Written by: 0xFishylosopher Compiled by: Deep Tide TechFlow

introduce

MEV, or Maximum Extractable Value, is a by-product of blockchain design and a unique DeFi phenomenon.

Essentially, MEV is just an instance of profit-maximizing behavior, where validators operating a blockchain seek to maximize their profits on the task of validating transactions. While one could argue that MEV can be beneficial by improving capital efficiency, it can significantly impact the user experience of using decentralized applications, including higher gas fees, slippage, and risks such as validator collusion and centralization.

In this article, 0xFishylosopher will first explore MEV as a theoretical concept and the systemic risk it poses to the ecosystem. It then follows, using Flashbots as a case study, to explore how the DeFi community is trying to address all of these negative externalities of MEV.

「Flash Boys」Club

MEV is a feature of blockchain technology, not a bug of blockchain technology. In a given blockchain network, validators (or miners in the traditional PoW model) decide what data to put on-chain. Specifically, they can control the order of which data is on-chain. It turns out that certain transactions give validators huge profits. Therefore, as rational economic agents, validators will arrange transactions in a way that maximizes transaction fees.

The concept of this MEV was first elaborated by smart contract researcher Phil Dainan in an important paper called "Flash Boys 2.0," in which the researchers highlighted the existence of a large number of bots and arbitrage agents trying to "predict and exploit" ordinary users' DEX Trading, similar to high-frequency traders in traditional finance, actively optimizes transaction delays. To get an idea of the scale of this phenomenon, in the last 24 hours of this writing alone, 2578 ETH, or roughly $4.9 million in profits at current prices, has been realized through MEV operations.

While MEV is a broad term that encompasses many different arbitrage methods and scenarios, there are a few key features that underpin DeFi's many MEV opportunities. First, many MEVs are implemented through a process called Priority Gas Auction (PGA), where users pay higher transaction (gas) fees in order to have their transactions run first. Since many arbitrage bots rely on having their transactions run first for profit, these bots will engage in Gas bidding wars, constantly raising prices in order to get their transactions run by validators, causing severe network congestion and making it impossible for regular users to run them transactions unless they also pay exorbitant transaction fees.

Validators, on the other hand, are one of the main beneficiaries of this scenario. In fact, the greater the power, the greater the profit: since validators (at least in theory) have the power to decide which transactions to run, they can earn "ordering optimization" fees by determining which transactions bring them the most cash. In practice, however, it is too cumbersome for validators to go through the entire MEV search, packaging, and execution process. As a result, most of the "ranking optimization" is outsourced to specialized searchers, builders, and relayers, intermediaries who can be imagined as "secretaries" to validators who simplify the MEV process for a portion of the profits. Specifically, Seekers will look for MEV opportunities, Builders will bundle these opportunities into complete "blocks", and relayers will send these complete "blocks" to validators or actual block builders. Thus, the general picture of the modern MEV ecosystem is as follows:

As we mentioned before, while the arbitrage enabled by MEV can bring some benefits, including greater capital efficiency and ensuring that prices are consistent across exchanges, there can be huge negative externalities for end users. Sexuality, such as resulting in higher transaction fees, slower execution, and higher slippage (such as sandwich attacks). However, this is not the biggest risk MEV poses to the blockchain — especially if validators collude with each other, MEV could actually undermine the security of the blockchain’s consensus layer.

This security issue stems from the problem of incentive alignment - in all these profitable MEV opportunities, miners can make more profits by optimizing transaction fees rather than sticking to a constant block reward subsidy. As Dainan writes:

Thus, a miner can fork a high-fee block, reserving some of the fees to entice other miners to build on that fork. In extreme cases, incentives to deviate from the protocol can cause confusion in the strategies of economically rational miners, reducing the security provided by block confirmations.

