MEV: Standoff, truce, or a never-ending saga?
The resolution to the reorg drama shows how MEV will be dealt with in the future
The rise of MEV is shaking the foundations of the Ethereum community. Some are now calling it a crisis. While a valid term for the increasingly worrisome situation, it shouldn’t come as a shock.
MEV, after all, is downstream of the growth of DeFi. As more and more financial activity transacts on Ethereum, along with it comes more arbitrage and liquidation opportunities.
So, while there are hopes that DeFi will one day power the global financial system, the value that can be extracted scales with the size of the market. And with it, the criticality of addressing MEV and its reach only intensifies.
Most worryingly, that reach is also expanding. A recap: MEV comes from increased economic value transfer on top of Ethereum. Before the emergence of MEV activity, miners of blockchains were incentivized through rewards native to the protocol: either block rewards from new issuance or transaction fees paid by users. Since then, the rise of MEV has created another incentive layer for miners – or more accurately, block producers – and it’s a far more lucrative one. But ultimately, these miners need the industry to survive. Will they really shoot themselves in the foot for a quick buck?
MEV has been a topic of discussion for a few years, and awareness in the DeFi world has stepped up over the past six months. But over the last few weeks, a more extreme MEV exploit – specifically the possible threat of a reorg or time-bandit attack – has unnerved the Ethereum community.
The main concern is that if miners can reorder transactions to extract value, then theoretically an MEV opportunity could be so alluring that it justifies the hash-power investment needed for a reorg. The Block’s Tim Copeland wrote a great explainer on the reorg drama:
In short, it’s possible for a miner who sees a lucrative transaction in a new block to go back in the chain to the point before the transaction occurred and create a new sequence — one that replaces the original transaction with one in which the miner takes the profits for themselves. It’s also called a “time bandit attack” because it’s like blockchain time travel.
This possible threat has long loomed against all blockchains (double spend). But it’s only because DeFi has experienced such rapid growth with so much value being transacted that this now seems an existential threat to Ethereum (and public blockchains writ large).
Manifested, this would shatter confidence in Ethereum’s security and censorship resistance. It would deal a crippling blow to the process of onboarding large pools of capital. The community still hears of chain roll backs from the DAO more than five years ago, but nothing would compare to outright market manipulation by those powering the network.
The concern is now so great that much of the community has begun to shun those who’ve suggested building software that would seek opportunities across blocks. Flashbots has come out unequivocally against, as have major mining pools and prominent searchers (developers who write MEV strategies). Meanwhile, Vitalik penned a piece last week on how the switch to Proof-of-Stake (PoS) mitigates these attacks because it introduces to finality. A few days after the post, EIP-3675 appeared on the Ethereum github, which is the long-awaited shift towards PoS and commonly referred to as, ‘the merge’.
The ETH2 beacon chain has been live since December 2020. Yet the merger – which was expected to happen sometime over the next six months – looks set to be expedited among mounting community fears of a reorg, and the destabilizing catastrophe it would have. And with the implications of new MEV reorg software being so dangerous, the Ethereum community needs to mount a counterattack to ensure its immutability.
All of this seems like the end of a chapter, or maybe the first book in the MEV saga.
Amongst all the concern, there seems to be a few key truths:
MEV is fundamental; networks with economic value transfer will always have value leakage.
The public mempool is dead. Smart traders will route directly to miners.
The emerging model has become a huge black box of how value is fairly distributed, shaking the transparency and permissionless of blockchains.
MEV has everyone spooked. Yet the likelihood of a reorg is low – as miners inevitably won’t bite the hand that feeds them.
The role of Flashbots
Flashbots are at the core of the MEV story. One of its founders, Phil Daian first discovered MEV in a seminal 2019 paper, where he coined the term to describe the front-running activity on Ethereum’s decentralized exchanges. Flashbots bills itself as, “a research and development organization formed to mitigate the negative externalities and existential risks posed by miner-extractable value (MEV).”
Flashbots recognized early that the Ethereum network was being clogged with bots competing for liquidation or arbitrage opportunities with Priority Gas Auctions (PGAs). Before Flashbots, if searchers identified an on-chain opportunity, setting a high gas price was the only way to ensure the arbitrage transaction would go through. This led to high gas prices for everyone on the network.
