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Non-Atomic Arbitrage in Decentralized Finance

Published 3 Jan 2024 in cs.CE and q-fin.GN | (2401.01622v3)

Abstract: The prevalence of maximal extractable value (MEV) in the Ethereum ecosystem has led to a characterization of the latter as a dark forest. Studies of MEV have thus far largely been restricted to purely on-chain MEV, i.e., sandwich attacks, cyclic arbitrage, and liquidations. In this work, we shed light on the prevalence of non-atomic arbitrage on decentralized exchanges (DEXes) on the Ethereum blockchain. Importantly, non-atomic arbitrage exploits price differences between DEXes on the Ethereum blockchain as well as exchanges outside the Ethereum blockchain (i.e., centralized exchanges or DEXes on other blockchains). Thus, non-atomic arbitrage is a type of MEV that involves actions on and off the Ethereum blockchain. In our study of non-atomic arbitrage, we uncover that more than a fourth of the volume on Ethereum's biggest five DEXes from the merge until 31 October 2023 can likely be attributed to this type of MEV. We further highlight that only eleven searchers are responsible for more than 80% of the identified non-atomic arbitrage volume sitting at a staggering $132 billion and draw a connection between the centralization of the block construction market and non-atomic arbitrage. Finally, we discuss the security implications of these high-value transactions that account for more than 10% of Ethereum's total block value and outline possible mitigations.

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Citations (13)
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Summary

  • The paper introduces non-atomic arbitrage as a form of MEV by capturing on-chain and off-chain price discrepancies between DEXes and CEXes.
  • It presents a profit model using CFMMs and analyzes a case study from block 18,360,789 where 26 arbitrage transactions were identified.
  • The study highlights the integration of searchers and builders, discussing centralization risks and suggesting mitigations to secure blockchain operations.

Non-Atomic Arbitrage in Decentralized Finance

Introduction

The concept of maximal extractable value (MEV) has been a focal point in the Ethereum ecosystem, particularly with the introduction of non-atomic arbitrage. This paper investigates non-atomic arbitrage, a form of MEV that capitalizes on price discrepancies between decentralized exchanges (DEXes) on Ethereum and centralized exchanges (CEXes), or other blockchain platforms. Such arbitrage involves both on-chain and off-chain mechanisms, presenting unique challenges and opportunities for traders in the decentralized finance (DeFi) sector. Figure 1

Figure 1

Figure 1: The process of non-atomic arbitrage illustrating the interaction between DEXes and off-chain markets.

Non-Atomic Arbitrage Model

The paper proposes a model for quantifying profits from non-atomic arbitrage trades between two cryptocurrencies. In DEXes, prices result from previous transactions and can differ significantly from CEX prices, creating arbitrage opportunities. Utilizing constant function market makers (CFMM) like Uniswap, traders can exploit these price discrepancies. The model calculates arbitrageur profits based on liquidity pools and price differences, showcasing significant profits for substantial price changes. Figure 2

Figure 2: Arbitrageur profit as a function of price difference, highlighting profitability in significant price variations.

Case Study and Data Collection

An in-depth analysis of block 18,360,789 provides insight into real-world non-atomic arbitrage execution, demonstrating substantial price changes in ETH and BTC preceding the block proposal. Builders submit bids reflecting these changes, resulting in high-value transactions driven primarily by integrated searchers. The study reveals that 26 non-atomic arbitrage transactions were identified in this block, underscoring the volume and value extracted during times of volatility. Figure 3

Figure 3: Bids submitted by builders during volatile market conditions, showcasing strategic responses to price changes.

Searcher and Builder Integration

A notable aspect of non-atomic arbitrage is the potential integration between searchers — entities identifying and executing arbitrage opportunities — and builders, who construct blocks in Ethereum's PBS scheme. The paper speculates on the relationship between builders like beaverbuild and rsyncbuilder and their corresponding searchers, suggesting that integrated searchers are pivotal in capturing arbitrage opportunities, thereby influencing block construction and increasing centralization in the block building market. Figure 4

Figure 4: Cumulative volume of non-atomic arbitrage illustrating dominance by integrated searchers.

Effects of Market Volatility

Arbitrage opportunities correlate strongly with cryptocurrency price volatility. The paper establishes that non-atomic arbitrage volume spikes during periods of high volatility, such as the FTX collapse and USDC depeg events. Builders with integrated searchers are more likely to win blocks during these periods, reflecting a centralized approach to block construction that favors volatility. This behavior underscores concerns about centralization and security implications within the Ethereum ecosystem. Figure 5

Figure 5: Daily volume of non-atomic arbitrage trades and their correlation with the volatility of ETH and BTC prices.

Mitigations and Implications

Several mitigations are proposed to address the centralizing effects of non-atomic arbitrage, such as separating top-of-block extractions and reducing block time. These strategies aim to lessen arbitrage profitability and mitigate security risks associated with high-value trades, offering a path forward for maintaining decentralized balance in Ethereum blockchain operations.

Conclusion

The prevalence and impact of non-atomic arbitrage in Ethereum's DeFi landscape are profound, accounting for significant DEX volume and influencing the centralization of the block construction market. The insights provided by this paper are vital for understanding the dynamics of MEV in decentralized systems and devising strategies to promote equilibrium and security in blockchain ecosystems. Figure 6

Figure 6: Daily share of non-atomic arbitrage volume in HFT builder blocks, demonstrating the centralization trend.

Overall, this paper informs future research directions about MEV and decentralization challenges in Ethereum and similar blockchain systems, setting the stage for subsequent advancements in transaction security and efficiency.

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