Title: Introducing the Concept of MEV Taxes
Researchers Dan Robinson and Dave White from Paradigm have proposed a new concept called “MEV taxes.” The MEV tax mechanism allows applications to recover a portion of MEV from transactions in order to redistribute the value of MEV and prevent it from being completely captured by transaction searchers. This mechanism can be effectively implemented on OP Stack L2 solutions such as OP Mainnet, Base, and Blast.
Introduction to MEV Taxes
MEV taxes are a mechanism that allows 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 that users pay to accelerate the confirmation speed of their transactions on the network. After 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 block proposers to incentivize them to prioritize processing their transactions.
Smart contracts charge an additional fee proportionate to the priority fee by examining the priority fee in 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 processing the transaction. In order for the searcher to capture all the MEV from this transaction (e.g. profit 100u), they must pay 99u to the smart contract based on a 1:99 fee ratio set by the smart contract interacting with the transaction. This 99u will be 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 still receive 1u if they processed the transaction, but all the MEV generated from this transaction (100u) would go to the searcher.
Effectiveness Based on Competitive Priority Ordering Rules
The effectiveness of MEV taxes is based on the rules of “competitive priority ordering”:
Sorting by priority fee: Block proposers should sort transactions based on the priority fee, 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 and delays: Block proposers cannot front-run transactions or unnecessarily delay the processing of certain transactions.
Based on these rules, MEV taxes are only effective on OP Stack L2 solutions where block proposers (sorters) follow the rules of competitive priority ordering. If sorters violate these principles, they could manipulate the order of transactions to evade MEV taxes and capture the value for themselves.
For Ethereum L1, block construction occurs through competitive block-building auction systems like MEV-Boost, where multiple block builders compete to maximize income by including high fee transactions. Since MEV taxes would reduce the income of builders, in highly competitive block-building environments, builders may prefer to prioritize transactions without MEV taxes, rendering this mechanism ineffective on Ethereum.
Issues Addressed by MEV Taxes
MEV taxes can be adopted by any smart contract without specific external infrastructure, allowing smart contract developers to customize their fee models based on application requirements. This flexibility ensures that different blockchain protocols and applications can optimize their strategies while maintaining compatibility with other systems. For example:
Optimizing DEX trades: Introducing MEV taxes in DEX trades means that transaction execution prices depend not only on market supply and demand but also on MEV tax components. Searchers need to pay higher MEV taxes to complete trades faster and get better prices. This fee can be used to increase the priority of the transaction in the block or as a reward mechanism, returning profits to users or liquidity providers, potentially changing the execution price of the transaction and indirectly reducing the slippage.
Reducing losses and rebalancing issues for liquidity providers in AMMs: AMMs can prioritize processing transactions that pay higher MEV taxes, allowing them to directly recover profits from arbitrageurs and return them to the AMM or liquidity providers, ensuring more stable income for liquidity providers.
Capturing “backrun” MEV generated by transactions: By integrating MEV taxes into smart contract wallets, mechanisms can be designed to automatically collect MEV taxes when users make transactions. This way, when other market participants try to exploit the MEV generated by user transactions, they must pay MEV taxes, which can be returned to the original user of the transaction. This mechanism effectively allows users to capture the MEV generated by their transactions, protecting their interests.
Limitations of MEV Taxes
In addition to the high dependence of the effectiveness of MEV taxes on strict compliance with competitive priority ordering rules by sorters, 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 transactions later. Moreover, the success of MEV taxes requires market competition, meaning that transaction opportunities need to be widely known. For some applications based on user intent, this may require the public disclosure of user intent, potentially leading to value leakage in competition.
While the MEV tax mechanism faces some challenges and limitations, this innovative approach is a way to redistribute MEV more fairly, returning MEV profits that would have originally gone to searchers back to applications. MEV taxes and MEV share have similar objectives, both seeking ways to redistribute MEV returns to promote fair distribution within the MEV ecosystem.
