The elephant in the room: Flashbots' commercialization path prediction.

Original Title: "The Elephant in the Room: Flashbots Predicts the Commercialization Pathway"

Original Author: Catrina Wang @curiouscatwang

What can be expected from this article?

The core issue explored and researched in this article is how auxiliary participants (non-validator, non-proposer, non-searcher) in the MEV market can accumulate value. Flashbots is a microcosm of these auxiliary participants. In this article, I will use Flashbots as a case study to analyze the business model of MEV.

The research report is divided into four parts:

Part One: Assessing Flashbots' ability to maintain its market leadership position.

Part 2: Predicting Flashbots' future business models, commercialization paths, and trade-offs. Discussion is conducted on two choices and designs.

Turn on the charging switch and launch the token (SUAVE).

Part Three: Analyzing the growth trend of MEV and the development of this emerging industry.

Part Four: Finally, predict how the MEV industry will evolve.

Overall, my view on the commercial feasibility of MEV is optimistic pessimistic optimistic.

At first glance, optimism arises: MEV may be the industry with the shortest commercialization time span. So far, the $1 billion revenue generated by MEV has proven this.

At second glance, it feels pessimistic: participants in the MEV industry are profit-driven and filled with Bertrand-style competition (homogeneous goods, price competition). The current market leader, Flashbots, is a top loser, creating $700 million in revenue for Validators and Searchers, but has no profit of its own.

The Third Eye is optimistic: the future of MEV is a gold mine. The endless permutations of MEV, EIP 4337 (account abstraction), the increasing number of DeFi activities, the nascent cross-chain MEV, various types of private order flows (POF), and the creative fusion of MEV, cross-chain bridges, and DeFi primitives (DEX, lending, staking/LSD, etc.) bring enormous potential for development.

Let's get started!

Background

Briefly describe the amazing achievements that Flashbots has achieved since its launch.

Within the past 14 days, approximately 91% of blocks have utilized MEV Boost (a free and open-source software that helps validators maximize their block rewards by selling block space to builder slot shares on a public market).

-MEV Boost increases Validator/Proposer block rewards by about 60%, which means validators have increased gross profits of about $250 million.

-MEV brought a total profit of about 450 million US dollars to Searchers and a total MEV income of about 700 million US dollars to both Searchers and Validators.

However, the Flashbots entity itself does not generate any revenue. Currently, Flashbots is a feature of Ethereum, rather than a standalone product. The difference is that "products" can be commercialized, while "features" can attract a large number of users, but may not necessarily generate value to sustain the business.

However, the situation in the future may not be like this. I will assume how Flashbots may adjust its business model to achieve profitability in the future.

Part 1: Assessing Flashbots' ability to maintain its market leadership

Although MEV is a market with enormous potential, whether Flashbots can maintain its market leadership depends on the following three factors:

-Targeting the achievable market of L2 and Ethereum's native MEV functionality.

-Maintain competitive advantage.

-Emerging alternative methods to solve the MEV problem.

Consideration #1: Flashbots' current addressable market is being squeezed by the upcoming Ethereum native MEV and L2 rollups.

Here are three assumptions that Flashbots maintains to sustain its influence:

The first assumption: Ethereum's dominant position in DeFi will be maintained.

Possible realization. Despite the rise of application chains on Cosmos, as well as new alt L1s (such as Sui and Aptos) and other non-EVM DeFi chains (such as Fantom), Ethereum's dominant position in DeFi may still be maintained, thanks to Ethereum:

-Continued network effect.

-Passionate community.

-Upcoming Shanghai upgrade, supporting withdrawals and reducing gas fees.

- Introduce shared security and re-collateralization through Eigenlayer to further expand the network.

Second assumption: Ethereum will continue to outsource MEV solutions to Flashbots.

This needs a question mark. As the Ethereum Foundation gradually incorporates MEV as part of its protocol functionality (which will be implemented outside of Ethereum's upcoming PBS protocol), it may phase out Flashbots' "sticky" solution, such as MEV-Boost.

