Original source: Alana Levin, Variant Fund (in collaboration with Frontier Research)
Original Compilation: Cecilia, bfrenz DAO
MEV (Maximum Extractable Value), the maximum extractable value, refers to the value extracted from users by reordering, inserting and reviewing transactions in blocks, such as arbitrage, liquidation, etc. The most fundamental understanding is "the additional benefits obtained by adjusting the order of transactions when creating a new block". According to different classifications, it can be divided into different types such as arbitrage, liquidation, and sandwich attacks.
MEV has been in development for some years. After Ethereum was merged into a PoS mechanism, MEV has entered the field of vision of more people. NFT MEV is an emerging way. Although there are some risks in making money, its greatest value lies in the fact that searchers (that is, arbitrage robots) run algorithms on blockchain data to detect MEVs with profitable opportunities and automatically Extract to the web) provides more opportunities.
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TL;DR
Compared with the token market, the NFT market has a different market structure. The NFT market is capitalized due to frequent mint events, the secondary trading volume is low, bidding liquidity is challenging, and there is a large off-exchange order book.
As a more mature market, the DeFi market offers some useful implications, such as the need for MEV-aware minting solutions, more open pricing data, dynamic on-chain order books, experimenting with new auction formats, and providing traders with additional communication channel.
As a more mature market, the DeFi market offers some useful implications, such as the need for MEV-aware minting solutions, more open pricing data, dynamic on-chain order books, experimenting with new auction formats, and providing traders with additional communication channel.
At present, the value flow of NFT mainly occurs at the time of issuance and during the transaction and lending process in the secondary market. The process of these flows may involve MEV (for example, the economic inefficiency of extracting from users when trading on the chain), which will affect the business model and beneficiaries of market activities, including traders, markets, Wallets and developers.
However, MEV within the NFT space feels like a little-known topic compared to the DeFi market. There are larger differences in the structure of the NFT market, including more primary activity, smaller token supply, and less secondary liquidity, and these differences also affect the way value flows.
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The current NFT market ecology
Understanding the current structure of the NFT market is an important prerequisite for identifying how MEVs will behave in the market.
We can look at it from the perspective of a cyclical cycle, which starts from the user mint NFT. I call this a capital formation moment, similar to an airdrop or token launch (creating new assets on-chain) in fungible tokens. However, there are at least three aspects to the distinction between fungible and non-fungible markets:
Capital formation events are more frequent in non-substitutable markets than in alternative markets.
The order of mints in a non-fungible market can be important, as mints sequentially can have financial value through classification as rare traits or status symbols.
Non-fungible collectibles tend to have smaller supplies; a collectible can mint 10,000 NFTs, while fungible tokens are usually released with a supply of 1 billion or more. This may affect the liquidity of the secondary market.
When users decide to sell their NFTs, they can place an order to sell them on marketplaces such as OpenSea, Blur, Reservoir, etc. These pending orders are usually listed in an off-chain order book, where the order exists until it is executed or canceled. There are several touchpoints to the on-chain activity related to these off-chain order books: order approval needs to be set up when an order is first placed, order cancellation, and order execution. If the order price needs to be changed, the seller needs to sign, but does not need to pay additional gas fees. Additionally, there are order books that operate directly on-chain, such as Zora and Sudoswap.
In addition to the NFT issuance market and secondary market transactions, it is worth noting that the practicality of NFT is also gradually emerging. Using NFTs on the blockchain can involve staking NFTs for rewards, delegating rights to upcoming airdrops, burning NFTs when using them as game assets, and more. With the continuous emergence of these application scenarios, the practicality of NFT is gradually being recognized and developed.
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What are NFT MEVs?
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1) Arbitrage
Arbitrage and sandwich attacks typically require high volumes and depth of liquidity, as spreads are often very tight and arbitrageurs want to get in and out of their positions quickly. However, NFT markets generally lack both of these conditions. In addition, there are liquidity challenges. More often than not, there isn't a ready buyer on the other end of each listing. This means that even if someone spots an arbitrage opportunity, relisting and selling could be risky.
Some NFT-native forms of arbitrage, and the risks associated with each:
Raise the base price cap and relist for a higher price. In order to get a higher price, some traders will raise the floor price ceiling and re-list items. They claim to be able to make profits by taking advantage of buy orders placed above the floor price. In this case, traders almost artificially create the high volumes needed for arbitrage. However, this arbitrage strategy carries the risk of high capital costs and inventory requirements.
