Shedding Light in the Dark Forest: A Theory of Liability For Cryptocurrency "MEV" Sandwich Attacks

Abstract

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.

Keywords: MEV, market manipulation, blockchain, ethereum, cryptocurrency, financial regulation, financial law