UC Berkeley boffins have found that strategies for squeezing extra profit out of Ethereum transactions come at the cost of other cryptocurrency investors and threaten the security and stability of the entire Ethereum ecosystem.
In a paper titled, “Extracting Godl [sic] from the Salt Mines: Ethereum Miners Extracting Value,” doctoral students Julien Piet and Jaiden Fairoze, with computer science professor Nicholas Weaver, throw down a hat-trick of allusions – gold, hodl, and Godel – to make the case that MEV, or “Miner/Maximal Extractable Value” undermines the integrity of the Ethereum network.
The Ethereum network relies on a blockchain made of cryptographically linked blocks of data. Those mining on the network perform proof-of-work calculations with a computer to aggregate a set of transactions into a block and add it to the chain. Doing so incurs transaction fees tied to computational effort known as “gas.”
MEV, as defined in the Ethereum documentation, “refers to the maximum value that can be extracted from block production in excess of the standard block reward and gas fees by including, excluding, and changing the order of transactions in a block.”
It exists because Ethereum miners control the inclusion, exclusion, and ordering of transactions. Though miners are compensated for their contributions to the blockchain, they can order transactions specifically to boost their reward. As the university trio put it, with MEV, “miners make the lion’s share of the profits, rather than independent users of the private relays.”
At its heart, MEV is a form of arbitrage – taking advantage of a price difference or market inefficiency – but it exists in flavors that would be illegal in regulated financial markets. For example, MEV can be extracted via frontrunning – capitalizing on the knowledge of a pending transaction before it gets committed to a block.
Piet, Fairoze, and Weaver note that there’s been concern about frontrunning in the Ethereum community since 2014 and the problems with MEV were made apparent in a 2020 paper titled, “Flash Boys 2.0: Frontrunning in Decentralized Exchanges, Miner Extractable Value, and Consensus Instability.”
The threat posed by MEV has been acknowledged by those overseeing the Ethereum ecosystem, who noted: “As DeFi grows and increases in popularity, MEV may soon significantly outweigh the base Ethereum block reward. With that comes a growing possibility of selfish block remining and consensus instability. Some consider this to be an existential threat to Ethereum, and disincentivizing selfish mining is an active area of research in Ethereum protocol theory.”
In their MEV paper – submitted for review at the 2022 Workshop on the Economics of Information Security – the University of California, Berkeley academics describe how they developed an algorithm to analyze MEV exploitation in previously mined blocks and found that Ethereum miners were collecting most of the rewards, at the expense of other participants.
They found most MEV extractions rely on private transactions, 73 percent of which hide trading activity or re-distribute miner rewards. They also found that 87.6 percent of MEV collection is done through privately submitted transactions. Private transactions on the Ethereum blockchain are rare – only 2.07 per cent of all observed transactions in blocks were private.
Nonetheless, the researchers consider the impact of MEV to be material to the viability of Ethereum. Of more than $6m in MEV profit over a 12-day period, two thirds, the researchers say, went directly to miners. And MEV, they said, represented 9.2 percent of the miners’ profit from transaction fees, or 22.7 per cent when restricted to income from DeFi transactions.
“In total, the MEV extractions in our data generated 2,159 ETH (about 6,400,000 USD), only over 12 days,” the paper says. “As a measure of comparison, this represents 2.2 per cent of the total ETH supply created during that same time, and extrapolates to almost 200,000,000 USD in profits per year.”
MEV, they argue, threatens the stability of the Ethereum network because it “creates network congestion, increases transaction prices, increases the cost of participation in DEXs [decentralized exchanges], and most importantly, threatens blockchain consensus.”
“MEV is basically any strategy you can implement by reordering transactions in a blockchain in order to profit,” said Julien Piet, a doctoral student at UC Berkeley and the lead author of the paper, in a phone interview with The Register. “Some of it is just plain arbitrage, where you’re just exploring basically inefficiencies between different exchange platforms to make money, but most of it is arbitrage at the expense of other users.”
“So let’s say a user wants to buy a lot of some token,” Piet explained. “This person submits this transaction to buy that token. What happens is that, like in traditional finance, the price of the token is going to increase because there’s high demand and less offer.
“The main strategy for MEV is for a person that has more control to buy some token before the transaction and sell it right after and basically benefit from the price increase at the cost of the individual actually buying the token in the middle who’s going to have a worse exchange rate.”
That buyer, Piet said, would lose a few per cent on the transaction.
Essentially, the miners through their transaction ordering ability have financial superpowers that others participating in the system lack.
Piet said there was a system put in place called Flashbots that attempts to address this by making MEV distribution opportunities more fairly available. “But what we found is basically despite the system for fair MEV redistribution, miners still make over 50 per cent of the profits,” he said.
Piet said there are some potential defenses that might be worth investigating, like random transaction order.
“One of the interesting issues is that in Ethereum, like in many blockchains, there’s no regulation authority,” he said. “And so there’s nobody to say well, we want to ensure a specific ordering. We want to make sure this doesn’t happen. In traditional finance, this type of activity – frontrunning and sandwiching – is illegal.”
Given that a significant amount of profit is made today through MEV, and that those conducting transactions don’t have visibility into costs until the transaction is recorded in a block, Piet said he believes regulation is necessary to make Ethereum compatible with traditional finance. ®