This is known as an "undercutting attack" and is one of several ways in which MEV can undermine the basic security guarantees of the blockchain. Other known attacks include "time bandit attacks", where instead of colluding to steal profitable transactions from the current block, validators collude to rewrite MEV opportunities in past history. Furthermore, MEV withdrawals don’t even need to happen on-chain, as they can be done entirely through off-chain backdoor transactions, such as between large transactors and validators.

Therefore, we can see that MEV practices face a lot of risk in the blockchain ecosystem.

Flashbots and the War Against MEV

Given the potentially serious consequences of unrestricted MEVs, several projects and groups have worked on mitigating the negative externalities of this practice. One of the most important groups in this space is Flashbots, a project dedicated to realigning MEV incentives in a way that sufficiently rewards validators for building the chain honestly, while mitigating the worst effects for ordinary users. Way.

To this end, Flashbots attempt to take three distinct steps: (1) uncover the "dark forest" of MEVs, (2) democratize MEV extraction, and (3) redistribute benefits back into the ecosystem. To achieve the first goal, Flashbots has a dedicated product called MEV-inspect, which aims to "light up" the "dark forest" of MEVs, to quantify the negative externalities caused by MEVs and highlight the scale of the problem.

On the other hand, democratizing MEV's twin goals of extracting and redistributing benefits is more complex, encompassing a full suite of products that evolve over time as the scope and focus of the problem change. In some respects, it could be argued that Flashbots’ history of product development over the past two years is itself a timeline of Ethereum’s growth and development.

The first significant set of products released by Flashbots was the MEV-Geth client, or a modified version of Golang for Ethereum, which is better able to prevent MEV manipulation by routing it to a private transaction pool. A MEV auction market is built on top of this new client, using the "first price sealed bid" method (also known as "blind bidding"), where each participant is only allowed to submit one price, and none of the auction participants know The price at which other participants bid. By this design, Flashbots mitigate the previously discussed "price bidding" wars.

The guiding principle behind the creation of MEV-Geth and the MEV marketplace is to decentralize the power and responsibility of the validator building blocks themselves through an incentivized realignment process called "proposer-builder separation". Instead of having to go through the complicated MEV search and transaction packaging process, validators using MEV auctions can simply look at the MEV market, find which transactions will give them the highest MEV, and place a single bid that reflects their actual preferences. Additionally, to prevent validators from including their own transactions and profiting from user transactions preceded by transactions, actual transaction details (buy orders, sell orders, liquidations, etc.) are not made public until after block construction is complete.

So why would a validator use this algorithm and forego the previously mentioned profitable MEV opportunity? This is because the Flashbots algorithm only needs to select MEV transactions from the market, which is easier and cheaper for validators. As more and more high-quality MEV transactions go through this market rather than directly on-chain, validators can earn higher rewards by sticking with Flashbots. The results are very impressive: shortly after the release of MEV-Geth, over 90% of Ethereum validators started using this scheme, thus showing the importance and effectiveness of incentivized realignment in solving potential problems. But as the Ethereum ecosystem evolves from a Proof of Work (PoW) model to a Proof of Stake (PoS) model starting in September 2022, this conceptual change based on the "proposer-builder separation" also become inevitable.

The main reason why PoS is more efficient than PoW is that in PoW, every node has to build and propose blocks from scratch, while in PoS, only a few validators act as the main block proposers to append data to the blockchain . While this is great for the environment and computational efficiency, due to the favorable attractiveness of MEV, this may introduce additional centralization risks, especially if validators ("proposers") are linked to the key "builders" of market sellers. "collusion. Even private exchange pools run by Flashbots themselves may be tempted by collusion, and of course placing trust in a single entity such as Flashbots goes against the idea of decentralization.

The release of MEV-boost decentralizes the "supply side" of this MEV market. MEV-boost not only includes transactions from Flashbots private transaction pool (essentially a monopoly), but also allows any builder running this software to submit transactions to all participating validators. For validators, as more builders participate in building all these different blocks, this allows them to earn more income and balances which validators have access to which transactions, creating a stronger and more secure ecosystem. Like MEV-Geth, this novel design realigns the incentives of multiple parties to avoid centralization risk, and has been a huge success, with over 85% of the network adopting this design, of which Flashbots only passed 34% of the trade.

