Title: Introducing a New Concept: MEV Tax
Authors: 0XNATALIE, Source: Author’s Blog
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 aim of redistributing the value of MEV to prevent it from being completely captured by transaction miners. This mechanism can be effectively implemented on OP Stack L2 networks such as OP Mainnet, Base, and Blast.
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. 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 incentivize miners to prioritize their transactions.
Smart contracts collect additional fees proportionally based on the priority fee of the transaction, known as MEV Tax. For example, under MEV Tax, a user pays a priority fee of 1u to the miner to prioritize the transaction. In order to capture all the MEV from this transaction (e.g. a profit of 100u), the miner must pay 99u to the smart contract based on the 1:99 fee ratio set by the interacting smart contract. This 99u is returned to the application (used to provide rewards to users, etc.). Without MEV Tax, if a user pays a priority fee of 1u, the miner would still receive 1u for processing the transaction, but all the MEV generated by the transaction (100u) would go to the miner.
Effectiveness Based on Competitive Priority Ordering Rules
The effectiveness of MEV Tax is based on the “competitive priority ordering” rules:
Sort by priority fee: Miners should prioritize transactions based on the priority fee, with higher priority fee transactions being processed first.
No censorship: Miners cannot censor or exclude any transactions, even those with lower priority fees.
No front-running or delays: Miners 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 miners (sorters) follow competitive priority ordering rules. If sorters violate these principles, they can manipulate the transaction order to evade MEV Tax and capture the value for themselves.
For Ethereum L1, block construction is done through competitive block-building auctions such as 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 may prefer 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 the need for specific external infrastructure, allowing smart contract developers to customize fee models according to their application needs. This flexibility ensures that different blockchain protocols and applications can optimize their strategies while remaining compatible with other systems. For example:
Optimizing DEX transactions: Introducing MEV Tax in DEX means that transaction execution prices depend not only on market supply and demand but also on the MEV Tax component. Searchers need to pay higher MEV Tax in order 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 price slippage.
Reducing losses for liquidity providers in AMMs and addressing rebalancing issues: AMMs can prioritize processing transactions that pay higher MEV Tax, directly recovering 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, which can be returned to the original transaction user. 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 on sorters strictly adhering to competitive priority ordering rules, there are other limitations. For example, when a block is completely full, miners may have to abandon lower priority transactions rather than simply include them 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 public disclosure of 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 redistribute MEV more fairly, returning MEV profits that would have originally gone to miners back to applications. MEV Tax and MEV Share have similar goals in finding ways to return MEV, promoting fair distribution within the MEV ecosystem.
