Learning Market N°4: MEV 2.0
This is a summary of the 41-page article written by Ali Sheikh from Reciprocal Ventures.
This is the 4th edition of the “Learning Market”, a series that I launched to share some of the content I read and listen to.
Instead of focusing on crypto prices, this is the perfect time to study, learn, and be one step ahead of everybody else when the next bull run hits.
I read the 41-page article by Ali Sheikh from Reciprocal Ventures. Here’s the summary.
What is MEV or Maximal Extractable Value?
MEV refers to the extraction of value from users by reordering, inserting, and censoring transactions within blocks.
MEV Market
What makes the MEV Market unique is that there are two participants, Miners & MEV Searchers, that work together to extract value. The overall MEV Market resembles more of an oligopoly structure when assessed holistically. An oligopoly is a market characterized by a small number of firms that realize they are interdependent in their pricing and output policies.
Why is the MEV Market an oligopoly?
High barriers to new entry.
Imperfect Competition / Price-setting ability: MEV Searchers & Miners will work together to maximize total Extractable Value even if it is at a cost to the User.
The interdependence of firms: how a Miner structures MEV influences the action of other Miners.
Non-price competition.
Possibility of Collusion: Miners can work together to collude in this space.
MEV Searcher Market
MEV Searchers are like the “plumbers” of Blockchains. They go deep into transactions within blocks to find MEV. It is a group of artisan & specialty anons who
have valuable technical knowledge on how to extract value. This dynamic has characteristics of monopolistic competition.
Why is the MEV Searcher Market a monopolistic competition?
Slightly Differentiated Services: MEV Searchers all try to find extractable
value on-chain, though the method of MEV differs from Searcher to SearcherMany Searchers
Maximize profits: each Searcher will try to find as much MEV as possible.
Imperfect Information: MEV Searchers have an informational advantage over Users
Consequences: Searchers operate with the knowledge that their actions will not
affect other searchers’ actions.
The MEV Miner market is highly concentrated. It scores 0.545 on the HHI (an index to measure market concentration).
Today’s MEV dynamics for Searchers & Miners are not enough to fully democratize MEV and move it into a perfectly competitive market because they don’t include USERS. However, Proof-of-Stake might change this and ultimately lead us to a theoretically perfectly competitive market.
A New Paradigm: Enter Proof of Stake
What fundamentally breaks the oligopolistic competition in Proof of Stake is that Users are able to decide which Validators to stake assets with, which may impact Leader selection or stake-weight. This opens the door for MEV innovation.
In PoS, instead of miners competing with each other to validate & confirm transactions, “validators” are randomly selected to verify transactions based on a Leader schedule.
Users will select Validators that give them the highest starking rewards as well
as Validators that charge the lowest fees/commissions.
Users will choose the Validator with the highest return and lowest fees.
The more stake-weight the Validator has, the higher its chances of being the Leader.
Think of it as a Lottery System where the more stake-weight a Validator has – the higher chance it has of being selected as a Leader.
Enter MPSVs, The Future of Efficient MEV Markets
Some fascinating game theory happens when MEV Searchers are able to work with Validators to extract MEV. Users are finally able to passively earn a portion of MEV rewards.
There is an interdependency between MEV Searchers & Validators for the MEV Market. One cannot exist without the other. So:
If a Validator loses its Users, it can no longer be a Leader (given all of its tokens have moved to another Validator)
If a Validator loses its Users, it no longer receives any MEV transactions from Searchers and instead, the MEV transaction goes to the other Validator
The Nash Equilibrium: For both Validator A and Validator B there is only one potential outcome where both Validators are best responding and that is if both Validators set their profit at $60. This will be the sole Nash Equilibrium and they will each earn a $60 total profit.
This is what gives rise to MPSVs = MEV Profit Sharing Validators.
Proof of Stake gives Users the ability to decide where they want to stake their assets. Ceteris paribus, having more stake-weight allows you as a Validator to be the Leader in the PoS model. For rational economic actors, deciding where to stake comes down to where you can earn the highest APY with the lowest fees/commissions.
CONCLUSION: What breaks the Oligopoly of the MEV Market is User Choice!
Previous Editions of The Learning Market:
Learning Market N°2: Fantastic Macro Article by Lyn Alden
Learning Market N° 3: Chainalysis State of Web3 Report
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