Ramifications of MEV in Proof-of-Stake: What’s Next?

Post-Merge, all eyes in the Ethereum ecosystem have been on the pre-chain layer. MEV, Proposer/Builder Separation, MEV-Boost relays, and block building have all been hot topics at every Ethereum event.

It’s no secret that Blocknative is extremely passionate about these topics. From operating one of the few MEV-Boost relays to participating in community panels regarding the technical underpinnings of The Merge and how it will change MEV, it has been an exciting few months for the team. 

We feel uniquely positioned thanks to our history of navigating the web3 transaction lifecycle to participate in this new landscape. With this in mind, we’re publishing answers to a few common questions we get regarding what we do and how we see ourselves fitting into the evolving Ethereum ecosystem. 

What does Blocknative do? 

We specialize in real-time infrastructure for Web3 specifically at the pre-chain layer—everything that happens to a transaction between ideation to when it goes on-chain. Our global infrastructure captures, normalizes, and enriches primarily pre-chain data as well as other forms of data that render this information accessible and usable by everybody in the Web3 ecosystem. 

Why do we focus on pre-chain data?

Any transaction seeking to go on-chain has to go through a mempool where it is still mutable. If you can make sense of mempool or pre-chain data, you can see the future. Sophisticated actors use this data to optimize transactions and impact outcomes. We are ensuring everyone in the Web3 ecosystem can operationalize this data for transaction simulation and to build successful blocks. 

What’s MEV, and is it good?

Maximum Extractable Value (MEV) is profit derived by reordering blockchain transactions. MEV is a fact of life for all ordered transaction systems, which is to say all transactions. It exists in stock markets, credit card clearing houses, and in Web3 transaction systems. We can’t have a transaction system without ordering. Ordering itself introduces MEV effects. In Web3, MEV is programmable and transparent, if you know where to look. 

MEV isn’t inherently good or bad. It just is. Our job as an ecosystem is to develop mechanisms to mitigate, manage, and recirculate it. We need to move MEV around Web3 transaction systems in ways that are net constructive rather than net disruptive.

What are the different kinds of MEV?

MEV creates order in a collateralized system, ensuring the protocol works properly. What happens without it? On Black Thursday, for example, Maker DAO liquidations resulted in protocol losses of 5.67 million uncollateralized DAI. This happened due to the opportunity to win liquidation auctions with zero bids, resulting in $8.32 million worth of withdrawals through zero bids auctions.

Some MEV creates arbitrage opportunities, which is how markets achieve price equilibrium when disparity occurs. 

Other forms of MEV come in the form of sandwich attacks or front running, which is when a trader targets a victim trade with a trade buying the same asset resulting in no settlement or other unfavorable outcomes to the victim. 

Complex MEV across multiple DEXs involving many different tokens is emerging as searchers grow more sophisticated as well as cross-chain MEV.

What can be done to ensure MEV is net constructive to Web3?

The work is already underway. Several years ago, there were only a small number of mining pools responsible for block construction. Gas wars, a public expression of this, drove up the cost of transactions for end users. Flashbots wrote a seminal white paper highlighting the lack of transparency and put in play systems and tools to help eliminate it. 

Our pre-chain infrastructure aims specifically to not only eliminate uncertainty about the mempool but also ensure traders have ways to ensure the profitability of transactions. Transparency and access are key to ensuring MEV is net constructive.

What is the role of MEV in a proof-of-stake system?

MEV extraction becomes a fundamental part of the network in proof-of-stake systems. To learn more, we recommend our full guide to MEV on proof-of-stake.

MEV is everywhere and present in most transactional systems from stock exchanges to web searches (because ordering matters).  

What are the ramifications of MEV in proof-of-stake?

In proof-of-work (PoW), the MEV flowed down the supply chain. Users initiated a transaction with a dapp or via a wallet, signed a transaction, and submitted it to a gateway. The transaction then entered the mempool where entities called searchers, which are bots, chunks of code, inspected transactions for MEV.

