Ethereum's Value Extracting Bots: Explainer and Project Map
The ability to write flexible smart contracts in Ethereum and to create composable money lego’s out of it is one of the main reasons why decentralized finance has seen such explosive innovation and growth. But the complexity that is brought by stacking these blocks creates an opportunity for blockchain miners to extract value by excluding,…
By: Eugenio CroitoruDeFi 101
The ability to write flexible smart contracts in Ethereum and to create composable money lego’s out of it is one of the main reasons why decentralized finance has seen such explosive innovation and growth.
But the complexity that is brought by stacking these blocks creates an opportunity for blockchain miners to extract value by excluding, including or re-ordering the transactions on the block they produce. This is known as MEV (miner extractable value) and complexity is only going to go up in the future with increasing cross-chain transactions.
To understand MEV, let’s consider a simple example: in AMM’s like Uniswap, a large trade will often leave the pools unbalanced, thus creating an arbitrage opportunity. Suppose you notice this opportunity imbalance and make a transaction to profit from this and keep the gas price as 80 Gwei. An arbitrage bot in this situation will notice this and resend the transaction with a higher gas of 120 Gwei, essentially getting its transaction to execute before yours. So in the end you’ll either end up buying high and missing out on the arbitrage altogether. This kind of MEV is very common and is called Frontrunning.
The exponential growth of MEV: Flashbots Dashboard
The cumulative MEV has reached $559 million, according to Flashbots’ dashboard, which tracks the data. This will likely become one of the biggest narratives going forward as the volume on DeFi increases, and it will create a huge problem if it’s not dealt with. In this article, we’ll be covering a few of the projects working on solving this problem.
Flashbots are an open-source research and development organization. They focus on building a variety of tools that help bring the power to analyze and extract MEV to everyone. By definition, MEV exists in places where there is high complexity which requires significant knowledge of smart contracts to understand. Flashbots work reducing this complexity by working on three fronts:
- Provide tools to inspect and quantize the impact of MEV – This helps reduce the information asymmetry and people can understand the problem and its impact better. (MEV-Inspect)
- Democratize the extraction of MEV – The power to extract MEV exists in the hands of few people so they provide tools for everyone to start extracting MEV. (MEV-Geth)
- Distribute the benefit of MEV – Currently, the miners and validators extract a disproportionate amount of benefits. So it’s important to redistribute these to all the participants.
No discussion about MEV beings without mentioning Flashbots, they’ve played an integral part in bringing this issue to the attention of the masses and will continue to do so in future.
- KeeperDAO ($ROOK)
To take advantage of opportunities like arbitrage and liquidation in DEX’s and derivative platforms, you need to have enough resources to keep scanning for these and have the capital to take advantage of them when the time comes. KeeperDAO provides a pool of funds that anyone can borrow to take advantage of this opportunity and receive a share of the profits.
There are two stakeholders in the KeeperDAO ecosystem: Keepers and Liquidity Providers. The keepers take part in the strategies to realise the value arbitrage and liquidation opportunities, and liquidity providers provide the funds to take advantage of these opportunities.
Let’s take an example to understand how it works. Say you notice an arbitrage opportunity, you can get a zero-interest flash loan from the liquidity pool. You take the loan, perform arbitrage/rebalancing and once this opportunity is realised, the funds+profits are returned to the protocol. You receive a share of the profits in the form of $ROOK, the native token for the KeeperDAO ecosystem.
Flash loans are a special kind of zero-collateral instant loan which are designed in a way that the liquidity is returned to the pool within one transaction block. But are flash loans secure? Mostly, yes. The amount you take has to be returned within a single transaction block, if the borrower doesn’t follow the rules it’s not issued in the first place. I say mostly because there is always smart contract risk involved with any DeFi application. If you’re coming from a traditional finance background, all this might sound a bit ludicrous to you. If you want to learn more about flash loans, this would be a good place to start.
- Secret Network ($SCRT)
Blockchains like ethereum are public, which means that anyone can jump on etherscan and look at all the transactions. If by any chance someone knows your address, then it’s easy to look at all the trades you’re doing. Secret network solves these problems by embedding privacy into a smart contract and calls these privacy baked smart contracts a Secret contract. Platforms built using Secret network which uses its native token standard (SNIP-20) allow for all the transaction information to be encrypted, thus providing complete privacy.
Ok, that’s great! But how does it help with MEV? Let’s understand this with a platform built on top of the Secret Network, i.e. Secret Swap. Secret Swap is a cross-chain AMM, but unlike other AMM’s, the transactions have encrypted inputs, outputs, and state, which means that no one can snoop in on the details. This prevents the miners from re-ordering transactions in a block based on their fees and also prevents frontrunning by any adversary.
The secret ecosystem has two tokens, $SCRT and $SEFI. The gas fee for transaction in a network is paid in the form of $SCRT to incentivise the network validators. The $SEFI token is the governance token that allows you to shape the future of the Secret Network ecosystem creating and voting on proposals. The secret network also has a bridge that supports a range of assets to be ported over to the Secret ecosystem. Overall, the Secret Network is a very ambitious project because it allows anyone to build applications on top of it. It’ll be interesting to see how the ecosystem grows in the future.
- ArcherDAO ($ARCH)
Unlike Secret Network and KeeperDAO which try to eliminate MEV, ArcherDAO works with the miners to provide them with non-malicious MEV. By providing only those MEV transactions which don’t hurt the traders, it creates a positive-sum game where the miner doesn’t profit at the expense of the trader. ArcherDAO was built on top of the existing Flashbots transaction re-ordering system (Geth) and built optimisations to improve the transaction re-ordering system to benefit without hurting the traders. They offer a five-minute integration on the existing code for ETH miners to boost their revenue using sustainable MEV.
Once the EIP-1559 gets implemented, it dramatically changes the way transactions happen in the ecosystem. The transaction fees paid in ETH are burnt, reducing the supply of ETH and the miners get paid in the form of a tip on top of the burnt base fee. Archer DAO offers miners a new, risk-free and sustainable revenue stream by identifying (MEV) on-chain and this will get even more important going forward.
ArcherSwap is a demo of their product that allows users to use the liquidity from Uniswap/Sushiswap and perform transactions with no gas fees, zero slippage and a small tip to the miner. They look to be partnering with Sushiswap and 1Inch soon. Projects like ArcherDAO are interesting because they are compatible with the keeper strategies from the KeeperDAO ecosystem. Recently, during the massacre of all SHIB and ELON coins, Vitalik Buterin used ArcherDAO to dump ELON after his first transaction was rejected. Few endorsements are bigger than Vitalik Buterin himself using your product. Keep an eye on this one to see how it evolves in the future.
MEV is a tough problem and I expect there will be multiple projects working on it in the future, possibly in a symbiotic manner. This is a technical problem and is tough to understand for people who’re not aware of the inner working of smart contracts. Here are a few resources to understand MEV better in increasing order of difficulty:
- Enter the Dark Forest: the terrifying world of MEV and Flash bots
- MEV and Me
- Ethereum is a dark forest
- FlashBoys 2.0
Please note that the projects discussed above is by no means a comprehensive survey and there are plenty of other projects like Chainlink working on MEV. But the goal of this article was to provide you with a high-level understanding of MEV, why it’s important to solve it and explain a few projects working to solve it. If you found this helpful, then follow me on Twitter for more beginner-friendly introductions to major narratives in the crypto ecosystem.