The rapid adoption of public blockchain networks and decentralized finance (DeFi) protocols has presented new challenges in decentralized applications geared toward financial use cases. One such challenge is Maximal Extractable Value (MEV), a controversial issue that affects many blockchain networks, DeFi protocols, and retail users.

In this article, we’ll explore the concept of MEV, including a real-world example, MEV’s implications on ecosystem stakeholders, and how Hedera is natively resistant to MEV behavior by using its unique consensus mechanism and low, fixed fee economics.

Understanding MEV: The Good and the Bad

MEV refers to the potential profit validators can extract from reordering or manipulating transactions within a block. MEV is a multifaceted issue with both positive and negative aspects. While it offers incentives for validators and can contribute to network efficiency, it can also lead to unfair advantages, reduced decentralization, and market manipulation. Let's explore a real-world example of MEV in action and consider “both sides of the coin” to provide a comprehensive understanding of MEV's implications.

Real-world example of MEV: Uniswap front-running on Ethereum

To better understand MEV in practice, let's consider a real-world example using Uniswap, a decentralized exchange (DEX) built on Ethereum. Uniswap enables users to trade ERC-20 tokens without an intermediary, using an automated market maker (AMM) model to determine token prices.

Imagine that Alice, a trader, identifies an arbitrage opportunity in the market. She plans to trade 10 $ETH for a certain amount of $LINK (Chainlink) on Uniswap, and then immediately sell $LINK on another DEX for a higher price, making a profit. Alice submits her transaction to the Ethereum network, which includes a gas fee to incentivize validators to include her transaction in the next block.

However, before her transaction is processed, a validator (or a bot monitoring the mempool) spots Alice's profitable trade and decides to front-run her. The validator creates their own transaction, swapping 10 $ETH for $LINK, but sets a higher gas fee to prioritize their transaction over Alice's. As a result, the validator’s transaction is included and processed before Alice's, and they buy $LINK at a lower price.

When Alice's transaction is finally processed, the price of $LINK has increased due to the validator’s trade, reducing her arbitrage profit or even causing a loss. The validator then proceeds to sell $LINK on the other DEX, realizing the profit Alice initially intended to make.

This example demonstrates how MEV can be exploited in a DeFi protocol like Uniswap, leading to front-running and other manipulative practices that affect the fairness and security of the ecosystem.

Pro arguments for MEV

• Incentive for validators: MEV can be seen as a natural byproduct of the competitive nature of blockchain networks. Proponents argue that it provides an economic incentive for validators to contribute to the network's security and maintain its infrastructure.

• Compensation for risks: Mining or validating transactions involve costs and risks, such as hardware investments and energy consumption. MEV offers a means for validators to recoup their expenses and compensate them for these risks.

• Network efficiency: Some supporters of MEV believe that it can contribute to network efficiency by encouraging validators to prioritize transactions with higher fees, which can result in faster transaction processing times.

Con arguments for MEV

• Unfair advantage: Critics argue that MEV can lead to an unfair advantage for validators or validators with more extensive resources or inside knowledge, enabling them to front-run transactions and exploit other users.

• Reduced decentralization: MEV can contribute to centralization, as validators with stronger capabilities could potentially dominate the network and manipulate transaction ordering, diminishing the core value proposition of decentralized systems.

• Market manipulation: MEV can result in market manipulation, as front-running and other exploitative practices distort asset prices and undermine the integrity of decentralized markets.

• Higher gas fees: MEV can result in inflated gas / transaction costs for everyone due to competing bids or bribes by clients requesting that validators prioritize their transaction.

Hedera: MEV-Free Due to aBFT, Fair Transaction Ordering, and Low, Fixed Fees

Hedera presents a robust solution to MEV by leveraging its unique hashgraph consensus algorithm with the attribute of asynchronous Byzantine Fault Tolerant (aBFT), ensuring fair ordering of transactions with consensus timestamps. This innovative approach addresses the MEV issue in the following ways:

• Leaderless network: Hedera is a leaderless network, which means that no single node can unilaterally decide the order of transactions and all nodes are able to receive transaction submissions. This approach eliminates the possibility of a single node or a group of nodes unilaterally deciding the transaction order, making it virtually impossible for an attacker to exploit MEV.

• No mempool: Transactions on Hedera are not held in a memory pool by validators, making it impossible for a malicious node to exploit transaction ordering.

• No bribing of validators: Hedera does not have variable transaction fees — they’re fixed, based in USD, and paid in $HBAR. This fee structure eliminates the ability for clients submitting transactions to pay more/incentivizes validators to prioritize their transactions.

• Consensus timestamps: Using consensus timestamps helps to ensure that no participant can manipulate the order of transactions by adjusting their local clocks. This feature adds another layer of protection against MEV-related attacks and reinforces the fairness of the transaction ordering process.

By adopting an aBFT consensus mechanism and guaranteeing fair transaction ordering with consensus timestamps, Hedera effectively eliminates the fundamental premise for MEV to exist. This approach provides a more secure, fair, and decentralized environment for Web3 applications and represents a significant advancement in addressing the challenges posed by MEV in the blockchain landscape.

Theoretical attempts at MEV on Hedera

Even if a validator attempted to manipulate transaction ordering on Hedera, several factors make it challenging to extract any value:

• Low probability: If users send the same transaction to multiple consensus nodes, the chance of a single node receiving all relevant transactions before the others are near zero.

• Reputational damage: Validator nodes attempting to delay transactions submitted to them risk being detected, leading to reputational damage and loss of stake by participants staking $HBAR to the validator.

• High costs: Consensus on transaction ordering is reached regardless of execution. Attempting to analyze and front-run transactions in this environment is costly and unlikely to succeed.
  

• No mining incentives: Blockchain platforms reward validators with coins and fees, encouraging MEV attacks for profit. Hedera Hashgraph's consensus mechanism doesn't involve mining, and its validators, chosen by the Governing Council, have reduced incentives for malicious behavior.

The DeFi Ecosystem on Hedera

Hedera Hashgraph offers a unique solution to the MEV problem by eliminating its fundamental requirements. With no leaders, memory pool, variable transaction fees, or blocks, Hedera provides a more secure, fair, and decentralized environment for financial applications in Web3. As the blockchain landscape continues to evolve and legacy financial institutions begin exploring modern decentralized solutions, it is essential for developers and users alike to understand the implications of MEV and support platforms that prioritize fairness and security.

The DeFi ecosystem on Hedera offers ecosystem wallets, decentralized exchanges, network bridges connecting Hedera to over 10 chains, on/off-ramps, stablecoins, and more. Some of the largest decentralized exchanges on Hedera include SaucerSwap, Pangolin, and HeliSwap. Get started by visiting https://www.hedera.com/use-cases/defi to explore the entire DeFi ecosystem on Hedera.