alone), it is not surprising that much of the MEV conversation is centered on profits for MEV extractors. However, the scope, evolution, and governance of MEV are far-reaching topics with potential implications for blockchain security in the long run.

In this article, we will aim to clarify some important topics related to MEV. We will first give and illustrate the precise definition of MEV. We then discuss how MEV has evolved over the past year and extrapolate to understand the key questions and concerns raised by the continued growth of MEV and the broader crypto economy in the coming years. We will pay special attention to the incentives (existing incentives and new ones) that can motivate different players in the MEV ecosystem. Finally, we give a brief overview of future research directions.

During the creation and extraction of MEV, the interlinkages between block producers, searchers, protocols, and users interact in various dynamic ways, often confusing discussions about MEV. Through this article, we will attempt to analyze MEV from the perspective of how different systems or proposed solutions can benefit and harm different actors in the system. As we will see, this is a clear and valid framework through which we can begin to derive the long-term end-state of MEV in different cryptoeconomic systems.

What are MEVs?

According to Ethereum.org, MEV is precisely defined as "the maximum value that can be extracted from block production in excess of standard block rewards and gas fees by including, excluding, and changing the order of transactions in a block". At first glance, this may seem quite different from the common concept of MEV, which is used almost interchangeably with "running a trading bot" in buzzwords. However, if we take a closer look at a few common examples of MEV, we will easily understand how they relate to formal definitions.

To recap, MEV was originally defined by Daian et al. (2019) in Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges, first examining "broadly increased deployment of arbitrage bots in blockchain systems" , and then deduce the more general phenomenon of value extraction through prioritization of transactions within and across blocks. In addition to arbitrage, another classic example of MEV that many users have experienced first-hand is the sandwich attack phenomenon.

Besides arbitrage and sandwich attacks, there are many other forms of MEV, especially so-called "heterogeneous" or "long-tail" MEV. For example, in the very popular article "Ethereum is a Dark Forest," Dan Robinson from Paradigm vividly illustrates the phenomenon of generalized front-running, and Qin et al. (2021) in "Quantifying Blockchain Extractable Value: How dark is the forest?" examines this phenomenon more fully. In this article, we will not seek to comprehensively catalog every form of MEV. Curious readers are referred to the Flashbots Research Vault.

By analyzing arbitrage and sandwich attacks, we can see that both of these attacks derive value from a node's ability to arbitrarily reorder transactions, so MEV can be appropriately considered:

arbitrage. Arbitrage opportunities are characterized by a series of trades that a trader closes with a large amount of initial equity. When executed atomically (i.e. the entire sequence of transactions is contained in a single transaction, each part of which is executed only if the entire arbitrage is successful), this profit is risk-free (net of transaction fees).

Assume that for the same asset, the price of two markets (including, for example, two independent liquidity pools on the same AMM) differs significantly, so that there are profitable arbitrage opportunities. This "unbalanced" state must be the final result of the user's transactions with the relevant market. Suppose a user creates an arbitrage opportunity (e.g., a large purchase or sale); miners can then insert their arbitrage transaction immediately after creating it to capture the arbitrage.

In this case, in principle, arbitrage opportunities for many blocks may go unclaimed. However, block producers are privileged to be able to "reverse run" transactions that create arbitrage, which leaves their profits unrisked. In contrast, a non-block producer entity attempting to exploit an arbitrage opportunity must either pay the block producer for the privilege of inserting its arbitrage transaction as soon as it is created, or risk the transaction failing if the arbitrage opportunity disappears before its transaction . So we see that in this common case, even if external (non-block producer) users capture some arbitrage profits, they fundamentally rely on the block producer's ability to reorder transactions to ensure no risk profits.

Sandwich attack. "Sandwich attack" refers to the phenomenon that a user's transaction is sandwiched between two transactions. Typically, block producers have the ability to monitor pending transactions (those transactions that have not yet been ordered and assembled into a validated block, they reside in a location called a "mempool"), so, at some point Inserting their own transactions before some target transactions is known as "frontrunning". When noticing that a user is about to buy a given asset, "sandwiches" (1) insert a large buy (frontrun) on the same asset before the target trade, and (2) insert sells of all buy quantities after the target trade (so-called "backrun"). Since the target transaction is executed between the two, the selling price is higher than the buying price, thereby bringing a profit to the party that initiates the sandwich attack.

We immediately see that ideal execution of a sandwich attack relies on transaction ordering privileges. If transactions cannot be ordered as required, then other transactions may occur between the two parts of the sandwich attack, which may cause losses to the sandwich attacker. Similar to arbitrage opportunities, many sandwich attacks are carried out by non-block producing entities. However, these entities still rely on the privileges of block producers and compete for the value of these privileges by paying block producers fees.

In both examples, it becomes evident how maximum value extraction depends on the ability to reorder transactions, a privilege granted to block producers.

Occasionally it has been claimed that this definition of MEV is "too broad", a criticism that applies more to examples of arbitrage than sandwich attacks. Even in the case of arbitrage, however, there is clearly non-zero value in the ability to schedule trades so that the arbitrage trade is placed directly after the trade that created the arbitrage opportunity. Thus, we may be able to distinguish two different definitions of "MEV opportunity":

1. strict definition. MEV opportunities are characterized by most or all of the value captured through transaction sequencing privileges.

