MEV and Market Abuse under MiCA

The Markets in Crypto-Assets Regulation (MiCA) introduces measures similar to traditional financial instruments to combat insider trading and market abuse in the crypto-asset space. But how do these regulations intersect with maximal extractable value (MEV) — a phenomenon driven by the decentralized nature of the blockchain? This article delves into MiCA's market abuse provisions, explains the idea behind MEV and explores MiCA's potential impact on MEV practices.

Insider Trading and Market Abuse

MiCA introduces an insider and market abuse regime resembling that for financial instruments. This regime mandates the public disclosure of inside information and prohibits insider dealings, unlawful disclosure of inside information and market manipulation. It also requires measures for the prevention and detection of market abuse. The regulations apply to all acts in connection with crypto-assets that are admitted to trading or for which admission to trading has been requested, regardless of whether such a transaction is carried out on a trading platform or not.

• Inside Information: Inside information, as per Article 87 MiCA, can be generally described as any non-public, precise information that could significantly influence the price of crypto-assets if made public. Such information must be disclosed to the public promptly and in a manner that enables fast access along with complete, correct and timely assessment of the information by the public.
• Insider Dealing: Insider dealing under MiCA generally means the use of inside information to acquire or dispose of crypto-assets. This includes canceling or amending orders based on inside information as well as submitting, modifying or withdrawing a bid by a person on its own account or for the account of a third party. Article 89 MiCA prohibits such dealings and applies to any person in possession of inside information due to various reasons, including their role in the entity or involvement in criminal activities.
• Market Manipulation: Market manipulation under Article 91 MiCA refers to entering into a transaction, placing an order to trade or engaging in any other behavior that provides false or misleading signals about the supply, demand, or price of a crypto-asset or secures its price at an abnormal or artificial level. This includes employing a fictitious device or any other form of deception or contrivance that can influence the price of a crypto-asset as well as spreading false or misleading information or rumors through the media.
• Prevention and Detection: Pursuant to Article 92 MiCA, those professionally arranging or executing crypto-asset transactions must have systems in place to prevent and detect market abuse. Suspicious activities must be reported to the competent authority of their member state.

What is MEV?

While transactions on traditional financial markets are generally processed by regulated intermediaries in the order they are received, on the blockchain they are handled in a decentralized and competitive manner. On the Ethereum blockchain, for example, transactions are arranged into 'blocks' by network participants called 'validators' and are then added to the blockchain. Validators are compensated for this work with block rewards and transaction fees. Validators can arrange the transactions in the blocks in any way they like, including to maximize the fees earned. Maximal extractable value (MEV) therefore refers to the maximum value that can be extracted from block production in excess of the standard block reward and transaction fees by including, excluding, and changing the order of transactions in a block.

MEV and Market Abuse

Some MEV strategies contain the hallmarks of market manipulation, as it resembles the illegal 'front-running' by brokers in traditional markets. For example, if a validator observes a large upcoming transaction that can significantly alter market prices, they can place their own transaction just before this large transaction to profit from the price change. The validator's profit then comes at the expense of the other market participants. Conversely, validators can also engage in 'back-running' by placing their own transaction immediately after the recognized profitable transaction. This allows them to benefit from short-term price increases before the market adjusts. Ultimately, so-called 'sandwich attacks' are possible. In this approach, the validator places transactions both before and after the user transaction. By doing so, profits can be generated without long-term commitment to the respective crypto-asset.

MiCA's Impact on MEV

Considering the newly introduced MiCA regulations regarding market abuse, the question is raised as to whether MEV will remain permissible. MiCA's market abuse provisions apply to any transaction, order or behavior related to crypto-assets, regardless of whether they occur on a trading platform or their geographical location. Given this broad scope, there is an implication that MEV business models might fall under these provisions. If classified as market abuse, MEV activities would be subject to the prohibition of Article 91. However, a more differentiated approach is recommended here. While MiCA does not explicitly mention or prohibit MEV activities, it emphasizes the prevention and detection of market abuse. Classifying MEV as market abuse from the outset may be an overly simplistic view. Instead, it should be examined on a case-by-case basis whether the applied procedure actually constitutes a form of market abuse. For instance, it is essential to clarify whether the MEV activity in question involves misleading signals or manipulation of market prices. In addition, consideration should be given to whether the knowledge of an impending transaction, which might influence market prices, can be deemed inside information. 

Conclusion

In conclusion, MiCA seeks to address insider trading and market abuse in the crypto-asset ecosystem, drawing parallels to traditional financial frameworks. The intersection of MiCA and MEV is particularly interesting given the potential market manipulation inherent in MEV. While MiCA's provisions could encompass MEV practices, caution should be exercised in classifying MEV as market abuse. A detailed, case-specific analysis is essential to determine whether MEV actually represents market abuse or whether it is an inherent result of decentralized blockchain operations. Given this ambiguous landscape, the European Securities and Markets Authority (ESMA) will play a key role in providing clarity on the classification of MEV. The crypto world awaits clearer guidelines and interpretations to effectively navigate this regulatory maze.