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Valid Points: The Problem With MEV on Ethereum
The new frontier of miner/maximal extractable value (MEV) on Ethereum may have negative consequences for network finality and immutability. Key to defending Ethereum against these MEV forces is the upcoming transition to Eth 2.0 and proof-of-stake (PoS). But will the transition come soon enough?
This article originally appeared in Valid Points, CoinDesk’s weekly newsletter breaking down Ethereum 2.0 and its sweeping impact on crypto markets. Subscribe to Valid Points here.
Bitcoin dominance tends to fall every crypto bull market cycle. As background, BTC dominance is a metric tracking the percentage of total cryptocurrency market capitalization made up by BTC.
Related: Bitcoin Is Already Incentivizing Renewable Energy
During the most recent bull market cycle, BTC dominance dropped from roughly 70% in January to as low as 40% in May. While the volatile crypto markets have since turned bearish over the latter half of Q2 2021, causing BTC dominance to pick back up again, the metric continues to trend between the range of 40% and 50%.
Among the alternative cryptocurrencies eating up the market share of BTC, the native cryptocurrency of Ethereum, ether, is the next largest coin, making up roughly 18% of total crypto market share. While ETH is the second-largest cryptocurrency next to BTC and has been since as early as 2016, it is not the fastest-growing altcoin on the market.
In 2021 Q2, the fastest-growing altcoin, excluding stablecoins, by monthly market cap growth, was the native token of Chiliz, a blockchain services network for sports and entertainment providers.
The chiliz token (CHZ) is the exclusive marketplace currency on Socios.com. Socios.com aims at decentralizing fanbase interaction with sports teams by leveraging blockchain infrastructure to facilitate payments for team merchandise, voting rights and other rewards. The marketplace has partnered with over 20 sporting and esports organizations including FC Barcelona, Juventus and Atletico de Madrid.
Related: Ether Erases Early Losses, Faces Resistance Above $2K
Fans for each of these teams can purchase branded “Fan Tokens” on Socios.com that allow them to vote on certain team decisions such as renaming facilities or changing entrance songs. Since the CHZ is the exclusive means of exchange in the marketplace, the token accrues in value alongside demand for voting rights and rewards provided by the entertainers on the Socios.com platform.
The sports industry alone has a yearly value in the hundreds of billions of dollars and could gain further value through strong customer loyalty programs like the ones being experimented on through CHZ and Socios.com. The Chiliz token is one way to speculate on the use of Ethereum-based tokens for fan engagement and the continued growth of the Socios.com marketplace as the main platform to do this.
Block subsidies, transaction fees and miner/maximal extractable value (MEV): These are the three main revenue streams of Ethereum miners.
In efforts to combat currency inflation, protocol developers lowered block subsidies from 5 ETH to 3 ETH in 2017, and again from 3 ETH to 2 ETH in 2019. Starting in August 2021, transaction fees are also expected to decline as a result of Ethereum Improvement Proposal 1559 and its fee-burning mechanism. The only revenue stream that is expected to grow larger and more lucrative for miners in the months to come is MEV.
MEV refers to the income a miner receives as a direct result of their ability to insert, leave out and reorder transactions within a block. The order of transactions is of utmost importance in the context of high-frequency trading on decentralized exchanges (DEXs) where automated bots can identify buy or sell orders waiting for execution on Ethereum and front-run these trades before they get executed.
The higher the liquidity and value being moved on-chain through these DEXs, the greater the profit opportunity for miners to earn additional income through MEV.
*Missing values for daily extracted MEV appear in this chart as interpolated dotted lines that connects the plot points immediately preceding and succeeding the missing value
The larger MEV rewards become in comparison to block subsidies and transaction fees, the greater the financial incentive for miners to adjust not only the order of transactions but also the order of blocks themselves. In what is known as a “time bandit” attack, miners may begin to identify MEV opportunities in blocks that have already been finalized and reorganize the blockchain in their favor if potential rewards from frontrunning are larger than earnings from honest mining (i.e., block subsidies and transaction fees).
Speaking to the potential for miners to reorganize Ethereum blocks and disrupt chain finality, Georgios Konstantopoulos and Leo Zhang from Paradigm Research wrote in a blog post back in March, “This scenario is not obviously plausible: Miners are (for the most part) structurally long ETH, and such an action would directly negatively impact their ETH investment.”
However, it would appear the tools for MEV extraction by way of block reorganization are actively being built and already being executed in primitive forms.
