MEV Has Spread to Bitcoin, in Subtler Forms Than on Ethereum

Before centralized crypto exchanges offered these tokens for sale, early investors acquired them through decentralized Automated Market Makers (AMMs) without the need for sharing personal information or waiting in line. AMMs function as decentralized platforms that connect buyers and sellers of cryptocurrencies directly, allowing users to buy a desired asset by simply connecting their digital wallets, specifying the amount they wish to purchase, and completing the transaction with a single click.

As a researcher exploring Automated Market Makers (AMMs) and their distinction from traditional equities markets, I find it intriguing that despite the crypto community’s advocacy for cryptocurrencies and blockchains as the future of stock trading (imagine a stock market that never closes, where mistakes are irreversible, but potentially profitable if you capitalize on them – like when Berkshire Hathaway stock seemed to trade at around $180 instead of $600,000), equities markets remain more dynamic and responsive than AMMs.

Crude example: Person A wants to buy Stock XYZ at $100 and Person B is selling Stock XYZ at $99. Because today’s financial markets are so hyperconnected, Person C somehow knows this (there are legal and illegal ways to find and act on this information) and buys Stock XYZ from Person B for $99 and instantly sells it to Person A for $100. Everyone is happy: Person A gets Stock XYZ, Person B gets $99, and Person C gets $1 arbitraging the trade.

The opportunity for profiting from the price discrepancy between Stock XYZ’s buyers, Person A, and sellers, Person B, through arbitrage has now been seized by Person C. Consequently, the market inefficiency, represented by the $1 difference between their transactions, has been eliminated. This occurred sequentially in real time, necessitating Person C to perfectly time their intervention between Person A and B for the successful execution of the trade (A -> C -> B).

As a crypto investor, when I come across trades involving buying large quantities of tokens followed by immediate selling of smaller quantities, I refer to them as “sandwich trades” or even “sandwich attacks.” The automated market makers (AMMs) aren’t perfectly matching buyers with sellers in these situations. Instead, they may prioritize other orders, potentially causing me to miss out on my intended trade or receive a less favorable price. It can be quite frustrating when I attempt to buy a significant amount of tokens only to end up with fewer than expected due to AMM inefficiencies leading to sandwich trades.

In the realm of crypto, Maximal Extractable Value (MEV) refers to the practice of strategically ordering transactions in a block for personal profit, as opposed to following the sequence preferred by transactors. This concept arises due to the gap between the confirmation time of Ethereum transactions and real-time, enabling arbitrage opportunities for bots during this interval. Essentially, MEV is a way for crypto market participants to capture value from transaction ordering that isn’t immediately apparent to the transactors.

Considering the information provided, it’s not hard to visualize that MEV (Minimum Value Extracted) has broadened its scope beyond Automated Market Making (AMMs). In simpler terms, the complexities of a task increase the likelihood of MEV being present, just as in traditional finance.

MEV: Merits, drawbacks, and its tenuous existence on Bitcoin

The discussion around MEV is expansive. Is it good? Is it bad? Is it illegal?

Depends whom you ask.

MEV represents the market’s self-correcting mechanism on blockchains, eliminating inefficiencies and reducing potential exploits. However, this also exposes novice users to significant risks as they may unwittingly fall prey to more experienced traders taking advantage of these opportunities.

Up until now, Ethereum is the sole blockchain we’ve discussed due to its early adoption. However, Mechanized Economic Value (MEV) has primarily been a non-issue on Bitcoin. The concept was theoretically sound, but in reality, it hasn’t been financially worthwhile (applicable only in rare circumstances).

“You might be thinking: ‘Is there no Minimal Value Extraction (MEV) for Bitcoin automated market makers (AMMs)? If so, shouldn’t there be?'”

Although you’re correct that there aren’t significant Bitcoin Automated Market Makers (AMMs), the reason for this lies in Ethereum’s greater expressiveness. With Ethereum, you have the ability to create and trade various assets, such as coins featuring dog mascots or memes, which isn’t easily achievable on Bitcoin. This flexibility makes Ethereum a more attractive platform for AMMs and potential financial gains.

As a Bitcoin analyst, I can tell you that the lack of expressiveness and scarcity of new tokens on the Bitcoin network translates into a less vibrant market and Automated Market Maker (AMM) ecosystem. With limited non-Bitcoin assets available, opportunities related to AMMs and their associated Miner Extractable Value (MEV) are significantly reduced since these often depend on the trading of various assets against each other. Essentially, without the presence of new, diverse assets to trade, one would primarily be engaging in Bitcoin for Bitcoin transactions.

Well, yes. This is exactly where MEV on Bitcoin has begun to present itself.

MEV on Bitcoin

As a crypto investor, I’ve noticed that Minimum Value Extraction (MEV) isn’t nearly as strong of a factor in Bitcoin compared to Ethereum. This observation often comes up in conversations among industry experts, but we always qualify it with cautions.

