What Are MEV Bots And How They Extract Value

With the continued growth of the decentralized finance space in network after network, another, less widely discussed but even more influential force has operated in the background of much transaction-specific MEV bots. Such automated software crawls blockchain networks and looks for opportunities to obtain profit in the form of an impending transaction before it is finalized. By so doing, they are able to obtain what can be referred to as Maximal Extractable Value (MEV), which has since become a staple occurrence in the modern blockchain markets.

MEV is defined as the profit that network participants can obtain by ranking transactions, placing transactions, or censoring transactions strategically in a block. Although the term was initially popularly researched with reference to the Ethereum ecosystem, it currently influences various blockchain networks that sustain the example of decentralized finance.

In reality, MEV bots can execute their transactions much faster, continuously scanning the pool of unverified transactions called the mempool. These bots can quickly place their own trades to take advantage of a good opportunity before other traders can respond when they identify promising opportunities.

The Origins of MEV

The name Miner Extractable Value was initially known as Miner Extractable Value, the name came about because miners played a role in proof-of-work networks like Ethereum before it became proof-of-stake.

Scientists found out that miners could rearrange transactions in a block to get some extra profit, other than regular transaction fees. Miners could effectively extract value from users by interacting with decentralized finance protocols by prioritizing some transactions or inserting their own trades.

Following the transition of Ethereum to proof-of-stake in 2022, the term was renamed to the Maximal Extractable Value, as it acknowledges that the validators and other external participants can also be involved in such strategies.

Nowadays, there is competition between specialized trading robots and search networks that seek the opportunity to detect MEV on decentralized exchanges and lending platforms

How MEV Bots Work

MEV bots work on the principle of reading through blockchain mempools in search of transactions that may result in a lucrative market environment.

Once a user sends a trade to a decentralized exchange, the trade can be seen in the mempool and then confirmed on the blockchain. Within this brief period, bots examine transaction information and see whether they can make a profit out of it.

When an opportunity is identified, the bot is able to submit a competing transaction with a higher gas fee in a short time, giving it a higher chance of being given priority in the next block by the validators.

This priority race has created a highly competitive landscape commonly known as the MEV market, in which bots are competing with each other to gain profits out of blockchain activity.

Common MEV Strategies

MEV bots are typically known to employ several varieties of strategies to derive value in the markets of decentralized finance.

Front-running is one of the most actively debated strategies, where a bot notices that a large impending order is coming and makes its own order before it can. The robot will make a profit in the price fluctuations created to accommodate the initial trade by purchasing an asset at a price lower than that of a large purchase and selling right after that purchase.

The other type of attack is called a sandwich attack. The bot in this case will put a purchase right at the front of the trade of the victim and a sale right behind it. The original transaction causes the price to move up, the victim makes his trade at a lower price, and the bot sells at the higher price to make a profit.

Source: X

Arbitrage is another opportunity that is utilized by bots in the case of price discrepancies between decentralized exchanges. Due to the presence of various platforms that crypto markets work on at the same time, price divergences may momentarily arise. MEV bots observe these gaps and make trades that earn a profit from the difference in price.

Another significant source of MEV is liquidation events. In case the borrowers in the decentralized lending platforms fail to hold enough collateral, their positions may be auctioned. The bots are competing to make such liquidations as fast as they can, since it usually involves financial incentives.

Billions in Value Extracted

MEV has become a major economic power in the blockchain world. Due to the popularity of decentralized finance in 2020, billions of dollars worth of MEV have been appropriated through blockchain networks.

Much of this action is on the Ethereum network because it is the most popular in decentralized finance. Nonetheless, MEV has also been growing around other networks that support DeFi applications, such as high-performance blockchains.

With the increase in trading volumes on the decentralized exchanges, the possibility of MEV extraction increases as well.

Others might argue that MEV has essentially added a level of financial infrastructure to blockchain ecosystems, a level where dedicated traders compete to optimise the placing of trades in a profitable way.

The Debate Around MEV

Although MEV may enhance the efficiency of the market in some instances like arbitrage balancing prices between the exchanges, it has raised controversy in blockchain circles.

Some MEV strategies are criticized as unfair towards the ordinary user by manipulating the order of transactions. Sandwich attacks, such as those, tend to make traders get less favorable prices than they had anticipated when they transact swaps in the decentralized exchanges.

This interaction may undermine the trust in the services of decentralized financial systems, in particular, among retail users who might not know why their orders are fulfilled at an inappropriate price.

Proponents claim, on the other hand, that MEV is an unavoidable output of transparent blockchain systems. Since before confirmation, the transactions will be seen publicly, greedy traders will of course, have a desire to seize the prospects offered.

Attempts to Reduce Harmful MEV

Developers have also responded to these concerns by coming up with a number of solutions that curb the adverse effects of MEV activity.

The most noticeable one is the MEV-Boost, which is a framework that divides block building and block validation. This will enable the competition of specialized builders to develop the most profitable blocks, and the best is chosen by the validators.

The system has an objective of building a more transparent market in which the ordering of transactions can take place, and decreasing the incentive of validators to directly manipulate blocks.

Protections to reduce sandwich attacks have also been implemented in some decentralized exchanges. Such protections can involve the restriction of visibility of transactions or a change in the manner of trade execution.

Other research efforts are also investigating cryptographic methods that would conceal the transactions till confirmed, so that bots cannot use them in the mempool.

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