• Wed. May 29th, 2024

MEV Bot Beginner’s Guide: 2024 Ethereum Arbitrage

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.

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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!

What is MEV?

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 arrange transactions in a specific 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 apps 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 phenomenon as MEV, wherein miners and validators have the ability to strategically generate and order transactions to extract additional earnings, because they have complete control over transaction ordering.

MEV on Ethereum

Although MEV applies to all blockchains, we typically 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, anyone can act as a block validator and profit from MEV opportunities.

The Ethereum update encourages the usage of “searchers,” or people 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 fees while searchers prioritize their transactions and pay higher gas fees. It’s an arrangement 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 run ahead

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.

Switching between bots

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:

Quick loan robots

These bots execute sophisticated trades requiring substantial capital 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 through 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 receive 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.

MEV Bots’ Benefits & Drawbacks

Now let’s examine the benefits and drawbacks of MEV bots:

MEV Bots’ benefits:

MEV expands Ethereum users’ ability to take advantage of lucrative on-chain opportunities by not being restricted to miners.

Non-techie players can pool liquidity and profit from it with the help of easy-to-use tools.

MEV bots with an emphasis on arbitrage improve market efficiency by adjusting price discrepancies among decentralized exchanges (DEXs).

The drawbacks of MEV bots:

Possibility of undermining blockchain’s equity and transparency in favor of individuals with greater power and resources.

might cause erratic changes in the market, surprising traders and causing them to hit their stop losses.

Alluring instruments for fraudulent operations, allowing malevolent entities to take advantage of flaws in smart contracts.

There are inherent dangers, and failing tactics could cost money.

MEV Bot Examples

MEV bots have been known to make millions of dollars, however many of them employ dishonest strategies that don’t help normal traders.

An Ethereum bot used sandwich attacks and arbitrage techniques to make almost $34 million in three months in the first half of 2023. Due to the bot’s high activity, Ethereum’s transaction fees increased significantly in May, surpassing $25.

800 ETH, or more than $1 million, were obtained in an arbitrage transaction carried out by a MEV bot known as 0xbad last year. Ultimately, the bot lost all of its earnings and an additional 300 ETH from the cryptocurrency wallet when a hacker exploited a weakness in its coding to outwit the bot.

Since Ethereum’s PoS update, the total Realized Extractable Value (REV) has surpassed 416k ETH, or more than $500 million at today’s rates, according to data from Flashbots!