Flashbots SUAVE

As such, the task of mitigating all centralization risks and shielding decentralized finance from the most pernicious effects of MEV remains unfinished so far. By enforcing a proposer-builder separation, Flashbots' solution has decentralized or redirected key power and responsibility of validators to "builders", treating these "builders" as distinct from the builders who choose validator transactions The entity import. In practice, however, there are significant builder economies of scale, which in turn lead to a risk of centralization of the builder role.

So what do economies of scale for the builder role look like? Recall that the previously mentioned searchers, builders, and relayers all play different roles, with searchers searching for MEV opportunities and then sending them to builders, who in turn send complete blocks to relayers. This means searchers have to choose who to send their results to. To maximize their rewards, they select the highest quality builders whose transactions are most commonly selected by validators. This creates a centralizing effect as more and more high-quality deals flow to the top builders, who will always get the highest quality MEV deals from Seekers, strengthening their position.

Practice has proved that this builder centralization effect exists. In the last 24 hours of writing, the top 5 builders proposed about 90% of the total MEV-Boost blocks. As this level of centralization increases, these oligarchs may begin to use their dominance to manipulate transactions, including colluding and censoring certain transactions, which could again compromise the security of the underlying blockchain. That's the motivation behind Flashbots' latest project: a single unified auction of value expressions, which aims to disentangle the block building process from any single blockchain and outsource it to a separate network, thereby decentralizing the Role.

SUAVE is actually an independent, dedicated block ordering chain that will be responsible for the transaction mempool and builder roles, while the validators of the original chain (such as Ethereum) will be responsible for the proposal and proof roles. As we can see, SUAVE is a natural extension of the "proposer-builder separation" principle, where we put proposers and builders on two completely separate chains so that they are both sufficiently decentralized and separated from each other . Furthermore, the vision of SUAVE is that it will serve as a common ordering layer for many different chains, so that whether you are a validator of Ethereum, Arbitrum, Polygon or any other EVM chain, you can use SUAVE to find the best MEV opportunities, not only for It is applicable to the original chain you are in, and it is also applicable to the cross-domain MEV of cross-chain transactions, which cannot be obtained by simply looking at the transaction memory pool of the chain.

Although SUAVE has a grand vision to ultimately benefit all parties involved and make the Ethereum ecosystem more decentralized, there are still some key design issues that need to be resolved in the 6 months since its inception in November 2022. For example, one of the central questions is whether to build SUAVE as a separate L1 chain (similar to Chainlink), or use a Rollup solution, or "borrow" a re-staking service for Ethereum validators, such as Eigenlayer. Each solution has its own unique trade-offs in terms of ease of implementation, validator retention, security, and flexibility, which we won't discuss in detail here.

Another central question is whether SUAVE will issue its own token. While the SUAVE forum is currently denying that it will not launch its own token "for now" and continue to use ETH as its native token on its native chain, there are several questions as to whether Flashbots will stick with this, especially since in the long run Looking at it, launching the SUAVE token seems to be the most economical option for Flashbots as a private company. Furthermore, it is fair to argue that the reason Flashbots believes it can raise a $1 billion unicorn valuation in a bear market is the implicit promise of a future SUAVE token launch.

So what's stopping Flashbots from announcing that it is launching SUAVE tokens? As it turns out, launching a token comes with several head-scratching design decisions. For example, is this token useful for certain transactions, or is it just "another governance-only token"? If this token is going to have utility, what will that utility look like? How to incentivize different stakeholders of Flashbots (e.g. different chains, end users, builders on Flashbots, etc.) to use and trust this new token over more established tokens like ETH or even L2 tokens like ARB? In any case, the complex incentive alignment process would need to be resolved, so the Flashbots team has every reason to avoid this problem for now.