The Ethereum Foundation is exploring and researching many protocol-level proposals to reduce malicious MEV, such as:

-PBS (Proposer/Builder Separation): The content of the bundle/transaction is hidden until the proposer/validator signs the proposal, to prevent malicious proposers. This occurs in the third stage of PBS.

-PEPC ( Protocol-enforced proposer commitments): Creating a universal trusted signaling mechanism by establishing a non-trusted and non-permissioned scheme for validators to sign commitments with third parties. Eigenlayer is a good testing platform for PEPC.

-crListcrList: Basically, it forces the Builder to fill each block up to its gas limit.

-Encryption for mempool privacy: Masking the content of block proposers before the transaction order is determined.

That being said, Flashbots has demonstrated impressive execution in seizing the first-mover advantage to rapidly develop its products and maintain a leading position in the competition from Ethereum's native functionalities. In the long run, I am curious to know how this "act fast and keep moving forward" strategy will evolve.

Third assumption: Flashbots' SUAVE blockchain can capture value from the sorting market of L2/rollups.

This needs a question mark. This is one of the biggest and most unstable issues for Flashbots. Currently, all transactions from MEV-Boost are on the Ethereum base layer. However, the future of DeFi is moving towards Layer 2 solutions such as Optimism, Arbitrum, ZKsync, and Starknet.

L2s/rollups handle batch processing and execute off-chain transactions, with their own transaction ordering mechanism (currently centralized, with plans to decentralize). Additionally, L2 has different design principles when it comes to MEV. For example:

- The founder of Optimism invented MEV auction: the winner of the auction has the right to reorder the submitted transactions and insert their own transactions, as long as they do not delay any specific transaction for more than N blocks.

-Arbitrum believes that MEV auctions are harmful and has chosen Chainlink's Fair Sequencing Service (FSS) to minimize malicious MEV and make transaction sequencing fair and predictable for all users.

-zkSync plans to use time-lock encryption/privacy methods to minimize MEV. In addition, zkSync utilizes propellerheads to protect MEV by reclaiming it from bots and miners and returning it to the protocol and users.

-Starkware (VeeDo) tends to use time-lock encryption/VDF solutions.

- Other design and trade-offs solutions for solving transaction privacy.

The third assumption also carries a high execution risk.

Flashbots' goal with SUAVE is to become the memory pool and decentralized block builder for all EVM blockchains, and this goal comes with very high execution risk. The Flashbots team must provide strong reasons to convince L2s to outsource their sorters to SUAVE. This is another blockchain. The three main obstacles to overcome are:

-Customization: Each L2 has different tolerance for MEV methods. Can SUAVE be flexible enough and customizable enough to meet the needs of each unique design?

-L2 coordination of value capture between native tokens and SUAVE/Flashbots tokens (assuming SUAVE will have its own token, which will be explored later). In what business model will Optimism allow potential token value to leak into SUAVE tokens?

-Users adopt friction: Compared to just adding a few lines of code now, how much adoption friction would introducing token purchase for sorters bring? This depends on the design of the SUAVE token - if SUAVE is a pure governance token with little use case, this may not be a problem.

Consideration #2: MEV products often have low stickiness, and currently, Flashbots is continuously sacrificing competitive advantages for the public interest. So far, two market factors have contributed to Flashbots' dominant position:

-The market is still in its early stages.

-Lack of competitive opponents.

Using MEV-Boost only requires validators to add about one hundred lines of code, which is beneficial for adoption by users, but has the same impact on users leaving: the cost for profit-seeking MEV participants to switch to more profitable tools is low. As the MEV market transitions from an esoteric topic to a major web3 field, there may be more and more competitors offering similar products to erode Flashbots' market share.

As of March 7th, 2022, the market share of Flashbots relayed blocks is approximately 36% over the past 24 hours and approximately 52% over all time. As shown in the MEV Boost Transparency Report, the number of proposed blocks by MEV Boost relays is decreasing (which the Flashbots team understandably takes pride in).

One of Flashbots' main competitive advantages today is its ability to obtain proprietary data when transactions are sent to its private memory pool. With a bird's-eye view of order flow and transaction data, Flashbots can continuously improve its algorithms and become the highest-performing (e.g. high inclusion rates and speed) and "most profitable block generator."