Extracting MEV in PoW required searchers to add new transactions, which take block space, creating a sort of block space tax. Searches created bundles, ordering bundles with precise sequencing – either before or before and after, in the case of sandwiching – designed to extract MEV. Bundles were sent to builders to create profitable blocks and the value flowed to the searcher and the miner, which is to say downstream and away from the initiator of the transaction. Furthermore, miners would then remove value from the system by converting earnings to fiat currency to buy computers to support more mining activity. Value leaving was net destructive for the ecosystem value.

With proof-of-stake (PoS), we are professionalizing MEV extraction as an ecosystem. In PoS, block construction requires two entities, a proposer and a builder. Proposer/builder separation (PBS) divides the head of the chain into a validator, known as a proposer, and a new class of actors called block builders. Building a profitable block requires finding profitable transactions and extracting MEV. A percentage of the rewards will go to the validator, making MEV an important source of annual percentage yield. Value can still roll downhill. And this system could fuel validator centralization where as validators get more yield and accrue more wealth, they stand up more yet more validators to get more yield.

On the one hand, these conditions create a high degree of incentive to extract more MEV of all types, benign, constructive, and malicious. On the other hand, the builder contributes a lot of CPU to the network enabling more programmability and expressivity at the block building level, which – importantly – enables the recirculation of MEV. This means value could recirculate. Your wallet could pay you to use it. 

Note: If you are an MEV searcher, Blocknative now offers an MEV bundle RPC endpoint. Searchers can interact with the RPC endpoint at https://api.blocknative.com/v1/auction. The API provides JSON-RPC methods for interfacing with Blocknative builders, which are documented via our bundle docs.

How will MEV value recirculation occur?

That’s what we are learning today as we watch the new PoS unfold. There will be many approaches to enable the recirculation of MEV. For example, a web3 wallet or dapp could establish rules upfront about MEV sharing. If you don’t like the rules, that’s OK, you don’t participate. There are some projects looking at various forms of MEV recirculation, such as capture and token accrual. Importantly, there’s more creativity than ever before being applied to the problem, which is net constructive to the ecosystem. 

What is Blocknative doing to support MEV value recirculation? 

Blocknative is building infrastructure to support these and other scenarios that enable MEV recirculation. Specifically, the following tools and products reduce complexity for end users and provide them with the greatest possible optionality and transparency when originating a transaction.

Web3-Onboard

This open-source, framework-agnostic JavaScript library helps onboard users to web3 apps by enabling wallet connection, multiple account connection, and real-time transaction states. If you use Curve Finance or Zapper, there’s a pop up that says “select your wallet.” That pop-up is powered by Blocknative’s Web3-Onboard—technology designed to empower end-users. 

Web3-Onboard integrates with all of Blocknative’s web3 tooling, including Transaction Preview which enables dapp users to simulate their transactions pre-flight to identify net balance changes due to expected slippage and, eventually, identify when their transaction is high risk for MEV. Being able to identify a transaction’s MEV-risk exposure is the first step in being able to recirculate that MEV-extracted value back to users.

Gas Estimator

Having access to the most accurate gas estimation in the ecosystem, in real-time, empowers end users and traders with the most up-to-date information so they can decide when and how to make transactions. 

Transaction Simulation 

Dapps and wallets can submit unsigned transactions to our infrastructure through an API for transaction preview. We simulate that transaction against the current block in real-time and return a well-structured JSON, allowing wallets, dapps, and protocols to show the user what might occur if that transaction occurred.

We are working toward the ability to reveal an MEV score, presenting the user with options when seeing if a transaction has MEV or not. We want to expose this MEV optionality to all network participants without making the experience overly complex. In this world, users will be able to simply click to decide how a transaction gets routed. For example, a user could decide to transact with speed regardless of a sandwich attack. Or a user could elect to receive a 10% rebate on gas in return for a 30-second delay on settlement. So the user could decide if they are willing to take a slower settlement in return for a rebate on gas.  

