What is the MEV Supply Chain?

The MEV Supply Chain describes the chain of activity which helps users transform intentions into finalized state transitions in the presence of MEV. While the terminology is new, this supply chain actually exists in all blockchains regardless of the MEV mitigation technique or ordering rules they use. In fact, I would go as far as to say it exists in any market for user data, including traditional financial markets. But, this is a topic for a separate discussion. For today, let’s focus on blockchains.

User - The user is anyone with an intention to enact a state transition on a blockchain. More abstractly, you can think of this as anyone with a specific preference on the future state of the world. An example of a specific user intent is swapping USDC for ETH at the best possible price. Since users don’t yet have their brains plugged directly into the metaverse, they need help to execute their intentions.

Wallet - The wallet is the user interface which helps the user encode their intent into a transaction that the blockchain can understand. Here, I group together everything at the application layer including dapp UI, wallet, and smart contract protocol as they work together to express user intent. Note: developers at this layer make decisions on behalf of their users on how to deal with MEV. One key decision they make is whether to route user transactions to a public transaction pool where they can be picked off by searchers indiscriminately, or to send them to a private routing system like Flashbots Protect which restricts what searchers can do with the transactions. You can find the mev.day panel discussion about dealing with MEV at the application layer here.

Searcher - Searchers have a simple job: extract all the MEV possible for themselves. A searcher takes user transactions from all sources and converts them into complex transaction types like bundles. This is an important role because the liquidity, arbitrage, and liquidations performed by searchers is what makes markets possible. However, in a dysfunctional supply chain, searchers can extract disproportionate value relative to the service they provide.

Builder - Builders have many names today, but their job is to aggregate transactions from various sources and construct a block. In Ethereum today, mining pools are performing the builder role. In a L2 execution system, the sequencer is the builder as they construct rollup payloads to submit to the L1.

Validator - Validators perform consensus duties which include validating and finalizing blocks. Historically, builders and validators have been the same logical entity. The introduction of Block Proposer / Builder Separation (PBS for short) to the Ethereum roadmap and the development of rollup centric data availability chains aim to separate these roles. As Vitalik describes in his Endgame post, such a separation aims to maximize validator decentralization.

MEV Supply Chain - Utopia or Dystopia?

In my last post, I trolled about the idea of the MEV Utopia and Dystopia and the characteristics that each future presents. Let’s see how we can apply this dichotomy to the MEV supply chain.

MEV can generally be thought of as originating from user interactions, whether directly or indirectly. A user submitting a large trade against a CEX can generate a direct arbitrage opportunity against multiple DEX and CEX on various domains. A user taking out a loan on a lending protocol creates an indirect liquidation opportunity at a future point in time.

I find the most useful heuristic for identifying if an MEV supply chain is tending towards a Utopia or a Dystopia is to look at value accrual.

In the MEV Dystopia, the MEV generated by users is captured in the center of the supply chain. We can call this future Centralized Block Building.

There are many paths to centralized block building. The most likely is for some sophisticated searchers with a monopoly on their strategy space to integrate up and down the supply chain in an attempt to obtain a competitive advantage in other strategies and increase barriers to entry. This kind of vertical integration is textbook anti-competitive behavior and we are already seeing it emerge in various domains leading to what we can describe as the “MEV MegaFund Blackbox”. Hasu gave a great talk at mev.day which explored this failure mode in depth.

In the MEV Utopia, all the MEV generated by users is returned to users, either in the form of direct cashbacks, gas fee subsidies, or network security subsidies. We can call this future Decentralized Block Building.

Decentralized block building means each role is fulfilled by independent entities who compete in an open marketplace with low barriers to entry. The Flashbots Auction successfully introduced such a market between searchers and builders. In POW Ethereum there is little incentive for searchers to vertically integrate with miners while network security subsidies are maximized. Flashbots Protect and MEV-Boost extend this market to other layers of the supply chain.

