Author: 0XNATALIE, Source: Author’s Blog
Researchers Dan Robinson and Dave White from Paradigm have introduced a new concept called “MEV Tax”. The MEV tax mechanism allows applications to recover a portion of MEV from transactions, with the goal of redistributing the value of MEV to prevent it from being completely captured by the transaction searchers. This mechanism can be effectively implemented on OP Stack L2 networks such as OP Mainnet, Base, and Blast.
Introduction to MEV Tax
MEV taxes are a mechanism that allows smart contracts to automatically extract fees by analyzing the priority fees 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 speed up the confirmation of their transactions on the network. After EIP-1559, Ethereum’s transaction fees are divided into base fees and priority fees. The base fee is automatically set by the network and dynamically adjusted based on network congestion, while the priority fee is an additional fee paid by users to the block proposers to incentivize them to prioritize processing their transactions.
Smart contracts charge proportionate additional fees based on the priority fee of the transaction, known as MEV tax. For example, under MEV tax, a user pays 1u as a priority fee to the block proposer to incentivize them to prioritize this transaction. To ensure that all the MEV from this transaction goes to the user (for example, a profit of 100u), the searcher must pay 99u to the smart contract based on the 1:99 fee ratio set by the smart contract interacting with the transaction. This 99u will be returned to the application (to provide rewards to users, etc.). Without MEV tax, if a user pays 1u as a priority fee, the proposer would still receive 1u if they process the transaction, but all the MEV generated by the transaction (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”:
Sort by priority fees: 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 peeking and delays: Block proposers cannot peek at transaction contents in advance, nor arbitrarily delay the processing of certain transactions.
Based on these rules, MEV tax is only effective on OP Stack L2 networks. This is because the block proposers (sorters) on these chains 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 income by including high-fee transactions. Since MEV tax reduces the income of builders, in highly competitive block-building environments, builders are likely to prioritize transactions without implementing MEV tax, making this mechanism ineffective on Ethereum.
Issues Addressed by MEV Tax
MEV tax can be adopted by any smart contract without the need for 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 own strategies while remaining compatible with other systems. For example:
Optimizing DEX transactions: Introducing MEV tax in DEX means that the execution price of transactions depends not only on market supply and demand but also includes a component of MEV tax. Searchers need to pay higher MEV tax to prioritize completing transactions and getting better prices. This portion of the fee can be used to increase the transaction’s priority in the block or as a reward mechanism, returned to users or liquidity providers, potentially changing the execution price of the transaction and indirectly reducing transaction price slippage.
Reducing losses and rebalancing issues for liquidity providers in AMMs: AMMs can prioritize processing transactions that pay higher MEV taxes, directly recovering some profits from arbitrageurs and returning them to the AMM or liquidity providers, ensuring more stable income for liquidity providers.
Capturing “backrun” MEV generated by transactions: By integrating MEV tax into smart contract wallets, users’ wallets can automatically collect MEV tax during transactions. This means that when other market participants try to exploit the MEV generated by user transactions, they must pay MEV tax, and this tax 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 Tax
In addition to the high dependence of MEV tax effectiveness on sorters strictly adhering to competitive priority ordering rules, there are other limitations. For example, when blocks are completely full, block proposers may have to prioritize higher priority transactions rather than simply including lower priority ones later in the block. The success of MEV tax also requires competition in the market, meaning that transaction opportunities need to be widely known, which may require disclosing user intent for some intent-based applications, potentially leading to value leakage in competition.
While the MEV tax mechanism faces some challenges and limitations, this innovative approach is a way to fairly redistribute MEV, returning MEV profits that would have otherwise gone to searchers back to applications. MEV tax and MEV Share have similar goals of finding ways to return MEV, promoting fair distribution in the MEV ecosystem.