MEV must exist in the Blockchain: Unveiling the dark pool economy of Crypto Assets

MEV is an inevitable product of an efficient market, and as long as there is profit margin, someone is bound to grab it. The point is not to eliminate MEVs, but to decide who gets those benefits and on what terms. This article is from an article by Sumanth Neppalli, Decentralised.co, curated, compiled and contributed by Yangz, Techub News. (Synopsis: In-depth good article: The evolution of the MEV pattern on Solana and the advantages and disadvantages) (Background supplement: GMGN how to trade small class: Gas, priority fee, slippage, MEV) In 2010, Google launched the second-highest price ad auction system, the specific rule is that the highest bidder wins the ad space, but only pays the second highest offer. This looks like an ideal model for economists to avoid situations where advertisers overbid. Secretly, however, Google secretly made millions of dollars in hidden profits by manipulating the auction mechanism. For example, when the highest bid is $20 and the next highest bid is $16, the winner only pays $16. Google, on the other hand, actually pays the publisher the third-highest price (let's say $10), stealing $6 of the difference. The money flowed into secret accounts known as the Bernanke pool, which were used to achieve corporate goals such as Wall Street expectations. It wasn't until the antitrust lawsuit in 2016 that the operation came to light. While Google switched to a first-price auction system in 2019 (where the highest bid is settled to the publisher), the lesson remains profound: When auctioneers control the underlying rules, even the most perfect mechanics can be distorted. Interestingly, the cryptocurrency world is repeating this scene. Blockchain is facing its own "Bernanke moment" – the maximum extractable value (MEV, i.e. the profit obtained through restructuring, addition and deletion of block transactions) has become the most critical but least understood phenomenon in the cryptocurrency space. Just like Google's hidden auction manipulation, this kind of value extraction, although out of the eyes of ordinary users, affects all blockchain participants, forming a kind of "hidden tax". Will MEV follow in Google's footsteps towards black box operation and centralization, or can it evolve into a transparent decentralized system that rewards users with profits? Can we devise a mechanism that allows value extraction to feed back the ecology, rather than concentrating wealth on a few? Let's dive in. The physics of latency A blockchain is a decentralized network of thousands of validating nodes (validators or miners) around the world. These nodes play a dual role: they are communication hubs for receiving and broadcasting transactions, and computing terminals for executing and validating transactions. Since nodes are distributed across the globe, there is bound to be a delay in communication between validators – a physical bottleneck determined by the speed of light limit. To ensure that all nodes follow the same sequence of transactions, each blockchain has a "block time": a validator is selected through a consensus mechanism (such as proof of stake) to propose a new block, and the remaining validators accept the block after confirming that the transaction is compliant. After each block produced, the proposal rights are rotated in the validator set to maintain network security. For example, Bitcoin blocks every 10 minutes, Ethereum speeds up the cadence to 12 seconds, Solana is trying to break the 400 millisecond limit, and L2s such as Arbitrum are challenging the 10-250 millisecond UHF range. Regardless of length, each block time window creates an opportunity for validators to restructure transactions for profit, rather than prioritizing user fairness. Ideally, this principle should be followed on a first-come, first-served basis, but this criterion is difficult to achieve due to the global distribution of nodes. When a user initiates a transaction, due to network latency, it is almost impossible for all nodes to receive the transaction synchronously. This means that even if the block construction rules are fully followed, unfair transaction ordering (resulting in additional fees paid by users, MEV arbitrageurs withholding the difference) can still be included in the block. MEV (Maximum Extractable Value) refers to the profits made by block producers (miners in proof-of-work or validators in proof-of-stake) and other participants (by bribing block producers to keep users trading first) by strategically adjusting the order of transactions within a block. MEV: Hidden Profiteering Business Let's say Joel is using a DEX like Uniswap to buy ETH for $1800. He set the slippage tolerance at 10%, i.e. he could accept the price increase to $1980 when the trade was completed. Joel's transactions first go to the mempoll — a public waiting room for pending transactions to be packed into blocks. At this point, a trading bot spotted his trade and immediately copied the order, "cutting the queue" by paying a higher gas fee (a higher gas fee is essentially a bribe to the validator to ensure that the transaction is executed before Joel). When the robot's buy order pushed the ETH price on the DEX to $1900, Joel's trade ended up at this inflated price. The robot then sells ETH back to the pool at this price, earning the difference (after deducting the gas fee). In the end, Joel paid an extra $100 for ETH, and the money went into the robot's pocket. This kind of operation is played out thousands of times a day in the cryptocurrency market. A more extreme example is when a robot intercepts $200,000 in profit from a single trade because a trader forgot to set a slippage tolerance. The "culprit" in this incident is jaredfromsubway.eth, a bot that always gets its hands done before the transactions it wants to snipe by consistently paying the highest gas fees in all of Ethereum. According to statistics, Jared made more than $10 million from such MEV attacks. MEV is mainly manifested in three forms: Arbitrage trading: finding price differences between different exchanges, buying low and selling high in the same block. For example, when ETH is quoted at $2500 and Sushiswap is quoted at $2510 on Uniswap, the robot can complete buy and sell operations within the same block, making a risk-free profit of $10 per ETH. It should be noted that this type of operation actually benefits the market, as it promotes price convergence between platforms. Sandwich Attack: The bot observes Alice's large buy order in the memory pool, preemptively buys and pushes up the price, and sells immediately after Alice trades at the high price. The robot earned the spread, while Alice suffered a slippage loss. The aforementioned case of Joel paying $100 more is a classic sandwich attack, and this extra spending ultimately translates into profits in the MEV value chain. Such actions are clearly detrimental to the user and cause them to pay unnecessary additional costs. Liquidation arbitrage: In a loan agreement, when a certain part meets the liquidation conditions, the MEV withdrawer will compete to be the first liquidator to obtain a reward. For example, Saurabh lends 10,000 USDC with $15,000 worth of ETH as collateral, triggering liquidation when the price of ETH drops causing the collateral value to drop to $11,000. At this point, the robot immediately repays the loan of 5,000 USDC and receives $5,500 worth of ETH (including a 10% liquidation reward), making an easy profit of $500. The impact of such operations is two-sided: liquidation mechanisms are necessary from the perspective of maintaining the health of the DeFi system...