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 reclaim 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 Mainnet, Base, Blast, and other OP Stack L2 platforms.
Introduction to MEV Tax
MEV taxes are a mechanism that allows smart contracts to automatically extract fees by analyzing the priority fees in transactions. In this framework, smart contracts collect a certain percentage of MEV tax based on the priority fees of transactions. Priority fees are fees paid by users to speed up the confirmation of their transactions on the network. After EIP-1559, Ethereum transaction fees are divided into base fees and priority fees. The base fee is automatically set by the network and adjusted dynamically based on network congestion, while the priority fee is an additional fee paid by users to incentivize miners to prioritize their transactions.
Smart contracts collect proportionate additional fees based on the priority fees of transactions, known as MEV tax. For example, under the MEV tax system, a user pays 1u of priority fee to the miner to prioritize their transaction. In order to capture all the MEV from this transaction (e.g., making a profit of 100u), the searcher must pay 99u to the smart contract based on the 1:99 fee ratio set by the interacting smart contract. This 99u is then returned to the application (used for rewarding users, etc.). Without MEV tax, the miner would receive 1u for processing the transaction, while 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 “competitive priority ordering” rule:
Sort by priority fees: Miners should sort transactions based on their priority fees, with higher priority fee transactions being processed first.
No censorship: Miners cannot censor or exclude any transactions, even those with lower priority fees.
No peeking or delays: Miners cannot peek at transaction contents in advance or unnecessarily delay the processing of certain transactions.
Based on these rules, MEV tax is only effective on OP Stack L2 platforms, where miners (sorters) follow competitive priority ordering rules. If sorters violate these principles, they can evade MEV tax by manipulating the order of transactions to capture the value for themselves.
For Ethereum L1, block construction is carried out 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 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 specific external infrastructure, allowing smart contract developers to customize their 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 transactions means that execution prices not only depend on market supply and demand but also include a component of MEV tax. Searchers need to pay higher MEV taxes to complete transactions first and get better prices. This fee can be used to increase the transaction’s priority in the block or as a reward mechanism, benefiting users or liquidity providers, potentially reducing transaction slippage indirectly.
Reducing losses and rebalancing issues for liquidity providers in AMMs: AMMs can prioritize processing transactions with higher MEV taxes, allowing them to directly recover profits from arbitrageurs and return them to the AMM or liquidity providers, ensuring more stable earnings for liquidity providers.
Capturing “backrun” MEV generated by transactions: By integrating MEV tax into smart contract wallets, users’ wallets automatically collect MEV tax during transactions. This means that when other market participants try to exploit MEV generated by user transactions, they must pay MEV tax, 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 Tax
In addition to the high dependence of MEV tax effectiveness on strict adherence to competitive priority ordering rules by sorters, there are other limitations. For example, when blocks are completely full, miners may have to prioritize higher-priority transactions and abandon lower-priority ones, rather than simply including them in the later stages of the block. The success of MEV tax requires competition in the market, meaning that transaction opportunities 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 entirely to searchers back to applications. MEV tax and MEV Share have similar goals in finding ways to redistribute MEV, promoting fair distribution in the MEV ecosystem.