Maximal Extractable Value (MEV)

Why Trust Techopedia

What is Maximal Extractable Value (MEV)?

Maximal extractable value (MEV) is the maximum profit that blockchain miners and validators can make by including, excluding, and changing the order of transactions in a block.

Advertisements

MEV was initially an abbreviation for ‘miner extractable value’ when the two biggest public blockchains in the world – Bitcoin and Ethereum – relied on proof-of-work (PoW) miners to validate transactions and create new blocks. It changed to ‘maximal extractable value’ after Ethereum’s move to proof-of-stake (PoS) as mining is no longer part of the protocol.

Though it is important to note that MEV practices are not exclusive to Bitcoin and Ethereum – they are practiced in alternative blockchains, too, such as Binance Smart Chain (BSC) and Solana.

MEV is a controversial subject that has both positive and negative effects on the blockchain network. MEV practices can fix economic inefficiencies in decentralized applications (dApps) but can also lead to high gas fees and poor user experience.

How Does MEV Work?

To understand the definition of maximal extractable value (MEV), you need to know how miners and validators perform their basic functions on a blockchain.

Miners and validators are block producers who are responsible for batching pending transactions to a block. Each time a user transacts on the blockchain, they pay a transaction fee called a gas fee to the block producer.

Each block can only fit in a limited number of transactions. Typically, block producers prioritize transactions with the highest gas price in order to maximize their profits. Users can choose to pay higher gas fees to ensure that their transactions are included in the upcoming block.

It should be noted that block producers have full autonomy on the transactions to include in the upcoming block. As the pending transactions are visible to everyone in the mempool, block producers can pick and choose from thousands of pending transactions to extract the maximum value from a block.

There are players other than validators and miners in the MEV game. According to Ethereum.org, a large portion of MEV is extracted by independent network participants referred to as “searchers.”

Searchers implement elaborate algorithms to detect MEV opportunities and use bots to automatically submit those transactions to the network. These MEV opportunities can range from decentralized exchange (DEX) arbitrage to loan liquidations.

The competition can be very high for certain lucrative MEV opportunities. During such a time, a searcher may pay gas fees as high as 90% of the MEV revenue to ensure that their transaction is executed before the competition. Validators and miners will always get a portion of the MEV as searchers pay high gas fees to ensure transaction finality.

MEV Examples

In the table below, we review a few examples of MEV opportunities.

Frontrunning As all pending transactions are visible on the blockchain, searchers scout the mempool to detect profitable transactions. The searcher will test the transaction locally to double-check the resulting profit of the transaction.

If the test indicates a profitable trade, the searcher will copy the transaction and submit it with a higher gas fee so that the copycat transaction is prioritized over the original transactions by miners.

DEX arbitrage DEX arbitrage is the simplest form of MEV opportunity. A DEX arbitrage opportunity occurs when two DEXes offer a token at different prices. A searcher will buy the token at a cheaper price and sell it immediately for a higher price.

DEX arbitrage is seen as a positive consequence of MEV as it helps maintain the correct prices of cryptocurrencies across DEXs.

Loan liquidations Decentralized finance (DeFi) users take out loans by depositing cryptocurrency as collateral. If the value of the collateral drops below a certain value, the collateral is automatically liquidated.

DeFi lending protocols also allow anyone to liquidate the collateral and earn a liquidation fee if the collateral value drops below a certain threshold. MEV searchers look for such opportunities.

Sandwich trading Sandwich trading is an MEV extraction strategy where a searcher scouts the mempool for large trades that are big enough to raise the price of the token in question.

The searcher will aim to buy the token cheaply before the large trade occurs and will immediately sell the tokens for a higher price after the large trade.

What Does Maximal Extractable Value Mean for End Users?

The effects of MEV on the end user can be both good and bad. As we mentioned earlier, DEX arbitrages result in better economic efficiencies on DeFi protocols and DEXs by correcting cryptocurrency prices.

Meanwhile, the incentivized liquidation of collateralized loans helps ensure that lenders get their money back from risky customers. Moreover, the growth in MEV revenue for miners and validators will ensure that these blockchain operators are incentivized by revenue sources other than block rewards.

However, the practices like sandwich trading and frontrunning result in a poor experience for users. The high competition among MEV searchers has also translated to gas fee spikes and network congestion on Ethereum.

The Bottom Line

MEV represents an intriguing yet complex aspect of blockchain networks. The growth of MEV revenue is playing an important role in shaping how network participants interact with one another.

In the meantime, there is a growing fear that MEV incentives will lead to larger, dominant staking pools in PoS blockchains that have the resources to invest in optimized MEV extraction techniques.

Advertisements

Related Terms

Mensholong Lepcha
Crypto & Blockchain Writer
Mensholong Lepcha
Crypto & Blockchain Writer

Mensholong is an experienced crypto and blockchain journalist, now a full-time writer at Techopedia. He has previously contributed news coverage and in-depth market analysis to Capital.com, StockTwits, XBO, and other publications. He started his writing career at Reuters in 2017, covering global equity markets. In his free time, Mensholong loves watching football, finding new music, and buying BTC and ETH for his crypto portfolio.