Market abuse and fairness

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”) should be considered as abusive and how the regulators should respond.

MEV: broader policy questions

By Dr Mikołaj Barczentewicz

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 under US commodities and securities law

By Dr Mikołaj Barczentewicz, Dr Alex Sarch and Natasha Vasan

Blockchain Transaction Ordering as Market Manipulation

Article forthcoming in the Ohio State Technology Law Journal. Draft available to download from SSRN. TLDR version in a Twitter thread.

MEV is often condemned. Techniques like “sandwich attacks” which involve trading ahead of other users' trades, have been described as toxic, fraudulent, manipulative – even theft. However, this broad denunciation of MEV is too quick, as the technical nuances of how each kind of MEV extraction operates are determinative of the legal risk it entails. The legality of MEV extraction under U.S. financial laws has yet to be subject to sustained scholarly analysis, and the present Article aims to fill this gap. We undertake the first systematic analysis of how U.S. securities and commodities law, particularly the broad anti-manipulation rules wielded by the SEC (Rule 10b-5) and CFTC (Rule 180.1), apply to core MEV extraction techniques on Ethereum.

In so doing, the Article confronts how basic notions of fairness and trust play out differently in a world of discretionary transaction ordering in crypto markets compared to the first-come first-serve world of traditional finance. Behaviors that might seem outrageous off-chain look very different when examined in light of how blockchains actually work.

Nonetheless, this Article argues that some forms of MEV extraction entail a significant risk of market manipulation liability. Focusing on sandwiching in particular, we provide novel arguments showing that there is a route for courts that adopt a moralized lens, focused on behavior that exploits privileged control over financial infrastructure, to find sandwiching impermissibly manipulative. We argue, further, that the legal hazards are even greater when it comes to sandwiching private transactions, which more clearly involves a heightened trust relationship, as well as disruptive schemes like oracle manipulation, wherein MEV is part of an independently manipulative strategy. Nonetheless, we argue, this alone does not mean a sweeping ban on these forms of MEV is necessarily a desirable policy. It remains unclear whether a strict ban on MEV sandwiching, for instance, would be prudent, given the unknowns about the net effects of MEV extraction and behavioral impact that a ban on MEV sandwiching would entail.

Battle of the Crypto Bots: Automated Transaction Copying in Decentralized Finance

Article forthcoming in the University of Pennsylvania Journal of Business Law. Draft available to download from SSRN.

Markets built on public, permissionless blockchains like Ethereum are radically transparent. This creates opportunities and strategies that are rarely, if ever, seen in traditional markets. Among the most interesting but understudied of these is the use of sophisticated algorithms (“bots”) to automatically copy and front-run or otherwise exploit other users’ trades, as these are typically publicly viewable while they wait to be executed. In crypto markets like Ethereum, Generalized Profit-Seeker (GPS) bots can access publicly available pending orders (blockchain transactions), simulate them to determine if they will be profitable, and copy (or otherwise piggy-back on) those transactions deemed profitable according to the parameters of the bot. Sometimes, this benefits the sender of the copied order—the copier effectively facilitates, even subsidizes, its execution. Other times, the sender of the copied order is blocked from a profit opportunity because the copier manages to get there first, thus making it entirely unavailable or at least less profitable for anyone who comes second. To further complicate matters, such automated “strategy copying” may involve replicating or facilitating criminal or otherwise illicit transactions, such as attempted hacks of blockchain applications or platforms.

This Article explores the legal implications of this type of radical transparency found in crypto markets and offers the first sustained legal analysis in the academic literature of the use of Generalized Profit-Seeking bots in crypto markets. This Article is part of a series on the legality of so-called Maximal Extractable Value (“MEV”) extraction techniques, which exploit the ability to order transactions in profitable ways including through the use of GPS bots which are the focus of this Article.

In particular, we argue that, given the public and competitive nature of transaction ordering in crypto markets, the operation of GPS bots to copy profitable transactions submitted publicly is generally unlikely to be a legal violation in run-of-the-mill-cases. However, we highlight several exceptions to this default permissibility, for example where the GPS bot is operated by a validator, or when the bot copies criminal or illicit transactions. The Article provides a technical introduction of transaction ordering and execution on Ethereum to serve as a necessary resource for pressing legal and policy discussions. It then examines relevant U.S. laws governing market manipulation, insider trading, and front-running in securities and commodities markets, and analyzes what these entail for the use of GPS bots in crypto markets. Ultimately, the Article aims to offer guidance to regulators and policymakers, as well as courts and practitioners, on the legality of GPS bots and MEV extraction more generally under U.S. law, as well offering suggestions and questions for further research about how the use of crypto bots should be regulated going forward.