Introduction to MEV Bots
Miner Extractable Value (MEV) bots are computer programs that exploit certain pricing discrepancies created by blockchain miners on Decentralized Exchanges (DEXs). By monitoring the blockchain, they can detect these discrepancies and execute trades that generate profits for themselves at the expense of other users.
MEV bots cause pricing inefficiencies in decentralized markets by exploiting the fees and rewards miners receive from executing transactions. Specifically, by watching when miners broadcast blocks to the network, they can detect and execute trades that capture the difference in price (known as an “arbitrage opportunity”) between when the transaction was seen by the miner and when it was broadcast to the network.
Additionally, the price discrepancies created by miners can be exploited by MEV bots to “frontrun” transactions. By monitoring the blockchain, MEV bots are able to identify when miners are about to execute certain transactions. Knowing that they will soon be executed, the MEV bots can then jump in ahead of the miners and reap the rewards. This is known as “frontrunning”.
Risks Associated with MEV Bots
MEV bots pose significant risks to traders as they can manipulate prices and create significant slippage. MEV bots are automated programs that exploit any flaws or inconsistencies in pricing between different exchanges and markets to quickly buy or sell a large amount of a cryptocurrency on one exchange at a lower price than it is being simultaneously sold on another exchange for a higher price. This can create significant slippage, where the transaction is completed at a price substantially different than the expected current market price. MEV bots work by “sniping” the market and take advantage of large spreads in pricing caused by inefficiencies in market data. This can lead to significant losses for investors who are not able to keep up with these ever-changing prices.
One example of a real-world scenario where MEV activity through bots has led to losses is the 2018 EtherDelta hack. In this incident, an MEV bot was used to exploit a vulnerability in the EtherDelta smart contract, which allowed the hacker to steal millions of dollars worth of Ethereum by front-running trades and driving prices down. As a result, traders suffered significant losses as the price of coins fluctuated rapidly, and traders who had placed their orders before the attack quickly liquidated their assets at drastically reduced prices.
Slippage and Its Effects
Slippage is the difference between the expected price of a trade and the actual price at which the trade is executed. In other words, it is the difference between the price that a trader initially wanted to buy or sell an asset at, and the actual price at which the trade takes place. Slippage can be caused by market volatility, large orders, low liquidity, and the use of certain high-frequency trading (HFT) strategies such as MEV bots.
MEV bots can cause slippage by executing continual high-volume trades simultaneously. This can cause the prices of assets to become volatile, resulting in slippage. This trading activity can drive up the marketplace prices for certain orders and adversely affect the execution of trades.
Slippage can have a damaging impact on traders’ profits and strategies. High slippage can reduce profitability and profitability margins, while also leading to missed opportunities since the anticipated price of a specific asset might no longer be available when a trade is executed. Small investors can be particularly vulnerable to slippage, as they tend to have more limited capital and access to resources.
By understanding the risks and causes of slippage, traders can take steps to protect themselves and reduce their exposure to these events. This might include monitoring market conditions before executing trades, trading within narrower price ranges, and employing strategies to gain information and market insights that can be used to reduce the risk of slippage.
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