Beyond Flashbots: The big picture of the future of DeFi

While it's too early to tell what form SUAVE will ultimately take, and whether this brand new ordering chain will be able to achieve its original goals and align incentives in a way that actually mitigates MEV's negative externalities, I think MEV and Flashbots represent a canonical image of the various tradeoffs, issues, and principles that go into designing a truly decentralized financial system.

First, as mentioned before, MEV is a feature of blockchain technology, not a bug. These arbitrage opportunities and profit incentives for validators stem from the instant accessibility of the blockchain and guarantee the capital efficiency of DeFi. The negative effects of MEV, including network congestion, gas wars, and end-user slippage, are just by-products and negative externalities of this process.

By definition, negative externalities do not affect agents engaging in negative behavior. In this case, causing network congestion and slippage to end users does not harm validators or arbitrage bots engaging in this profitable activity. In traditional economics, a purely market-based system cannot handle all these externalities well. Traditionally, governments or other regulators have stepped in to correct market dynamics and minimize the impact of negative externalities (such as taxes on tobacco and alcohol).

DeFi, on the other hand, is inherently trustless and opposed to any form of human government enforcement. The closest it comes to a "law enforcement agency" is to achieve certainty and transparency by encoding rules and regulations in code (e.g. through smart contracts). Thus, as the Flashbots story demonstrates, reducing the negative externalities of the MEV phenomenon has always relied on a complex process of incentive redesign and alignment. After all, like Wall Street quantitative traders, DeFi arbitrage bots are not known for their high ethical standards and goodwill.

Using incentive redesign to reduce MEV's negative externalities is not just an intrinsic feature of the Flashbots team. In addition to Flashbots, there are many other teams trying to realign incentives and develop protocols to reduce the impact of MEV. For example, Chainlink’s Fair Sequencing Service (FSS) leverages its decentralized oracle network to outsource the “transaction ordering” process to validators, achieving a goal similar to what the SUAVE network is pursuing. Another example is the "Coincidence of Demand" (CoW) mechanism on the CoW protocol (formerly known as Gnosis Chain), which is based on whether the transaction is complementary (for example, I want 1500 USDC for 1 ETH, and you want 1 ETH for 1500 USDC) Automatically glue deals together and use solver algorithms to ensure everyone trades at the best price.

However, doing incentive redesign in a decentralized setting where you don't trust any single party can be a very difficult task because, fundamentally, you're trying to negate economies of scale. For example, where builders of Flashbots are centralized, builders who have "proven their worth" are more likely to be "trusted" by searchers, who will give them more high-quality deals and solidify them as market leaders position of the recipient. Identifying, addressing, and implementing decentralized alternatives through incentive realignment is essentially playing whack-a-mole - you never know what centralization vulnerabilities and hidden vulnerabilities a newly introduced incentive system may contain. Economies of scale, all of which only matter in hindsight.

Furthermore, in a complex system (such as a blockchain) with many different stakeholders and agents, it is nearly impossible to avoid externalities, as there will almost certainly be corners where the actions of one stakeholder will spill over and affect Action by another stakeholder. As Dainan demonstrates in "Flash Boys v2.0," many of these externalities can pose real threats, destabilizing the entire system. Therefore, any decentralized system - even those with a well-designed game theory - will always have this inherent complexity, subtlety and vulnerability, where an unexpected loophole could threaten its existence.

Compared with centralized systems, decentralized systems do not contain any obvious "single point of failure" - but it is this that makes decentralized systems sometimes more lethal than their centralized counterparts. Each node has the potential to become a "single point of failure" if there are loopholes in the system design.

In the end, the story of MEV and Flashbots tells us that maintaining the health of a decentralized system will always require continuous, hard work—continuous participation in the game of whack-a-mole. Diffusion of trust in decentralized systems requires diffusion of responsibility and vigilance, especially since there are so many economic incentives in staking: for better or for worse, MEV is always there.