Then came Flashbots, which inserted itself between searchers and miners. Miners run MEV-GETH, which is a fork of the common GETH client with a separate communication and payment network that connects miners to searchers. Instead of sending an MEV opportunity to the public mempool with a high gas price, searchers will send the transaction to Flashbots, which connects it to miners running MEV-GETH. For each MEV opportunity, searchers will attach a proportion of the MEV proceeds to be distributed to the miner and to the searcher.
Out of sight, out of mind
The Flashbots design bypasses the public mempool, which is how most users’ transactions end up in Ethereum blocks. This relieved network congestion (and lowered gas prices) because the transactions with the highest gas fees were being rerouted through Flashbots. Miners and searchers both profit and the rest of Ethereum pays less gas. In short, a positive sum.
This model has grown considerably; the MEV-GETH mining software is now run by almost 70% of the Ethereum network’s hash power. This puts Flashbots in an extremely important position, mediating between Ethereum’s fastest trading bots and the industrial miners that power the network.
So far, Flashbots has done a good job of limiting MEV and has been a phenomenal educational resource for the industry. Other dapps and protocols have also been helpful in constraining MEV. Every on-chain trade submitted through the public mempool triggers an opportunity to front-run, backrun or sandwich it.
Increasingly, Dapps like Archerswap are allowing traders to bypass the mempool and send trades directly to miners, much like Robinhood’s payment-for-order-flow system. Other options aim to maintain a permissionless, public transaction submission but rely on some type of fair ordering system. Gnosis’s Batch Auction and Chainlink/Arbitrum’s fair sequencing network are some examples.
But the question of how to ‘democratize MEV extraction’ remains unanswered, although Optimism is hoping to auction if off to ‘fund public goods’. Identifying and redirecting high-value network traffic benefits DeFi and Ethereum now, but what rules will govern this new network? Will this become a dark pool of liquidity?
Trust and reputation: Allowing DeFi to scale
The MEV crisis and its diplomatic truce show just how large DeFi and Ethereum have become. The market cap of Ethereum and ERC20 tokens is close to $500 billion, and investors, traders and miners make billions of dollars a year supporting it. Many people have gotten phenomenally rich and are invested in seeing Ethereum and DeFi grow further. No one wants to kill the golden goose.
What’s more, DeFi’s success has made the major actors in this saga – miners, developers, Flashbots and their VC investors – too big to anon. These crypto behemoths are not going to engage in industry sabotage; in fact, they’ll act swiftly to defend DeFi. Ethereum is lucky that the beacon chain has been running without major incident for almost 8 months. MEV reorgs are much easier in Proof-of-Work than Proof-of-Stake.
If the merge is fast tracked and the reorg is averted, the question of how to limit and democratize MEV will remain, but with less urgency than witnessed over the last few months. Since it seems that the Ethereum community has uniformly rejected a reorg bodes well for how it will tackle the longer-term problem of maintaining permissionless and fair access to the network.
Odds and Ends
Rekt: Thorchain took a hammering Link
Uniswap Labs restricts access to certain tokens through front-end Link
Aave to launch institutional DeFi platform Aave Arc within weeks Link
Blockworks: Bitgo and Index Coop partner on institutional product Link
Stakingbit: The best DeFi tools Link
Thoughts and Prognostications
DeFi Uncovered: Adjusting to the New Normal [Luke Posey/Glassnode]
Taking lending off-chain [Joel John/Decentralised.co]
How Stoner Cats Lost Collectors $800K in 35 Minutes [Ilan Gitter]
ETH, The World’s Most Valuable Asset [Andrew Bakst/Bizantine Capital]
Scaling Ethereum with ZKsync [Chris Burniske/Placeholder]
An analysis of the anon trend in crypto discourse [Odette/eGirl Capital]
Time-weighted automated-market maker [Dave White/Paradigm]
Sushi’s phantom troupe [Kerman Kohli/DeFi Weekly]
That’s it! Feedback appreciated. Just hit reply. Written in Brooklyn. Big thanks to Sarah and Denis on help with this piece.
Dose of DeFi is written by Chris Powers. Opinions expressed are my own. I spend most of my time contributing to DXdao. All content is for informational purposes and is not intended as investment advice.
Great writeup, Chris!