Title: Introducing a New Concept: MEV Tax
Researchers Dan Robinson and Dave White from Paradigm have introduced a groundbreaking concept called the “MEV tax.” This mechanism allows applications to recoup a portion of MEV from transactions, with the goal of redistributing the value of MEV and preventing it from being solely captured by transaction searchers. This mechanism can be effectively implemented on OP Mainnet, Base, Blast, and other OP Stack L2 networks.
Introduction to MEV Tax
MEV taxes are a mechanism that enables smart contracts to automatically extract fees by analyzing the priority fee in transactions. Under this framework, smart contracts charge a certain percentage of MEV tax based on the priority fee of the transaction. The priority fee is the fee paid by users to expedite the confirmation of their transactions on the network. Following EIP-1559, Ethereum transaction fees are divided into base fees and priority fees. The base fee is set automatically by the network and adjusts dynamically based on network congestion, while the priority fee is an additional fee paid by users to incentivize block proposers to prioritize their transactions.
Smart contracts collect additional fees in proportion to the priority fee by examining the priority fee of transactions, known as MEV tax. For example, under MEV tax, a user pays a priority fee of 1u to the block proposer to incentivize them to prioritize the transaction. In order for the searcher to capture all the MEV from this transaction (e.g., profit of 100u), they must pay 99u to the smart contract based on the 1:99 fee ratio set by the smart contract interacting with the transaction, with the 99u returned to the application (used to provide rewards to users, etc.). Without MEV tax, if a user pays a priority fee of 1u, the proposer would receive 1u for processing the transaction, but all the MEV generated (100u) would go to the searcher.
Effectiveness Based on Competitive Priority Ordering Rules
The effectiveness of MEV tax is based on the rules of “competitive priority ordering”:
Ordering by priority fee: Block proposers should prioritize transactions based on their priority fees, with higher priority fee transactions being processed first.
No censorship: Block proposers cannot censor or exclude any transactions, even those with lower priority fees.
No front-running or delay: Block proposers cannot front-run transactions or unnecessarily delay the processing of certain transactions.
Based on these rules, MEV tax is only effective on OP Stack L2 networks where block proposers (sorters) follow the rules of competitive priority ordering. If sorters violate these principles, they can also evade MEV tax by manipulating the order of transactions to capture the value for themselves.
For Ethereum L1, block construction is done through competitive block-building auction systems like MEV-Boost, where multiple block builders compete to maximize their income by including high-fee transactions. Since MEV tax reduces the income of builders, in highly competitive block-building environments, builders tend to prioritize transactions without MEV tax, rendering this mechanism ineffective on Ethereum.
Issues Addressed by MEV Tax
MEV tax can be adopted by any smart contract without requiring specific external infrastructure, allowing smart contract developers to customize fee models based on their application needs. This flexibility ensures that different blockchain protocols and applications can optimize according to their strategies while remaining compatible with other systems. For example:
Optimizing DEX trades: Introducing MEV tax in DEX trades means that the execution price of trades depends not only on market supply and demand but also includes the component of MEV tax. In order to execute trades faster and get better prices, searchers need to pay higher MEV taxes. This additional cost can be used to increase the priority of the trade in the block or as a reward mechanism, given back to users or liquidity providers, potentially altering the execution price of the trade and indirectly reducing the trade price slippage.
Reducing losses and rebalancing issues for liquidity providers in AMMs: AMMs can prioritize processing trades that pay higher MEV taxes, allowing them to directly recoup some profits from arbitrageurs and return them to the AMM or liquidity providers, ensuring more stable income for liquidity providers.
Capturing “backrun” MEV generated by trades: By integrating MEV tax into smart contract wallets, mechanisms can be designed for wallets to automatically collect MEV tax during trades. This way, when other market participants try to exploit the MEV generated by a user’s trade, they must pay MEV tax, which can be returned to the original user. This mechanism effectively allows users to capture the MEV generated by their own trades, protecting their interests.
Limitations of MEV Tax
In addition to the high dependence of MEV tax effectiveness on sorters strictly following competitive priority ordering rules, there are other limitations. For example, when blocks are completely filled, block proposers may have to prioritize higher-priority transactions rather than simply including lower-priority ones later in the block. Furthermore, the success of MEV tax requires competition in the market, meaning that the opportunities for transactions need to be widely known, which may require disclosing user intentions for some intent-based applications, potentially leading to value leakage in competition.
Although the MEV tax mechanism faces some challenges and limitations, this innovative approach is a way to fairly redistribute MEV, returning profits that would have otherwise gone solely to searchers back to applications. MEV tax and MEV Share serve similar purposes in finding ways to return MEV and promote fair distribution in the MEV ecosystem.