However, through a decentralized block builder, Flashbots gives everyone access to the same data, which has caused SUAVE to lose this rare "moat". This is philosophically commendable, but may not be the most reasonable decision for maintaining a competitive advantage based on its current business model.

Consideration 3: There are too many new entrants and alternative solutions in the MEV industry.

-MEV solutions include: RFQ/quotation request (Hashflow), MEV DEX (CoW Swap), and new clearing system (Maker, Euler).

-Partial MEV boost based on EigenLayer: allows proposers to prove the selected price's Merkle root, but if the relay fails to broadcast the selected price transaction in time, a backup package can be constructed to fill the block.

- Private RPC terminals: including wallets, dapps, and MEV redistribution, such as Blocknative's Wallet Boost and Flashbots' MEV sharing. According to some estimates (source of statistical data not found, but referenced in multiple Flashbots articles and EF conversations), Infura owns approximately 70% of RPC terminals, overseeing transaction routing comprehensively and sometimes making decisions on its own.

With such a favorable position, it is not surprising that wallet providers would enter the MEV game by promoting themselves as "MEV-resistant wallets" or "gas rebate wallets" and setting their default RPC to their private relays.

In addition, it is worth mentioning "the sleeping dragon" Metamask, which according to some research, accounts for about 70% of ETH transactions. Imagine if Metamask itself became a builder network, extracting and sharing MEV by creating its own private memory pool, would it involve centralization?

In short, to maintain its market-leading position, Flashbots needs to continuously innovate to stay ahead of its competitors while adapting to the designs of L2 and other EVM MEVs. Such a situation may arise.

Part 2: Predicting Flashbots' Business Model and Commercialization Path

Flashbots, the conclusion that it is a top loser is based on past snapshots. But what if this is part of Flashbots' overall plan to become an "aggregator"? The aggregator theory holds that in the Internet era, whoever aggregates users will have the ultimate advantage and business "moat".

According to Ben Thompson, aggregators have three key characteristics:

Related directly to users. In the case of MEV, users are validators, searchers, builders, etc. Flashbots' MEV-Boost, Relay, Protect and other product suites are impressive and attractive to users.

The marginal cost of providing services to new users can be ignored: yes. This is because the software products of Flashbots have very low costs for each new user added.

The network is demand-driven, and the cost of customer acquisition is reduced, also known as network effect. For example, the more relays participating in MEV-Boost, the more validators using MEV-Boost, and the greater the likelihood of other relays joining.

In order to continue this thought experiment, let's assume how the team will proceed when that day comes.

Option 1: Turn on the cost switch and increase equity value.

Possible outcomes: Decrease in market share, emergence of new competitors in the market, market trend towards NFT market (cost competition).

MEV is a commercialized market. Searchers, builders, and validators pursue profit maximization with almost no loyalty to the platform. Although Flashbots has significant brand assets and trust in users and the Ethereum community, its public encouragement and invitation of new competitors exclude the feasibility of charging for its products. Turning on the fee switch may create a homogenized competitive landscape, as happened during the surge in the NFT market.

Option one NGMI.

Option 2: Launch the Flashbots/SUAVE token. This means profiting through tokens in a "web3" way. There are several methods to tokenize SUAVE, and different designs may lead to vastly different outcomes.

Design 1: SUAVE is purely used as a governance token, with minimal interference to user experience.

-Advantages

1. Will not introduce user friction.

2, minimize interference to users when entering and exiting.

3, beneficial for the commercial expansion of EVM and L2 chains, as there is no concern about conflicts of interest arising from the value leakage from EVM/L2 chains to SUAVE tokens.

-Disadvantages

1, just another governance token.

2, the token's performance is entirely based on the public's perception of Flashbots (speculation).

Design 2: Empower SUAVE token use case by requiring MEV participants to purchase SUAVE using Flashbots products and services.

-Advantages

1. Generate more demand for SUAVE tokens.

2, create opportunities to activate fee switches through tokens.

3, laying the foundation for future defi<>MEV projects related to tokens, such as bridges, cross-chain MEV, and flash loans for MEV arbitrage (for example, Aave will provide flash loans for searchers/arbitrageurs).

