Crypto-finance not only reproduced old methods of market abuse (e.g. simple fraud, “pump and dump” schemes), but also created opportunities for novel kinds of potentially abusive behavior. We investigate which behaviors (e.g. types of “MEV extraction”) should be considered as abusive and how the regulators should respond.
MEV extraction: broader policy questions
- “MEV on Ethereum: A Policy Analysis” - a white paper published by the International Center for Law & Economics (January 2023).
- “Law and regulation vs MEV extraction” (Flashbots Collective, 7 October 2022).
At least some features of MEV extraction will likely look very suspicious to a regulator used to policing traditional finance. However, even if some MEV extraction strategies seem to be causing individual harm, the question whether they should be seen as “manipulative” or “abusive” in a legal sense should also be informed by social welfare (including market efficiency) considerations. Moreover, there is also a risk that some regulatory responses will cause more harm than benefit. Certain forms of enforcement or other regulatory interventions may have relatively little effect on the broader DeFi and Ethereum ecosystem, but others may have significant negative unintended consequences. For example, requiring block-builders or relay operators to register as dealer-brokers would likely negate the benefits of permisionless and decentralized nature of a network like Ethereum.
MEV extraction under US commodities law
By Dr Mikołaj Barczentewicz and Dr Alex Sarch
Draft available to download from SSRN. TLDR version in a Twitter thread.
In the “dark forest” of the Ethereum blockchain, novel strategies of maximal extractable value (“MEV”) extraction – such as validators or searchers running “sandwich attacks” on other crypto traders – are increasingly threatening to disrupt the market in cryptocurrencies. Such attacks can inflict substantial losses on other users. Nonetheless, MEV extraction has yet to receive any systematic discussion in the legal literature despite being a significant market phenomenon, estimated at $550-650 million since 2020, and despite suggestions that analogous actions to some forms of MEV extraction would have been illegal in traditional markets. This is the gap we begin to fill here.
In particular, this short essay will discuss the core legal implications of sandwiching – one of the main MEV extraction strategies – on Ethereum. We discuss three theories of liability: fraud, insider trading, and “manipulation-as-fraud.” We note that though fraudulent trading or trading with the use of material non-public information could be applicable to some instances of sandwiching, those theories would face significant evidentiary difficulties in practice. However, the “manipulation-as-fraud” theory may pose a higher legal risk for market participants involved in MEV extraction. This theory is based in the chief anti-fraud provision of the Commodities Exchange Act, § 9(1) as effectuated by CFTC Rule 180.1. Drawing on prior arguments that some High Frequency Trading practices artificially alter prices in a way that amounts to a fraudulent form of manipulation, we suggest that the front-running involved in a sandwich attack likewise could be considered as manipulation through artificially altering the prices applicable to crypto assets. Nevertheless, we also note that classification of sandwiching as manipulative requires further investigation, as there are individual and societal welfare and efficiency arguments on both sides of the question.