2. Definitions allowed. A feature of the MEV opportunity is that at least a fraction of the value is captured by transaction ordering privileges.

In both cases, however, at least some value (even if relatively small) is captured through transaction ordering privileges. It is likely that the confusion of "is" or "is not" MEV is caused by a failure to distinguish between MEV, strictly defined MEV opportunities, and allowable defined MEV opportunities.

For MEV, a stricter criterion is also sometimes assumed, namely that the value extracted must be close to risk-free, and the amount of risk warehousing must be minimal before profits are realized. This definition excludes so-called "probabilistic MEV", where the value of the MEV chance is not calculated exactly, but randomly sampled from some distribution. While readers are free to define MEV, we do not believe that an overly restrictive definition of MEV is actually useful. Ultimately, considerations of the risks and rewards of MEV apply not only to risk-free profits from complex transaction reordering schemes, where much of the value is inaccessible without reordering privileges, and accordingly, more Broader, more inclusive definitions proved to be of greatest practical value. Whenever users are not completely insensitive to the exact position of their transactions in a given block or even a series of consecutive blocks, they are willing to pay to reduce the uncertainty of the relative position of their transactions, which represents a significant implication for the crypto-economy. presence of MEVs.

Beneficiaries of MEV Extraction

As noted above, while MEV is inherently associated with the block production privilege, and correspondingly with the ability to arbitrarily reorder transactions, a complex economy has developed around MEV extraction such that block producers is not the only beneficiary of MEV extraction. Due to the complexity of identifying and acting on MEV extraction opportunities, the vast majority of MEV is currently extracted by external "seekers" who submit transactions to block producers for inclusion in future blocks. in the block. In some (perhaps many) cases, block producers may themselves be searchers. If not, the Seeker typically pays the Block Producer to place their transaction where they want it within the block (usually at the top), most commonly through a Priority Gas Auction (PGA) or Sealed auctions (eg, via Flashbots) determine.

In addition to block producers and searchers, the wider ecosystem may gain general benefits or bear various costs from MEV extraction. For example, especially before the implementation of EIP-1559, the PGA would frequently push the gas price on the Ethereum mainnet to very high levels, which greatly reduced the usability of the network to ordinary users due to expensive and unpredictable transaction costs. At the same time, however, efficient arbitrage among AMM pools ensures consistency of asset prices across the market and the spread of price discovery. Additionally, some protocols rely on arbitrageurs to function "correctly", such as Balancer, where external arbitrage is a mechanism for rebalancing a user's fixed-weight asset portfolio, or Primitive, where external arbitrage evolves a user's option position into the correct return. Therefore, designing appropriate MEV extraction methods that incentivize positive-sum behavior and accumulate rewards for the correct participants has profound implications for the long-term health of any given blockchain.

Block producers and searchers

Due to the large number of participants in the MEV ecosystem, it is easiest to first analyze the benefits gained by block producers, as they play an important role in blockchain functionality. Early blockchains such as Bitcoin and Ethereum relied on proof-of-work as a consensus mechanism in which miners were block producers. However, as blockchain architectures have evolved, we have seen the development of proof-of-stake blockchains, where validators incentivize good behavior through their stake tokens, taking on the role of block producers. (The ethereum mainnet itself is scheduled to transition to proof-of-stake in 2022, an event known as a "merge.") The growing popularity of proof-of-stake blockchains is what drives the shift from "miner-extractable value" to "maximum extractable value." reason. Likewise, considering block producers in general rather than miners individually would broaden the applicability of our analysis. As we will see, due to the great advantage of bringing these two roles together, studying the perspective of block producers will also allow us to understand the dynamics that drive seekers.

Block producers mainly benefit in two ways. First, when block producers propose blocks, they can run software to search for opportunities to extract MEV. Second, they may sell searchers the right to reorder deals. In the first case, they capture all values extracted. It is worth noting that in the second case, as competing searchers submit higher offers, they currently receive an increasing proportion of the extracted value (that is, competing searchers in order to obtain any value, willingness to accept a lower and lower share of extracted value).

There are a number of interesting dynamics at play here:

Increasing web dominance. Independent block producers implementing different MEV search strategies are strongly incentivized to merge and form larger and larger entities. By merging their MEV strategies and investing in search R&D with greater capacity, the merger allows both parties to extract more value than they could extract on their own (i.e., MEV extraction is subject to economies of scale). In particular, small block producers that do not have sufficient capital to develop a competitive MEV strategy are likely to be acquired by larger integrated search block producers, threatening the decentralization of the entire blockchain. While auction mechanisms like Flashbots can mitigate this risk by allowing small validators to capture a significant portion of MEV revenue, adding complexity to MEV could lead to differential performance of synthetic search block producers (discussed below) , which will over time exacerbate centralization risk through block producer mergers and acquisitions.