4, there may be benefits to token economics, such as requiring block builders to lock SUAVE tokens as collateral to join the SUAVE network, thereby reducing the circulating supply of SUAVE.

-Disadvantages

1. Business expansion risk: This design makes it more challenging for EVM chain partners to join, as they may be concerned about token value leakage.

According to the SUAVE website, it hopes to be used by all chains. Outsourcing the sorter to Flashbots' incentive mechanism is challenging for L2 and other EVM chains. This fee token design will bring another layer of complexity to negotiate revenue distribution and value increase between the sorter chain (SUAVE) and the execution chain (L2s).

2. Risk of Adoption: Increases user friction as MEV participants must first purchase SUAVE tokens rather than simply running software.

Currently, MEV-boost is quickly gaining popularity among users because it only requires adding a few lines of code and can be used for free. When users need to purchase tokens and pay fees, using curves may appear very different.

One way to alleviate this issue is to airdrop SUAVE tokens to builders as a customer acquisition strategy, in order to incentivize usage and align the interests of builders and the network. However, it is still necessary to consider whether the incentive of the airdrop is sufficient to keep builders on the network in the long term, rather than turning to alternative solutions with less friction for users (i.e. free services that do not require builders to purchase tokens to use).

Of course, there are other design options, such as hybrid tokens that include governance and use cases, platform tokens, profit-sharing tokens, and so on.

Part Three: Analyzing the Growth Trend of MEV and the Development of this Emerging Industry

There is a lot of hype in the MEV industry. To analyze the noise, there are two fundamental questions:

- How much MEV will there be at the beginning?

- How much value can auxiliary service providers capture?

On the first issue, ETH, L2s, alt L1, EIP 4337 (account abstraction), and the expanding DeFi landscape on cross-chain have increased the overall addressable market, but are simultaneously offset by numerous MEV minimization designs.

-ETH Protocol (PBS, crList, encrypted memory pool)

-L2s (Fair Sort Service (FSS), Time-Lock Encryption), and

-Third-party (such as RFQ, MEV minimizing DEX, new clearing design, private order flow, etc.).

The net and total addressable market of MEV is steadily growing.

On the second question, the answer is "it depends on the situation" which is your favorite. Although most MEV startups today are building free features similar to public goods, there is no clear commercialization path other than "possible" tokens. The key to commercial sustainability is to introduce non-commoditized products to build a moat.

Having public awareness and providing free services does not necessarily mean that you cannot make a profit. Some feasible commercialization cases include:

-Skip Protocol (similar to MEV-Boost but for Cosmos) is available for free to validators, but it generates revenue through a B2B business model by charging for deployment on application chains. Additionally, it actively proposes to build a module for Osmosis to capture on-chain MEV revenue and redistribute it back to the community, taking a small portion from the net new profits generated by the module.

-Blocknative runs a permissionless RPC terminal for anyone to submit packages to the Blocknative builder, as well as a currently licensed relay.

1, profitable block builder margin.

2, a SaaS model that provides access to underlying data infrastructure for builders and searchers to maximize profits.

So...what Alphas are there? What trends are worth paying attention to?

1, Cross-chain MEV

-闪电贷为跨链套利提供流动性（想象一下 Aave 与 SUAVE 或类似的区块构建服务合作，为跨链 MEV 提供闪电贷）。 Translation:

- Flash loans provide liquidity for cross-chain arbitrage (imagine Aave partnering with SUAVE or similar blockchain building services to provide flash loans for cross-chain MEV).

-Cosmos Interchain Scheduler, through block space auction, brings MEV onto the chain.

-CEX, DEX arbitrage tool.

-There may be services added to existing or new bridges that can monitor and alert complex cross-domain arbitrage opportunities. Professional traders may customize this service for themselves, but there may be more modules available for amateur traders who pursue profits.

-MEV custody service ensures cross-chain execution of smart contracts (as cross-chain MEV execution lacks atomicity).

Cross-chain MEV will not have atomic (single transaction) arbitrage, currently atomic arbitrage has reached a ratio of 80%+ in ETH arbitrage. I see a lot of demand here to bridge the gap between non-atomic transaction demand and supply.

