Key points to remember
- While MEV is typically associated with Ethereum, proof of stake networks are also affected.
- In addition to giving users lower rates on transactions, MEV also undermines decentralization on proof of stake networks.
- Eden Network aims to fight against SRM by redistributing profits via the EDEN token.
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While maximum extractable value is typically associated with the Ethereum network, there are many ways to extract value from transactions on proof-of-stake networks. In this feature, Caleb Sheridan of Eden Network explains how MEV on proof of stake chains undermines decentralization and makes transactions more expensive for users.
MEV on proof of stake networks
Maximum extractable value, also known as Miner Extractable Value or MEV, refers to the profits made by reorganizing, inserting or censoring transactions on a blockchain network. This usually affects users who interact with decentralized exchanges and others DeFi applications. While MEV is typically associated with Ethereum, which is currently a Proof-of-Work blockchain, other blockchains using validation mechanisms such as Proof-of-Stake are not immune.
Many forms of SRMs that reorganize or execute batches of transactions can be more difficult to perform on networks such as Solana. However, even on high speed blockchains, transactions are still vulnerable to SRM via front-running.
Front-running consists of identifying a favorable transaction submitted to the blockchain and quickly placing another transaction to be processed before it. An example of how this can extract value is when a transaction appears on the network for a large order to buy a certain token.
When large orders are placed, asset prices typically increase due to supply and demand. Knowing that a large transaction has been made but not yet processed, a third party may have their own buy order for the token processed first, knowing that the price will increase after the initial transaction is processed.
The whole process takes place in a few milliseconds and is therefore always carried out by advanced MEV robots. Even on networks like Solana, which has a block time latency of 400 milliseconds, MEV bots have more than enough time to identify those favorable transactions from which to extract value.
While this top-notch process levies an “invisible tax” on traders by making their buy orders slightly more expensive, it also performs many valuable functions. MEV researchers specializing in extracting value through loan offsets in loan markets such as Aave and Compound help keep those markets healthy. When multiple MEV robots compete to liquidate positions, it also helps keep prices optimized. It also improves decentralization as liquidations don’t rely on a single bot or mechanism.
While MEV can be a nuisance for merchants, it also helps DeFi protocols work more efficiently. However, for Proof-of-Stake chains, MEV doesn’t just mean getting slightly lower rates on your trades, it is an active incentive for centralization.
SRM and Centralization
Before considering how MEV increases centralization, it is worth defining the main difference between Proof-of-Work and Proof-of-Stake validation.
On proof of work networks like Ethereum, most blocks are mined by pools like Ethermine and f2pool. These pools link individual miners all over the world and combine their hashing power to try and mine blocks. Miners process thousands of equations per second, hoping to find the correct answer first and receive the privilege of mining the next block. Using this validation method means that there is no guarantee as to which individual miner in a pool will reach the next block, if any, making it nearly impossible to predict.
In contrast, for most Proof-of-Stake networks, the more participation a validator has delegated to them, the more often they are chosen to write new transactions in the next block. While this mechanism is necessary in order for the rewards to scale the number of tokens involved, it does pose issues as to how it affects the behavior of those who conduct SRM activities.
Since dominant validators are often able to write transactions first due to their high turnout, they have the most opportunities to run MEV on transactions. Eden Network Caleb sheridan explained to Crypto Briefing how validators with the highest stakes can form a monopoly on MEV as they can submit responses to transactions they hear about before anyone else. He said:
“Let’s say you had 100 tokens wagered, or enough to give yourself an edge, you would make more money from SRM activities, and you could wager more tokens, and you could actually have more power in the network.” to do more powerful things. It just goes on like this, and no one can really knock you down, and that’s why it has the name “The Kingmaker Effect”.
This creates a situation where a single validator or “T-Rex” can take advantage of almost any VPD opportunity on a network. Sheridan explained how a dominant “T-Rex” recently took advantage of MEV opportunities on Avalanche:
“On Avalanche, there was a T-Rex, there is always one. But in this case, there was a bot that did every decentralized exchange arbitrage and liquidation. Each all, then just apply the profits in the underlying bet and become very powerful doing it. In the case of Avalanche, they actually tweaked their consensus mechanism a bit to prevent it from happening. “
In addition to centralizing MEV activities on a single validator, the mechanisms that produce the Kingmaker effect also encourage validators to group together geographically to more quickly discover transactions on the network. Sheridan added:
“If you have a server with a huge amount of stakes sitting next to a bunch of other servers, you hear about transactions faster. You can propagate your own transactions and blocks faster, so it is very beneficial for you to sit right next to everyone’s nodes.
The most likely way for this clustering of nodes is to go through a centralized provider such as Amazon Web Services. As those looking to conduct MEV activities are encouraged to host their nodes on the same servers as the larger validators, much of the network can end up concentrated in a single data center. This could expose a network to a single point of failure if the server hosting the majority of nodes goes offline.
Although the SRM on Proof-of-Stake networks has proven to be problematic, the situation is not irreparable. As Avalanche did, other networks may modify their consensus mechanisms to prevent “T-Rex” validators from dominating the SRM and undermining decentralization. Additionally, projects like Eden Network allow users to regain control of their transactions by protecting users from previews and redistributing SRM profits through the EDEN token. While Eden Network currently only operates on Ethereum, Sheridan has revealed that he plans to expand to other Layer 1 chains in the future when transaction volumes increase enough to make a launch viable.
Disclosure: At the time of writing this feature, the author owned BTC, ETH, and several other cryptocurrencies.
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