It’s important to keep in mind utopias are often unreachable and reality lies somewhere between utopia and dystopia. My goal in framing the MEV supply chain using this dichotomy is to provide a simple heuristic through which you can evaluate the quickly evolving ecosystem. As users and developers, it’s your responsibility to use and build products which help the industry trend towards a decentralized utopian future rather than a centralized dystopian one.

Utopia or Dystopia, which will you pick?

Stephane Gosselin (thegostep)

Architect, Steward, and Founder @ Flashbots

The outcome of the ConstitutionDAO was somewhat predictable. With the max bid of the DAO being public information, any interested buyer was aware of the floor price and could make sure to have sufficient capital on hand to win the auction. Meanwhile, the DAO was unable to collect additional capital, even though it was clear it could have with more time.

Ken has made his fortune benefiting from exploiting asymetric information advantages in markets. His company, Citadel Securities, makes money by purchasing the exclusive right to see the state of retail orders before anyone else. Ironic to say the least.

Many crypto believers presume this behavior is impossible in defi. They take censorship resistance and equal opportunity for granted. What they fail to realize is that the defi ecosystem is shifting towards the tradfi model of finance at an accelerated pace.

I call this the MEV dystopia.

https://twitter.com/thegostep/status/1456304174178742276

It's easy to brush off MEV as inconsequential and ignore the impact it has on economic systems. "Arbitrage is not MEV" and "CEXs can't have MEV" are both narratives that miss the forest for the trees.

The reality is, without active efforts to build technical solutions which enable the democratization of MEV in all its forms, blockchains will turn into systems in which a small set of actors have an entrenched advantage which cannot be displaced due to barriers to entry.

This transition might be portrayed as "the market finding efficiency" but in reality it involve hiding skeletons in the closet. Those skeletons come back out to haunt retail investors in the form of flash crashes, cascading failures, and censorship.

Protocol developers today are building systems which have the embedded assumption that actors like Ken Griffin have the best economic interest of retail investors at heart.

Maybe it’s time to think again.

In this article, we cover the context and motivation for this project. Technical details of our proposed solution can be found on the ETHResearch forum.

What is MEV

Miner extractable value (MEV) is a measure devised to study consensus security by modeling the profit a miner (or validator, sequencer, or other privileged protocol actor) can make through their ability to arbitrarily include, exclude, or re-order transactions from the blocks they produce. MEV includes both 'conventional' profits from transaction fees and block rewards, and 'unconventional' profits from transaction reordering, transaction insertion, and transaction censorship within the block a miner is producing.

The term MEV can be misleading as one would assume it is miners who are extracting this value. In reality, the MEV present on Ethereum today is predominantly captured by DeFi traders through structural arbitrage trading strategies; miners indirectly profit from these traders' transaction fees. One example of such structural arbitrage opportunities are Uniswap price arbitrage trades: when a Uniswap pool's assets become mispriced, a profit opportunity is created to arbitrage the Uniswap pool back to parity with other trading venues. Of course, rather than letting the trader pay them a transaction fee for the privilege of collecting the arb profit, a miner could simply decide to run this strategy themselves.

The MEV Crisis

Transactors on Ethereum express their willingness to pay for inclusion in a block through their transaction's gas price, and therefore through the transaction fee they indicate they are willing to pay miners. Miners, as economically rational actors, pick the transactions with the highest gas price and order them by gas spend in the block they are producing. The financial system being built on Ethereum creates many 'pure' profit opportunities such as liquidations and arbitrages of many kinds. However, these opportunities are finite and episodic, and as such, traders compete to claim them. Right now, this competition is primarily expressed either via frontrunning, or via backrunning:

Frontrunning (also known as Priority Gas Auctions (PGAs)): Transaction A is broadcasted with a higher gas price than an already pending transaction B so that A gets mined before B. (eg. to snatch a Uniswap price arbitrage trade to rebalance a pool).

