What’s MEV?
In the absence of a better explanation, Maximal extractable value (MEV), is a term that refers to various methods used by different market players in order capture more money by exploiting inefficiencies with price on blockchain transactions.
The naive MEV form is known as “transaction sniping.”
Recent manifestations have started appearing in local Bitcoin memepools, thanks to the advent of ordinary trading. On-chain trading is currently done through pre-signed Bitcoin Transactions (PSBTs) without going into detail.
Simple: Some users will list photos on an online market by creating a deal with details, including the price. This feline grail can be purchased by you, as a cat enthusiast, by adding your name, your email address, your transaction fee, and signing the purchase transaction. This transaction will be broadcasted and settled by the Bitcoin network.
Easy, right?
No, it’s not so.
It turns out that cats are very popular these days, and your prize is being eyed by other cat lovers. Open offers allow anyone to influence your purchase. PSBT listings work as auctions and not exclusive sales. Each transaction associated with the cat in the mempool is available for bidding. Bitcoin’s 10 minute block interval allows for cat traders to take advantage of the opportunity. “snipe” The most valuable items are traded for. A transaction is not settled until it becomes a block.
From this, we can learn that auctions on the chain are susceptible to the settlement times of the blockchain where they take place. The problem is especially difficult for those who want to do more than trade cat images.
What causes MEV?
Why is MEV so important? Aren’t we all agitated by a couple of degens competing to outbid each other over cat images?
To answer this question, you’ll need to open up a new can of worms. The answer to this question will require you to open up a whole new can of worms.
MEV, as you can see, is a huge business. MEV-Boost is the software that coordinates the MEV extraction on Ethereum. In less than two years it has distributed close to 500,000 ETH In rewards Nearly 2 billion dollars in rewards!
The trading market drives the entire industry. (read: degens)
Automated Market Makers (AMMs) on-chain use the popular liquidity pool concept to let users trade assets, without having to rely on central order books. The pool is usually made up of a couple of assets such as Ethereum and USDC.
Users can interact with liquidity pools when they want to swap one asset for another. The relative price of each asset in the pool is affected by every trade. AMMs, which do not require centralized orderbooks where the buyer and seller are always matched up for each transaction, can instead be used as decentralized contracts on chain.
Upon creation of a trading pair, users can choose to trade in the pool against it or provide liquidity. Liquidity is contributed by supplying both or one of the assets, and ensuring that the ratio remains correct. Arbitrage is possible when there’s an imbalance. Market makers can buy the asset at the lower price from the pool, and sell it for a higher rate in another venue such as the centralized exchange. These activities and the fees earned by liquidity providers from trades encourage traders to maintain these liquid markets.
You may have heard of DeFi, but you might not know what they are. Here’s the scoop. The permissionless nature of liquidity pools has led to their popularity. Upon closer inspection, we can observe that these trades are not fundamentally different from the cat market we discussed earlier — they’re just on-chain auctions.
You can imagine that Ethereum’s additional programability and architecture creates a fertile environment where these auctions could be manipulated and misused.
Front running is the one that many people choose. AMMs don’t settle instantly. Ethereum has a similar army to cat snipers that can watch the Bitcoin mempool looking for lucrative deals. financial Mercenaries carefully monitor every business opportunity.
But the ETH Boys aren’t messing around with that stuff. There’s not Private Ryan there, but SEAL team six. The SEAL Team Six uses a variety of elaborate methods to take advantage of the gap in time between the broadcasting and confirmation on the blockchain. The front runners can then place their bets. own Transactions made before the original transaction, allowing them to profit from any price increases they cause. It is common for regular users to get lower prices than they expected. Sandwiching is one of the most common ways to do this. A buy order will be placed before the user trades and then a sale order immediately after. This allows the trader who originally traded the order to capture the difference in price.
Although these dynamics were controversial for their effect on user experience they are only part of MEV’s economy. While these dynamics have been controversial because of their effect on user experience, they only represent a portion of the MEV economy. biggest source of MEVBy a large margin, the word comes from “Loss-Versus-Rebalancing.” Simply put, this is a negative form of pool arbitration described above that impacts liquidity providers.
Arbitrage traders rebalance a liquidity pool when the asset prices diverge from those at which the assets were initially deposited. This reflects the current global market price. As liquidity providers are not able to react to the market fluctuations between blocks, they become vulnerable. They are easy targets for traders who have access to central order books due to the fact that they’re exposed to old prices. The traders take advantage of the discrepancies in prices, leaving liquidity providers with less desirable asset mixes and lower overall values.
It is a dire situation. recent research paper The matter is:
In the vast majority of pools that currently contain hundreds of millions US dollars, we found the main result to be the fact that arbitrageurs’ losses are greater than earnings on fees. It is interesting to note that this result makes us wonder why LPs continue to contribute money into the pools.
Hedging and other factors have been able to mitigate these issues in larger operations, but it is likely that the extreme conditions have resulted into the consolidation of the liquidity provisioning among a small number of players.
Why are we interested in Ethereum?
Good question, anon! It’s because I think that a large part of recent discussion around MEV for Bitcoin has completely overlooked the fact these systems do exist within a technical context. It’s understandable that unfamiliar concepts may cause some skepticism. However, the majority of these dynamics have been well-understood by now. It is a mistake to view it strictly through a technical prism.
It’s not impossible that different proposals to enhance Bitcoin scripting could introduce more expressiveness to the protocol. A combination of features might allow for someone to develop the equivalent of AMMs on-chain. There’s no doubt that something of the magnitude of Ethereum could have negative effects on Bitcoin’s decentralization. MEV is known to encourage high-level specialization in mining. Matt Corallo, the Spiral creator has put together an excellent guide to help you understand what risks are involved. primer On the subject.
Unfortunately, everyone has ignored the main aspect of this topic. The economic incentive is the driving force behind MEVs and all associated systems. Different factors can significantly impact the viability.
The story of the cats shows how the time interval between blocks is crucial to the on-chain game theory. The theory has been confirmed by documented evidence. Researchers generally agree The longer block time exacerbates issues with MEV. It is a challenge to anyone who wants to build AMM on the Bitcoin blockchain.
Is Bitcoin in danger?
It’s reasonable to question whether, when comparing Bitcoin with Ethereum and its block interval of 10 minutes to 12 seconds that the Proof of Work-based security is compatible in all of these large on-chain transactions.
A prolonged time interval between Bitcoin block means that the liquidity providers will be subjected to stagnant prices, and this can make it unfeasible to commit large amounts of capital. The increased latency can increase the risks of MEV abuse and front-running. Arbitrage is a dream come true!
Those observations show that Bitcoin on-chain trading may not even be possible if the technology is developed. This use case is increasingly optimized for speed and efficiency. Bitcoin has little chance to compete. Users will prefer platforms that are more aligned to their needs and capital allocators may shy away from this risk.
It is important to consider the economic implications of any technical change made to the Bitcoin protocol. Do not be misled, this discussion is being driven by those who want to duplicate the success of Bitcoin. financial MEV flywheel on Bitcoin. They see this as an opportunity for reusing proven business models worth billions of dollars, now that attitudes have changed in regard to protocol-level innovation.
Bitcoin’s long-term, slow and steady settlement is an effective deterrent for predatory MEVs. The study is not comprehensive and more evaluations are needed to determine the MEV risks of layers that have been built on top of the protocol. The fear that Bitcoin will be overrun by the MEV monstrosity is a very compelling one. Bitcoin offers an inherent protection against MEV attacks, as the transactional finality delay is a form of security.
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Source: bitcoinmagazine.com