DeFi’s Unfair Advantage: How MEV and Front-Running Hurt Traders

Unfair trading practices like MEV, slippage, and front-running have long plagued decentralized exchanges, eroding both profits and the core principles of fairness. David Wells suggests that traders can spot these problems by watching for unusually high slippage, trade executions at worse-than-expected prices, and the “sandwiching” of transactions.

Watch Out for MEV, Front-Running, Traders Told

For years, the promise of decentralized finance (DeFi) has been somewhat tarnished by the persistent specter of unfair trading practices. Crypto traders on decentralized exchanges (DEXes) have frequently voiced concerns about an uneven playing field, plagued by irregularities like Maximum Extractable Value (MEV), unexpected slippage, and the insidious practice of front-running.

As a Feb. 13, 2024, op-ed in Bitcoin.com News explains, irregularities like MEV, when toxic, pose an existential threat to the blockchain industry. This is because such irregularities not only erode profitability but also undermine the very principles of transparency and fairness that DeFi aims to uphold.

To overcome these and other associated challenges, crypto traders must rely on experienced professionals or learn ways to decode red flags themselves. For traders choosing the latter option, David Wells, CEO of Enclave Markets, a firm focused on creating fairer trading environments, encourages them to understand on-chain activity. Wells points to several key warning signs that should raise alarm bells.

“Traders should look for several warning signs that indicate MEV and front-running issues. First, consistently experiencing price slippage beyond what market volatility would justify is a major red flag,” the CEO states.

Traders should also monitor transaction timing for signs of front-running, where trades execute at worse prices than expected. If this constantly happens, that is “often evidence of front-running.” Additionally, traders must check the blockchain for sandwich attacks by analyzing transactions immediately before and after theirs.

However, traders can opt for exchanges that employ encrypted order flow, where orders remain private until execution. This crucial feature significantly mitigates the risks of MEV and front-running by ensuring that pending transaction details are shielded from prying eyes. By keeping order information confidential until the precise moment of trade execution, these platforms prevent malicious actors from observing and strategically exploiting pending orders for their own profit.

Wells meanwhile recommends traders understand how an exchange’s underlying infrastructure works.

“I also suggest traders diversify across execution venues and use limit orders whenever possible. Most importantly, educate yourself about how the exchange’s underlying infrastructure works – if a platform is vague about how they prevent front-running or MEV, that’s usually because they don’t have robust solutions in place,” Wells explains.

Although millions of dollars of digital assets are lost courtesy of these activities, the Enclave Markets CEO insists many of the platforms implicated do not willfully engage in such harmful practices. Instead, the CEO believes the infrastructure they operate is leading to these problems.

“The core issue is that traditional blockchain design inherently creates transparency trade-offs. Public mempools broadcast transactions before they’re executed, giving opportunities for MEV extraction. This wasn’t necessarily a design flaw – in early blockchain thinking, transparency was a feature, not a bug.

Crypto Industry Too Focused on Retail Traders

The CEO asserts some platforms prioritize profits over fairness, earning more by selling order flow data or supporting high-frequency trading strategies that take advantage of retail traders. Others avoid addressing technical challenges, as the existing system remains highly profitable for them; hence, the continued existence of the irregularities.

Although institutional investors are said to be interested in the crypto market infrastructure, Wells argues that many view the industry as “relatively immature” and too focused on retail investors. In the case of DEXes, institutional investors also are put off by what they see as a lack of confidentiality when executing trades.

“They need to execute large orders without signaling their strategies to the market. This is perhaps the most significant structural limitation of current DEXs, where all pending transactions are visible, Wells explains.

Meanwhile, Wells offered advice to traders aiming to emulate him and become seasoned traders rather than becoming victims of pump-and-dump schemes disguised as memecoin investment opportunities.

“Focus on developing a sustainable edge that doesn’t rely on emotion but on time-tested, primarily automated strategies. In trading, an edge comes from either information asymmetry or execution quality,” the CEO advised.

As crypto markets become more efficient, execution quality is crucial, Wells said, adding that traders should understand how exchange mechanisms affect their trades and choose platforms that minimize extraction risks. Effective risk management is key to long-term survival in the crypto space.

“The most successful traders aren’t those who make the biggest gains – they’re those who survive the longest. Set strict position size limits, use stop-losses, and never risk more than you can afford to lose. Remember that in volatile markets, capital preservation often matters more than maximization,” Wells states.

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