High-Frequency Trading on Decentralized On-Chain Exchanges

Abstract

Decentralized exchanges (DEXs) allow parties to participate in financial markets while retaining full custody of their funds. However, the transparency of blockchain-based DEX in combination with the latency for transactions to be processed, makes market-manipulation feasible. For instance, adversaries could perform front-running -the practice of exploiting (typically non-public) information that may change the price of an asset for financial gain.In this work we formalize, analytically exposit and empirically evaluate an augmented variant of frontrunning: sandwich attacks, which involve front-and back-running victim transactions on a blockchain-based DEX. We quantify the probability of an adversarial trader being able to undertake the attack, based on the relative positioning of a transaction within a blockchain block. We find that a single adversarial trader can earn a daily revenue of over several thousand USD when performing sandwich attacks on one particular DEX -Uniswap, an exchange with over 5M USD daily trading volume by June 2020. In addition to a single-adversary game, we simulate the outcome of sandwich attacks under multiple competing adversaries, to account for the real-world trading environment.

Cyclic Arbitrage in Decentralized Exchanges

“…Moreover, because of the high miner-extractable value, fee-based forking attacks and time-bandit attacks are created and bring systemic consensus-layer vulnerabilities. Zhou et al [38] and Qin et al [32] studied sandwiching attacks, i.e., combinations of front-and back-running, in DEXes. When observing a victim transaction, attackers place one order just before it (front-run) and place an order just after it (back-run) to benefit themselves through the variance of the exchange rates.…”

“…All information is public to everyone due to the transparent nature of blockchains. Therefore, arbitrageurs can prejudge the price of each upcoming transaction in advance and exploit the price difference to their advantage across different markets [10,32,33,38].…”

A theory of Automated Market Makers in DeFi

“…AMMs are inherently hard to design, implement and understand, since they involve sophisticated economic incentive mechanisms. Although they generally only expose a handful of callable functions, interactions with AMMs are sensitive to transaction ordering [18,20,24,27]: thus, actors with the power to influence the order of transactions in the blockchain may be incentivized to do so for profit or to harm specific users. Thus, there exists a need for foundational work to devise formal models of AMMs which allow the study of their fundamental properties, transaction concurrency and the effect of economic incentives.…”

“…We present in this paper a theory of AMMs that addresses the above described challenges. The core of our theory is a formal model of AMMs ( §2), based on a throughout inspection of leading AMM implementations such as Uniswap [11], Curve [14] and Balancer [3], as well as existing models from the literature [1,27]. Our model precisely describes the typical interactions between users and AMMs, and their main economic features.…”

“…research efforts [18,20,24,27] are devoted to understanding vulnerabilities and attacks, which we plan to investigate formally, exploiting our theory.…”