Understanding MEV Bots

MEV bots are software programs or scripts that exploit opportunities presented by transaction ordering in blockchain networks. 

The primary objective of MEV bots is to maximize profits by strategically manipulating the order of transactions. They achieve this by identifying specific transaction sequences or patterns that they can exploit for financial gain. MEV bots closely monitor the mempool, the pool of unconfirmed transactions, and swiftly submit transactions with precise timing to capitalize on favorable market conditions, price discrepancies, or liquidations within DeFi protocols.

These bots leverage their speed and automation to gain an edge in the highly competitive and rapidly changing blockchain environment. They constantly look for opportunities to front-run trades, exploit inefficiencies, and extract value from other users’ transactions.

Understanding the Sandwich MEV Bot

A sandwich MEV bot derives its name from strategically placing its transactions like a “sandwich” around a pending trade. The goal is to profit from the resulting price movement caused by the execution of that trade. The bot identifies a large pending trade within a DEX, typically involving a substantial amount of a specific asset. This pending trade becomes the focal point for the sandwich bot’s exploitation.

So how does the bot manipulate a trade? Here is a step-by-step explanation:

Order manipulation

A sandwich attack is an MEV exploit that can manipulate a trade by exploiting a user’s high slippage tolerance. Here’s an example of how it works:

1. A user wants to swap 1,000 ETH for USDT on a decentralized exchange with a 1% slippage tolerance.
2. A searcher sees the user’s transaction in the public mempool, constructs a bundle of frontrunning and backrunning transactions, and sends it to validators via a channel called mev-boost.
3. The searcher first front-runs the user’s transaction by selling ETH before the user’s transaction, allowing the user to sell at their lowest defined limit.
4. The user’s trade is then executed at an unfavorable price.
5. After this, the searcher backruns the trade by buying back ETH at a relatively deflated price, netting a profit.

In this example, the searcher manipulated the trade by taking advantage of the user’s high slippage tolerance and front-running and back-running their transaction.

The key idea behind the order manipulation in a sandwich trade is to place transactions strategically before and after the pending trade execution, creating a “sandwich” of the pending trade and allowing the bot to profit from the resulting price movement.

Types of MEV Bots

Apart from the sandwich MEV strategy, other MEV attacks can occur in the blockchain ecosystem. These attacks exploit the miner or validator’s ability to order transactions and extract additional value. Here are a few examples:

Miner-Extracted Flash Loans: Flash loans are uncollateralized loans that allow users to borrow funds temporarily within a single transaction. MEV can be extracted by miners or validators who include flash loan transactions and manipulate their execution order to their advantage, potentially profiting from price discrepancies or exploiting vulnerable smart contracts.

Transaction Insertion: MEV can be extracted by inserting transactions into the mempool with high transaction fees, incentivizing miners or validators to prioritize these transactions and include them in blocks. This action enables the attacker to profit by taking advantage of market movements or executing specific trades ahead of others.

Liquidation Sniping: In decentralized lending platforms or protocols, liquidations occur when collateralized assets fall below a certain threshold. MEV attackers can monitor these liquidations and attempt to “snipe” the liquidated assets by quickly executing transactions to acquire them at a lower price before others.

Governance Manipulation: In decentralized governance systems, MEV attackers may influence decision-making by strategically ordering transactions to vote or delegate tokens in a way that favors their interests. This action can give them an unfair advantage in shaping the governance outcomes or controlling protocol changes.

Bitcoin MEV vs. Ethereum MEV

Bitcoin and Ethereum, two of the most prominent blockchain networks, differ in their design, purpose, and Miner Extractable Value (MEV) extraction. While both networks experience MEV, there are distinct differences in how it manifests and the strategies employed by MEV bots. Let’s explore the nuances of MEV extraction on Bitcoin and Ethereum.

Smart Contract Capabilities

Bitcoin’s smart contract capabilities are limited in scope, primarily focusing on basic financial transactions and multi-signature requirements. Ethereum, on the other hand, boasts a more advanced smart contract platform with its Solidity programming language, enabling the creation of complex and sophisticated smart contracts. This disparity in smart contract functionality directly impacts the complexity and range of MEV strategies deployed on each network.

Transaction Handling and Order Manipulation

Bitcoin’s UTXO (Unspent Transaction Output) model straightforwardly handles transactions, making it challenging for MEV bots to manipulate transaction orders. The Bitcoin mem pool includes only eligible transactions that meet specific criteria, limiting the opportunities for MEV extraction through order manipulation. Conversely, Ethereum’s mem pool encompasses a broader range of transactions, providing more flexibility for MEV bots to manipulate transaction orders actively and exploit price discrepancies within the dynamic DeFi ecosystem.

Block Finalization Time and Fee Volatility

Bitcoin’s 10-minute block interval provides fewer opportunities for MEV extraction compared to Ethereum’s 12-second block finalization time. The longer block interval in Bitcoin creates a less dynamic environment for transaction ordering, reducing the chances for front-running transactions. Furthermore, Bitcoin’s design disincentivizes excessive network load, leading to lower transaction fees and lesser fee volatility than Ethereum.

