Blockchain technology transformed the financial landscape, bringing forth features like decentralization and transparency. However, with the rapid growth of this ecosystem, certain exploitative practices have been discovered, especially in the area of transaction processing.
Two concepts that are considered critical in this respect are Maximal Extractable Value (MEV) and sandwich attacks, both of which impact traders and the efficiency of blockchain networks.
What is the Maximal Extractable Value (MEV)?
Maximal Extractable Value is essentially the excess gain that miners in a blockchain are able to earn by ordering transactions in ways, including, and excluding particular transaction(s) into a block.
This usually takes place within a blockchain system using smart contracts as seen with Ethereum. For such chains, transactions aren’t always carried in the sequence provided.
This arises because of how transactions are broadcasted in a mempool before they are finalized. Sophisticated actors are monitoring these transactions and adjusting their strategies to get a financial advantage.
MEV is generally observed in DeFi protocols when large trades, liquidations, and arbitrage opportunities are prevalent. Front-running is perhaps the most widespread exploitation of MEV, which is when a participant identifies an upcoming transaction and executes its trade in front of it to exploit expected price moves.
Similarly, back-running is placing a transaction immediately after a significant trade to capitalize on price changes that follow. These strategies contribute to network congestion, increase transaction fees, and create an unfair trading environment for regular users.
Understanding Sandwich Attacks
A sandwich attack is a type of MEV exploitation that targets users executing trades on decentralized exchanges. This technique is particularly damaging to traders as it manipulates token prices by exploiting the delay between a transaction being submitted and confirmed on-chain.
A sandwich attack works as follows: A malicious trader notices that a huge token swap is pending. The attacker then does two things: executes the transaction before the victim’s trade is front-running and then executes the transaction right after it, known as back-running. The process is as follows:
- Front-running. The attacker puts in a buy order for the same token just before the victim’s trade and drives up the price.
- Victim’s trade: The user’s transaction goes through at an inflated price, the user pays more than they are supposed to unknowingly.
- Back-running: After the victim’s transaction executes, the attacker immediately sells the token at a higher price, capturing the profit.
The trader initiating the trade receives fewer tokens than they would have anticipated because of artificial inflation caused by the attacker in the price. The malicious actor benefits from this price manipulation at the expense of the regular user.
A sandwich attack is a specific type of MEV exploitation that targets users executing trades on decentralized exchanges (DEXs). This technique is particularly harmful to traders as it manipulates token prices by exploiting the delay between a transaction being submitted and confirmed on-chain.
Mitigating MEV and Sandwich Attacks
Several blockchain developers and DeFi communities have begun working on solutions that would mitigate the risks due to MEV and sandwich attacks. Some of the most effective strategies are reported to be:
- Private Transaction Pools: Some of the projects provide private or encrypted transaction pools to prevent the details of transactions from being in the public mempool.
- Slippage Controls: Most DEX platforms provide users with the ability to set slippage limits, ensuring that their trade is only executed within a certain price range so that they are not significantly losing due to manipulation.
- Batch Auctions: This method involves collecting multiple transactions together and executing them at the same price, thus preventing individual transactions from being exploited by MEV searchers.
- MEV-Resistant Protocols: Other blockchain networks are experimenting with consensus mechanisms that restrict MEV opportunities or make for fairer ordering of transactions.
The existence of MEV and sandwich attacks exposed vulnerabilities within blockchain networks, particularly in decentralized finance.
While this is very profitable for skilled actors, in other words, it often hurts the interests of common traders and the overall efficiency of blockchain systems. These issues are simultaneously being addressed by technical progress, regulatory efforts, and efforts by users to increase awareness.
By introducing solutions such as private transaction pools, slippage controls, and MEV-resistant protocols, the blockchain community can begin to work on reducing the damage that these manipulative strategies could cause.
As the industry continues to evolve, further research and innovation will play a significant role in the establishment of a more fair and transparent trading environment for all participants.
Ultimately, it will take an effort from developers, users, and industry leaders to create fair and trustless blockchain ecosystems. Informed stakeholders will play a defining role in their quest to create a decentralized financial landscape that emphasizes security, efficiency, and fairness.
