Blockchain Maximum Extractable Value - How it Affects Decentralised Market Integrity

Unveiling Blockchain MEV: Decentralized Economy Challenges Explored

The decentralised economy involves multiple participants that contribute to the success of each crypto transaction and blockchain operation. Nevertheless, the bandwidth of operations extends beyond sending virtual money to mining, node validating, crypto staking, yield farming, BTC mining and more.

The maximum extractable value is a common practice for blockchain validators and miners to settle transactions and earn their share of rewards. However, some ethical considerations are usually involved in this process. 

Let’s explore the blockchain MEV, how it works, and what the challenges are for decentralised markets.

Understanding Blockchain MEV

When a crypto transaction is initiated, validators and miners are tasked with validating the operation against the set rules of the corresponding blockchain. The process ensures there are sufficient funds in the sender’s wallet and that the operation does not involve malicious actors or elements that might damage the decentralised economy.

Blockchain validators are powered to change and swap the sequence of the pending transactions. This way, they decide which transactions they want to be rewarded for, and logically, high-value transactions are most likely to be chosen first.

The maximum extractable value refers to how much nodes and mining machines earn from each settled transaction. This operation impacts market stability, prices, trading volume and security. 

However, miners and validators seek their personal compensation, which makes them seek transactions that are more rewarding according to the blockchain reward system.

The MEV process takes place in multiple blockchains. However, it is more effective in ETH chains because smart contracts give validating nodes more control over processing transactions in the memepool.

In fact, the process name was changed from miner extractable value to the maximum extractable value because of the Ethereum blockchain, which does not use mining (Proof-of-Work) to settle crypto transactions. Instead, it uses proof of stake.

How Crypto Transactions are Processed?

Let’s take a look back at how crypto transactions are processed. Once a payment is sent from the sender, it goes to the memepool, which gathers all pending transactions on the blockchain. 

Then, nodes start processing and validating on a priority basis. They are more likely to pick up high-value transactions because they bring higher gas fees and compensation. 

Impact of MEV on Decentralised Markets

The MEV principle is common in blockchain transactions. However, operators and participants are concerned about the reordering capability of nodes and miners, which can potentially cast the following outcomes.

Price Arbitrage

Arbitrage is the process of buying from one source at a lower price and selling in another place at a higher price. This might theoretically become applicable if nodes process transactions at different gas fees.

For example, a 10,000 ETH transaction is more likely to cause major price changes to Ethereum, causing the price to drop or surge massively and allowing price arbitrage to happen.

Price Manipulation

When transactions are rearranged, a sandwich attack might happen. This is when a particular pending payment gets surrounded by two transactions aiming to momentarily increase the market price and then decrease it, causing losses to transactions with the same currency.

Transaction Front-Running 

Front-running might be less damaging to the entire economy. However, it might cause severe damage to the affected users. Front-running a transaction means locating a pending payment and placing a new one right before it in the memepool. 

This way, when the new transaction gets processed first, the market price might increase if the new payment is considerably high, causing the following transaction to be validated at a higher rate and gas fees.

DeFi Collateral Liquidation

This process has its pros and cons. It happens when a DeFi project entails lending and when a user or entity takes a loan and fails to repay it on time. In this case, the loanee will lose the collateral they put in exchange for the loan.

However, since decentralised exchanges and economies do not involve a centralised power to perform these duties, MEV participants can find these instances, liquidate the collateral and claim the rewards for themselves.

Conclusion

The blockchain MEV entails validating and mining crypto transactions after reordering and rearranging their sequence in the memepool. The concept refers to how much nodes and miners can make from blockchain operations.

There are a few concerns regarding this operation, involving the nodes’ capabilities to manipulate market prices and payment priorities, leading to significant price changes and settlement delays.