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 in order to redistribute the value of MEV and prevent it from being entirely 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 Tax (MEV taxes) is a mechanism that allows smart contracts to automatically extract fees by analyzing the priority fee in transactions. In 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 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 that users pay to block proposers to incentivize them to prioritize processing their transactions.
Smart contracts charge proportionally 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 processing 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, and this 99u will be returned to the application (used to provide rewards to users, etc.). Without MEV Tax, if a user pays 1u as a priority fee, the proposer would still receive 1u for processing 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 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 delay the processing of certain transactions without valid reasons.
Based on these rules, MEV Tax is only effective on OP Stack L2 networks. This is because the on-chain block proposers (sorters) on these networks 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.
In contrast, 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 would reduce the income of builders, in highly competitive block-building environments, builders would tend to prioritize transactions that are not subject to MEV Tax, making 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 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 means that the execution price of trades not only depends on market supply and demand but also includes a component of MEV Tax. Searchers need to pay higher MEV Tax to complete trades faster and get better prices. This portion of the fee can be used to increase the trade’s priority in the block or as a reward mechanism, feedback to users or liquidity providers, potentially changing the trade’s execution price and indirectly reducing the trade price slippage.
Reducing losses and rebalancing issues for liquidity providers in AMM: AMMs can prioritize processing trades that pay higher MEV Tax, directly recovering profits from arbitrageurs and returning them to the AMM or liquidity providers, ensuring more stable profits for liquidity providers.
Capturing “backrun” MEV generated by trades: By integrating MEV Tax into smart contract wallets, a mechanism can be designed to automatically collect MEV Tax from users’ wallets during transactions. This way, 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 own transactions, protecting their interests.
Limitations of MEV Tax
In addition to the high dependence of MEV Tax’s effectiveness on sorters strictly adhering to competitive priority ordering rules, there are other limitations. For example, when blocks are completely filled, block proposers may have to prioritize higher priority transactions instead of simply including lower priority ones in the later stages of the block. Furthermore, the success of MEV Tax requires competition in the market, meaning that the opportunity for transactions needs to be widely known. For some intent-based applications, this may require disclosing user intent, 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 MEV profits that would have originally gone to searchers back to applications. MEV Tax and MEV Share have similar goals in finding ways to return MEV and promote fair distribution within the MEV ecosystem.