Previewing the content of transactions before they’re confirmed in a block could result in market abuse, according to European regulators. The latest proposals for the EU’s Markets in Crypto-Assets (MiCA) Regulation set reporting obligations for digital asset service providers on the detection/prevention of market abuse, investor protection, and operational resilience.
Previewing and/or re-ordering transactions for inclusion in an unconfirmed block is known in the blockchain world as “maximal extractable value” (MEV). MEV techniques are most commonly known in the DeFi, decentralized exchange (DEX), and Ethereum worlds, where there’s more opportunity to examine the contents of a smart contract before it’s included in a block.
The comment on potential market abuse via MEV was published in the third consultation package report from the European Securities and Markets Authority (ESMA) on March 25.
“ESMA notes that MiCA is clear when indicating that orders, transactions, and other aspects of the distributed ledger technology may suggest the existence of market abuse e.g., the well-known Maximum Extractable Value (MEV) whereby a miner/validator can take advantage of its ability to arbitrarily reorder transactions to front-run a specific transaction(s) and therefore make a profit.”
To be clear, ESMA/MiCA does not propose that all MEV techniques should be considered market abuse. However, if service providers identify a particular use of MEV that might fall under this description, they would be obligated to report it. One example would be the bot-based “sandwich attack” described below.
The comment still drew criticism from some sectors of the blockchain industry and media, who claimed ESMA would act outside its scope by interfering in transaction processing/validation practices. Others noted that there’s nothing especially wrong with choosing transactions based on their profitability and that it forms an integral part of mining’s economic incentive model.
What is MEV?
MEV is not a specific technique, but the term refers to practices by which transaction processors (i.e., miners or nodes actually writing blocks to the chain) preview pending transactions in the mempool—and re-order them in a way advantageous to themselves.
The mempool is publicly available information, and on some chains, unconfirmed transactions may sit in the queue for several minutes or even hours (or longer) before a miner selects them for inclusion in a block.
Originally called “miner extractable value,” MEV arose from theoretical discussions about five years ago. This was a technique initially used on the Ethereum blockchain when ETH still ran on a proof-of-work (PoW) algorithm. MEV also works on other blockchains, though it is more popular on Ethereum since that network runs contract code on-chain, allowing processors to see what the code is doing before adding it to a block.
Ethereum has since shifted to a proof-of-stake (PoS) processing algorithm and no longer has miners per se (they’re now called “validators”). However, MEV practices have continued to exist under the newer term “maximal extractable value.” Previewing and value-extraction processes are automated, often by third parties who scan transactions and then replicate them with a higher fee, ensuring their replacement transaction gets validated/processed first.
DeFi/DEX platforms process trades using these on-chain contracts, and there’s potential for an MEV bot to front-run a transaction on a DeFi exchange if it can detect large trades and/or potential price swings before that trade is executed. This is known as a “sandwich attack” and can result in price slippage and loss of profits for the victim, who remains unaware the attack ever happened.
MEV is also used for arbitrage, examining which assets are hot on particular platforms and exploiting subtle price differences to trade them at large volumes. All these techniques can be extremely lucrative, with some estimates saying MEV sandwich bots make around US$50,000 profit daily.
Is this tolerable or abuse? It depends on who you ask. Many DeFi/DEX users have identified it as a problem—in fact, the MEV sandwich attack was theorized as early as 2014, before Ethereum even launched. Unknowing investors, including businesses and their customers, face additional fragility in trying to compete against bots operated by a small handful of traders.
On the other hand, finding new efficiencies in a market and using them for gain isn’t illegal, even if it’s to someone else’s disadvantage. That’s just how markets work.
Is MEV an issue on the BSV blockchain?
In theory, any blockchain network with a visible mempool provides the chance for processors to identify the most profitable transactions and re-order them to take advantage. On low-data-limit chains like BTC, this would simply be a process of identifying those with the highest fees and putting them first (it goes without saying, but this is why paying a higher fee on BTC will prioritize your transaction).
This is much less of an issue on the BSV blockchain since the network generally has the capacity and throughput to allow everyone to pay the same miniscule fee (though it does still fluctuate). With the coming Teranode upgrade, it will be able to process millions. Since everyone’s transaction goes through, ordinary users aren’t disadvantaged.
BSV blockchain also doesn’t run smart contract code on-chain like Ethereum does, meaning miners only process the updated state of a contract as a UTXO, rather than see its details. That’s not to say it could never happen, though, as new contract types such as token protocols emerge. There are always theoretical techniques that could be put into practice by smart and creative coders—it just hasn’t happened yet.
Another viewpoint is that as (BSV) block sizes grow, the calculation costs of building the most profitable block grow with them. However, they could potentially run custom node clients with different fee policies, combined with an overlay network that listens to each client and attempts to “best-guess” which transactions are paying the highest fees.
GorillaPool Co-Founder Kurt Wuckert Jr. explained:
“For now, the return on calculating the most valuable possible block to build is diminished, or possibly even in the negative because the cost of calculating the possible UTXO set of any variation is prohibitively large, especially with bigger blocks, so it’s not something we are doing at GorillaPool.”
Overall, whether MEV may constitute market abuse is another symptom of blockchain technology being developed and deployed mainly for the purposes of speculative trading and fiat gains. And as long as those markets exist with billions of investors’ dollars (or euros) at stake, regulators will step in to install guardrails.
The digital asset trading world has so far enjoyed more freedom to deploy techniques and scams that have been either regulated or outlawed in the traditional financial world. The excuse that governments are interfering in technological development by regulating blockchain rings hollow when participants’ main concern is making (fiat) profits while producing nothing of real economic value. A real blockchain-driven digital economy provides plenty of other opportunities for innovation.
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