The blockchain industry has seen remarkable growth in the past few years, maturing from a niche interest to a trillion-dollar market. A growing number of institutions have been getting involved in the industry carrying out activities such as investment and product launches.
One of the most important roles that institutions have been exploring is that of block validation. Validators play a critical role in how blockchains establish consensus and are essential to the security of the networks. They allow valid transactions to be processed while also reducing the risk of attacks on a blockchain network.
While Bitcoin utilizes proof-of-work mining to validate blocks, staking has become the predominant way to establish consensus for other blockchain networks. At Foundry, we have always had a core focus on helping institutions participate in the validation process. Operating the largest Bitcoin mining pool and facilitating the exchange of Bitcoin mining hardware are among our core activities. We also help institutions participate in blockchain validation outside of Bitcoin mining through staking opportunities.
Staking essentially involves entities locking a significant amount of the network’s native tokens. If the entities act against the consensus rules of the network, these tokens will be slashed, incentivizing entities to act in the interest of the network. For their role as validators in the staking process, institutions will get a return in the form of newly issued tokens and transaction fees, which users attach to their transactions. However, it’s possible to get returns in excess of this by tapping into a new field known as Maximum Extractable Value (MEV).
As one of the few players offering staking services to institutional clients, we ensure that our clients get the maximum returns for their staking activities by tapping into MEV. Herein, we will break down what exactly MEV is, and we will explain the infrastructure which we use to ensure our clients are getting the maximum return for their validator roles.
Understanding MEV: A General Concept
MEV can be a tricky concept to initially get your head around. This is mainly because the process involves several different entities and software layers. To make it easy to understand this process, we are going to explain the key entities and steps involved briefly before we dive into more detail surrounding the motivations for MEV and the result.
In terms of the goal of MEV, it allows validators to maximize their return while also providing the opportunity for other actors to profit, which will become clear shortly. Here are the key terms and layers you need to be familiar with to understand the MEV process. Refer to these and the above schematic to help with understanding MEV.
Mempool: This is a public database where pending transactions wait. When you send a transaction on a blockchain network, it stays in the mempool until a validator includes it in a block which is later added to the blockchain. Network users will attach different fees to transactions based on their urgency. If they want the transaction to be immediately picked, they will apply a high transaction fee. This note on fees is important to note as it is key to the MEV process.
Searchers: Searchers are the first actor that we need to understand. Searchers use complex algorithms to identify transactions that provide opportunities for profit. These transactions will often be associated with activities like decentralized exchange (DEX) arbitrage and frontrunning. Searchers pay a high transaction fee to ensure that their transaction is included which moves a lot of their profit over to validators. For instance, with DEX arbitrage, they regularly have to pay more than 90% of their expected revenue to be included as many searchers are running the same strategy. Searchers can put their MEV transactions into the mempool or they can use private relay software which connects them directly with validators. Searchers often submit to private relays as it gives them privacy preventing frontrunning protection. These relays also allow searchers to remove the risk of their transaction failing as they can make payments only if their transaction is successful. If they use private relay software, these following entities will come into play in the MEV process.
Builders: Private pool software allows validators to outsource the building of blocks to a separate entity called “builders”. Builders accept bundles of transactions from users and will build blocks from these transactions. Builders compete with one another and will receive a fee if their proposed block is included in the chain. Builders prioritize transactions with MEV potential to make their blocks more appealing to validators.
Relays: Once builders put together blocks with the available transactions, they send them to relays. Relays will keep the transactions in a block private until a validator commits to including the block in their chain. Validators can view the block header before committing to include a block. There are several relays who have different block options from different builders.
MEV-Boost: MEV-Boost is a software solution that validators use to select the most profitable block from the relays which it is connected to. MEV Boost which is connected to more relays will have a greater range of blocks to choose from. The MEV Boost selection process is similar to the Bitcoin network, where miners naturally choose to include mempool transactions that pay the highest fees to maximize revenue.
When all these entities and the above process comes together, we have a system that increases rewards for validators, allows searchers to tap into profit opportunities, and provides execution fees for builders. What are some of the transactions that searchers include to allow them to tap into profit opportunities?
The most common strategy which searchers use is DEX arbitrage. Searchers use this strategy to capitalize on any price discrepancies that arise between DEX exchanges. If the price of the same asset is lower on one DEX than another, searchers can propose a single transaction that both buys on the lower-priced exchange and sells on the higher-priced exchange. This can be done within one transaction and allows searchers to tap into risk-free profit. It also brings benefits to the broader blockchain marketplace by creating more liquid pricing.
