03/02/2025
Hi Folks!
Take a few moment to read about MEV!!!
Is it evil? Is it legitimate? Let's dive into our topic of the day.
1. What is MEV?
MEV stands for “Maximal Extractable Value”.
2. Qui prodest?
Any time you make a DeFi trade, buy or sell an NFT, or lend tokens to a liquidity pool, opportunistic users known as “searchers”😤 may manipulate your trades!
3. How does this work?
Pretty easy, the opportunity is there. Since validators (Proof-of-stake (PoS) blockchains such as Ethereum use parties known as “validators” in order to ensure that the consensus rules of the blockchain are followed by all participants) get randomly selected to add the next block to the blockchain, in order to maximize their profits, these brave people determine what transactions are included in the block, and in WHAT ORDER! All transactions you submit on Ethereum do not immediately get added to the next block. Instead, they first go into the “mempool” which is the collection of all pending transactions. Validators then pull transactions from the mempool and add them to the next block. Here comes the catch! The brave "searchers" can pay validators a fee to order transactions in a specific way.
4. In what environment a MEV would work?
On-chain trading through decentralized exchanges (DEXs) uses Automated Market Makers (AMM), a trading mechanism that allow traders to buy and sell assets in real time maintaining a constant ratio between the prices of two assets. When placing a trade, because the prices of crypto assets are constantly fluctuating, traders set a “slippage tolerance” for their transactions, which represents the maximum price difference they’re willing to accept for their trade. If the gap is too high, a searcher comes in and exploits your trade! How fancy, isn't it?
5. Different MEVs, yes!
Unfortunately the following MEVs can happen 2U:
A) Frontrunning. It occurs when a user makes a transaction but gets “front run” by an MEV bot who makes the same transactions ahead of them. Frontrunning disrupts the fair operation of blockchain transactions, leading to distorted prices, value drain.
B) Backrunning. It's the opposite of latter, and happens when a user makes a transaction that gets followed by an MEV bot executing a strategic transaction right after theirs in order to capture a price movement, so the "backrunner" sells for a profit on a different exchange. Less harmful than the former one, since it does not realize the profit at the expense of the trader.
C) Sandwich attacks. They are a combination of frontrunning and backrunning for maximum profit on the part of the searcher, therefore, are considered the most dangerous type of MEV as they extract the most value from users!!! Sandwich attacks occur when a user’s transaction gets trapped, or “sandwiched,” between two hostile transactions — one before and one after. As a result, the original transaction executes at a much higher price than necessary, leading to an inflated price for the original trader and a profit for the searcher placing the two extra trades.
D) The worse comes at the end: Loss-Versus-Rebalancing (LVR)
This one is hell. LVR is a form of arbitrage that occurs whenever an AMM has an outdated (stale) price in comparison to some other trading venue. Arbitrageurs exploit this price difference by trading from the AMM to the more liquid exchange (usually a centralized exchange like Binance), correcting the arbitrage and extracting value from liquidity providers (LPs) in the process.
6. How to Protect Yourself from MEV?
A) Reduce slippage
B) Use a Custom RPC Endpoint! A Remote Procedure Call (RPC) endpoint is an intermediate layer that routes transactions from a user’s wallet to the blockchain itself. Use a RPC that has a MEV-Blocker!!!
C) Use an MEV-Protected DEX!
Happy trading Folks! 😎
