Trading cryptocurrencies does not come without complications. Have you heard of the “Ethereum is a Dark Forest” analogy? This metaphor came about because users on decentralized exchanges (DEXes) face unique and challenging dangers within the network, caused by excessive power in miners’ hands.
DEXes were developed in response to the limitations of centralized exchanges, such as a reduced risk of theft and hacking, prevention of price manipulation and increased levels of privacy. The great growth in interest in decentralized finance (DeFi) applications caused a significant shift of users from centralized to decentralized exchanges, with Ethereum’s blockchain at the foundations. According to CoinGecko’s report, 2020’s third quarter resulted in a $155 billion increase, or 88%, in total trading volume, while The Block Research found that the ratio of DEX-to-centralized exchange volume reached almost 4%. Despite the rising popularity of DEXes, a new set of dangers and complications have arisen for their users.
The relationship between miners and users has become increasingly predatory. As users on Ethereum-based networks express their desire to put through a transaction to the miners by paying a gas fee, miners include the transaction onto the block. With access to all of the transaction data, miners are able to arbitrarily re-order the transactions within the block, insert their own or even censor the transaction data.
Decentralization and open source protocols inherent to decentralized exchange infrastructures mean that past and future transactions are open to view and can be exploited. This transparency reveals zero-risk profit opportunities, which present themselves in the form of arbitrage opportunities where actors can take advantage of price differences created from a single transaction.
As rational actors with economic incentive, miners have taken advantage of their power over the transaction data and opportunities for profit. Unfortunately, this black-hat behaviour comes at the expense of the user, as we explain below. This kind of profit is known as Miner Extracible Value or MEV (also known as Maximal Extractible Value), and it worries many users to see it become part of the decentralized finance (DeFi) blueprint.
MEV is observed on DeFi platforms through a set of strategic market manipulations. Front-running, for example, is an attack where an attacker sees an upcoming trade and puts their own transaction ahead of it, thus making the initial transaction less profitable, and their own more profitable. For a “sandwich attack”, this is followed up with a back-run by trading the amount gained after the victim executes their transaction.
Essentially, the attacker gets to buy for cheaper, lets the victim buy at an increased price, and then sells the amount again at a higher price. These manipulations can happen at any time, targeting any DEX user. Since the beginning of 2021, daily extracted MEV ranges between $0.6 million and $3.3 million per day, with up to close to $430 million extracted since the start of 2020 as recorded by Flashbots’ MEV Explore on April 28th 2021.
It is no wonder that the “Ethereum is a dark forest” analogy has endured — as coined by Dan Robinson and Georgios Konstantopoulos in their 2020 essay. It reflects the reality of this Hobbesian environment, where each user is fending for themselves. Excessive miner power is encouraging front-runners and sandwich attacks, creating an adverse trading experience nowadays.
Dapplication tech is committed to helping users come out of the dark forest. We solve the problems taking over the DeFi space by developing ethical tools that prioritise the user’s protection. There are many exciting things coming your way!