Another strategy searchers employ is quickly liquidating borrowers when they drop below their collateral thresholds in the DeFi ecosystem. DeFi borrowers need to keep their collateral above certain limits if they wish to continue their loans. When their collateral falls below these limits, lenders depend on third parties to liquidate the borrower. Searchers often carry out this activity and receive a liquidation fee for their role.
Overall, MEV allows validators to tap into greater rewards by choosing blocks that maximize transaction fees and provide profit opportunities to other entities. As explained in some of the strategies which searchers carry out, MEV also provides some benefits to the ecosystem, such as more liquid pricing and fast liquidations.
While the concept of MEV is relatively new to the crypto space, it is not an entirely novel idea. Popular trading platform Robinhood generates 80% of its revenue by selling order flow to institutional market makers like Citadel Securities. This allows Citadel to maximize its trading operations by leveraging the data and orders from the retail market. Similarly, validators maximize their rewards by using builders to select the most profitable transactions to build a block.
Foundry Staking makes sure that institutions using their service are using the most reliable technology to maximize their MEV earning potential. In the next section, we detail the specific technology we use to accomplish this.
Foundry’s Approach to MEV: MEV Boost, MEV Software (Flashbots)
Foundry validators tap into greater earning potential by using the private relays detailed in the previous section as opposed to picking transactions from the public mempool. Foundry uses the MEV Boost and MEV Flashbots software to access these relays and maximize MEV earning potential.
The MEV Boost software is a separate piece of software from the main beacon chain node that Ethereum validators operate. This software allows validators to access the most profitable blocks from the block-building market. Foundry combines MEV Boost with the most well-known relays in the validator space, allowing them to access a broad range of block builders.
Flashbots MEV software is the technology that operates the wider private relay. Picking MEV-related transactions directly from the mempool can lead to several problems, such as network congestion, as searchers aim to front-run each other. They can also incentivize chain reorganizations which would pose a risk to consensus and could undermine confidence in the network.
By operating in the Flashbots private relay, these risks are reduced, and Foundry can have access to risk-free MEV opportunities. On top of this, Foundry can actively monitor relays and blocks to ensure that they are maximizing their MEV potential by connecting to leading relays like Flashbots and bloXroute. Foundry can also choose to connect to relays that only provide them with regulatory compliant blocks, allowing institutions using their staking service to stay in line with financial regulations.
Validator Rewards and Foundry’s Strategy
Validators play a vital role in a blockchain network. Validators are the backbone of a network’s security and ensure that transactions are processed in a decentralized manner. Any problem with validators poses risks to the consensus of a network, and that’s why their locked coins are slashed if they break the rules of the network. That’s why Foundry takes its staking service extremely seriously and provides around-the-clock monitoring to ensure that validator nodes run smoothly.
By effectively participating as a validator, Foundry clients are compensated with block rewards which come in the form of newly minted coins and transaction fees, which are maximized through the MEV process detailed in the previous sections. Being backed by Digital Currency Group allows Foundry to have an extremely experienced team managing the Foundry staking business to optimize and secure validator nodes for all institutional clients.
The Future of MEV and Foundry’s Vision
The MEV landscape is rapidly evolving, with several changes being implemented into Ethereum and the broader DeFi ecosystem which impact MEV. For instance, Flashbots is working on a new tool called SUAVE which is designed to be the mempool and block builder for all blockchains.
Such developments will change the MEV landscape and Foundry is committed to staying afront of such changes to ensure long-term competitive rewards for Foundry Staking clients. The tech team is always monitoring the MEV landscape for potential optimizations that can be made to further increase returns while also looking ahead to potential changes which could change the nature of MEV and preparing for these changes.
Forging Ahead in MEV and Staking for Institutional Clients
Foundry is the ideal digital asset staking partner for custodians, exchanges, banks, liquid staking providers, funds, and other institutional players. With the backing of one of the biggest players in the blockchain industry in Digital Currency Group, Foundry offers an unparalleled level of security and profitability to staking clients. Foundry is ready for institutions who want to participate in or offer staking services.
Stay informed about Foundry’s latest developments and opportunities in the MEV industry.
This content is sponsored by Foundry.
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Source: https://blockworks.co/news/tapping-mev-rewards-institutions