Edgar Aroutiounian of Flashbots tweeted on Thursday, July 8, that he had created a personal GitHub repository codifying how payments to miners can be facilitated in exchange for destabilizing blockchain consensus. Shortly thereafter, on Saturday, July 10, Twitter user “0xbunnygirl” announced their own code repository for MEV extraction through block reorgs called “Request for Reorg.”
While the possibility of MEV negatively impacting chain finality and immutability has been a long-running concern, discussed as early as November 2020 among Ethereum researchers, the reality of this happening appears to be manifesting today.
In light of this reality, there are a handful of defense mechanisms that researchers insist will protect the integrity of Ethereum’s blockchain. First, there is the collective will of the Ethereum community to censor this kind of behavior. Users can leave mining pools that are using their computational power, also called hashrate, to reorg blocks. Honest miners can resist accepting blocks they know to be from hostile miners engaging in these MEV practices.
Second, there is the forthcoming upgrade to a proof-of-stake (PoS) consensus protocol with Eth 2.0, after which miners will no longer have the ability to propose blocks or reorder transactions within blocks. These two responsibilities will fall into the hands of validator node operators, who are required to own a large investment of ETH, worth roughly $63,600 or 32 ETH, and have skin in the game in order to participate in blockchain consensus.
Neither of these two defenses is convincing. The former assumes the collective will of the community is homogeneous and aligned on resisting MEV extraction through block reorgs despite clear evidence to the contrary. For some, such as Aroutiounian, if block reorgs can be done on Ethereum and there is a clear financial incentive for them to happen, they should – regardless of how it impacts public perception of the network.
The upgrade to Eth 2.0 and PoS as a defense against block reorgs for MEV extraction does not address the present reality and the impact these events can have on the value of Ethereum in the interim before the upgrade is ready for deployment. The readiness checklist which outlines all the tasks needed for PoS activation remains in large part unfinished. The earliest that developers estimate Ethereum’s transition to PoS will happen is the beginning of 2022.
Ethereum needs a stronger line of defense to combat the reality of MEV extraction through block reorgs.
Short-term profitability proves more important for decentralized exchange (DEX) users on Polygon than Ethereum. TAKEAWAY: Polygon’s DEX trading volume and liquidity came and went with a spike in rewards during the month of June, while remaining comparatively more stable on Ethereum over the same time period. (Data, Glassnode)
Sygnum Bank becomes the first banking institution to offer staking services for Ethereum 2.0. TAKEAWAY: The Swiss bank built for digital asset custody, brokerage and tokenization is expanding its offering of yield generating products by offering clients up to 7% per annum on their ETH through staking. In today’s low or negative interest rate environment, the bank wrote in a blog post, digital assets offer an alternative to yield generation. (Article, Yahoo)
Gas prices on Ethereum have been on a downward trend since late April, dropping from roughly 150 gwei to 15 gwei. TAKEAWAY: A higher block capacity, the rising popularity of layer 2 scaling solutions and increased use of alternative payment channels between DEX traders and miners are all likely factors contributing to lower gas prices on Ethereum. (Newsletter issue, Coin Metrics)
Circle, the co-creator of dollar-backed stablecoin USDC, is set to go public at a $4.5 billion valuation. TAKEAWAY: USDC is the second-largest stablecoin on Ethereum by circulating supply next to tether. In a presentation on Circle’s plans to go public, the company predicted sevenfold growth in USDC’s market capitalization by 2023. The predicted circulating supply would be $190 billion, much higher than leading stablecoin, USDT, which currently is sitting around $63 billion. (Article, CoinDesk)
Weekly volumes in dollar markets for BTC and ETH reached new all-time highs in 2021 Q2. Notably, notional volumes in ether-dollar pairs consistently surpassed bitcoin pairs for the first time ever in the month of May. TAKEAWAY: Surging interest in NFTs and DeFi since the beginning of this year are likely factors contributing to the growth of ether trading volumes. (Report, CoinDesk)
Valid Points incorporates information and data directly from CoinDesk’s own Eth 2.0 validator node in weekly analysis. All profits made from this staking venture will be donated to a charity of our choosing once transfers are enabled on the network. For a full overview of the project, check out our announcement post.
You can verify the activity of the CoinDesk Eth 2.0 validator in real time through our public validator key, which 46d323ddad0f574fdcc50eeefec34ed9d2039ecb.
Search for it on any Eth 2.0 block explorer site.
New episodes of “Mapping Out Eth 2.0.” with Christine Kim and Consensys’ Ben Edgington air every Thursday. Listen and subscribe through the CoinDesk podcast feed on Apple Podcasts, Spotify, Pocketcasts, Google Podcasts, Castbox, Stitcher, RadioPublica, IHeartRadio or RSS.
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