The 14th MEV Roast was hosted this past Thursday, May 6, at the Scaling Ethereum Summit.
MEV Roasts are a monthly discussion organized by the research and development group Flashbots to promote greater understanding of and discussion on the topic of Maximal or Miner Extractable Value (MEV) on Ethereum.
The first half of the roast was centered around how MEV could impact staking dynamics on Ethereum 2.0. This week, we’ll break down the good, the bad and the ugly about MEV on proof-of-stake (PoS).
Pulse check: Ethereum fees hit all-time high
It’s more expensive than ever to use the Ethereum blockchain.
On Monday, May 10, average daily fees on Ethereum reached a new all-time high of $51.84. The rise in fees is largely due to bullish price activity inflating the costs of sending transactions on the network.
In native units, average fees are trending at roughly 0.013 ETH but have in the past trended as high as 0.03 ETH. The issue of high fees on Ethereum stems from the network’s limited block capacity which processes just under 20 transactions per second (TPS). In comparison, payments giant Visa processes on average 2,000 TPS.
Contrary to what you may have heard, upcoming upgrades on Ethereum such as Ethereum Improvement Proposal (EIP) 1559 and the merge to proof-of-stake will not significantly impact network fees or scalability. EIP 1559 is designed primarily to improve the predictability of fees, not reduce them, while Ethereum’s merge aims to reduce network energy consumption by removing the need for mining. PoS alone is not a solution for increasing block capacity.
There are upgrades scheduled tentatively for 2022 that build on EIP 1559 and PoS that are aimed at making Ethereum more scalable and competitive with the likes of Visa but in the near-term, high fees are an unfortunate reality that users are stuck with.
For Eth 2.0 validators, who presently only earn network rewards in the form of new coin issuance, high fees mean a greater future return on their investment. As of Tuesday, May 11, CoinDesk’s validator operations are estimated to earn around 8% annual percentage return (APR).
After the merge to PoS, transaction fees normally awarded to miners will be pocketed by validators. Ben Edgington, lead product owner of Ethereum 2.0 software client Teku at ConsenSys, estimated that validator returns are likely to jump to 25% APR.
It’s not only high fees Eth 2.0 validators will profit from once they take over the process of transaction validation and finalization from Ethereum miners completely. They’ll also inherit the ability to extract additional value from users by ordering and reordering transactions on blocks.
This is traditionally called Maximal or Miner Extractable Value (MEV).
New frontiers: How MEV works
The ordering of transactions matters on Ethereum particularly to traders on decentralized exchanges (DEXs) and other decentralized finance (DeFi) protocols. The reason here is that executing a trade first, even milliseconds ahead of another trader, is sometimes all that matters and all that stands in the way of either making thousands of dollars or losing thousands of dollars.
Miners have the ability to earn more rewards from these types of users on Ethereum who value the speed and order in which their transactions are executed on the blockchain more than the average user does. Miners also have the ability to take advantage of profit-making opportunities themselves if they are knowledgeable about the crypto markets and how DeFi protocols work. The most common source of MEV for miners is through identifying arbitrage opportunities within and among DEXs.
MEV is the amount of money a miner on Ethereum, and eventually a validator on Ethereum, can stand to make as a direct result of their ability to insert, leave out and reorder transactions within a block.
Over the last 30 days, Ethereum miners have made over $140 million from MEV income, according to research by Flashbots. Of this MEV income, 46% is extracted from traders on Uniswap, which is one of Ethereum’s largest DEXs by total value locked.
How MEV impacts Eth 2.0
MEV income, as mentioned in a previous Valid Points issue, is not going away once Ethereum 2.0 validators take over the responsibility of transaction sequencing from miners after the transition to PoS.
In fact, analysis by Alex Obadia, researcher for Flashbots, estimates that Eth 2.0 validators stand to earn 1.93 ETH per year, or 70.9% more than what they are currently earning from network rewards alone, with the addition of MEV income.
This income opportunity for validators will have two main effects, according to Obadia.
First, higher validator incomes are likely to attract more users to stake their ether and become validators. The more active validators there are on Ethereum, the greater the overall security of the network.
Second, because MEV can only be extracted by the validators who are proposing blocks and writing transactions into blocks, the variance in income between validators who are randomly assigned block proposal responsibilities versus validators who are assigned other responsibilities such as attestations will increase significantly.
At present, without MEV income, Zelda, CoinDesk’s Eth 2.0 validator, earns roughly 15% more in network rewards every time she is randomly selected for a block proposal.
Once Zelda is able to write in real user transactions onto the blocks she is proposing post-merge with PoS, additional MEV income is likely to widen the difference in income between days she has the opportunity to create blocks on the network and days she does not.
The chart above illustrates the gap in income between the unluckiest 1% of validators who are randomly selected to produce (at most) 15 blocks in a year (yellow line) versus the luckiest 1% of validators who are selected to produce over 39 blocks in a year. The minor difference is what results without factoring in MEV income.
The chart below illustrates the same gap in income between the unluckiest 1% of validators (yellow line) and the luckiest 1% of validators (blue line) with MEV income.
Greater variance in validator income raises important questions about the dynamics of staking on Ethereum under PoS.
“Does it exert pressure for pooling dynamics to happen? Because you want to smooth out that variance of luck,” said Obadia in a presentation on Thursday at Scaling Ethereum. “Does it mean that MEV is prohibitive to being a solo validator or does it exert additional pressure for oligopoly dynamics to form? [Because] people that have a large validator stake will have more blocks that they propose, they will get more MEV rewards from that and then they will have more ether and then they can stake more. That kind of cycle.”
Flashbots is one of many organizations and businesses actively researching the impact of MEV on Ethereum and its future as a PoS protocol. When it comes to developing solutions to mitigate MEV because of centralization risks and other negative externalities to the Ethereum network, Phil Daian, another researcher for the Flashbots projects, warns users and protocol developers against “silver bullet solutions.”
“We can reduce [MEV] in a lot of ways with smart dapp design,” said Daian in a separate presentation at Scaling Ethereum. “[But] we need to beware people who are trying to sell silver bullet solutions saying this one protocol, whatever the protocol might be, will eliminate MEV for all use cases … because it’s still going to exist in the cryptocurrency world no matter what you do.”
Validated takes
- Ebay allows sale of NFTs on Ethereum (Article, CoinDesk)
- Is ether headed toward a trillion-dollar market cap? (Video, CoinDesk)
- Merriam-Webster is auctioning an NFT of its definition of an NFT (Video, CoinDesk)
- VanEck files for an Ethereum exchange-traded fund (Article, CoinDesk)
- Why Ethereum’s miner extractable value problem is way worse than you think (Op-ed, CoinDesk)
- Why FATF’s guidance would stifle growth and innovation in DeFi (Op-ed, CoinDesk)
- Diversity for a healthy Ethereum 2.0 beacon chain (Blog post, phil.eth)
- The road to $150,000 ETH with Nikhil Shamapant (Podcast, Villa Straylight)
Factoid of the week
Open comms
Feel free to reply any time and email christine.kim@coindesk.com with your thoughts, comments or queries about today’s newsletter. Between reads, chat with me on Twitter.
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 is:
0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.
Search for it on any Eth 2.0 block explorer site.
I’ll be extending today’s conversation on Ethereum 2.0 with Consensys’ Ben Edgington in a CoinDesk podcast series called “Mapping Out Eth 2.0.” New episodes air every Thursday. Listen and subscribe through the CoinDesk podcast feed on Apple Podcasts, Spotify, Pocketcasts, Google Podcasts, Castbox, Stitcher, RadioPublica, IHeartRadio or RSS.