Keep an eye open and be on the lookout for Maximal Extractable Value (MEV) practices! It’s undeniable that blockchain is a game-changing technology in the financial sector due to its capacity to act as a permissionless ecosystem for decentralized finance. With its ability to ensure trust through its underlying technology and consensus protocols, cryptocurrency revolutionizes the way we do transactions by removing intermediaries from the equation.
Not every blockchain is the same, and depending on the consensus mechanism, cryptocurrency transactions may vary in length from a couple of minutes up to several hours. In Proof of Work (PoW) and Proof of Stake (PoS), two of the most popular consensus mechanisms, pending transactions are held in a waiting room of sorts called mempool or transaction pool. In turn, validators or miners are tasked with building new blocks of transactions to add them to the blockchain. To do this, they select pending transactions from the mempool, bundle them together in a block and append it to the blockchain. The problem is that traditional blockchain systems give miners and validators the freedom to choose and order transactions however they want.
Maximal Extractable Value, formerly known as Miner Extractable Value, is a byproduct of this design as validators and miners have found loopholes through which they profit off of pending transactions like including, excluding or reordering transactions in any block they mine.
The Humans Blockchain take on MEV
Humans.ai is taking charge in the tech revolution with its ambitious goal of democratizing artificial intelligence by putting real humans behind every decision made by AI. Furthermore, the company is working hard, developing a way to help AI take a step into the unknown and make the transition to web3, the decentralized era.
To achieve its goals, Humans AI is building a unique infrastructure, a blockchain network capable of supporting the development, deployment and execution of artificial intelligence. Tailored to answer some of the most pressing issues intrinsic to AI, like governance, monetization and execution, the Humans Blockchain will act as a framework that guarantees an ethical use of the technology.
What makes the Humans Blockchain stand out from other similar networks is the fact that it leverages Cosmos SDK to deliver an enhanced blockchain ecosystem that addresses a series of shortcomings associated with this type of framework, like the hidden tax MEV. The Humans Blockchain solves this issue by targeting the problem at its root cause. MEV takes place because validators and miners can select pending transactions from the mempool and organize them how they see fit in a new block of transactions. The solution provided by Humans.ai is elegant in its simplicity. Each pending transaction is accompanied by a timestamp, and transactions are added to a new block based on what order they arrived in the mempool. In short, first come, first served. Through this approach, miners can no longer extract additional value by including, excluding or reordering transactions in the blocks they mine.
What is MEV?
Although a relatively new phenomenon, MEV has garnered the attention of research and development groups, who are trying to alleviate some of the negative impacts it can have on the general stability of the network and user experience. In general, MEV is most commonly associated with blockchains that support smart contracts because they present a wider opportunity for MEV extraction. Ethereum is the most well-known example being the first network that introduced this concept, but this does not mean that MEV is an issue specific only to Ethereum.
Interestingly enough, the issue of MEV was identified in 2014, a year before Ethereum was launched, by an algorithmic trader that operates under the pseudonym Pmcgoohan who underlined a critical flaw, namely the fact that miners had absolute control over how transactions are included and ordered. He suggested that by reordering transactions, miners could extract additional value from unsuspecting users.
Unfortunately, Pmcgoohan’s warnings went largely unnoted until 2019, when a research group signaled the same issue in a paper called Flash Boys 2.0, where the term MEV was first introduced. Furthermore, some articles from 2020 like Dan Robinson’s & Georgios Konstantopoulos’ Ethereum is a Dark Forest, and Samczsun’s Escaping the Dark Fores further cemented MEV as a fundamental concept in crypto economics, marking it as one of the most pressing challenges that the blockchain community has to overcome.
Why is MEV possible?
MEV was initially used in blockchains that operated under the PoW consensus mechanism, where miners control the order and the inclusion of transactions inside a block. So, initially, the abbreviation MEV stood for miner extractable value. In preparation for Ethereum’s shift to PoS dubbed The Merge, which just recently happened, by the way, the community decided to adopt a more inclusive term — maximal extractable value, as value extraction methods will continue after the transition.
In a blockchain network, miners or validators are tasked with selecting, ordering and adding transactions into blocks. To perform this operation, they have autonomy in deciding which transactions from the mempool they can include in the new block. As a result, miners/validators are incentivized to select and order transactions based on the highest gas price. The issue is that traditional blockchain protocols don’t call for transactions to be ordered based on their fees, giving miners/validators leeway to reorder transactions to generate additional income from users. This is what MEV is in a nutshell.
How MEV impacts crypto owners?
MEV is not just a theoretical issue but a phenomenon that is already impacting users. At the time of writing, Flashbots, a MEV extraction tool, estimates that over USD 675 million has been extracted from transaction reordering on Ethereum since the beginning of 2020.
At its core, MEV is an invisible tax that miners and validators collect from unsuspecting users. The bottom line is that each dollar extracted through MEV is siphoned directly from the pockets of users. But MEV as a whole has deeper ramifications as it can lead to network congestion, putting high upward pressure on gas prices.
If left unchecked, MEV has the potential to destabilize a blockchain network in the long run by putting transaction finality and immutability into question. Also, by incentivizing miners and validators who are better at extracting value from transactions, MEV slowly degrades the usability, security, transparency and decentralization of a blockchain.
Common MEV tactics
Decentralized Exchange (DEX) Arbitrage Exploitation is one of the most commonly occurring MEV exploitations. Crypto varies in price across exchanges, and the DEX arbitrage tactic tries to exploit this. MEV bots will scan exchanges to buy lower-priced tokens and sell them on higher-priced DEX, often in a single transaction.
Front-running is a tactic that involves moving a transaction ahead of a known pending transaction in the execution queue. Specialized bots called “generalized front-runners” scan the mempool for profitable transactions. When a suitable one is found, the transaction is replicated with a higher gas fee to get mined before the victim’s transaction.
Sandwich attacks are a variation of front-running in which a malicious trader attempts to manipulate the price of a cryptocurrency. In a sandwich attack scenario, a bot searches for a large pending transaction on a decentralized exchange and executes two transactions. The first transaction takes place before the target victim, aiming to push the price up. The second transaction profits from the rise in price and sells the crypto to the victim at a higher price. Sandwich attacks reduce the amount of cryptocurrency the victim purchases, while the attacker benefits from the artificial price increase.
Liquidation. DeFI lending protocols require users to deposit cryptocurrency as collateral. If a user can’t repay the loan, the protocol is designed to allow anyone to liquidate the collateral and earn a liquidation fee. Liquidators, searchers that specialize in extracting MEV through liquidations of over-collateralized loans, scan the network for transactions that show liquidation opportunities and act to be the first to liquidate a loan, earning the liquidation fees.
MEV practices have certainly placed a strain on cryptocurrency users over the years, presenting a real threat to blockchain ecosystems and the ideals of decentralization and transparency promoted by this technology. Humans.ai is setting the stage for the AI of tomorrow with a state-of-the-art blockchain ecosystem that removes MEV from the equation.