Backrunning: Transaction A is broadcasted with a slightly lower gas price than already pending transaction B so that A gets mined right after B in the same block. (eg. to execute a DyDx liquidation after a price oracle update that triggers a DyDx loan to go under the required collateralization ratio).

Unfortunately, both frontrunning and backrunning are inefficient and lead to negative externalities such as network congestion (i.e. p2p network load) and chain congestion (i.e. blockspace usage). In addition, this competition for MEV opportunities leads to Ethereum consensus security instability due to the creation of incentives for time-bandit attacks and permissioned communication infrastructure between traders and miners. Such an infrastructure erodes the neutrality, transparency, decentralization, and permissionlessness of Ethereum today.

While none of these existential risks and negative externalities are new, we find ourselves at a critical junction between alternative futures for Ethereum. A series of events in the past 6 months have lead usage of the network to reach a tipping point:

• Steadily increasing contract interactions (ie. there are more complex transactions on Ethereum than before which increases the absolute amount of MEV up for grabs.)

• Token market cap exceeding ETH market cap (ie. MEV revenue in ERC-20 tokens is starting to compete with regular transaction fees paid in ETH.)

• Transaction fees exceeding block rewards (ie. transaction fees have reached unprecedented levels partly due to traders pushing the gas prices up when competing for trading opportunities. It is a clue that MEV-related revenue may surpass block reward for miners.)

• Adoption of generalized frontrunners (ie. an indicator of increased sophistication in MEV extraction.)

• Adoption of permissioned mempools (ie. another indicator of such sophistication)

These events indicate an accelerating trend towards the foretold existential risks and negative externalities.

Frontrunning the MEV crisis

Enter Flashbots

Flashbots is a research and development organization formed to mitigate the negative externalities and existential risks posed by MEV to smart-contract blockchains. We propose a permissionless, transparent, and fair ecosystem for MEV extraction to preserve the ideals of Ethereum.

Our approach to mitigating the MEV crisis can be broken down into three parts: Illuminate the Dark Forest, Democratize Extraction, and Distribute Benefits. We believe each part is necessary for Flashbots to succeed.

Illuminate the Dark Forest

MEV is currently opaque to users of Ethereum. It requires significant data analysis and in-depth knowledge of smart contracts to understand as it involves transactions with complex, sometimes obfuscated, logic and adversarial games played on several meta-levels (users, traders, generalized frontrunners, miners).

As more and more security-critical infrastructure moves off-chain, and as chain state and size grows, this problem will only get worse and it will become increasingly difficult to leverage one of the original promises of cryptocurrency: transparency. By Illuminating the Dark Forest, we aim to preserve this original promise. More practically, we aim to allow for the objective assessment of the negative externalities of the MEV crisis and the impact of Flashbots technologies, and for the quantification of user harm caused by MEV extraction in order to provide tooling for builders to reduce their dApp's surface for MEV extraction.

Our first step to Illuminate the Dark Forest is quantifying its impact. We've built MEV-Inspect for this purpose. It scans Ethereum blocks and enables visualization of MEV metrics over time. We use it to better understand the MEV ecosystem and provide it to the community in an attempt to annihilate information asymmetry.

Democratize Extraction

MEV Extraction could likely go in a direction where it is centralized to a few players, for instance by being limited to permissioned dark transaction pools that have access to significant hashrate, or through unilateral off-chain deals between large traders and miners.

This power and capital centralization is a key point of security weakness, and erodes core properties of Ethereum: namely permissionlessness and decentralization. We believe that without the adoption of neutral, public, open-source infrastructure for permissionless MEV extraction, MEV risks becoming an insiders' game. By Democratizing MEV Extraction, we aim to ensure both small and large participants have equal access to low-level financial primitives and that core Ethereum properties are preserved.

