Today, Blockdaemon is proud to join as a founding member of Flashbots’ Ethereum 2.0 (ETH2) Working Group.
Blockdaemon manages over 12,000 active ETH2 validators. With the responsibility as one of the world’s largest ETH2 operators lies the seed of many opportunities. Such opportunities can be cultivated by validators such as Blockdaemon to benefit ETH2 over time.
For Blockdaemon, we believe it is important to collaborate with Flashbots towards a democratized, rather than proprietary, MEV (Maximum Extractable Value) extraction ETH2 solution.
Ethereum’s open-source ecosystem relies on such contributions from Blockdaemon, and others, to foster innovation and transparency. Blockdaemon joins the ETH2 Working Group to help Flashbots deepen the roots of these principles in the important realm of MEV.
We’d like to take you through why we have joined the ETH2 Working Group, what is MEV, why it matters and how we hope to contribute to ETH2’s staking success.
What is the ETH2 Working Group?
The goal of Flashbots is to help improve Ethereum by mitigating the negative side-effects of MEV.
The ETH2 Working Group’s purpose is to ensure that there is a fair and efficient MEV solution adopted by PoS validators on Ethereum post-merge.
To understand MEV, it’s important to first understand Ethereum’s design in context.
What is MEV on Ethereum?
Ever since its launch in 2014, Ethereum’s miners’ revenue comes from two primary sources.
Firstly, miners earn block rewards. These are native Ether tokens issued by the protocol. They are incentives for miners to bundle transactions and mint blocks.
How miners compose transactions within an Ethereum block is a second source of revenue.
This is referred to as Maximal (formerly Miner) Extractable Value. It is the total value that can be extracted permissionlessly (i.e. without any special rights) from the re-ordering, insertion or censorship of transactions within a block being produced.
Since February 2020, over $720 million has been extracted from transaction ordering.
What role does MEV play in Ethereum’s blockchain?
The first transactions in a block are the first that get executed. This gives rise to PGAs (priority gas auctions). In these auctions, users specify how much they’re willing to pay for each unit of computation on the chain.
Users compete for miners to prioritize their transaction. This is often to take advantage of arbitrage and other profit making opportunities. Miners then select the maximum bid submitted by users, to extract as much value as possible.
To understand by way of analogy, Ethereum is the motorway that transactions rely on to get to a destination. These transactions are sent between a global network of users. Validators are the taxi drivers of this motorway, chauffeuring transactions from A to B.
A portion of a taxi driver’s salary is paid by the network itself. This is the block reward of the blockchain. However, whether a transaction goes in the fast or slow lane depends on the tip paid to the driver. The higher the tip, the higher the transaction priority.
MEV’s negative side effects on users
The Ethereum DeFi boom of 2021 resulted in a surge of value extracted by miners. However, this resulted in high gas fees for average users. Performance dropped, while fees soared.
The emergence of Flashbots’ MEV relay has reduced the effectiveness of generalized frontrunners and has taken gas price auctions off-chain. The result has been lower gas prices for ordinary users. Flashbots delivered a net positive for the entire chain, while keeping MEV lucrative for miners.
Now, Flashbots is leading the charge in optimizing MEV for ETH2.
Why is ETH2 MEV important?
MEV will play an extremely important role in the future of ETH2.
ETH2’s proof of stake validators will replace the older proof of work miners. These new validators will also receive the Ether block rewards that miners previously enjoyed.
However, the launch of ETH2 will see a significant drop in Ether issuance by the protocol over time. In the below diagram, we see issuance decay on the following timeline:
- Ethereum 2 phase 0;
- The end of mining; and
- Ethereum 2 phase 2.
Ethereum Issuance Over Time
(Source: Attestant.io, 2021)
With Ether issuance declining, MEV, the second source of revenue beyond block rewards, will become more important to validators over time.
MEV will increasingly be seen as a lucrative income stream in this new stake based paradigm.
Transaction ordering in ETH2 will remain the same as it does in Ethereum’s proof of work, yet the financial opportunities for MEV in ETH2 will become more attractive.
How much will MEV be worth to validators?
The rewards validators can earn with MEV on ETH2 is substantial. One scenario researched by Flashbots looked at potential rewards on an ETH2 network with 250k validators and 8 million Ether staked.
Under these network conditions, running Flashbots MEV would increase validator rewards by 60%.
This number would vary given network participation, yet still remains significantly higher than MEV on the original Ethereum chain.
As outlined below, validators earn higher yield when they have an MEV implementation. This directly incentivizes validators to optimize for MEV.
Ideal case annual validator rewards
(Source: Flashbots, 2021)
It is clear that MEV is important in ETH2. However, we have seen the negative side-effects that can happen when MEV is not managed correctly. Network quality and user experience can suffer greatly.
That’s where Flashbots ETH2 Working Group, with Blockdaemon as a founding member, steps in to help.
How will Blockdaemon contribute?
As the world’s largest independent node and staking infrastructure provider, we are dedicated to the long-term success of each protocol we host. Our commitment to Ethereum is no exception. Ever since Blockdaemon’s inception, we have launched thousands of the highest quality Ethereum nodes available on the market.
With the ETH2 Working Group, Flashbots focuses on what an optimal MEV outcome will look like for the next evolution of Ethereum.
This means implementing a solution which will benefit the entire community rather than a small set of actors.
Blockdaemon’s responsibilities as a founding member will include:
- Using Flashbots on Ethereum post-merge.
- Participating in user interviews and product feedback with Flashbots.
- Testing the Flashbots software on ETH2 testnets.
The proven success of Flashbots’ MEV solution on Ethereum has come from high miner participation. Our significant staking footprint means that continuing this success relies on us, and other validators in the community, to take the place of miners.
We at Blockdaemon are aligned to Flashbots’ values. We recognize the benefits of coordinating to use a single MEV solution.
By working with Flashbots and our fellow validators, we hope to help contribute to an open-source, fair MEV solution. This will, we hope, be a net positive to all in the ecosystem, as we stride together towards the launch of ETH2.