How crypto traders can use MEV in blockchain transactions

Maximum Extractable Value (MEV) refers to all the money that can be extracted by rearranging, displaying, adding, including or excluding transactions within a block. The vast majority of MEV happens via decentralized exchanges (DEX) such as Uniswap.

In all financial markets, the order of transactions is one of the most important determinants of price – think of quants aggregating nearby exchange servers with fiber optic cables to ensure orders are filled first.

Very often, discussions about MEV include the parties responsible for validating transactions for ERC-20 tokens on Ethereum, which can come with issues such as validators being complicit with trading bots. Digital asset market participants have other ways of extracting MEV using the different types of maximum recoverable value.

Here are the four types of MEV:

The sovereign MEV

Blockchain communities can attempt to control their own MEV through sovereign MEVwhich refers to setting protocol rules for mining MEV, such as what tactics for mining MEV are allowed – and where MEV can be accumulated.

A protocol’s community can decide who and what should be prioritized via sovereign MEV practices, often with consequences for breaking these rules. With some blockchains with sovereign MEV rules, for example, an abusive validator could face penalties such as staking pool users moving to another staking platform or validator. Others let society decide who gets MEV or how MEV is generated.

Read more: Ethereum is trying to reduce MEV with blockers and discounts

Internal MEV

Internal MEV refers to MEV generated directly on an application-specific blockchain or ‘appchain’. This form of MEV allows application developers to set rules that include the acceptable methods for capturing MEV. It can use nuclear arbitrage, a trading strategy that places a buy order on one trading platform and a sell order of the same amount on another trading platform at the same time.

CeFi-DeFi MEV

CeFi-DeFi MEV uses a form of arbitrage that exploits the differences between centralized exchanges and decentralized financial apps. An asset price tends to be updated on centralized exchanges before on-chain pools and DEX liquidity providers can reposition.

CeFi-DeFi MEV is one of the largest generators of MEV due to activity from arbitrage traders.

Interchain MEV

Interchain MEV takes advantage of the idea that most blockchains operate in “silos” that do not allow them to “see” what is happening on other blockchains. For example, the Bitcoin network (except through the use of third-party oracles) cannot ‘see’ transactions on the Ethereum blockchain.

Interchain MEV allows traders who can analyze cross-blockchain data to profit from exchanging assets across blockchains via bridges or DEXs. Interchain MEV and associated arbitrage tactics most often occur in cross-domain blockchains such as Cosmos.

MEV is inevitable

Even Ethereum founder Vitalik Buterin has admitted that MEV will always exist in Ethereum. Validators can always select transactions with higher fees – even if those transactions are from obvious front-running or sandwich attackers. MEV traders use a variation of arbitrage and other techniques to maximize profits.

On the bright side, developers can build ways to keep MEV under control by adding rules for who can get the rewards and how users can extract MEV from their blockchains through sovereign MEV practices.

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