February 21, 2024

MEV bots are computer programs designed to keep an eye on the Ethereum network, spot lucrative possibilities, and carry out such transactions on the user’s behalf automatically.

MEV bots are computer programs that make money by front-running or sandwiching transactions on a decentralized cryptocurrency exchange in the context of Decentralized Finance (DeFi). We’ll explain their operation to you in this tutorial!

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MEV: What is it?

The potential profit block producers may be able to realize by carefully arranging or controlling the transactions that make up a blockchain block is referred to as maximum extractable value (MEV), formerly known as miner extractable value.

The “mempool,” a public area where miners or validators choose and organize transactions in a certain order to be added to the next block, is where all blockchain transactions end up initially. The transactions that have the greatest associated gas fees are selected for validation first.

Block validators typically benefit from transaction fees and block rewards, but the rise of Web3 applications and decentralized finance (DeFi) has created a new revenue source related to the order in which transactions are added to a block.

We refer to this phenomena as MEV, wherein miners and validators have the ability to strategically generate and arrange transactions to extract more earnings, because they have complete control over transaction ordering.

Ethereum’s MEV

Although MEV applies to all blockchains, we often talk about it in relation to Ethereum because it is the biggest blockchain with smart contract functionality and dominates the DeFi industry.

Prior to 2023, Ethereum used the Proof of Work (PoW) method, which allowed a small number of users—mostly miners who created the blocks—to benefit from MEV extraction. Now that the Proof of Stake (PoS) consensus mechanism has been implemented, anybody may act as a block validator and profit from MEV opportunities.

The Ethereum update encourages the usage of “searchers,” or those who utilize sophisticated algorithms to find lucrative possibilities on the blockchain. MEV bots are used by searchers to forward these profitable transactions to validators.

In this arrangement, validators profit from the higher costs while searchers prioritize their transactions and pay higher gas prices. It’s an agreement that benefits both parties.

How Do MEV Bots Work and What Are They?

The majority of specialist teams operate MEV bots, which are complex algorithms. They are designed to keep an eye on mempools that have outstanding transactions, spot MEV chances, and then automatically carry out tactics like frontrunning.

MEV bots raise serious problems as well as new prospects for profit and increased competitiveness in the MEV industry. Since MEV causes network congestion on Ethereum, many see it as a “invisible tax” on average users.

Primary MEV Bot Strategy Types

Based on their tactics, the following are the primary categories of MEV bots:

Bots for arbitrage

These bots detect discernible price discrepancies for an identical asset among many decentralized exchanges (DEXs) and take advantage of these variations by engaging in trading. For example, the arbitrage bot would purchase a token from Uniswap and then sell it on Sushiswap, making money, if the price of the token on Uniswap is lower than on Sushiswap, two well-known DEXs.

Bots that race forward in front

These bots scan the mempool for noteworthy or promising transactions. They plan to execute similar trades ahead of validation by charging a larger fee, which will allow them to enter the next block sooner.

Let’s take an example where a bot discovers a substantial buy order for a token on Uniswap. After the original order magnifies the token’s demand and price due to slippage, it would then try to buy that same token ahead of schedule and resale at a higher price.

putting bots in a sandwich

These algorithms use backrunning and frontrunning techniques to capture a desired transaction.

When a bot finds a large pending buy order for a token on a DEX, its goal is to buy the token before the main order is processed (frontrunning) and then sell it after the pending order is executed by the unwary trader at a higher price (backrunning). This is often a three-transaction harmful strategy:

The token price is inflated by a purchase order placed by MEV bot.

The token is bought by the MEV sufferer for a premium.

MEV bot takes advantage of the price differential by selling the token on the DEX.

Quick loan robots

These bots execute sophisticated trades requiring substantial cash by using flash loans, which are short-term loans completed in a single block. For instance, a bot may use a flash loan to borrow a sizable quantity of ether (ETH), swap it on one DEX for a different token, trade it on another DEX for ETH, and settle the loan with interest all in the span of a single block.

Bots for liquidation

Users must pledge cryptocurrency as collateral using DeFi lending protocols like Aave, Compound, or JustLend. If the borrower is unable to repay the loan, the cryptocurrency may be liquidated. Anyone can liquidate the collateral and get a liquidation fee thanks to the protocol. The borrowers who can be liquidated can be identified by MEV bots, which can subsequently collect these payments.