Furthermore, all else being equal, block producers who can extract MEV more efficiently will gain an increasing share of network dominance. In a world without MEV, a fixed set of nodes would have a constant hash rate or stake, rewards would be distributed roughly proportionally, and the relative power of different nodes would remain constant over time. Therefore, if certain block producers are effectively compensated higher than others through better MEV extraction, they will gradually dominate the network.

Rewards earned from MEV withdrawals can themselves be used to acquire a larger portion of the network. Furthermore, in a proof-of-stake blockchain, they can induce users to delegate tokens to their stake by providing them with liquid stake derivatives that can capture a portion of the MEV profits generated by the delegated stake, e.g. Eden Network recently released yyAVAX. Note that MEV extraction itself scales superlinearly with network dominance, with a direct linear component to reorder transaction power, scaling directly based on hash rate or share of stake, and another component from across multiple consecutive blocks New MEV opportunities for reordering transactions. That being said, these winner-take-all dynamics may take some time to kick in, as Ethermine maintains a high percentage of Ethereum’s total hash rate (currently 30%) despite banning DEX bundle front-running.

Taken together, these constitute the oft-discussed MEV centralization risks. As the degree of centralization increases, blockchains face adverse behaviors such as 51% attacks or malicious reorganizations. However, it is worth noting that as the network dominance of any given block producer increases, they have an increasing incentive to protect the value of the entire network, which may mitigate the risk of a truly destructive attack on the chain.

Integrate searchers and block producers. Block producers are strongly incentivized to sell the right to reorder transactions to seekers if they cannot extract MEV to the maximum, so MEV-Geth is gaining popularity - it supports a transaction known as Flashbots auction Bundled closed-bid auction system.

It is conceivable that a competitive market for MEV extraction would lead to a situation where the vast majority of block producers would be most profitable from selling their reordering rights on this market, rather than extracting MEV themselves. Therefore, some hypothesize that competition among Seekers gradually reduces Seekers' profit margins to very low levels, and in turn allows Block Producers to capture the vast majority of MEV, Flashbots or similar at near-zero marginal investment The mechanics of Flashbots will dominate for years to come.

However, as Doug Colkitt points out, this only works if all participants agree on the value of a given transaction reordering. This is currently the case for the vast majority of MEV opportunities. For example, the value of atomic arbitrage is easy to calculate. However, as the complexity of blockchain transactions increases, it is natural to expect that seekers will become increasingly diverse in their ability to assess the total extractable MEV in any given transaction set. In this case, being an integrated search validator has an advantage over being a searcher alone, because if other searchers get a higher chance of reranking than you, they will bid accordingly, and you will be able to extract zero value. Instead, if you are an integrated search-validator (or you have exclusive private relationships with block producers, etc.), you will be able to act on your private information and capture associated value.

In essence, the above situation is similar to the "winner's curse" in classical auction theory, where participants obtain private information about the value of the item being bid on. As discussed above, private information, i.e. the divergence in the valuation of any given transaction reordering opportunity, may arise with the increased complexity of blockchain transactions where sophisticated searchers Will have a big advantage over naive searchers. In addition to the complexity of transactions within any given blockchain, statistical MEV can also lead to divergent valuations, where seekers spread risk over time and/or space (e.g., executing transactions on multiple blockchains), while Not purely concerned with atoms and guaranteed profit opportunities. Finally, the growing popularity of low-fee blockchains (such as Solana or AppChains in the Cosmos ecosystem) effectively makes high-complexity, low-margin MEV opportunities increasingly viable, while having high transaction fees Blockchains such as the Ethereum mainnet set a higher lower bound on the profitability of MEV opportunities, and thus a lower upper bound on their complexity (under reasonable assumptions about the complexity vs. profit trade-off of the MEV opportunity space) . Jump Capital’s dominance of Solana validators provides empirical evidence for this hypothesis. They account for about 20% of Solana's total share, and they are likely using their high level of human capital to extract the vast majority of available MEVs.

Extensive security benefits. The presence of MEV incentivizes new networks, although the ability of block producers to capture MEV may lead to long-term centralization risks where dominant producers have increasing ability to launch attacks on the network as described above entrants, which directly counteracts the centralization risk from highly capable search-validators. Additionally, the growing financial value of the block producers themselves increases the security of the entire network against external attackers. These attackers would have to deploy more funds to control a majority of the network's hash rate or stake.

Therefore, MEV can have both positive and negative impacts on the security of a given chain. The overall benefit of MEV to block producers increases network security, while specific benefits to specific block producers reduce network security.

Fundamentally, differences in block producers’ ability to extract MEV are likely to intensify as transaction complexity and search power increase. Thus, we can imagine a world where the most capable searchers integrate with block producers and end up with a very large percentage of the network's hash rate or stake, while almost all other searchers (with top searchers relatively less private information compared to the former) captures fewer and fewer MEVs through Flashbots-like auction mechanisms. While this may be an acceptable compromise for improving overall network security, some further strategies have been proposed to reduce centralization risk, which we discuss in the next section.

Ordinary blockchain users

In addition to block producers and searchers, ordinary users can also benefit from efficient MEV extraction (beyond the extensive security benefits previously discussed):

• Cross-market price stability. Arbitrage between liquidity pools ensures that asset prices do not diverge drastically across different DEXs and blockchains, allowing users to trade freely without having to check prices on dozens of markets beforehand.

