2024 DOJ tackles wire-fraud and market manipulation on the blockchain
The arrest of the Pepaire-Bueno brothers in Boston yesterday brings the progress in cryptocurrency regulation into focus. The two brothers used a bug in the FlashBot relay system to frontrun MEV bots and managed to drain $25.38 million worth of assets from bots in only 8 transactions, 12 seconds. The preparation took months, based on their discovery of a bug in the FlashBots relay system.
Quick background
The FlashBots network, unlike the Ethereum blockchain, is not public. It was built to allow Ethereum users to pay miners extra in exchange for priority in including their transaction in blocks, skipping the line to this public database. This ‘bribing’ of miners facilitates front-running of normal on-chain traders. This practice, nicknamed MEV, netted over $1 billion in profits since 2019.
FlashBot operators are usually unable to see or modify transactions they are relaying, but the Pepaire-Bueno brothers found a bug. They relayed a block after slightly changing it to make it invalid. As a result the system automatically exposed the content of the block. Then, the brothers modified the transaction data to suit themselves, signed it and broadcasted it to the miners, this time without the mistake in it.
Why were the brothers arrested while MEV front-runners are free?
The brothers ‘skimmed’ the $25 million by finding a bug which let them bypass the normal functionality of the FlashBot system. Now that the bug has been discovered it was fixed. In contrast, the practice of MEV uses normal blockchain rules to front-run traders, and this can not be fixed. But you can also argue that the FlashBot network itself helps MEV traders game the normal Ethereum network.
Another answer may be in the definition of front running. Illegal front running is defined as using privileged information to gain an advantage for example, a stock broker front-running a client. Using public Ethereum transaction information for profit isn't obviously illegal front-running.
MEV is not off the hook though. While you can say MEV is just arbitrage, arbitrage has a function in markets- it improves liquidity and lowers prices in addition to raising them. MEV only hikes prices, sometimes substantially. Miners and front runners are the only ones benefiting.
Everyone else, the everyday users of the Ethereum network, are manipulated. It’s definitely possible to categorize this practice as not front-running, serving no purpose but hiking prices for profit. It’s possible that continued regulation of blockchain activity will put MEV in question as well.
What’s clear is that the DOJ is watching activity around DEXs and DeFi closely and taking regulating seriously. Their 19-page detailed report on the matter proved they have access to people who understand these technologies and activities well. Arresting people for ‘wire-fraud’ on the Ethereum blockchain is a big step and a huge signal to all operators across all blockchains.Furthermore, their ability to arrest them shows additional expertise. We’re now in yet another new phase of cryptocurrency regulation.