Maximum Extractable Value (MEV), the process of miners or validators reordering transactions in a block to extract profits, prevents financial institutions from adopting decentralized finance (DeFi), which hurts retail customers, according to Aditya Palep, CEO of DEX Labs, a leading contributor to decentralized crypto derivatives exchange DerivaDEX.
All electronically traded markets suffer from maximum extractable value or similar problems inherent in information asymmetry in ordering trading transaction data, Palepu told Cointelegraph.
The solution is to prevent order flow data from being visible before execution through transaction processing in trusted execution environments, which manage transactions privately through a funded vault or some other mechanism, Palepu said. He added:
“What makes them really powerful is that they can process orders privately. So your trading intentions aren’t broadcast to the world before execution. They’re encrypted client-side and only decrypted within a secure enclave once they’ve been sequenced.”
This makes initial transactions “impossible,” he said, protecting users from things like “sandwich attacks,” a form of market manipulation where validators or miners place transactions before and after a user’s order to manipulate the price and extract a profit.
The presence of MEV as a core infrastructure in crypto and DeFi has caused intense development debate among industry executives and protocol founders as they try to address MEV’s potential to increase centralization, drive up costs, and stifle mass adoption.
Related: How Batched Threshold Encryption Could End Extractive MEV and Make DeFi Fair Again
Institutions that stay out of the DeFi game hurt small users
The lack of transaction privacy prevents financial institutions from adopting DeFi because it exposes them to market manipulation and the upfront risks of transactions being broadcast before they are executed, Palepu told Cointelegraph.
“When institutions cannot participate effectively, everyone suffers, including retail,” Palepu told Cointelegraph, adding that institutions create the “highways and roads” or necessary trading infrastructure for financial markets to function smoothly.
These include non-extractive arbitrage trading opportunities that reduce price volatility and keep asset prices at or near parity on exchanges, he added.
“Exchanges, like any market, need vibrancy and diversity of participation,” Palepu said, adding that a lack of institutional involvement can cause liquidity to dry up, volatility to rise, market manipulation to increase and transaction costs to jump.
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