To understand how flashbots work, one must first be familiar with the term "maximal extractable value" (MEV). MEV refers to the profit that miners can gain by including, excluding, or reordering transactions when mining a block.
Flashbots play a crucial role in crypto trading, DeFi, and the broader blockchain ecosystem as they focus on bringing transparency and democratizing access to MEV activity. This include preventing frontrunning and backrunning transactions, which can adversely affect traders and users.
Frontrunning is the act of gaining an unfair advantage by submitting a transaction ahead of another user's transaction, while backrunning refers to intentionally submitting a transaction after another user's transaction.
To combat these issues, Flashbots create a separate channel for including transactions in a block, facilitating an open and fair auction for the transaction ordering process. The process looks something like this:
Third-party block builders create bundles of transactions and submit them to miners via the Flashbots network.
Block builders base their selection and the arrangement of transactions by potential profit to be gained (MEV).
Miners then interact directly with the network and decide which bundles to include in the new blocks based on the profit share offered by block builders.
Users who submit transactions to block builders with a tip (incentive) will get prioritized, resulting in a transparent, efficient and fair marketplace for transaction ordering.
Flashbots offers a variety of products and services to its users and contributors:
Flashbots Auction: An open marketplace for efficient and fair transaction ordering. It allows validators to delegate the task of block construction to a third party network of block builders, optimizing block profitability.
Flashbots Protect: A Remote Procedure Call (RPC) endpoint that anyone is able to use to protect themselves from frontrunning, backrunning and failed transactions. RPC is a sort of computer server that allows users to read blockchain data and facilitate transactions to, and across, different networks.
Flashbots Data: dashboards and tools to improve transparency of MEV activity on the Ethereum blockchain and the Flashbots Auction.
Let's look into some of the distinct benefits Flashbots offer within the crypto landscape:
Through the auction mechanism for transaction ordering, miners are able to extract more profits by including and prioritizing transactions with higher fees.
Flashbots reduce the likelihood of frontrunning and backrunning. This ensures that transactions are executed in a fair and secure manner
Flashbots reduce the risk of malicious actors taking advantage of MEV extraction by creating an open auction for transaction ordering
Flashbots increase transparency by allowing traders to see the true cost of placing transactions.
Let's look into the limitations of using Flashbots within the crypto trading landscape:
Flashbots operate through an off-chain transaction system which can inadvertently centralize the control of transaction ordering. If control of the decision-making process is external, and made by a small number of parties, it could lead to fraudulent practices.
The risk of market manipulation is present. As Flashbots allow miners to prioritize transactions with higher fees, certain traders could potentially drive up prices to gain an unfair advantage over others.
Smaller traders may struggle to compete against larger traders who can afford higher transaction fees, leading to an uneven playing field for small fish.
Implementing Flashbots can be challenging due to technical complexities and compatibility issues with existing infrastructure in the ecosystem
In 2022, Flashbots proposed the concept of SUAVE aimed to decentralize the block builder role and combat the centralizing forces of exclusive order flow.