Thread by @0x___Brick

With #Ethereum's consensus mechanism changing from proof-of-work ("#PoW") to proof-of-stake ("#PoS"), as part of the merge scheduled for ~Q4 2022, let us look into what this implies for Miner Extractable Value ("#MEV")

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(1/x) It is difficult to maintain decentralisation while scaling a blockchain that utilises PoW since it becomes increasingly challenging to participate as a miner. This is currently happening to Ethereum, and mining has started centralising around a few large mining pools

(2/x) Through PoS, modularity increases as more investors can stake their $ETH than participate as a miner—the system is broken down into smaller parts and the net result is a more capable network less dependent on centralising forces

(3/x) So what changes will the move to PoS bring about? Currently, block templates are solved in order to mine the block itself. When a miner solves the template, it is sent to other miners who validate the block

(4/x) Miners generally participate in a mining pool, led by an operator who is in charge of the to be mined block, as a way to increase their cash flow. These pools increase centralisation

(5/x) Miners get paid through three channels:
a) Block fees – reward for a mined block
b) Transaction fees – under EIP-1559, consists of two parts:
- Base fee: set by the network and is burnt
- Priority fee: decided by the creator of a transaction and goes to the miner

(6/x) Cont.
c) MEV – fee from arranging a block in a specific way, i.e., revenue miners can make through their ability to arbitrarily include, exclude, or reorder transactions within the blocks they produce

(7/x) MEV exists in all transaction systems because a transaction system cannot exist without ordering. Generally, all blockchains have MEV as long as two characteristics are present—value and a smart contract of some form

(8/x) As a side note, a lot of MEV extraction is good-natured but there are extractions which do harm to other transactions through e.g., higher slippage and exchange rate fluctuations

A few examples of MEV include DEX arbitrage, liquidations, and sandwich trading

(9/x) MEV searchers screen for opportunities to generate MEV, create companion transactions which have to be placed before, after, or both, with respect to the transaction from which the MEV opportunity arises, and delegate the bundle to miners

(10/x) Currently, most of the value winds up within mining pools because they have a position where searchers have to compete against each other for a miner to include a searcher's bundle in the block

(11/x) Centralisation is a problem given that MEV grows as the blockchain grows

Consequently, corruption incentives also increase since miners presently build the blocks

(12/x) In PoW, miners run both a validator and execution client. Post-merge, validators will not have the responsibility of building blocks anymore. The task is delegated to participants solely focused on block building

(13/x) The disconnection is called proposer/builder separation ("PBS"), where block builders scan through the mempool, sequence transactions, and create blocks such that they occupy the maximum amount of gas available, finally sending the blocks to a validator

(14/x) Naturally, there are many builders who bid against each other in order to have their blocks validated, most likely leading to smaller margins, but more importantly, higher-quality blocks

(15/x) Builders will receive all of the transaction fees together with some MEV bribes from searchers. Then they have to decide how much of the total value they are willing to share with a validator

(16/x) An additional benefit of PBS is that it simplifies a validator's job since, at least theoretically, they are served optimal block templates

(17/x) However, what is defined as optimal also largely depends on the validator—in the Bankless podcast # 125, @mcutler argues that validators might not only look for the highest value generating blocks, but instead prefer blocks which represent their personal beliefs

(18/x) In-protocol PBS is included in the Ethereum roadmap but it will take some time for it to be implemented

Following the merge, PBS will initially be facilitated by middleware such as mev-boost

(19/x) Conclusion: going from PoW to PoS enables Ethereum to move away from centralised entities such as mining pools by separating validation and block building

(20/x) Ultimately, there is potential for creating an environment where MEV revenue is shared in proportion to the value created by each participant, and consequently, Ethereum could arguably become a more equal playing field

Thanks for reading! As always, all feedback is welcome💜