• Conditional transaction. Some systems depend on executing certain transactions in a timely manner when certain conditions are met. For example, lending platforms rely on users to liquidate positions when they fall below their minimum collateralization ratio. Protocols may also wish to run certain utility functions after fixed intervals. In both cases, there is a competition among Seekers to bribe block producers to reorganize blocks in a way that allows Seekers to be the first user to receive the reward associated with the desired transaction. So while these opportunities are simply dismissed by some as "on-chain bots, in the end they do qualify as MEV to some degree.

Of course, users may also suffer negatively from the proliferation of MEV:

• high transaction costs. As mentioned earlier, depending on the transaction fee structure of a given blockchain, priority gas auctions (essentially a public auction in which seekers repeatedly submit successively higher bids based on their observations of competing bids) can improve Transaction fees for regular users. This leads to unpredictable spikes in common transaction fees, greatly reduces quality of life, and makes it impossible for less well-funded participants to send any transactions at all.

• Internet spam. Conversely, if transaction fees are unusually low, scaling may be too slow, or complex computations are not required at all, then seekers are incentivized to send large numbers of low-value transactions to the network in order to capture MEV opportunities as soon as they arise. Even if only a fraction of these opportunities materialize for any given searcher, underpricing deals can be a net profit. We observe this in practice on multiple blockchains such as Polygon and Solana. Similar to the priority gas auction, this also reduces the quality of life for ordinary users, in addition to facing high transaction fees, non-seekers simply cannot confirm their transactions with any reasonable probability, because they are just flooded with network spam extrude.

• Front-running deals that extract value. Finally, some forms of MEV are purely about capturing value from users and do no good to the wider cryptoeconomy. A simple example is the existence of a sandwich attack, which is a pure transfer of value, from the user to the party acquiring MEV. It is clear that no entity other than the direct beneficiaries of MEV would benefit from the existence of a sandwich attack. More generally, almost all forms of front-running are pure extraction and reduce end-user quality of life by increasing costs and unpredictability.

Thus, the net effect of MEV on the average user is the sum of a large number of different factors, the sign of which is often unclear. As we will see shortly, different systems have been proposed that attempt to steer this computation in a direction that results in net benefits for the user.

Innovation in MEV Management

Over time, blockchain developers have come to appreciate the intricacies of MEV and its integral part in a modern cryptoeconomic system. Accordingly, they attempt to refactor the blockchain architecture and incentives to mitigate the negative effects of MEV while retaining or amplifying the positive effects. These attempts fall into two main categories:

• MEV is evenly distributed among block producers to avoid centralization risks while reaping the network security benefits extracted by MEV

• Mitigate the negative impact of MEV on ordinary users by reducing pure MEV adoption and/or distributing MEV profits to the blockchain ecosystem

These strategies have been tried at the infrastructure layer as well as at the protocol or application layer. To illustrate, the implementation of EIP-1559 was an architectural change designed to mitigate the negative impact of priority gas auctions on ordinary users, but made little change to the distribution of MEV profits among block proposers. In contrast, Flashbots-style transaction ordering privilege auctions allow block producers to leverage a competitive search market to provide an effective lower bound on their MEV extraction efficiency, thereby narrowing down the worst and best block producers in terms of MEV extraction gap, but does not prevent MEV from being extracted. In the following articles, we will touch on some of the updated systems or proposed changes, and their relative advantages and disadvantages.

fair sort

Naively, the easiest way to eliminate front-running is to impose a first-in, first-out rule on transaction processing. This is easily achievable if a centralized party has the power to order all transactions. In this case, there is a clear order of arrival, and as long as the centralized party is trusted, front-running cannot actually happen. For example, Arbitrum One, currently an optimistic rollup on the Ethereum mainnet,

Own a full node with total transaction ordering authority run by Offchain Labs. (Note that the use of orderers is an optional part of the Arbitrrum rollup technology, which allows for near-instant confirmation of transactions.) However, centralizing transaction ordering to a single orderer naturally exposes all users to malicious activity from that orderer risk, so hope to eventually move to a decentralized model.

However, in a decentralized environment where thousands of nodes may receive transactions at different times, the concept of implementing a precise fair order of arrival is not trivial. Kelkar et al. (2020) made some progress in this direction in "Order-Fairness for Byzantine Consensus", proposing a formal definition of "fair ordering", and a series of protocols called Aequitas, which provide various kind of guarantee. At a very high level, these protocols try to ensure that if there are many nodes that receive transaction A before transaction B, then the resulting ordering should place transaction A before transaction B. Arbitrum One plans to eventually implement such a fair ordering protocol with the help of Chainlink's decentralized network of oracles.

Over the next few years we will see further developments in fair ordering algorithms, and the actual use of these consensus protocols by blockchains like Arbitrum One will significantly reduce the severity of extractive front-running in some places. However, it's worth noting that relying on the FIFO pattern is not without its downsides:

• Latency advantage. Participants with the lowest node latency will be able to withdraw more MEV than those with high latency. This benefits highly capitalized entities that are able to invest resources to co-locate nearby nodes and establish fast network connections. In general, differences in network latency have a systemic adverse effect on less connected regions of the world, which are also the areas most likely to suffer severe economic resource shortages.

