Researcher: TBD
Summary
Maximal Extractible Value (MEV) presents a significant earnings opportunity on Ethereum and a number of other prominent blockchains. Moreover, MEV facilitates economic efficiency by driving price alignment on different exchanges. Despite these benefits, however, it seems that there is relatively little MEV extraction occurring in the Bitcoin ecosystem, with there being little insight into the extent/mechanisms of this extraction.
This research initiative thus aims to qualify and quantify MEV extraction on Bitcoin, additionally establishing a model for optimizing this MEV extraction.
This initiative will therefore contribute the following:
- A greater understanding of Bitcoin-based MEV
- A mechanism for optimizing Bitcoin-based MEV extraction
Background & Problem Statement
Background
Core background concepts/definitions are as follows:
Maximal Extractable Value (MEV):
MEV is a type of profit that can be extracted from pending transactions through various mechanisms such as including, excluding, or reordering the transactions in blocks.
In recent years, MEV has been explored and described in research, though with ever-changing technology, it is not fully understood. Daian et al., for example, were the first to coin the term “MEV” in their 2019 paper exploring a number of types of MEV extraction on Ethereum.
Some core types of MEV extraction are listed below:
- Frontrunning: searchers use bots to scan mempools for profitable transactions, replicating user transactions with a higher gas price so that new transaction will be chosen over the initial user’s transaction
- Sandwich attacks: a front-running strategy to manipulate crypto prices, accomplished by searchers placing a trade right before and after a large DEX trade to benefit from the artificial price change
- Arbitrage: traders leverage a price difference between two exchanges (such as two DEXes or a CEX and a DEX), making a buy at the lower price and then selling at the higher price for a profit; this also aligns the prices of the exchanges and makes the market more efficient
- Liquidation: when users do not repay their loans on a lending protocol, their collateral can often be liquidated by anyone to earn a liquidation fee
Bitcoin:
Bitcoin is the original cryptocurrency, with both the Bitcoin chain and its token being established in 2009. Bitcoin continues to be at the top of crypto rankings; at the time of writing, it has the largest Market Cap, which is over $890 billion (as per CoinMarketCap). Bitcoin is also the crypto that is arguably the closest to mass adoption, exemplified when Bitcoin ETFs were recently approved by the US Securities and Exchange commission. However, DeFi practices with Bitcoin are limited compared to other blockchains like Ethereum, partially due to its inefficiencies such as significant financial/energy costs to operate and slow transaction speeds.
Bitcoin is structured very differently from most newer blockchains (such as being the only significant proof-of-work blockchain, with other chains operating along proof-of-stake security models). This means that MEV extraction on this chain looks quite different than on PoS chains.
Problem Statement
The problem here is that the MEV landscape in Bitcoin is poorly understood, and it seems that relatively little MEV extraction is occurring in the space.
Thus, the questions that this research aims to address is as follows:
- To what extent is MEV extraction already occurring in the Bitcoin ecosystem?
- What mechanisms are being used for this extraction?
- How can we optimize MEV extraction in the Bitcoin ecosystem?
Plan & Deliverables
Expected outputs/deliverables are as follows:
- An understanding/quantification of how MEV is being extracted on Bitcoin
- A system for optimally extracting Bitcoin MEV
The plan for achieving this output is outlined below:
Experiment 1: Determine how MEV is being extracted within the Bitcoin ecosystem, and to what extent.
It is clear that a number of types of MEV are already being extracted on Bitcoin. In this experiment, we will assess to what degree the following MEV extraction mechanisms are being implemented in the Bitcoin ecosystem:
- Replace-By-Fee (RBF)
- Lightning Watch Tower Attacks
- Sniping Sidechain Auctions
- Frontrunning Ordinal Mints
- Feather Forks
- Empty Blocks, Full Mempool
- Miner Cartilization
A description of each of these types of MEV extraction can be found in the article by Walt Smith linked in the Reference section below.
We will also seek to identify (and quantify) any other types of MEV extraction occurring on Bitcoin as a part of this experiment. In particular, the introduction of layer 2s (L2s) in Bitcoin will likely drive new MEV extraction opportunities. Bitcoin Ordinals (e.g. the Bitcoin-based equivalent of NFTs) may also drive new MEV mechanisms.
Specific steps to implement this are:
- Find a way to measure overall MEV and order flow associated with every transaction in Bitcoin, likely involving pulling data from some sort of block explorer
Experiment 2: Architect a system for optimizing MEV extraction within the Bitcoin ecosystem.
Using data from experiment 1, we will develop mechanisms for optimizing MEV extraction on the Bitcoin blockchain.
References
How to Participate
If you’re a researcher who believes that you would be a good fit to contribute to any of the Composable RFPs, please reach out to Composable’s Lead Research Associate, Sydney Sweck, at sydney@composable.finance. In the email, be sure to include:
- The RFP number(s) you’d like to contribute to
- Your relevant background experience
- How you think you could contribute to the research