In-protocol MEV Capture (e.g., Osmosis) vs External MEV Searchers: Who Captures the Value?

In-Protocol Advantage: Aligns MEV revenue with protocol security and growth. Fees from arbitrage can fund staking rewards (Osmosis) or treasury grants (Canto), creating a direct value flywheel. Reduces extractive "leakage" to external actors.

In-Protocol Drawback: Requires complex, consensus-level changes (e.g., implementing encrypted mempools). Can stifle the rapid, permissionless innovation seen in Ethereum's searcher ecosystem. May lead to suboptimal extraction if the protocol's logic is gamed.

External Searcher Advantage: A competitive, profit-driven searcher network aggressively closes price gaps across DEXs (Uniswap, Balancer) and lending markets (Aave, Compound). This leads to highly efficient markets and is a primary source of on-chain liquidity.

External Searcher Drawback: Results in negative externalities for users: frontrunning, failed transactions, and unpredictable gas auctions. Also leads to centralization pressures, as sophisticated searchers (e.g., using Flashbots Protect) outcompete smaller players.

Direct value capture: MEV profits (e.g., from arbitrage, liquidations) are directed to the protocol treasury or stakers. Osmosis routes a portion of arbitrage profits to the community pool and OSMO stakers. This creates a sustainable, on-chain revenue stream, reducing reliance on inflation.

Reduced front-running: By internalizing common MEV strategies (like DEX arbitrage), the protocol can offer users more predictable execution and pricing. This mitigates the negative externalities of toxic MEV, such as sandwich attacks, leading to a fairer trading environment for retail users.

Increased attack surface: Building MEV logic directly into the consensus layer (e.g., via Threshold Encryption or specific modules) adds significant complexity. This can lead to higher development costs, longer time-to-market, and potential new vulnerabilities that externalizes risk to the core chain.

Suboptimal extraction: Protocol-level logic may not capture MEV as efficiently as a competitive, permissionless market of searchers. It can stifle innovation in MEV strategies and reduce overall economic efficiency, potentially leaving value on the table compared to ecosystems like Ethereum.

Maximized extraction: A competitive network of searchers (e.g., Flashbots on Ethereum) uses sophisticated algorithms to identify and capture every sliver of MEV. This competition drives extreme efficiency, ensures prices across venues converge rapidly, and can provide additional liquidity via backrunning.

Separation of concerns: The core protocol remains simple and secure, while specialized, off-chain actors (searchers, builders, relays) handle MEV extraction. This modular ecosystem, exemplified by the PBS (Proposer-Builder Separation) roadmap, allows for rapid, independent innovation in MEV tooling without protocol upgrades.

Direct value recirculation: MEV profits (e.g., from arbitrage) are captured by the protocol's liquidity pools and stakers via mechanisms like Threshold Encryption. This directly boosts protocol-owned liquidity (POL) and staking yields.

Key for: Protocols prioritizing economic security and community-aligned incentives, where value should accrue to token holders, not external agents.

Maximized efficiency & innovation: A competitive, permissionless market of searchers (e.g., using Flashbots SUAVE) drives sophisticated strategies and optimal price discovery. This typically results in better execution prices for end-users.

Key for: Ecosystems where liquidity depth and extreme efficiency are the primary goals, accepting that value accrues to specialized third parties.

Reduced toxic MEV: By design, it mitigates frontrunning and sandwich attacks against users through encrypted mempools. This leads to a superior user experience (UX) and predictable transaction outcomes.

Trade-off: Can reduce overall network throughput and complexity by limiting the searcher competition that drives block space optimization.

High network resilience: The searcher ecosystem is a distributed risk layer. Failed strategies or actor exit doesn't compromise core protocol security. Relies on robust relay infrastructure like BloXroute.

Trade-off: Creates user-experience risks (sandwich attacks) and can lead to centralization in builder/relay markets, posing long-term censorship risks.