• Internet spam. In order to increase the probability of their transactions being broadcast across the network as quickly as possible, users, especially MEV Seekers, are strongly incentivized to spam the network with the same transactions, repeatedly sending them to many different endpoints, and significantly increasing a common The probability that a user's single transaction will be abandoned or delayed.

• An intermediary between users and sequencers. Depending on how users typically send transactions to the orderer (or a decentralized network of oracles for fair ordering, etc.), the intermediary itself could be a source of risk. For example, if users send transactions to an Arbitrum-based blockchain via RPCs, those RPCs could in principle reorder transactions and extract MEV before passing them on to the orderer.

At the end of the day, "fair sequencing" is only fair relative to a particular set of priorities. Ultimately, the current proposed implementation can simply be considered as a set of alternative compromises relative to other MEV economies.

Auction of N block sorting rights

Instead of relying on a pre-determined set of entities to order transactions (e.g., a decentralized blockchain network that implements fair ordering), there is an alternative where block producers can be auctioned over consecutive N block windows The ability to reorder transactions at will. This mechanism creates a competitive market for MEV withdrawal rights, while guaranteeing that users' transactions will only be delayed by at most ~N blocks. The most famous implementer of this strategy is Optimism (an optimistic rollup on the Ethereum mainnet), which calls these auctions "MEVA" (MEV Auctions), and aims to use MEVA revenue to fund the development of public goods.

Analyzing the impact of MEVA from the perspective of individual beneficiaries reveals a lot of useful information:

• In principle, block producers should be able to capture most of the value through a competitive bidding process for transaction ordering rights. However, their short-term profits may be reduced because the blockchain requires that a fraction of the auction proceeds be diverted to public goods financing. This reduction may be partially or fully mitigated as searchers are able to capture more of the total MEV.

• The introduction of MEVA will greatly influence searchers. As the extraction of multi-block MEV becomes easier, the total profits of searchers may increase, but the distribution of these revenues may become very uneven, with the vast majority of gains going to the most skilled searchers.
  
  For example, suppose a searcher wins an auction to become a sorter in N blocks. Searchers will use their expertise to extract as much MEV as possible. However, it appears that there is still MEV in the block that has not been extracted. Thus, they can either sell the right to extract the remaining MEVs to other Seekers, or they can expand their capabilities to extract each MEV more fully. However, when the Seekers themselves do not know what MEV is left on the block (because if they knew, they would withdraw it themselves), the logic of auctioning the right to withdraw MEV is extremely complex. Therefore, the introduction of MEVA will accelerate the formation of a small number of monolithic MEV groups that are good at extracting every form of MEV and always win N block auctions.
  
  This could be in contrast to Flashbots’ sealed auctions, which allow searchers to bid only for the right to reorder select transaction portfolios. Although it is in principle possible for bundles to contain unfetched MEVs, the relatively targeted nature of bundle submissions means that there is relatively less incentive for seekers of different types of MEV to merge into a single entity compared to a multi-block MEVA setup.

• Ordinary users get a slight long-term benefit from public goods funding that benefits all blockchain users. However, the explicit introduction of a competitive market to extract multi-block MEV and overall centralized extraction of MEV may result in higher levels of short-term losses.

Interestingly, due to the "winner's curse" of the auction, where participants have different private signals, as mentioned earlier, if all transaction ordering privileges must be obtained through MEVA, the degree of complex MEV extraction may be limited to a relatively low s level.

Like fair sorting, MEVA appears to be another compromise. Blockchain users benefit from diverting a portion of MEV revenues towards financing public goods. But this comes at the cost of centralization of MEV extraction, resulting in higher levels of overall MEV extraction. In addition, there may be a small trade-off in cybersecurity commensurate with the extent of revenue for public goods funding withdrawals, although it may be offset by higher overall MEV revenues. Whether the MEVA model of MEV management is more attractive than other models remains to be tested in practice.

Proposer/block builder separation

A natural extension of optional auction usage to popularize MEV capture among block producers is to force necessary separation between roles. Currently, in most blockchains, block proposers are also block builders, which essentially gives them the ability to extract MEV from blocks, even though many may voluntarily choose to do so through auction-based mechanisms such as MEV-Geth) to obtain MEV income. In this scheme, known as proposer/block builder separation (PBS), block producers (or, alternatively, block builders or validators) must accept the highest bid from the block builder. Builders may try to extract MEV themselves. Alternatively, they can accept smaller bundles of transactions from Seekers and assemble them into a full block.

At a very high level, one might think of PBS as being roughly akin to requiring all block producers to run (some version of) a Flashbots auction, where they are bound to accept the highest bid, where the bundle contains the entire block's transaction value. Essentially, this is an enhanced version of the Flashbots auction. In this sense, PBS is likely to further democratize MEV extraction, keeping small validators somewhat competitive. However, in the presence of economies of scale and the complex, probabilistic proliferation of MEV, the dynamic towards centralization of block producers is only dampened, not eliminated.

