What Is Maximal Extractable Value (MEV)?

The popularity of smart contract-based applications opens loopholes for generating additional revenue due to market inefficiencies, the peculiarities of #Ethereum and other blockchain architectures, and the automatic market maker mechanism prevalent in DeFi with its inherent slippages and volatile losses.

One such loophole is MEV. MEV refers to the maximum amount of value a blockchain miner or validator can make by including, excluding, or changing the order of transactions during the block production process.

MEV occurs when the block producers in a blockchain (e.g. miners, validators) are able to extract value by arbitrarily reordering, including, or excluding transactions within a block, often to the harm of users.

How Does MEV Work?

Since each block in blockchain can only contain a limited number of transactions, block producers have full autonomy in selecting which pending transactions in the mempool—the location block producers store unconfirmed transactions off-chain—they will include in their block.

Block producers can extract additional value by taking advantage of their ability to arbitrarily reorder transactions, creating what is known as maximal-extractable value (MEV).

MEV Example (Frontrunning and Sandwich Attacks)

For example, if a large trade is spotted, a frontrunning bot can copy the user’s trade and create a transaction bundle where their transaction is processed first before the user’s trade. This moves the market price of the asset being traded, causing the user’s trade to incur a larger amount of slippage—the difference between the expected price of a trade and the actual price.

As a result, the user’s trade is executed at a suboptimal exchange rate, increasing the costs of using decentralized exchanges in the form of an “invisible fee” where fewer tokens than initially expected are received.

Sources: Chainlink, Forklog

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