There are a couple of ways to make money from decentralized AI trading on blockchains, ranging from AI sniper bots to liquidity management AI tools. Despite being associated mainly with negatives, especially on the Ethereum blockchain, MEV bots can also be used for legal profitability.
In this article, we aim to explain how these bots work and the strategies they use to make profits. Let’s begin with the basics.
What are MEV bots
MEV bots are automated virtual machines that allow you to profit from rearranging transactions on blockchains. Simply put, these bots monitor transactions about to occur on a specific blockchain and then place their transactions first. To understand MEV bots, we should establish what MEV is.
MEV is an acronym for Maximal Extractable Value, a rather complex blockchain concept. However, it refers to the highest amount of additional value miners, or validators can extract from reordering and including transactions in a block on a blockchain network. MEV is the extra profit miners or blockchain validators make aside from transaction fees and block rewards.
Here’s how it works. When you make a transaction on the Ethereum blockchain, your unconfirmed transaction is stored with other transactions on a temporary storage in a blockchain node called a mempool or memory pool.
Miners or blockchain validators then arrange your transaction and the others in the mempool on a transaction block based on transaction fees, gas prices, and the transaction size. Typically, more significant transactions are prioritized and processed first because they can bring higher gains for the validators and miners.
Validators and miners, also known as block producers, generate these gains by various means, ranging from arbitrage to reordering transactions and even causing on-chain liquidation. These processes extract additional profit other than the typical transaction fees and rewards that they receive. This additional profit is called MEV.
MEV operates primarily on blockchains that utilize the proof-of-stake (POS) algorithm, such as Solana and Ethereum. Ethereum introduced the concept of MEV when it operated under the proof-of-work (POW) system, where only miners could access MEV as they were responsible for creating blocks.
However, with Ethereum’s transition to the POS system, the MEV system is now accessible to any participant acting as a validator on the Ethereum blockchain, meaning you could profit from the system even without as much computing resources as miners.
It’s important to note that MEV can potentially occur on any blockchain network where miners, validators, or other network participants have control over the ordering and including transactions in blocks. But it is commonly associated with Ethereum.
Since blockchain transactions occur very quickly, block producers must use high-speed algorithms to find opportunities to make MEVs and execute them instantly. These algorithms or tools are called MEV bots.
How do MEV bots work?
In decentralized AI trading, MEV bots work by reordering transactions in a block and profit from the opportunities created by their strategic placement, such as on-chain liquidations, arbitrage, and other value-extracting activities beyond transaction fees and block rewards.
MEV bots make money in the crypto space in a couple of ways. The most common ones are arbitrage, front-running, back-running, sandwiching, and liquidation.
Arbitrage
Arbitrage is the most straightforward strategy that MEV bots employ. It involves identifying price differences of a particular token on two different decentralized exchanges and trading it on both to make a profit. They buy large volumes of the token on the exchange at a lower price and sell it on the exchange at a higher price almost instantaneously.
To ensure that the trade pulls through at that exact price point, they use higher gas fees than other transactions on the block, making theirs prioritized.
Front-running
Front-running involves using MEV bots to monitor the mempool for buy orders, which can significantly increase the price of the token in question. They then create a similar order but with a higher gas fee, so it takes priority over the other transactions on the block.
Once the other trades pull through, their sheer volume will impact the token’s value positively due to slippage, allowing the MEV bot to resell the token at this higher price and make a profit.
Back-running
Back-running is similar to front-running. In this case, it involves the MEV bots monitoring the mempool for a substantial transaction capable of influencing the token’s price in question either positively or negatively and placing a transaction immediately after that to capitalize on the price movement.
For instance, an MEV bot can monitor the mempool for large buy transactions. Once it spots one, it can place an order immediately after that transaction is executed and take advantage of the slippage. Once the token’s price soars to a certain level, the bot resells it, making a profit.
Sandwiching
Sandwiching involves the MEV bots combining front-running and back-running strategies to make insane profits. The bots watch the mempool for large transactions that may cause price spikes.
They then place the same order but with a higher gas fee, ensuring their order gets executed first. Once the transaction just behind theirs is finally executed, they sell the token, benefitting from the price hike the two transactions caused.
Liquidation
MEV bots also profit from liquidation strategies. Typically, this involves strategically reordering transactions within blocks to trigger on-chain liquidation events in DeFi lending protocols like Aave.
By prioritizing transactions that induce margin calls or liquidations of collateral assets, you can use MEV bots to exploit price movements and profit from liquidation fees once the assets are forcefully sold.
Advantages of using MEV bots
Using MEV bots comes with certain advantages. They include the following.
Profit Generation
MEV strategies can be a source of income, benefiting from optimizing blockchain transactions. Furthermore, you don’t need as much computational power as miners to use some MEV bots, allowing you to make decent profits even with relatively minimal resources.
Market Efficiency
MEV bots speed up decentralized trading by reordering transactions on blocks based on volume and gas fees, enabling smoother processing. Furthermore, their arbitrage activities reduce price discrepancies across DEXes, benefiting liquidity providers most especially.
Relatively Low Technical Skill Required
You don’t need to be a blockchain miner to use MEV bots. Also, some have relatively simple user interfaces, making it easy to take advantage of MEV strategies.
Cons of MEV bots
As helpful as MEV bots are, they also have disadvantages. Some of them include the following.
Unfair Advantage
MEV bots often give participants, such as large miners or well-funded entities, an unfair advantage over smaller traders and investors who may not have access to similar advanced trading strategies or tools. Being on the receiving end of an MEV bot-influenced transaction can be frustrating.
Market Manipulation
MEV bots tend to manipulate markets and exploit vulnerabilities in decentralized finance (DeFi) protocols, which can lead to adverse effects such as price manipulation, increased volatility, and reduced trust in the ecosystem.
Centralization Risks
MEV bots threaten further centralization of blockchain networks. This is because participants with greater resources and technical capabilities are better positioned to extract MEV, potentially undermining the decentralization of blockchain networks such as Ethereum and Solana.
Final Thoughts
MEV provides profitable opportunities for miners and blockchain validators to make the most from the blockchain network. Now, with MEV bots, anyone can extract MEV for optimal blockchain yield.
However, this profit-making strategy has risks, as malicious actors can misuse them. Thankfully, with the information in this article, you should be well-equipped with the basics of using these strategies positively.
FAQ
What does MEV mean in crypto?
MEV is an acronym for Maximal Extractable Value. It refers to the maximum amount blockchain validators and miners can make from blockchain networks in addition to the validator fees they are paid. These validators and miners extract MEV using strategies such as front-running and arbitrage.
Are MEV bots profitable?
Yes, using MEV bots can be very profitable. Earlier this year, a Solana-based MEV bot generated almost $2 million in profits in under 20 seconds using a combination of MEV strategies.
What are MEV trading strategies?
MEV trading strategies are how MEV is extracted on blockchain networks. The most common ones include front-running, back-running, arbitrage, flash loans, and liquidation.
