Uncovering Private Mempools: Ethereum Traders' Hideout from Bots

• Ethereum and the Increasing Trend of Private Mempools
• What is MEV and how does it relate to private mempools?
• Benefits of Private Mempools
• Risks Associated with Private Mempools

Ethereum and the Increasing Trend of Private Mempools

Ethereum$2,315 -2.42%'s blockchain is notorious for being besieged by bots programmed to front-run transactions. These bots take advantage of the small window of time between the submission and finalization of transactions, copying trades from other users to quickly execute them and thereby diminishing any potential profits. This practice, known as maximal extractable value (MEV), is a significant inconvenience for both novice and experienced crypto traders.

However, in the past two years, there has been a subtle shift in Ethereum's transaction pipeline as more users have started to opt for private mempools for their trades. This method circumvents the blockchain's public transaction lobby, preventing the broadcast of trades to the entire network before they are finalized, which benefits users by averting MEV and ensuring better settlement of transactions.

What is MEV and how does it relate to private mempools?

To comprehend transaction privatization, it's crucial to understand how the second-largest blockchain network currently operates. Generally, when a transaction is submitted to Ethereum or similar blockchains, it is sent to the chain's public mempool: a large holding area for transactions awaiting execution. Validators then collate these transactions into blocks, assisted by third-party block builders, based on specific criteria, including the fees paid to validators. Once added to a block, the transactions are officially recorded on the blockchain, where they are permanently etched.

However, this system presents a clear problem: Transactions in Ethereum's public mempool are easy targets. The small delay in queue time provides ample opportunity for savvy trading bots, often referred to as searchers, to front-run transactions or employ other tactics that impact the profits of regular traders.

Private mempools are proposed as a more discreet alternative, allowing decentralized finance (DeFi) traders to conduct transactions without exposing their trades to MEV bots, which scan mempool transactions to make a profit. Private mempools are currently handling around 10% of Ethereum transactions daily, double the number recorded in 2022, according to Blocknative. This trend towards mempool privatization is expected to grow in the foreseeable future.

Benefits of Private Mempools

Private mempool services offered by companies like CoW Swap, bloXroute, and Blocknative help to shield transactions from MEV bots. Large entities and individuals seeking superior security and privacy for their transactions often resort to these setups. They are also utilized by advanced trading firms requiring quick, assured transaction settlements without revealing their trades to rivals before they are completed.

Private mempool services are not just for high-level traders and privacy enthusiasts. Some services, such as CoWSwap, provide kickbacks, often referred to as refunds, to users whose transactions potentially yield block builders their profits from MEV. Products that use private mempools to assure better settlement for DeFi traders are also becoming popular. For instance, UniswapX, an initiative by Uniswap, the largest decentralized exchange on Ethereum, employs a private mempool to help retail traders obtain better prices for their token swaps.

Risks Associated with Private Mempools

Despite the benefits, private mempools also present certain risks. There is a concern that private mempools may consolidate new intermediaries in key areas of Ethereum's transaction pipeline. For instance, MetaMask, the most widely used Ethereum wallet, plans to introduce a transaction-routing feature in 2024, which could trigger the largest shift from Ethereum's public mempool. However, officials at Consensys, MetaMask's parent company, have refrained from labeling this a private mempool due to the inherent risks associated with the term.

Private mempools often require users to place their trust in individual third parties instead of the broader Ethereum network to guarantee transaction execution. If not carefully designed, these third parties could exploit users or front-run them, much like an ordinary MEV bot.

The Ethereum Foundation researcher, Toni Wahrstätter, commented that the impact of private mempools on Ethereum's network is a complex issue. He added that while they might lead to more centralization among builders and searchers, they are unlikely to affect the crucial aspect of validator decentralization. However, he also expressed concern about potential centralization issues among builders, as this could threaten essential features like censorship resistance.

Edited by Jonathan Stoker