What is a MEV bot and how to extract value from it

As the decentralized finance space on the network continues to grow, another less widely discussed but much more influential force is operating behind a lot of transaction-specific data. This is MEV bot. These automated software crawl the blockchain network and look for opportunities to profit in the form of impending transactions before they are completed. By doing so, they can achieve Maximal Extractable Value (MEV), which has become a major phenomenon in the modern blockchain market.

MEV is defined as the return network participants can earn by ranking transactions within a block, placing transactions, or strategically censoring transactions. The term was initially popularly studied in relation to the Ethereum ecosystem, but now has implications for various blockchain networks that hold examples of decentralized finance.

In fact, MEV bots can execute transactions much faster by continuously scanning a pool of unconfirmed transactions called the mempool. These bots can take advantage of good opportunities by quickly placing their own trades before other traders can respond when they identify promising opportunities.

Origin of MEV

The name Miner Extractable Value was originally known as Miner Extractable Value, a name that comes from the role miners played in proof-of-work networks like Ethereum before proof-of-stake.

Scientists discovered that miners can rearrange transactions within a block to earn additional profits beyond regular transaction fees. Miners can effectively extract value from users by interacting with decentralized finance protocols by prioritizing some transactions or inserting their own transactions.

With Ethereum’s transition to proof-of-stake in 2022, the term was renamed to maximum extractable value, acknowledging that validators and other external participants may also engage in this strategy.

Nowadays, there is competition between professional trading robots and search networks looking for opportunities to detect MEV on decentralized exchanges and lending platforms.

How MEV Bots Work

MEV bots work on the principle of reading through the blockchain mempool to find transactions that can create a profitable market environment.

When a user sends a transaction to a decentralized exchange, that transaction can be viewed in the mempool and confirmed on the blockchain. During this short period of time, the bot examines transaction information and determines whether it can be profitable.

Once an opportunity is identified, bots can submit competing transactions with higher gas fees in less time, making it more likely that validators will give them priority in the next block.

This priority race has created a highly competitive environment commonly known as the MEV market. Here, bots compete with each other to profit from blockchain activity.

General MEV Strategy

MEV bots are commonly known to use a variety of strategies to create value in decentralized financial markets.

Front-running is one of the most actively discussed strategies. The bot will notice when a large order is coming and place the order itself before it happens. The robot purchases assets at a price lower than the bulk purchase price and sells them immediately after purchase, profiting from the price fluctuations that occur to accommodate the initial transaction.

Another type of attack is called a sandwich attack. In this case, the bot places purchases right before the victim’s transactions and sales right after them. The original transaction causes the price to rise, the victim trades at a lower price, and the bot sells at a higher price to make a profit.

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Arbitrage is another opportunity that bots exploit when price discrepancies arise between decentralized exchanges. Since the cryptocurrency market has multiple platforms operating simultaneously, temporary price differences may occur. MEV bots observe these gaps and place trades that profit from the price difference.

Another important source of MEV is liquidation events. If borrowers on a decentralized lending platform do not hold sufficient collateral, their positions may be auctioned. Because liquidations typically involve financial incentives, bots are competing to perform liquidations as quickly as possible.

Extracting Billions of Dollars of Value

MEV has become a major economic force in the blockchain world. The popularity of decentralized finance in 2020 saw billions of dollars worth of MEV funded through blockchain networks.

Most of this work takes place on the Ethereum network because it is the most popular in decentralized finance. Nonetheless, MEV has grown around other networks supporting DeFi applications such as high-performance blockchains.

As trading volume on decentralized exchanges increases, the likelihood of MEV extraction also increases.

Others might argue that MEV essentially adds a level of financial infrastructure to the blockchain ecosystem. This is the level where dedicated traders compete to optimize their trade placements in a profitable manner.

Controversy surrounding MEV

Although MEV can improve market efficiency in some cases, such as arbitrage equilibrium prices between exchanges, it has caused controversy in the blockchain industry.

Some MEV strategies are criticized for being unfair to general users by manipulating the transaction order. Sandwich attacks like this tend to result in traders receiving less favorable prices than they expected when trading swaps on decentralized exchanges.

These interactions can erode trust in decentralized financial system services, especially among retail users who may not know why their orders are being fulfilled at inappropriate prices.

On the other hand, proponents argue that MEV is an inevitable outcome of a transparent blockchain system. Since transactions are publicly visible before being confirmed, greedy traders will of course have the desire to seize the prospects on offer.

Attempts to reduce harmful MEVs

Developers have also responded to these concerns by proposing various solutions to suppress the side effects of MEV activity.

The most notable one is MEV-Boost, a framework that separates block building and block verification. This allows competition from expert builders to develop the most profitable blocks, while validators select the best blocks.

The system aims to create a more transparent market where trade orders can be placed and reduce the incentive for validators to directly manipulate blocks.

Some decentralized exchanges have also implemented protective measures to reduce sandwich attacks. These protections may include limiting transaction visibility or changing the way transactions are executed.

Other research efforts are also looking into cryptographic methods to hide transactions until they are confirmed, preventing bots from using them in the mempool.