Frontrunning, or MEV (miner extractable value) strategies, are becoming increasingly popular in the blockchain world as a way to make money.
MEV is an economic phenomenon that can be exploited by miners, validators, and sequencers who have the ability to arbitrarily include, exclude, or re-order transactions within the blocks they produce. MEV strategies involve executing a set of on-chain interactions with the goal of ending up with more money than you started with by the end of it all.
However, due to MEV’s rising popularity in crypto markets, there has been an influx of automated “bots” designed to take advantage of MEV opportunities before anyone else can. These bots have made it difficult for MEV strategies to remain profitable as they can execute MEV opportunities faster than individuals.
Here is an example of how frontrunners and MEVs can be used to make money in cryptocurrency trading.
Let’s say a large trade on Uniswap creates a $10,000 arbitrage, and an arbitrage bot quickly spots this opportunity. To ensure their transaction is processed first, they submit the order with a small $10 tx fee – enough to hopefully get noticed by miners. However, other smart bots have likely also seen this chance and will bid higher tx fees in an attempt to out-compete the original bot and grab that delicious arbitrage for themselves. The battle for the right to seize the arbitrage is known as a Priority Gas Auction (PGA).
A miner might as well notice the opportunity and capture it for themselves by verifying their transactions instead of that of the arbitrators.
MEV strategies
MEV strategies allow users to increase their profits through a series of on-chain interactions. By responding quickly to changes in the decentralized finance space, these MEV traders can capture value in any situation, regardless of market conditions. As more people learn and understand MEV, the competition for profitable opportunities will only intensify and demand even faster reactions. This makes MEV an invaluable tool for fast and profitable trading if users can quickly spot favorable opportunities and thoroughly understand how to execute MEV strategies best.
Examples of common MEV strategies include:
1. Sandwiching
Sandwiching is a popular form of market exploitation on the blockchain, and traders have become notoriously adept at taking advantage of potential opportunities. For example, when a large order is detected (e.g., an order to buy 100,000 USDC worth of Ethereum through Uniswap) that is waiting for confirmation, smart traders or miners can anticipate the price change that will occur for the cryptocurrency once it is confirmed. By buying Ethereum just before the order confirmation and then selling it right after, they can make a handsome profit by ‘riding the wave’. Thus, sandwiches show how knowledgeable and agile blockchain traders can be when given the opportunity.
2. Frontrunning
Frontrunning is the practice of buying or selling a financial asset before large orders are executed to gain an edge over other traders. In the MEV world, this translates to miners, validators, and sequencers being able to take advantage of MEV opportunities by executing transactions before anyone else can.
By simulating unconfirmed transactions, a frontrunner bot can observe any resulting state changes and can identify arbitrage opportunities in the form of increased account balance by the initiating wallet. It then replicates the original transaction by copying all related data fields and sees whether its own simulated transaction would result in an increased balance. If it does, it attempts to submit its copy of the same transaction with a higher gas price as front-running to benefit from this advantage.
By using these strategies, frontrunners open up possibilities to capture these arbitrage opportunities in mere moments due to their automated nature that can monitor multiple variables simultaneously.
3. Arbitrage
Arbitrage is the process of buying and selling the same assets across different markets to capitalize on price discrepancies between them. MEV traders can take advantage of MEV opportunities by monitoring changes in the decentralized finance space, such as an increase or decrease in liquidity for a specific asset. They then exploit these situations by executing trades that benefit from the market price differences.
The traders can also use arbitrage to reduce their risk exposure by buying assets in one market and simultaneously selling them in another, thus creating a net-zero transaction that still yields a profit.
4. PGA
Priority Gas Auctions (PGAs) are common MEVs that occur when two or more bots/ traders compete for the same opportunity by raising gas fees. Initially, PGAs created significant amounts of spam and reverted transactions on the Ethereum network, causing congestion and making it difficult to use MEV strategies. Fortunately, Flashbots were able to eliminate the majority of them from Ethereum.
Despite this progress, PGA strategies have seen a resurgence due to the increasing popularity of new EVM-compatible chains with lower fees and shorter block times. As these networks expand, so does the number of PGAs that can exploit their advantageous parameters for MEV opportunities.
5. Long tail
Long tail MEV (LTM) is an MEV strategy that takes advantage of how Ethereum processes transactions. Ethereum miners process transactions in batches, and those with higher gas fees are prioritized first within their batch. This structure allows MEV traders to wait for their transactions to be assigned to a later batch, thus increasing the potential MEV profits as the price of gas increases over time.
LTM strategies are especially favored by traders who use MEV bots, as they can simulate MEV opportunities and optimize their profits by adding more MEVs to their front-running strategy. This type of MEV technique requires a sophisticated MEV bot that can monitor markets and efficiently execute MEV transactions.
The downside of MEVs
An MEV transaction has the potential to negatively affect users by exploiting their trades for a miner’s or arbitrage bot’s personal benefit. Specifically, this would be done through what is known as ‘sandwiching’, in which the miner or arbitrage bot places their buy and sell orders around the user’s order to receive an instant profit when the user inadvertently executes at an artificially inflated price.
MEV strategies have their risks, too; if done incorrectly, it is possible to lose money instead of making a profit.
Flashbots
Flashbots is an organization that provides a suitable approach to tackle the potential risks associated with a miner-extractable value (MEV) on Ethereum smart contract blockchains. The ecosystem proposes a transparent, permissionless, and fair system for MEV extraction that preserves the Ethereum ideals.
As technology advances, Smart Contracts will become increasingly prevalent in various industries — making it incumbent upon our organization to provide an adequate solution to this critical issue. To ensure this, extensive research and development have been deployed to evaluate the effectiveness of security protocols and economic models which underpin Flashbots’ patented architecture. We believe this comprehensive solution will be an integral component of blockchain ecosystems.
How to beat MEV bots
Fortunately, there are ways for traders to stay ahead of the bots. These include:
- Understanding the underlying mechanics of MEV and then developing strategies that incorporate them.
- Researching the latest MEV trends, monitoring the market for MEV opportunities, and employing multi-signature transactions and transaction batching tactics to increase their speed in executing MEV trades.
- Looking into MEV bots and understanding how they operate to find strategies to beat them.
- Using MEV services that offer advanced MEV trading tools such as MEV scanners and automated MEV robots.
- Adopting MEV-resistant wallets or services like Flashbots that protect them from MEV exploits.
Conclusion
MEV is an incredibly lucrative and potentially dangerous trading strategy that can be leveraged to maximize profits in Ethereum. Traders must exercise caution when conducting MEV transactions due to the potential for losses and MEV bots that can take advantage of their trades for personal gain.
Fortunately, services like Flashbots have developed a secure, fair, and transparent MEV system that will protect users from MEV exploits in the future.
Strategies such as transaction batching, multi-signature transactions, and advanced MEV monitoring tools can help traders beat MEV bots. With the right knowledge and techniques, MEV can help you make money in Ethereum without risking too much capital or exposing yourself to excessive risk.
