A comprehensive guide to sandwich attacks, their impact on decentralized exchanges, and strategies to prevent falling victim to these sophisticated attacks.
Cryptocurrency users face a new threat in the form of sandwich attacks, specifically targeting decentralized exchanges. In this guide, we will delve into the concept of sandwich attacks, the role of bots, and effective prevention strategies to ensure the security of your cryptocurrency holdings.
What are Sandwich Attacks?
Sandwich attacks are a relatively recent phenomenon within the crypto space that Ethereum co-founder Vitalik Buterin had warned about back in 2018. These attacks can disrupt the decentralized finance (DeFi) sector, leading to potentially problematic situations.
The concept of sandwich attacks revolves around the strategic use of information about someone else’s order to manipulate cryptocurrency prices. Specialized bots monitor unconfirmed blockchain transactions, identifying large orders that will impact asset prices. The attacker then executes a series of trades, capitalizing on the price fluctuations to generate profits.
Understanding the Smith-Davis Example
To grasp the mechanics of sandwich attacks, let’s examine the Smith-Davis example. When Mr. Smith attempts to exchange one cryptocurrency for another using an automated market maker (AMM), Davis, the attacker, keenly observes Smith’s trade to gain an advantage.
Davis employs two trades before and after Smith’s transaction, hence the name “sandwich attack.” By executing a strategically timed buy order, Davis artificially inflates the price of the asset. Consequently, Smith receives fewer tokens than expected. Davis then sells the asset at the inflated price, pocketing a substantial profit.
Decoding DeFi Terminology
To gain a better understanding of sandwich attacks, it is essential to familiarize ourselves with relevant DeFi terms:
- Smart Contracts: Self-executing contracts governed by predetermined conditions, extensively utilized in the DeFi sector.
- Decentralized Exchanges (DEX): Exchange platforms operating on smart contracts, facilitating peer-to-peer transactions without intermediaries.
- Liquidity Pools: Collections of cryptocurrency tokens locked within smart contracts, enabling decentralized trading and lending. Automatic market makers (AMMs) manage pricing and liquidity movements.
- Slippage: The price discrepancy between expected and actual transaction outcomes, influenced by market liquidity.
- Preemption: Gaining an advantage over others by leveraging information about pending orders to manipulate transaction orders and profit during the interim period.
The Role of Bots in Sandwich Attacks
Sandwich attacks are just one facet of Maximal Extractable Value (MEV), a broader phenomenon centered around manipulating transaction sequences for financial gain. Bots play a vital role in executing these attacks, scanning unverified transactions within the Ethereum network and strategically positioning their own transactions to exploit price fluctuations.
Bots employ “frontranking” to insert their transactions ahead of others, thereby influencing asset prices, and “backranking” to rearrange transactions for selling assets at higher prices. Sandwich attacks are a combination of both strategies, maximizing profits for the attackers.
Methods Employed by Attackers
Attackers typically replicate large transactions with higher gas fees, aiming to outpace other transactions and create unexpected slippage rates. In some cases, attackers resort to express loans, borrowing funds to manipulate trades and maintain liquidity pools. Victims of sandwich attacks have limited recourse to prevent these tactics.
Preventing Sandwich Attacks
While sandwich attacks pose significant challenges, several strategies can help cryptocurrency traders mitigate the risk:
- Avoid large trades during peak hours and high market volatility.
- Utilize slippage detection and protection tools.
- Verify all aspects of a transaction, including gas fees, exchange rates, and amounts.
- Exercise caution when interacting with liquidity pools, avoiding unsecured networks.
- Stay updated on the preemptive strategies implemented by DeFi platforms, such as flash bot transactions and order splitting.
Sandwich attacks, driven by automated market makers and the manipulation of transaction sequences, pose a serious threat to the decentralized exchange ecosystem. The adoption of countermeasures by AMMs, like the introduction of flash bot transactions, can provide enhanced protection for users. While existing solutions offer some respite, collaboration between AMMs and miners remains pivotal in devising long-term safeguards against sandwich attacks.