MEV-Geth is our initial effort to Democratize Extraction. It is an upgrade to the go-ethereum client to enable a sealed-bid block space auction mechanism for communicating transaction order preference. Fundamentally, MEV-Geth creates a more efficient communication channel for miners and traders bidding for inclusion of their transactions. While the proof of concept of MEV-Geth has incomplete trust guarantees, we believe it is a significant improvement over the status quo. The adoption of MEV-Geth should relieve a lot of the network and chain congestion caused by frontrunning and backrunning bots.

Distribute Benefits

MEV involves the entire Ethereum ecosystem, from miners, traders, DeFi developers, and, most importantly, Ethereum users. Our preliminary research shows MEV extraction currently disproportionately benefits traders and miners. As MEV extraction continues to grow in scale, we anticipate there will be a need for some value redistribution towards users and towards system stability.

We believe it is essential for Flashbots and the community working alongside us to be thoughtful and deliberate about value redistribution in order to maximize social good. This is particularly true given the aforementioned dangerous economic incentives inherent to MEV which cause existential risks. Not only do we want to mitigate such risks, but also believe it is our responsibility to replace them with virtuous economic cycles that will reinforce Ethereum's core value proposal by aligning incentives around MEV for all system participants.

Our Public Commitments

Flashbots arose from the MEV Pi-Rate Ship, a neutral, chain-agnostic, interdisciplinary research collective that supports MEV-related theoretical and empirical research. As an open research organization, we commit today and in the future, to:

• Preserving the core values of Ethereum in what we create, i.e. openness, permisionlessness, decentralization, against the coming MEV crisis.

• Making our research and core Flashbots infrastructure code open source for any community member to contribute to and benefit from.

• Creating sustainable alignment across key actors of the ecosystem by taking into account the needs of users, miners, developers, node operators, public infrastructure operators and developers, contract/dapp devs, and ecosystem researchers.

• Contributing to open-ended ethical research questions in the MEV space, 100% in the public domain.

It is our deeply held belief as both an organization and as the individuals involved that decentralized finance is at a critical crossroads. The substantial amount of value on the table from manipulating user transactions could serve as a centralizing force, damaging to consensus stability, and harmful to users of any system where such manipulation is valuable. MEV could grow to benefit a few at the expense of many, at the expense of the value of cryptocurrency itself.

Or, this value could stand to benefit all users, enhancing the security of a new generation of financial infrastructure that avoids the mistakes of its structurally unfair predecessors. By bringing MEV extraction and tooling into the open, by funding public research to answer open questions around MEV, and by using our organizational capital to align the incentives of all ecosystem participants, it is this new generation of fair infrastructure we aim to lay the foundations for.

This is a call to action. We can't wait to have you join us.

Learn more

Review our technical proposal on ETHResearch. We discuss the details of the Flashbots organization, our research roadmap, and the technical details of the initial projects, MEV-Inspect and MEV-Geth on the ETHResearch forum.

Subscribe to the MEV Ship Calendar. You can follow the latest Flashbots updates and events by subscribing to our MEV Ship Calendar: join us on our semi-monthly community call "MEV Ship Treasure Map Roast", semi-weekly core dev call, for our weekly research workshop, and for the upcoming unconference: MEV.wtf

Engage with us. Join the Flashbots community on Discord or contact us at info@flashbots.net

Flashbots is stewarded by Scott Bigelow, Phil Daian, Stephane Gosselin, Alex Obadia, and Tina Zhen. We exist thanks to the continued support of members of the MEV Pi-Rate Ship and Paradigm.

Special thanks to Andrei Anisimov, Ivan Bogatyy, Vaibhav Chellani, Brock Elmore, Georgios Konstantopoulos, Jason Paryani, Alejo Salles, samczsun, Austin Williams for their contributions on MEV-Geth and MEV-Inspect, and Sunny Aggarwal, Surya Bakshi, Phillippe Castonguay, Tarun Chitra, Dan Elitzer, Lev Livnev, Charlie Noyes, Dev Ojha, Dan Robinson, Mark Tyneway, and Micah Zoltu for their feedback on MEV-research.