“Colin Harper, the head of research and content at Bitcoin mining company Luxor Technology, described it as being similar to playable games rather than Multi- transaction Execution (MEV),” is a possible paraphrase.

Approximately three years ago, Bitcoin underwent an upgrade named Taproot, enhancing its capabilities for more complex transactions. Unexpectedly, this enhancement paved the way for creating Bitcoin-based counterparts of NFTs using Casey Rodarmor’s Ordinal protocol. In simpler terms, when I refer to “trading bitcoin for other bitcoins,” I’m talking about how NFTs can function on Bitcoin. The Ordinal protocol allows specific satoshis, the smallest unit of bitcoin (equivalent to a hundred millionth), to carry arbitrary data – be it an image, text or anything else. These unique collectibles are referred to as inscriptions to distinguish them from NFTs which remain separate tokens. Instead of purchasing a completely new token as on Ethereum, you’re just acquiring some bitcoin that holds significance only when viewed through the Ordinals protocol lens.

As a researcher studying non-fungible token (NFT) markets, I’d explain it this way: When you list an inscription for sale on Magic Eden or a similar platform, you engage in a PSBT (Partially Signed Bitcoin Transaction). In this setup, the seller signs their half of the transaction. Upon purchase, the buyer completes the deal by adding their signature and settling the transaction fee.

Though not identical to the MEV (Minimum Excellent Value) scenario described initially in this article, this situation bears similarities: The intended buyer and seller didn’t transact directly due to a third party stepping in, providing additional incentives for miners. In return, miners seized this opportunity, maximizing their own profits by executing the third-party transaction.

Other things that feel like MEV on Bitcoin

Bitcoin continues to have miners, a role distinct from Ethereum’s validators. Mining activities in Bitcoin involve certain recurring events reminiscent of Minimum Exchange Value (MEV) in the crypto space.

As a researcher studying the intricacies of the Bitcoin network, I’ve come across an interesting phenomenon: empty blocks. In essence, these are blocks that get mined without any transactions in them, apart from the coinbase transaction that rewards the miner. The transactions queue remains untouched during this process, with no confirmed deals taking place except for the one giving the reward to the successful miner. This situation arises due to the technicalities of mining, and it’s debatable whether it constitutes Market Evaporated Value (MEV) or benefits Bitcoin overall. While empty blocks are not an intentional part of the system and can be considered an accident, their implications for the network are still a topic of ongoing debate.

Bitcoin mining has seen the emergence of mining pools, where miners collaborate to increase their collective mining power and stabilize revenue by jointly processing transactions and receiving proportional rewards. However, as these pools continue to grow larger, concerns arise regarding potential negative consequences. Walt Smith of Cyber Fund highlighted this issue in a comprehensive article titled “MEV on Bitcoin.”

Currently, a few mining pools hold a significant portion of the overall network hashrate, with two or three of these pools potentially commanding over half of the computational power. If these pools managed to mine a consecutive series of blocks, they could leverage their dominant position to increase profits by wielding their monopolistic control.

As a crypto investor, I’ve come across another real-life instance of bitcoin miner activity that could potentially be classified as MEV, but with a twist – out-of-band payments. In simpler terms, this refers to situations where miners receive additional compensation, either off-chain or through separate transactions that seem unrelated, in order to process non-standard transactions.

Some researchers express concern that out-of-the-box payments may lead to a series of unwanted consequences, including obscuring incentives. However, miners are eagerly embracing this opportunity. For instance, Marathon Corporation, a publicly traded mining company listed on NASDAQ (symbol: MARA), has introduced a new service named Slipstream, which is designed to handle non-standard transactions.

There’s a worry that this hidden practice could result in the creation of private mempools on any blockchain, which is problematic. As Sam Kessler of CoinDesk explains, “the main concern is that the implementation of private mempools may establish new intermediaries in Ethereum’s transaction processing system.”

If private mempools emerge as the primary channel for transaction submissions, this could result in a concentration of power over Bitcoin transactions among a select few. Such a scenario would effectively centralize control on the blockchain, which is undesirable for those advocating for decentralization and censorship resistance.

As a cryptocurrency investor, I cannot stress enough the importance of being aware of Miner Extractable Value (MEV) on Bitcoin. While Ethereum has been the main focus of MEV discussions so far, it’s essential to note that similar opportunities exist on the Bitcoin network. These situations may not present themselves in quite the same way, but they are worth keeping an eye out for. The presence of MEV is inevitable, and as active participants in this ecosystem, we must remain vigilant and adapt accordingly.

As a researcher, I’d like to emphasize that the perspectives conveyed in this article are my own, and they may not align with those held by CoinDesk, Inc., or any of its proprietors and shareholders.