MEV and Proof-of-Stake With Eden Network’s Caleb Sheridan
Maximal Extractable Value isn’t limited to Proof-of-Work blockchains like Ethereum.
- While MEV is typically associated with Ethereum, Proof-of-Stake networks are also affected.
- In addition to giving users worse rates on trades, MEV also hurts decentralization on Proof-of-Stake networks.
- Eden Network aims to combat MEV by redistributing profits through the EDEN token.
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Although Maximal Extractable Value is generally associated with the Ethereum network, there are many ways to extract value from transactions on Proof-of-Stake networks. In this feature, Eden Network’s Caleb Sheridan discusses how MEV on Proof-of-Stake chains hurts decentralization and makes trades more expensive for users.
MEV on Proof-of-Stake Networks
Maximal Extractable Value, also known as Miner Extractable Value or MEV, refers to profits made by reordering, inserting, or censoring transactions on a blockchain network. It typically affects users interacting with decentralized exchanges and other DeFi apps. While MEV is usually 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 MEV that reorder or execute bundles of transactions can be more difficult to pull off on networks such as Solana. However, even on high-speed blockchains, transactions are still vulnerable to MEV via front-running.
Front-running involves identifying a favorable transaction submitted to the blockchain and quickly placing another transaction to be processed before it. One example of how this can extract value is when a transaction appears on the network for a large buy order of a certain token.
When large orders are placed, the asset price will usually rise due to supply and demand. Knowing a large transaction has been placed but not yet processed, a third party can have their own buy order for the token processed first, knowing that the price will increase after the initial transaction is subsequently processed.
The whole process takes place in milliseconds and is therefore always carried out by advanced MEV bots. Even on networks like Solana, which has a 400 millisecond block time latency, MEV bots have more than enough time to identify these favorable transactions from which to extract value.
While this front-running process levies a so-called “invisible tax” on traders by making their buy orders slightly more expensive, it also serves many valuable functions. MEV searchers specializing in extracting value through liquidations of loans on lending markets such as Aave and Compound help keep these markets healthy. When several MEV bots compete to liquidate positions, it also helps keep prices optimized. This additionally improves decentralization because liquidations don’t rely on a single bot or mechanism.
While MEV can be a nuisance for traders, it also helps DeFi protocols operate more efficiently. However, for Proof-of-Stake chains, MEV doesn’t just mean getting slightly worse rates on your trades—it actively incentivizes centralization.
MEV and Centralization
Before investigating how MEV increases centralization, it’s worth defining the key difference between Proof-of-Work and Proof-of-Stake validation.
On Proof-of-Work networks like Ethereum, most blocks are mined by pools such as Ethermine and f2pool. These pools link individual miners from all over the world and combine their hashpower to try and mine blocks. Miners process thousands of equations per second, in the hopes that they can 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 hit the next block, if at all, making it near impossible to predict.
In contrast, for most Proof-of-Stake networks, the more stake a validator has delegated to them, the more often they get chosen to write new transactions in the next block. While this mechanic is necessary for staking rewards to scale with the number of tokens staked, it causes problems with how it affects the behavior of those conducting MEV activities.
Because dominant validators are often able to write transactions first due to their large stake, they have the most opportunity to execute MEV on transactions. Eden Network’s Caleb Sheridan explained to Crypto Briefing how the 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 staked, or enough to give you an advantage, you would earn more money from MEV activities, and you could stake more tokens, and you could actually have more power in the network to do more powerful things. It just keeps going like that, and nobody can really unseat you, and so it has the name “the Kingmaker effect.””
This creates a situation in which a single validator or “T-Rex” can take advantage of almost all of the MEV opportunities on a network. Sheridan explained how a dominant “T-Rex” recently capitalized on the MEV opportunities on Avalanche:
“On Avalanche, there was a T-Rex—there’s always one of them. But in this case, there was one bot doing every single decentralized exchange arbitrage and every single liquidation. Every single everything, and then just applying the profits back into the underlying stake and getting very powerful doing it. In Avalanche’s case, they actually changed their consensus mechanism a little bit to stop it from happening.”
In addition to centralizing MEV activities to a single validator, the mechanisms that produce the Kingmaker effect also incentivize validators to group up geographically to discover transactions on the network faster. Sheridan added:
“If you have a server with a huge amount of stake sitting next to a bunch of other servers, you hear about the transactions faster. You can get your own transactions and blocks propagated faster, and it makes it really advantageous for you to sit right next to everybody else’s nodes.”
The most likely way this grouping of nodes happens is through a centralized provider such as Amazon Web Services. As those looking to conduct MEV activities are incentivized to host their nodes on the same servers as the biggest validators, a large portion 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 went offline.
While MEV on Proof-of-Stake networks has proven to be problematic, the situation isn’t unfixable. As Avalanche did, other networks can alter their consensus mechanisms to prevent “T-Rex” validators from dominating MEV and hurting decentralization. Additionally, projects such as Eden Network are allowing users to take back control of their trades by protecting users from front-running and redistributing MEV profits through the EDEN token. While Eden Network currently only operates on Ethereum, Sheridan revealed that it is looking to expand to other Layer 1 chains in the future when trading 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.