Cross-Chain Arbitrage: The Next Frontier of MEV in Decentralized Finance (2501.17335v2)

Abstract: Decentralized finance (DeFi) markets spread across Layer-1 (L1) and Layer-2 (L2) blockchains rely on arbitrage to keep prices aligned. Today most price gaps are closed against centralized exchanges (CEXes), whose deep liquidity and fast execution make them the primary venue for price discovery. As trading volume migrates on-chain, cross-chain arbitrage between decentralized exchanges (DEXes) will become the canonical mechanism for price alignment. Yet, despite its importance to DeFi-and the on-chain transparency making real activity tractable in a way CEX-to-DEX arbitrage is not-existing research remains confined to conceptual overviews and hypothetical opportunity analyses. We study cross-chain arbitrage with a profit-cost model and a year-long measurement. The model shows that opportunity frequency, bridging time, and token depreciation determine whether inventory- or bridge-based execution is more profitable. Empirically, we analyze one year of transactions (September 2023 - August 2024) across nine blockchains and identify 242,535 executed arbitrages totaling 868.64 million USD volume. Activity clusters on Ethereum-centric L1-L2 pairs, grows 5.5x over the study period, and surges-higher volume, more trades, lower fees-after the Dencun upgrade (March 13, 2024). Most trades use pre-positioned inventory (66.96%) and settle in 9s, whereas bridge-based arbitrages take 242s, underscoring the latency cost of today's bridges. Market concentration is high: the five largest addresses execute more than half of all trades, and one alone captures almost 40% of daily volume post-Dencun. We conclude that cross-chain arbitrage fosters vertical integration, centralizing sequencing infrastructure and economic power and thereby exacerbating censorship, liveness, and finality risks; decentralizing block building and lowering entry barriers are critical to countering these threats.

• The paper introduces two cross-chain arbitrage strategies (SIA and SDA), identifying over $9.4M profit from 260,000 arbitrages across nine blockchains.
• The study highlights how cross-chain arbitrages contribute to centralization and network congestion, noting a trend towards private mempools to hide strategies.
• Findings position cross-chain arbitrages as a critical MEV component, providing SIA/SDA frameworks for research and practical insights for interoperability efficiency and risk.

Systematic Analysis of Cross-Chain Arbitrages in Blockchain Interoperability

The authors of the paper presented the first comprehensive paper on cross-chain arbitrages, showcasing the intricacies and dynamics within blockchain interoperability. As the blockchain ecosystem proliferates, particularly with the introduction of new Layer-1 (L1) and Layer-2 (L2) networks, issues such as liquidity fragmentation become prevalent. This fragmentation leads to price discrepancies, offering arbitrage opportunities across chains, classified as a subset of Maximal Extractable Value (MEV) activities. While traditional MEV within singular domains has been scrutinized thoroughly, this paper pivots focus to cross-chain, non-atomic arbitrages, an area that has garnered less attention.

Key Contributions

1. Introduction of Arbitrage Strategies: The paper delineates two primary non-atomic cross-chain arbitrage strategies: Sequence-Independent Arbitrage (SIA) and Sequence-Dependent Arbitrage (SDA). The former strategy involves executing opposite-direction trades across chains independently, whereas the latter leverages asset bridges necessitating a sequential execution of trades.
2. Operational Insights and Results: Over a year-long period across nine blockchains, researchers identified 260,808 cross-chain arbitrages, amounting to a lower-bound profit of approximately $\text{\SI{9,496,115.28}{USD}}$ from a total trading volume of $\text{\SI{465,797,487.98}{USD}}$. Notably, bridging solutions facilitated 32.37% of these activities.
3. Security and Congestive Implications: The paper highlighted that cross-chain arbitrages can lead to enhanced centralization pressures among arbitrageurs and contribute to network congestion from failed transactions. Additionally, they observed a shift towards private mempool utilization, aiming to conceal arbitrage strategies from potential frontrunners.
4. Proposer-Builder and Sequencer Incentives: Considering the growing prominence of cross-chain opportunities, the role of shared-sequencing systems that can potentially mitigate or exacerbate these centralization tendencies was underscored. This is particularly relevant as the ability to control transaction sequencing across chains could significantly shift the balance within this domain.

Theoretical and Practical Implications

The findings position cross-chain arbitrages as a critical component within MEV discourse, extending the boundary of research from single to multi-domain perspectives. The SIA and SDA frameworks offer a foundational reference for both academic inquiry and industry practitioners aiming to explore or mitigate MEV-related risks on cross-blockchain platforms.

Practically, this paper provides valuable insights into the efficiency and risks of current interoperability solutions. With multi-chain engagements likely to increase, the strategic choice between SIA and SDA becomes pertinent, factoring in time-sensitivity and associated costs of bridging solutions. Furthermore, the increasing adoption of private mempools highlights the evolving strategies in circumventing frontrunning issues, pressing the need for more transparent and fair transaction environments.

Avenues for Future Research

While the paper presents robust findings on cross-chain arbitrages, several areas warrant further exploration:

• Enhanced Detection Algorithms: As cross-chain interoperability matures, the complexity of potential arbitrage strategies might require more sophisticated detection and verification systems to accurately measure and manage MEV.
• Extended Market Analysis: Future studies could further break down the competitiveness across different blockchains and asset classes, contributing to a deeper understanding of liquidity distribution dynamics.
• Security Enhancements: Development and testing of mechanisms that can dynamically detect and deter potentially harmful arbitrage practices without stifling legitimate trading activities.
• Impact on Emerging Blockchain Solutions: As more L2 solutions and interoperability protocols like Cosmos or Polkadot evolve, examining their integration and impact on MEV extraction will assume increasing significance.

In summary, the exploration of cross-chain arbitrages has unearthed significant insights into blockchain financial dynamics, emphasizing the need for strategic adaptations in both research methodologies and technological implementations. Such endeavors will help in building resilient, efficient, and equitable blockchain ecosystems.