Look for needs that aren't considered "coincidence". For example, one person lists a CryptoPunk he owns with a red/blue glasses element for 1 ETH, and another person has placed an order for any CryptoPunk with glasses elements. At this point, a Seeker bot can step in, call Seaport's MATCH function to match the two orders, and collect the difference as a tip or reward. This example makes people think that this is a low-risk arbitrage opportunity, although it does not occur too often. The main risk is that the searcher might not find enough matching orders to earn money.
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2) Sandwiching
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3) Liquidation Liquidation MEV
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Other types of NFT MEV:
Congestion while minting: Congestion while mint is a common problem. For those popular projects, users even need to pay millions of dollars in gas when mint. Although this is the value created by NFT projects, ultimately these fees are extracted by validators. Additionally, there are robotic operations involved in the mint process. Seekers can discover mint's first transaction in the mempool, check the supply of tokens to mint, and preempt the remainder of mint or all.
In the trading market, it often happens that a pending order is accidentally left, also known as an "inactive pending order". Because there is a fee to cancel pending orders, sometimes users choose to simply transfer the NFT to a new wallet in order to close the pending order. However, this doesn't technically cancel the original order. If that person re-transfers the NFT to the original wallet, the pending order will reappear. At this time, the reserve price may have risen above the original pending order, and a savvy third party may seize the low-priced NFT. This MEV phenomenon arises because Seekers may bribe Validators with high gas fees to ensure their bids on pending orders get prioritized.
Arbitrage related to NFT leasing: There is a recent trend to separate the rights or utility of NFTs from the assets themselves, which is like an NFT version of Airbnb. Similar to Airbnb's housing rental model, the holder can let others pay to use or enjoy the benefits of the asset, while still retaining the ownership of the asset. This liquid order is especially useful for arbitrage related to airdrops. Purchasing the rights to a large number of NFTs, rather than attempting to purchase the NFTs themselves, can be expected to require less capital, limit surges in reserve prices, and provide access to airdropped supply. If eligibility requirements for airdrops increase (as has already occurred in alternative markets), NFT holders may have asymmetric information about the size of airdrops their NFTs can claim.
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Opportunities at the infrastructure level
According to the current market situation and the areas where MEV is good at, the following are some ideas on building NFT MEV native infrastructure:
1. A mint solution to the MEV problem: In this regard, auctions for NFTs can help projects capture more of the value they create. By letting users bid for access and order it in the mint process, it can provide a way to help project pricing and mitigate high gas costs. If the sorting itself happens off-chain, concurrently or pre-mint, projects can spread mint over several days, or choose other on-chain activities during times when there is less on-chain activity, further mitigating the congestion problem.
2. Strengthening infrastructure related to pricing: There are several forms that can be taken to strengthen this infrastructure. For example, better data visualizations can help searchers identify uptake opportunities for specific NFTs, improving pricing. Additionally, dynamic pricing mechanisms, such as Sudoswap, can assist in pricing NFTs collectively rather than individually. Finally, approaches such as sequential auctions can improve pricing discovery or enhance pricing infrastructure using other methods.
3. Build infrastructure to reduce exit (liquidity) risk: I think pricing NFTs is a difficult task, so fewer people are willing to bid. One way that might help is the bargaining mechanism. For example, if a user has listed an NFT for 2 ETH and the buyer is only bidding 1 ETH, there may be an intermediate liquidation price that can be negotiated. This negotiation channel can increase overall liquidity while driving a better understanding of how to price NFTs. In practice, there may be overlap between this category and the pricing infrastructure described above.
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concluding thoughts
In the long run, we believe that as time goes by, more applications will be developed around the "non-fungibility" feature of tokens. Currently, most NFTs are heterogeneous, making them difficult to substitute. While shared features or underlying tokens are more akin to alternatives, consumer preferences may still vary. In contrast, NFTs can be used as tickets to golf events, they may have certain different characteristics (such as dates), which may affect consumer preferences, but in general, they can be regarded as approximate Alternatives, as consumers can choose different tickets on a given day (all tickets provide equal access to events). With NFTs as a vehicle to represent everything from on-chain art to tickets, affiliate links, IP licenses, property ownership, we think we'll see more MEVs emerge.
In general, we believe that we are in the early stages of NFT. NFTs have many possibilities, are a great way to bring outside capital into the crypto ecosystem, and the design space is open. However, in the early stages of any market, there will always be inefficiencies. We hope to help achieve the goal of mass adoption by exploring how MEVs exist across the market and the opportunities that such exploration presents for building more enjoyable user experiences.
