Cross-Chain MEV as an Essential Value Accrual Mechanism

Cross-domain MEV
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By 0xbrainjar

Summary

MEV has largely developed a negative connotation in the DeFi space. While some types of MEV extraction like frontrunning are certainly detrimental to users, other types have a positive impact on the overall industry. In fact, arbitrage actually enhances market efficiency, which is especially needed across different blockchains where price discrepancies abound.

In this article, I first define cross-chain MEV and explore its sources and extraction mechanisms. I then present an argument for why arbitrage in particular is an essential value accrual mechanism in DeFi - and should thus be further researched.

Defining Cross-Chain MEV

MEV in general has been defined as the maximal value extractable between one or more blocks, given any arbitrary re-ordering, insertion or censorship of pending or existing transactions (as defined by Obadia et al., 2021). Put more simply, it is the greatest profit that can be earned from rearranging transactions within a block.

Cross-domain MEV can thus be understood as the maximum value that can be captured from such arbitrage transactions executed in a specified order across multiple domains.

Sources of Cross-Chain MEV

Cross-domain MEV has been proposed to originate from two primary sources (McMenamin, 2023):

  1. Intrinsic-extractable value: Expected value for an extractor at the precise time the state or transaction must be acted on (t = 0).

    • In an order, this is approximately the expected value of all front- and back-running opportunities combined.
    • In a pool, this is approximately the expected value from moving a price up or down at the time when orders are included in the chain.

  2. Time-extractable value: Derived similarly to an option, this is the value derived because the extractor has the time between confirmation times/blocks to determine if they should act on a particular blockchain state.

    • For extractors, this is the sum of all paths with a positive extractable value at expiration multiplied by the probability of that path happening.

Types of Cross-Chain MEV

From these sources of cross-chain MEV, a number of types of cross-chain MEV extraction mechanisms can be implemented. MEV can either be extracted as a result or ordering or signaling (Chen et al., 2023):

  • Ordering: Transactions are strategically sequenced and inserted for execution based on on-chain information. The value of the tokens involved at the start of the sequence is greater than the value at the end of the sequence.
  • Signaling: Off-chain information is used to create profitable transactions on-chain. For example, an extractor of signaling MEV might use information such as underlying token valuations. Notably, unlike with ordering, in signaling the initial balance of tokens is worth less than the final balance to the MEV extractor.

Specific examples of ordering and signaling forms of MEV extraction are shown below:

  • Frontrunning: A type of ordering MEV where searchers use bots to scan mempools for profitable transactions. These bots replicate user transactions with a higher gas price so that new transactions will be chosen over the initial user’s transaction.
  • Sandwich attacks: A type of ordering MEV strategy manipulates crypto prices. Sandwiching involves searchers placing a trade right before and after a large DEX trade to benefit from the artificial price change they create.
  • Arbitrage: A type of signaling MEV strategy where traders leverage a price difference between two exchanges (such as two DEXes or a CEX and a DEX). They make a buy at the lower price and then sell at the higher price for a profit. This aligns the prices of the exchanges and makes the market more efficient.

Note that the first two types of MEV we have described (frontrunning and sandwiching, which are both types of ordering MEV) have negative impacts on users. In frontrunning, user trades are less likely to go through, and they may miss out on valuable opportunities they have identified because frontrunners essentially cut the line in front of them. With sandwich attacks, artificial price manipulation may result in suboptimal trading prices for other users.

However, arbitrage (a type of signaling MEV) has a more positive impact on users. In arbitrage, prices are better aligned across exchanges. This provides more accurate prices for users and makes the overall market more efficient.

Cross-Chain MEV Frequency & The Role of Bridges

In the cross-chain context, bridges play an important role in all types of MEV extraction. That is because they facilitate the movement of assets cross-chain. An example of cross-domain arbitrage between Ethereum and Polygon using the Polygon bridge (by Obadia et al., 2021) is shown below:

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One study (Ilisei, 2024) found an average of 32 cross-chain arbitrage occurrences a day on the Polygon bridge alone. Yet, cross-chain bridging is a relatively new technology. As cross-chain bridges such as that from the Picasso Network continue to expand, it is reasonable to anticipate that cross-chain MEV extraction will also grow.

Importance of Cross-Chain MEV

As we have described, not all types of MEV extraction have a negative impact on users. In fact, I see arbitrage as an essential value accrual mechanism:

Crypto markets are inefficient. As a result, the same assets will be trading at different prices in different locations. This is largely due to different fees and different levels of liquidity on these different exchanges. These prices tend to vary even more greatly between chains than within a single chain. There are no built-in mechanisms to identify these price discrepancies and stabilize them.

Thus, arbitrageurs play an important role in maintaining market efficiency. When they identify the price difference between two exchanges and extract this difference as MEV, the result is greater alignment between these exchanges. This positive benefit is a significant reason why cross-chain MEV is an active area of research for the Composable Foundation, such as our RFPs here:

Overall, we believe that it is important to thoroughly understand the role of MEV, particularly in the cross-chain context. With this knowledge, we will better be able to protect against detrimental forms of MEV extraction, and leverage a more positive form of MEV extraction to provide incentives to various actors while also enhancing market efficiency.