Within the scope of PBS, several different deployments have been proposed, as described in a recent Flashbots article "Why Building the Most Profitable Block is Important". Collectively, these deployments have taken different approaches to addressing block builder privacy concerns, a key hurdle to successful PBS implementations. Essentially, if the block producers selected for a given block are able to observe what block builders submit, and submit their own blocks based on that information, they can simply copy the block submitted by the highest bidder content, but arbitrarily high prices, capture all MEV in the process, and ultimately inhibit the construction of profitable blocks. Solutions fall into three main categories:

• Transaction confusion. Encryption can be used to obfuscate block producers' understanding of the content of proposed blocks. For example, transactions and bundles can be compiled by block builders in a secure enclave such as Intel SGX. In theory, since the use of secure enclaves can also be cryptographically verified, this would prevent block producers from observing transactions. (However, Intel SGX is particularly vulnerable to several attacks.)
  
  Alternatively, more straightforward encryption schemes can be used to protect the privacy of user transactions, such as timelock encryption (decryption requires time lapse) or threshold encryption (decryption requires some threshold proportion of the block producer's private key). Unfortunately, the former has poor composability and user experience, while the latter is vulnerable to collusion by multiple block producers.

• A pre-commitment to a proposed block. Instead of using cryptographic barriers, block producers can be asked to pre-submit a set of block headers (each corresponding to the block builder's proposal) before the block builder is willing to publish the full block content. Then, if block producers prove that a certain block header was not in the block they previously committed to, they are subject to a slashing rule. Therefore, block producers cannot observe blocks being built and then use that information to resubmit bids. Vitalik described the proposal in further detail in the article "Proposer/block builder separation-friendly fee market designs".
  
  While the permissionless nature of this solution is elegant, its design attributes need to be carefully considered in order to effectively protect against attack vectors. For example, malicious block builders may submit bundles with high fees to block producers, but they refuse to publish these bundles after committing, and if block producers have an upper limit on the number of blocks they commit to May crowd out legitimate block proposals. Markdown mechanisms also require careful calculation of potential failure modes. If not designed properly, it is conceivable that attack vectors could be open to block producers, either individually or in collusion.

• Permitted Relay. If one is willing to accept the introduction of trusted parties into the system - which could be an intermediate step in the transition to a fully decentralized PBS - deployment becomes much simpler. Just like Flashbots currently require bundles to be submitted to a trusted relay, which is believed not to steal users' bundles, introducing trusted relays between block builders and block producers can ensure block builds The proposal of the author will not be leaked to the block producer. A concrete deployment of PBS in this regard is MEV-Boost by the Flashbots research group.

Beyond the technical details of a particular PBS system, there is one unexpected benefit that deserves special mention. Enforcing PBS at the base layer means that block producers may credibly be able to claim complete neutrality in including user transactions, especially if they also do not participate in the open market for MEV extraction. Certain forms of MEV could be classified as illegal by regulators, in the same way that front-running by brokerages in traditional finance is considered a potential breach of fiduciary duty. While this concern remains largely theoretical, it’s worth noting that one of Ethereum’s largest mining pools, Ethermine, stopped accepting DEX frontrunner bundles half a year ago for “compliance.” If such concerns persist, PBS may allow centralized exchanges to continue offering staking services at competitive prices, as they will still generate revenue from all forms of MEV without being exposed to potential enforcement action .

Reducing MEV opportunities at the protocol level

Certain MEV opportunities can be understood as flaws in user behavior or protocol design that allow purely extractive MEV as a result of normal user-protocol interactions. These MEV opportunities may disappear over time as new protocols prevent them from being created.

For example, liquidity pool imbalances are often caused by users performing large atomic swaps within a single pool. In principle, users could spread trades across multiple DEXs to reduce overall price impact and execute trades at a lower cost. However, doing this manually is slow and tedious. As such, DEX aggregators such as 1inch, ParaSwap, and Rango, which determine the best path for transaction routing, providing users with superior transaction execution across many different DEXs (and in Rango’s case, across multiple chains), have become getting more popular. Ultimately, as more trading volume moves to these aggregators, there will be a corresponding reduction in the space for arbitrage opportunities available. (That said, it’s worth noting that individual routing transactions of larger orders through aggregators can still be sandwiched, and arbitrage between aggregating and non-aggregating DEXs is still possible.)

Similarly, the introduction of centralized liquidity on Uniswap V3 has led to the phenomenon of "just-in-time liquidity (JIT)", that is, seekers insert a very narrow range of deep liquidity before users trade, and then withdraw liquidity immediately, thus gaining a lot of liquidity. A large portion of the associated transaction costs. While this leads to price slippage on executed orders, it strongly disincentivizes the provision of private liquidity and, in the most pathological case, can lead to an equilibrium where all liquidity is JIT and nothing passive Liquidity forces traders to request quotes from JIT liquidity providers. This could be prevented by introducing protocol-level mechanisms that make JIT liquidity essentially impossible, such as CrocSwap's "time-to-live" requirement, which enforces user creation and subsequent redemption The lower limit on the speed of returning liquid positions.