2, EIP 4337 (Account Abstraction)

It introduces a new layer of user intent, which will further complicate the arrangement game of MEV. It splits the role of the current EOA (Externally Owned Account) wallet into Alt-Mempool, Bundler, and PayMaster (to me, it's like an order book for user intent).

Here are two useful charts from Blocknative's research on MEV supply chain under EIP4337.

3, MEV Facilitator on Alt L1

-Jito Labs: MEV infrastructure on Solana to reduce network spam.

-Skip.Money: MEV boost and explorer (satellite) on Cosmos.

-Mekatek: MEV on Cosmos.

-Fastlane Finance: Compensate validators and reduce junk transactions on Polygon.

4, EigenLayer's MEV-boost section.

5, MEV Minimized SDK. Bringing transaction privacy through encryption (with varying degrees of commercial viability).

-Astria Astria: Shared Sorter Network.

-Shutter Network: A distributed key generation (DKG) protocol based on threshold cryptography.

-ZeroMev: MEV Browser.

-0xPropeller: MEV keeper and MEV protection (used by zkSync).

-Primev: A data layer that maximizes the success rate of builders, accepted by a16z accelerator.

-FairBlock: (Transaction) Privacy before execution.

6, Reputation Market:

As Matt Cutler from Blocknative pointed out on the On the Brink podcast, searchers today to some extent trust that builders will not pre-run their MEV packages, and this relationship is primarily formed off-chain, with centralized risks. The reputation market of builders may interest searchers and even POF (private order flow) in choosing who to send transactions to.

7, Private Order Flow (POF):

POF is becoming a hot topic and may require further exploration. My biggest observation is that in POF, the roles of searchers and builders are increasingly merging due to the intertwined incentives of extracting value from transactions in private memory pools. POF from different sources and terminals can have endless permutations, as shown in the diagram below.

-Upstream

Wallet: Metamask, Rainbow, etc.

Searcher (robot) bundles.

Centralized RPC. User intent layer from EIP4337. (May inspire new sub-markets for user transaction intent auctions and matching). Dapps that control transaction flow (some Dapps even rely on MEV as their primary source of revenue, which may have interesting long-term regulatory implications).

-Relay

Unlicensed relay. Private or licensed relay. Relays owned by builders.

-Terminal (Block Space)

Directly to the validator/proposer. To the wholesaler (market maker with pre-bid slots). To the blockchain space auction.

Part Four: Summary Predictions for the Future of MEV

1. Flashbots tokenizes SUAVE and profits through brand assets to:

a, running MEV-boost and other public welfare functions (infrastructure functions that do not make money and are difficult to maintain, but someone must do it).

b, providing funding for the additional development of new features.

2, SUAVE will play an important role in cross-chain MEV by potentially offering the following combinations:

a, cross-chain and lightning loans for arbitrageurs (because arbitrageurs need liquidity on two chains - it would be interesting if Aave and SUAVE collaborate).

b, trading custody and insurance are used to bridge the atomicity problem of cross-chain MEV.

C, as well as additional and customized services based on MEV user types.

(It can be foreseen that Flashbots will further profit from the above services by opening the fee switch through the SUAVE token.)

3, Cross-chain MEV will surge, generating more collaboration, partnerships, and cooperation between DeFi protocols such as lending, AMM, staking/LSD, aggregators, bridges, and MEV startups.

4, EIP 4337 (Account Abstraction) will create a mechanism for the user intent order book (intent layer), which further splits transactions into Alt-mempool in addition to POF and public memory pools. Expect EIP 4337 to create a new category of MEV participants and compound the arrangement of MEV routes.

5, MEV startups will seek commercialization from POF. It is expected that more upstream (wallets, DEX) and downstream (in addition to existing proposers/validators, there are also market makers purchasing block space wholesale and block space auction markets) will participate in MEV.

MEV may become one of the few commercial levers for wallet industry, until the day when policy makers ban it.

In the long run, it is expected that more and more new participants will enter the blockchain space market, turning it into a Bertrand competition. The equilibrium price of blockchain space will emerge, and the invisible hand will be responsible for MEV smoothing.

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