# The Essential Role of Economic Incentives in Public Blockchain Networks

In the realm of decentralized network operations like public blockchains, economic incentives are critical. These incentives motivate participants to provide resources and conduct transactions, ensuring the security and stability of the system. By design, such networks operate autonomously, maintaining stability and reliability without centralized oversight.

Economic rewards not only drive sustained contributions from participants but also play a vital role in maintaining the blockchain ecosystem. However, these incentives can sometimes produce negative externalities. A prime example is Maximal Extractable Value (MEV). Though MEV was intended to optimize network efficiency, it has, in practice, exacerbated congestion and increased fees, effectively raising the cost for participants. MEV acts as an unseen tax within the incentivized system and presents challenges that need to be addressed.

# High-Profile MEV Exploitation: The MIT Brothers Case

In March, U.S. federal prosecutors indicted MIT graduates Anton and James for fraud and money laundering. They allegedly manipulated the Ethereum (ETH) network’s transaction verification and addition protocols to steal approximately $25 million in cryptocurrency within just 12 seconds.

Operating as validators on the Ethereum network, Anton and James employed bait transactions whenever selected as block proposers. They enticed front-running bots with these transactions, then altered the block content to swap these bait transactions with their own cryptocurrency sale transactions, thereby reaping profits by selling at higher prices. The prosecution views this as a severe breach of blockchain integrity.

Using their expertise in computer science and mathematics, the brothers exploited structural vulnerabilities in the blockchain. While blockchain transparency enhances security and trust as all transactions are publicly visible, it also allows malicious actors to monitor transaction data in real-time, offering opportunities for abuse.

# MEV’s Negative Externalities

Although MEV incentivizes block creation participants, it also has detrimental side effects. Since Ethereum usage surged in 2020, network congestion and fee escalation have intensified, further worsened by bots exploiting MEV.

These bots monitor pending transactions in the mempool in real-time, arranging them to their advantage, thereby straining the network and degrading performance. For instance, if a user opts to pay more for faster data processing, their transaction gets priority, causing delays for others. This mirrors how specific bots or miners prioritize their transactions under MEV, aggravating network congestion.

MEV exploitation methods include:
– **Front-Running**: Detecting submitted transactions and imputing similar or opposing trades before others are executed, capitalizing on price movements.
– **Back-Running**: Arranging beneficial trades based on an observed transaction’s outcome, minimizing losses in expected large sells.
– **Sandwich Attacks**: Inserting trades before and after significant orders to profit from price changes.

Highly active bots disrupt market efficiency, as highlighted by incidents on the Solana (SOL) network. Notably, a bot named ‘arsc’ snatched about $30 million from users through MEV attacks, hiding its tracks by transferring stolen assets to cold wallets.

# Is Regulation the Answer?

With recurring MEV exploitation, there’s growing advocacy for relevant regulations. The European Securities and Markets Authority (ESMA), as per MiCA guidelines, classifies MEV as unlawful market malpractice. ESMA claims MEV allows validators to gain by arbitrarily reordering transactions, reflecting the information asymmetry between block creators and general users despite blockchain’s transparency.

While MEV incentivizes block creators and enhances network stability, it’s critical for decentralized blockchains like Bitcoin and Ethereum to include incentive mechanisms for efficient operations. Public blockchain projects exemplify this by rewarding participants for contributing computational power or staking assets, ensuring their involvement and the network’s continuous security.

# Mitigating MEV: Flashbots and MEV-Boost

Innovations like Flashbots enhance MEV transparency and efficiency on Ethereum. By auctioning off MEV opportunities, Flashbots allocate gains more fairly while optimizing block creation for higher profitability without overburdening the network.

### MEV-Boost

Post-Ethereum’s transition to Proof of Stake (PoS), Flashbots introduced MEV-Boost to segregate block creation and validation roles, aiding decentralization and minimizing single-party dominance. MEV-Boost processes enhance transparency and fairness and optimize transaction arrangements, upping network efficiency, minimizing slippage, and preventing centralization.

### Decentralized Exchange Structure Alterations

Vitalik Buterin, Ethereum’s creator, has touted MEV as an invisible tax, inflating network costs while offering validators lucrative opportunities. He proposes off-chain methods and order-book-based decentralized exchanges (DEXs) to reduce MEV by handling transactions discreetly and providing a transparent environment, unlike AMM models.

Minimizing MEV requires lowering node operation requisites, fostering a decentralized, democratic Ethereum network, ultimately solving MEV challenges through structural and operational innovations.