Other protocols have successfully desensitized users to MEV by taking the previous general concept of an "open" process and adding a level of "privacy" so that external actors can no longer interfere with extracting MEV. For example, CowSwap performs periodic batch off-chain purchase limit order matching for orders submitted by users. Since orders are matched directly, these trades are unlikely to be sandwiched because execution prices do not interact with external factors such as liquidity pool balances. By limiting the interaction of the exchange to the direct interaction of buyers and sellers, the transaction avoids the typical form of front-running.

Another interesting application of range limits is demonstrated by the KeeperDAO system. This system seeks to establish permissioned channels between specific searchers (called Keepers) and platforms that generate MEV opportunities (such as DEXs where user-imbalanced exchanges create arbitrage opportunities). For example, Keeper addresses can be whitelisted to allow them to be exchanged with lower fees. We can in turn use a similar system for other types of protocols. Keepers will be able to profit from MEV opportunities ahead of non-Keeper Seekers, and since they do not participate in auctions with a larger class of non-Keeper Seekers, they will also be able to capture more MEV rather than necessarily being driven down to Extremely low profit margins. In return for access to the “walled garden” of MEV extraction, Keeper forgoes a portion of the profits to be shared with the KeeperDAO and the MEV generation protocol.

In addition to KeeperDAO, other protocols have proposed similar MEV sharing schemes, such as bloXroute’s BackRunMe, which protects users from front-running transactions while giving specific searchers an earlier backrun opportunity. Collectively, these arrangements bear some resemblance to the pay-for-order-flow (PFOF) practice in traditional finance, with privileged searchers benefiting from the “toxic flow” protections of the broader search block producer ecosystem , reducing their profits to near zero, much like how market makers avoid the toxic flow of highly informed high-frequency trading, and users in both cases experience lower trade execution costs. The MEV ecosystem created by these protocols shifts profits from block producers (who will be able to progressively capture 99% of the value of these opportunities) to the rest of the cryptoeconomic ecosystem. Reducing MEV revenue for unprivileged searchers and block producers in this way can alleviate MEV-based centralization while modestly reducing the overall security of the network.

As we have seen, there is a lot of interest from both users and developers in building a MEV-resistant blockchain ecosystem at the protocol level. Overall, the MEV opportunity is created by "leaving money on the table" transactions, arguably we should expect users to really like those that by allowing them to easily withdraw at least some of the inefficiencies that would otherwise be captured as MEV ) to provide a protocol of greater value. As the cryptoeconomic system matures, MEV searchers and block producers should expect the “easy income” from correctable inefficiencies to diminish over time. This could drive searchers (who have invested heavily in domain-specific expertise and hardware) to increasingly sophisticated forms of MEV.

Probabilistic MEV Extraction

Currently, most MEVs are captured in a very "low risk" manner. For example, atomic arbitrage transactions or sandwich bundles submitted through Flashbots auctions are completely risk-free. Either they are accepted, in which case they are profitable, or they are not accepted, in which case the committer is no worse off than before. However, as competition for MEV intensifies, whether from the constant influx of more and more searchers into a fixed MEV opportunity space, or from users and protocols constantly trying to eliminate the simple MEV opportunity and capture value itself, Searchers are likely to turn to increasingly sophisticated MEV strategies.

Similar to quantitative strategies in modern traditional finance, if MEV Seekers increase their willingness to store and manage risk, they will be able to access a wider range of MEV opportunities. That said, searchers would benefit if value could be extracted through the reordering of transactions. Reordering of transactions is not necessarily profitable, but is expected to be profitable if the associated risks are properly managed and diversified.

While seemingly abstract, a simple form of risk warehousing is sniping liquidity, where seekers race to buy an asset after a liquidity pool is created. Usually, tokens bought by liquidity snipers are not immediately sold in the same block, but within minutes to hours. We make the following comments:

• Despite its superficial resemblance to "simple botting," we believe liquidity sniping still falls under the MEV umbrella. A simple proof is that Seekers are generally willing to pay block producers more to get included in their buy orders as soon as liquidity is added. The expression of transaction ordering preferences within a block clearly indicates the presence of MEV.

• Liquidity sniper profits cannot be guaranteed. Depending on the pre-existing token allocation, the price may be lower than its entry price. However, under favorable market conditions, the prices of most new projects are likely to increase significantly after increased liquidity. Thus, searchers take on inventory risk, even though their transactions have positive expected value.

Recall that the market maker's role is characterized by accepting inventory risk in exchange for profit from the bid-ask spread. In low-latency, high-TPS blockchains that support traditional central limit order market-making strategies, we may see a merger of the roles of market makers and block producers, as transaction order privileges will allow them to act on them. Apply complex management strategies to the inventory risk of market strategies. (This may be one of multiple motivations for Jump Capital to invest heavily in the Solana ecosystem, they account for about 20% of total SOL staked.)

In a similar fashion, we might expect MEV seekers to also start to spread risk across the time dimension, in much the same way that modern high frequency trading firms execute hundreds of thousands of trades per day. Not all of these trades are profitable, but because there are many of them, the law of large numbers ensures that they are consistently profitable for hours or days. There is no particular reason why transaction reordering privileges would only lead to MEV extraction opportunities that are profitable over timescales of a few transactions or within a single block, and thus effectively risk-free for seekers. Therefore, search strategies will incorporate sophisticated modern financial quantitative techniques, allowing the extraction of low-certainty forms of MEV, especially on newer blockchains with low transaction fees and fast confirmation times.