How do you protect the user from malicious MEV or scenarios where the user thinks they are getting one thing but another outcome occurs?

Better infrastructure. Web3 builders want more people using Ethereum and more people transacting with transactions of greater and greater value. To get there, we and other key stakeholders in the Web3 ecosystem must facilitate a more equitable, much more transparent environment for end users. For this reason, Blocknative is focused on modularity and programmability at the block building layer, as well as decentralization. While more extractive and negative forms of MEV and arbitrage will continue, users will have options. 

Imagine if in order to understand the transaction fee on a credit card, shoppers had to factor in the time of day, location of the store, the weather, and traffic in order to make an optimal decision. It would certainly slow down the volume of credit card transactions. If we recirculate, moderate, and minimize MEV, it becomes something users don’t have to think or worry about. 

What is Blocknative’s stance on negative forms of MEV?

• We are focused on doing right by the end users through choice, flexibility, programmability, and transparency 
• Apart from extreme examples, MEV is incredibly difficult to classify. 
• We can tackle negative MEV at the protocol and infrastructure level rather than the protocol level.
• We strive to provide credibly neutral infrastructure. 
• Sunshine is the best disinfectant: Full transparency is essential.
• In general, negative forms of MEV is net destructive for the ecosystem. That said, creating rules that prohibit certain classes of transactions creates conditions for censorship.

Does the new PoS process for validating transactions create more centralization?

Under PoW, MEV searching initially involved a lot of individual searchers. Quickly as searches grew in sophistication, it became more viable to pool resources to compete, which meant teams replaced individuals. The same forces are at play under PoS with block building. 

Block building requires a level of sophistication, significant infrastructure, and technology so it is a foregone conclusion that with PoS only a small number of players will be able to do this. This could lead to corruption and censorship. Blocknative believes access to core infrastructure will encourage builder diversity so more people can build. 

Blocknative is also proud to contribute to the decentralization of Ethereum block building infrastructure via our MEV-Boost block relay and participation as a block builder. To date, we have contributed to the construction of over 290,000 blocks. We plan to support our builder, this relay, and the open-source software it is built with—Dreamboat—as a way of driving block builder diversity and equitable value recirculation throughout the web3 transaction supply chain.

How will Blocknative’s infrastructure mitigate centralization?

A block builder needs access to advanced simulation capabilities to determine, based on the current state of the chain, what would happen to a transaction bundle. Block builders need to rapidly simulate many different block configurations to re-order the transactions in each block to maximize profit. It’s not likely an individual will assemble the necessary code and expensive infrastructure to do high-scale simulations. 

We operate high-scale infrastructure to simulate complex transactions. We provide simulation capabilities to the ecosystem via an API, which is open to block builders who develop a commercial relationship with us. 

Additionally, self-staking will combat centralization. This can be done altruistically without great difficulty but while self-stakers contribute to decentralization, they forgo profit. Our infrastructure will enable self-stakers to be competitive, which will encourage more participation and therefore decentralization. 

What’s Blocknative’s ethos?

Blocknative is accelerating the arrival of a generation that is native to the blockchain. As our life moves from off-chain to on-chain, future generations won’t understand life before web3.

We want the pre-chain layer to have the same level of transparency and accessibility as transactions on-chain. To date, the mempool has been fairly opaque. Our technology is geared towards correcting this problem, which becomes even more important post-Merge. 

Build With Blocknative

If there’s a topic you were looking for that wasn’t addressed here, please connect with us. Joining our Discord gives you direct access to Blocknative employees and you can follow us on Twitter @Blocknative for the latest updates.

Post-Merge Ethereum is offering web3 users a fascinating and uncharted experience. We look forward to working closely with the ecosystem toward the goals of decentralization, scalability, and fair access for all.