DeFi Ecosystem

Ethereum has become a thriving hub for decentralized finance (DeFi) applications, offering various financial protocols, decentralized exchanges, and lending platforms. The vibrant and rapidly evolving nature of the Ethereum DeFi ecosystem presents ample opportunities for MEV extraction. In contrast, Bitcoin’s DeFi ecosystem is less mature and primarily revolves around simple financial transactions. This discrepancy reflects the scope and potential impact of MEV extraction in each network.

Understanding the nuances of MEV extraction on Bitcoin and Ethereum enables us to appreciate the unique dynamics of each network and the implications for participants and stakeholders in the blockchain ecosystem. It also highlights the ongoing efforts to balance innovation, security, and fairness in pursuing a decentralized financial future.

How sandwich MEV bots negatively impact the DeFi ecosystem

Here are general scenarios and potential consequences that illustrate the concerns associated with these bots in the DeFi ecosystem.

Front-running and unfair Advantage

Sandwich MEV bots can engage in front-running transactions, inserting their transactions before others to exploit price movements. This move can result in unfair advantages, as the bot operators have privileged access to market information and can profit from other participants’ expense. Such actions erode the principles of fairness and equal opportunity in decentralized markets.

Price Manipulation

By manipulating the order of transactions, sandwich MEV bots can create price discrepancies within decentralized exchanges (DEXs). They strategically place buy and sell transactions around pending trades, influencing the asset price involved. This manipulation can distort market prices, affecting the accuracy of price discovery mechanisms and potentially misleading other market participants.

Frontrunning Liquidations

In the DeFi ecosystem, liquidations can occur when collateralized assets fall below a certain threshold. Sandwich MEV bots can exploit these liquidation events by quickly executing transactions to take advantage of the price movements and potentially profit from the forced liquidation of other participants. This activity further exacerbates concerns related to fairness and transparency.

User Dissatisfaction and Market Confidence

The presence of sandwich MEV bots and their activities can lead to user dissatisfaction and erode market confidence. When users perceive that bots manipulate the system for unfair gains, trust in the DeFi ecosystem can be compromised. The realization may discourage new participants from entering the market and hinder decentralized finance’s growth and adoption.

Examples of MEV exploits

One instance involved an airdrop of Apecoin tokens by Yuga Labs to holders of BAYC. An MEV searcher was able to take advantage of this by purchasing all the fungible BAYC tokens in NFTX, redeeming them for an actual NFT, claiming the Apecoin airdrop, and re-supplying the NFTX pool. This MEV resulted in a profit of approximately $278k for the searcher.

Another example is when someone mistakenly listed an EtherRock NFT for 444 gwei instead of 444 ETH. A bot quickly purchased and resold it for 234 ETH, resulting in a profit of around $600k.

How blockchains are dealing with toxic MEVs

One way that blockchains are working to reduce toxic MEV is by encrypting the mempool. This solution is still an area of active research and debate.

For example, Osmosis, a DeFi app chain within the Cosmos ecosystem, plans to implement threshold encryption to reduce toxic MEV. This action involves encrypting transactions as they enter the mempool, which hides their information and prevents censorship or ordering. The private key for decryption is shared among all validators, and the block decrypted once it finalizes.

Shutter Network is also working on a similar solution for Ethereum rollups. On Ethereum itself, Flashbots has discussed using trusted hardware, such as MEV-SGX, to achieve similar results.

Benefits of MEV

While concerns and challenges are associated with Miner Extractable Value (MEV) extraction, it’s essential to recognize that there can be potential benefits to MEV in specific contexts. Here are a few potential benefits of MEV:

Liquidity Provision: MEV can incentivize liquidity providers to participate in the market and provide liquidity to decentralized exchanges (DEXs) and other DeFi protocols. MEV can offer an additional revenue stream for liquidity providers, which may encourage them to contribute to the liquidity and depth of the market.

Efficient Price Discovery: MEV can contribute to efficient price discovery within the DeFi ecosystem. By exploiting price discrepancies and executing transactions based on market conditions, MEV participants may help to align prices across different platforms, improving overall market efficiency.

Market Dynamics and Arbitrage: MEV extraction can facilitate market dynamics and enhance efficient arbitrage opportunities. Participants engaging in MEV extraction may identify and capitalize on mispricings or inefficiencies in the market, helping to align prices and reduce arbitrage opportunities over time.

Innovation and Market Development: The presence of MEV opportunities can spur innovation and development within the DeFi ecosystem. MEV encourages participants to devise strategies and build tools that seek to capture value, driving technological advancements and the evolution of the market.

Increased Transaction Throughput: MEV extraction can incentivize miners or validators to include transactions in blocks and prioritize them based on their profit potential. This move can lead to increased transaction throughput and faster confirmation times for users as miners compete to include transactions with higher MEV in their blocks.

As the blockchain community continues to evolve, ongoing research, development, and regulatory efforts aim to address the challenges and maximize the potential benefits of MEV extraction, fostering a more robust and equitable DeFi ecosystem.