Arbitrage, liquidations, and backrunning

Graduate · enrolled learners

This lesson opens with MakerDAO Black Thursday, 12 to 13 March 2020.

What happened

On 12 March 2020 the price of ether fell 43 percent in a day, from 194 to 111 dollars, its largest one-day loss. On MakerDAO, loans backed by ether became undercollateralized and were sent to collateral auctions, where liquidator bots called keepers bid to buy the ether and repay the debt. Liquidating is itself an MEV action: it is a backrun of the falling-price oracle update, and the keeper who acts first on the newly-liquidatable position captures the liquidation reward. But the price crash spiked network congestion and gas, and bids offering ordinary gas prices were not processed in time, and some keepers stopped bidding for fear of slippage, so for two to three hours one keeper, then copycats, won auctions with bids of zero DAI, taking bundles of 50 ether for almost nothing. Over 8 million dollars of ether went that way, and the vault owners lost all of their collateral; the system was left with 4 to 4.5 million dollars of unbacked DAI. The value of the liquidation MEV, normally competed down to a small margin, ballooned because competition itself was choked off.

The decision point

The sandwich is only one shape of MEV; the larger and more constant forms are arbitrage, liquidations, and backrunning generally, and they behave differently. A sandwich surrounds a victim; a backrun follows a price-moving event and profits from the state it left. Arbitrage backruns a trade that pushed one pool's price out of line, buying cheap on one venue and selling dear on another. A liquidation backruns a price update that made a loan undercollateralized, repaying the debt to seize the collateral at a discount. These are competitive: many searchers race for the same opportunity, and competition normally grinds the extractable value down toward the cost of winning. Black Thursday is the case where competition broke, congestion locked most bidders out, and the liquidation MEV that is usually a thin margin became free collateral. Reading these forms means reading a block for what followed a price-moving event, and asking whether competition was present or absent.

Recorded loss

$8,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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