Indeed, one can already imagine how existing MEV extractions can be extended to probabilistic settings. Currently, a type of sandwich attack is both front-running and back-running in its target transactions. The sandwich minimizes risk by excluding any other intermediary transactions between the two halves of the sandwich (for example, a price drop before stock is sold). However, this requires pinpointing two separate transactions, each with a corresponding swap fee (0.3% for Uniswap). Recall that in a liquidity pool with two asset pairs, A and B, the trades are "symmetrical", i.e. buying A is roughly equivalent to selling B, and vice versa. Consider the following sequence of events, where there are two independent, sandwichable target transactions:

• The sandwich attacker buys A

• Target Transaction #1 Buy A

• Sandwich attacker trades A for B

• Target Transaction #2 Buy B

• The sandwich attacker sells B

In the example above, the sandwich attacker only paid three swap fees, but if the sandwich attacker were to be sandwiched between two target transactions separately, they would have to pay four swap fees. Because the interchange fee is 0.3% of the overall transaction size, being able to take some inventory risk between target transactions 1 and 2 is potentially more profitable (extra variance in transaction return distribution for higher expected value). However, sandwich attackers must be careful to properly manage inventory risk. For example, if target trade 1 is actually arbitrage using A's below-market price, then this sandwich attacker is less likely to exit at a profit on the opposite direction "sandwich" (that is, the sandwich trade itself may carry information about future price movements). Depending on their particular setup, probabilistic MEV searchers may also impose position size limits on all open trades to prevent overexposure to the idiosyncratic risks of any single asset.

A final form of probabilistic MEV emerges considering MEV across domains, as discussed in "Unity is Strength: A Formalization of Cross-Domain Maximal Extractable Value" by Obadia et al. (2021). For Seekers who do not belong to block producers of all relevant domains, cross-domain MEV extraction (e.g., arbitrage across two different blockchains) necessarily involves some degree of relative ordering or confirmation status of their transactions uncertainty. For example, it is conceivable that one blockchain confirms a purchase while another blockchain does not process the offsetting sale, leaving the searcher holding inventory, possibly at a loss. Nonetheless, those seekers who can competently manage these risks will be able to take full advantage of MEV extraction in an increasingly cross-chain world. (However, it is worth noting that cross-chain MEV profitability may be an important driver of overall cryptoeconomic centralization, as validators, nodes, and miners of multiple blockchains or bridges come together under a single searcher umbrella , will allow for super-efficient, low-risk extraction of inter-chain and intra-chain MEVs.)

A word of caution to potential probabilistic MEV searchers: Because financial markets are adversarial, executing on probabilistic MEV may expose the searcher to a very large potential attack surface, depending on deriving the underlying The difficulty of the strategy. One could imagine being able to "bait" an algorithm into certain unfavorable trades, like how "toxic" liquidity pools are often deployed in the hope that an overly naive liquidity sniper will buy their (unsellable) tokens .

in conclusion

The enormous complexity of MEV is evident from the above discussion, but out of necessity, the above discussion only roughly touches the gist of the situation. However, there is still much room for more detailed studies of MEVs, such as:

• More comprehensive, cross-chain, quantitative analysis of MEV extraction

• Theoretical and Empirical Research on Probabilistic MEV and Its Similarities and Differences with Traditional Financial High Frequency Trading

• Apply a more complex auction mechanism to capture and distribute MEV to different ecosystem participants

We eagerly look forward to future work in these areas.

Finally, I will give my brief opinion on MEV. While this may border on pointless abstraction or speculation, I have come to believe that the "struggle" over MEV - around its extraction, beneficiaries, and mitigations - is a perfect microscopic illustration of what the cryptoeconomic network is How is inherently shaped by the competitive forces that continually drive the evolution of advanced technologies. Consider, for example, how the complexity of running transactions directly drives the development of different blockchain architectures and protocols that attempt to capture more value for users by internalizing what should be front-runner profits. Likewise, the generally adversarial nature of cryptoeconomic systems, whose permissionless and open nature allows any competent operator to extract value from flaws, forces these systems to prioritize security and robustness from the start.

This is a highly desirable quality for infrastructure that may one day form the basis for the development of new financial systems. Compare, for example, the clunky technology of traditional banks, characterized by compromised websites, outdated SMS authentication, susceptibility to social engineering, and often countless attack vectors that are only hastily patched after massive financial losses . This is the end result of a system that is inherently ill-adapted to the brutally confrontational nature of the globalized world. While it may take a while for cryptoeconomic systems to mature, they will be more durable, in part because the only survivors are those who have successfully adapted to the hostile environment from the very beginning of the genesis block.

For these reasons, and many more, I find MEV irresistible. It’s a beautiful game of technical sophistication and intellect, and as participants double down on it time and time again, the entire cryptoeconomic ecosystem is ultimately stronger for it. It will be a great honor to watch this drama unfold in the years to come.