TL;DR MEV is driving retail LPs towards extinction and the advent of intents is further enriching a small group of extractive actors. Arrakis offers a fix with HOT, an MEV-aware DEX that will challenge private market makers and empower LPs.

Key Takeaways:

• MEV is a problem for Ethereum’s DeFi ecosystem and users are losing out as value gets leaked to Centralized Vertically-Integrated Market Makers across the MEV supply chain.

• As intents have gained pace, these actors have started to monopolize DeFi, leaving retail LPs with less revenue and more exposure to toxic flow.

• Arrakis plans to fix DeFi’s private market maker problem by vertically integrating into the MEV supply chain.

• The HOT AMM sits at the core of Arrakis. HOT is an MEV-aware DEX built to offer retail LPs toxic flow protection and better returns.

How Retail Is Losing Out to the MEV Supply Chain

MEV is one of Ethereum DeFi’s biggest challenges. As Ethereum has grown, sophisticated actors have infiltrated DeFi and leveraged complex strategies to extract value from the ecosystem.

These players profit from users during Ethereum’s block production process. Alongside builders and proposers, they form part of what’s known as “the MEV supply chain.” Retail users lose out to the MEV supply chain while searchers, builders, and proposers win.

Most MEV is extracted through sandwich attacks and arbitrage. There are two types of sandwich attack: searchers frontrun orders to manipulate an asset’s price then backrun the user’s order to profit from the difference or they provide liquidity to a pool ahead of a swap then remove it after the transaction to extract fees from LPs. Sandwich attackers act fast when a transaction gets executed to profit from swappers or LPs.

MEV gets extracted through arbitrage when searchers find a price difference between two exchanges or DEX pools. CEX/DEX arbitrage is common because CEX prices update faster than DEX prices. When a user makes a DEX order, the CEX price may increase or decrease before the DEX price changes at the next block. LPs offer liquidity at the old price before the block updates, allowing arbitrageurs to buy and sell to profit from the price difference. However, atomic arbitrage accounts for the bulk of arbitrage-related MEV because prices so frequently differ between pools. In both cases, arbitrageurs take advantage of volatility and price discrepancies to profit from LPs.

The Impact of Intents

DeFi has recently evolved with the advent of intent-based protocols like UniswapX. Such systems let users express an “intent” and third-party solvers fulfill their request. With intents, users specify the chain’s end-state and receive their order extremely quickly because solvers compete to answer the request.

Intents give users CEX-like trading experiences, but there is a cost. Intent-driven order flows are frequently drawn to “private market makers” (PMMs) who provide liquidity to capture non-toxic flow. Composed of a handful of centralized entities like Wintermute, these PMMs account for a significant portion of DeFi volume.

As intents gain adoption, PMMs gain adoption because they dominate intent-driven order flows.

Intent-based systems now account for about 30% of all DeFi volumes. Due to the rising adoption of intents, PMMs have begun to receive more and more non-toxic flow.

As PMMs attract more non-toxic flow through intent-based systems, LPs on AMMs become exposed to a greater portion of arbitrage-laden toxic flow. LPs suffer in this environment because they rely on fees from non-toxic flow to offset losses incurred through toxic flow.

Intents have rapidly gained adoption since early 2022, now accounting for about 30% of DeFi volumes. PMMs capture the majority of intent-driven order flow and Wintermute dominates; the firm has consistently captured at least 50% of intent-driven flows facilitated by PMMs since September 2023.

As intents are growing in popularity, we believe that PMMs are here to stay. This means new AMM designs need to compete with PMMs if they want to capture non-toxic flow.

How Arrakis Is Taking on CVMMs

In 2024, DeFi’s top players extract value from retail users by verticalizing across every level of the MEV supply chain. These entities execute MEV strategies, produce blocks, and operate their own PMMs. We refer to them as Centralized Vertically-Integrated Market Makers (CVMMs).

CVMMs are operating across the MEV supply chain, monopolizing DeFi and extracting profits that would otherwise go to retail users.

While CVMMs can fulfill users’ intents at good prices, they hurt passive LPs. Retail LPs provide liquidity on AMMs to earn trading fees but they lose revenue when CVMMs dominate flows.

CVMMs can fulfill most users’ requests today because they have large inventories on major tokens like ETH and USDC. However, they are not as well equipped to cater to flows for longtail assets.

CVMMs risk their own inventory when they make markets, so they typically use hedging strategies to limit their risk. This is why CVMMs are unable to scale to support all assets. Wintermute is a case in point here, with most of its inventory held in major tokens and stablecoins.

As more of the world’s value moves onchain, CVMMs will not be able to accommodate for the vast number of tokens. While they provide good pricing and capital efficiency on majors, longtail assets are underserved, and the issue will worsen as more assets get tokenized. DeFi needs a solution that guarantees liquidity and capital efficiency for these assets.

In summary, CVMMs have created two problems:

• They hurt retail LPs because they impact their revenue.

• They only cater to a fraction of global onchain liquidity.

It’s clear that DeFi needs an AMM design that protects LPs from toxic flow and minimizes the impact of CVMMs. This is what we’re building at Arrakis.

HOT, the MEV-Aware DEX Built to Empower LPs

With our latest update, Arrakis is vertically integrating into the MEV supply chain with a next-generation AMM called HOT. This solution recaptures MEV for LPs and the goal is to build healthier and fairer onchain markets. With the HOT AMM at the core, Arrakis is taking a first step to fix DeFi’s CVMM problem by protecting retail LPs.

“HOT” stands for Hybrid Order Type and Arrakis built it in partnership with Valantis Labs. HOT is a Liquidity Module that’s attached to a Valantis liquidity pool known as a Sovereign Pool. HOT is the product of cutting-edge innovation in the AMM design space, forming part of DeFi’s first modular DEX.

The HOT AMM is best described as an MEV-aware DEX that uses intents to better serve retail LPs. It uses a flash swap service with a request for quote system, bringing LPs flow (plus fees on the flow) that would otherwise go to PMMs.

Until now, retail LPs have lost out from the rise in intent-based systems. HOT changes that so that LPs receive non-toxic, intent-driven order flow.

Arrakis developed HOT with Valantis Labs in response to a rapidly evolving DEX landscape. Uniswap V3 broke new ground in the AMM space with its concentrated liquidity feature, while V4’s hooks have introduced new possibilities in how we build permissionless DEXs. Similarly, HOT takes a groundbreaking approach to AMM design and the system’s modular framework unlocks new possibilities that redefine the way we think about DEXs.

We believe that DeFi is entering a DEX renaissance filled with new opportunities. In this new era, the solutions that solve Ethereum’s MEV problem will win.

If DeFi is to succeed, it needs robust foundations where permissionless retail users are afforded opportunities to participate in the ecosystem without losing value to powerful centralized actors. This is why we’re pledging our commitment to taking on CVMMs like Wintermute. Our goal is to vertically integrate into the MEV supply chain and launching the HOT AMM is the first phase in our journey.

To learn more about how Arrakis is changing the DeFi landscape with HOT, head to our introduction post and look out for our next piece, where we’ll cover our upcoming roadmap in full.