Maximal Extractable Value (MEV) Meaning
What Is Maximal Extractable Value (MEV)?
Originally called miner extractable value, maximal extractable value (MEV) is a strategy block producers (validators or miners) use to optimize their profitability by deliberately including, omitting, or changing the order of transactions during the block creation process. It is sometimes called the “invisible tax” as it extracts extra value from a block on top of block rewards and transaction fees.
Other independent network participants, known as searchers, also profit from MEV opportunities through arbitrage, front-running, or liquidation. Generally, both smart contract-enabled proof-of-stake (PoS) networks and proof-of-work (PoS) systems facilitate MEV.
How Does MEV Work?
When a user submits a transaction, the transaction goes to the mempool of every node in the network. The block producers can decide to include, exclude, or reorder the transactions within the next block. By design, validators and miners tend to prioritize transactions with the highest transaction fees as this is more profitable.
Block producers can extract MEV from organizing the transactions within a block regardless of fees. For instance, ordering transactions in a certain way can result in on-chain liquidation or arbitrage opportunities, resulting in extra profit besides transaction fees and block rewards.
As such, searchers using complex algorithms to spot profitable opportunities can outbid normal transactions by paying higher fees to be prioritized. This ensures that their profitable arbitrage transactions and strategies are executed before similar trades.
Types of MEV
MEV profits are mostly captured through arbitrage and are considered good MEV. Other types of MEV include:
- Front-running – A front-run trade entails block producers and searchers inserting a buy order before a similar order is executed. They benefit from the impact the other trade has on the price.
- Back-running – A back-run trade occurs when a target trade is immediately succeeded by that of an MEV actor. The MEV actor benefits by capturing a large portion of liquidity in a DEX and selling the asset at a higher price.
- Sandwich attack – A sandwich attack entails organizing transactions to execute a buy order before and a sell order after a target transaction. The network participant gains from the slippage of the original trade.
- Liquidation – DeFi protocols depend on MEV to liquidate the positions of borrowers when their collateral goes below the set threshold. Since the liquidation needs a faster response, MEV actors pay higher fees for priority. A portion of the fees goes to the MEV actor who facilitated the liquidation.
Pros and cons of MEV
The benefits of MEV are:
- Rapid liquidation by MEV actors ensures DEXs remain solvent.
- The competition among block producers to validate transactions enhances network security.
The drawbacks of MEV include:
- High slippage created by MEV sandwich attackers worsens end-user experience.
- MEV exceeding the block reward may lead to consensus instability, where the block producers are incentivized to reorder previous blocks to extract MEV.