Bots Are Overrunning Crypto Networks Like Solana as They Hunt for Profits
Deploying funny-sounding strategies like sandwich trading, bots have conquered the market for Ethereum-based digital tokens.
(Bloomberg) -- Deploying funny-sounding strategies like “sandwich trading,” bots have conquered much of the market for Ethereum-based digital tokens, scooping up hundreds of millions — if not billions — of dollars in trading profits over the years. Along the way, they’ve made enemies by front-running others’ transactions, something blockchain-fueled trading fundamentally permits. There’s been a benefit to the broader industry, too: By acting like old-school arbitrageurs, bots have made the Ethereum ecosystem more efficient, reducing price dislocations by methodically buying low and selling high, over and over and over.
They’ve been so successful, in fact, that it’s harder for bot-deploying traders to make money on their original turf in Ethereum. So the bots are searching elsewhere, causing havoc on nascent blockchains in the process. They’ve overrun market infrastructure that couldn’t handle the incredibly brisk pace of their trading. As crypto prices cratered in recent weeks, so-called liquidation bots bogged down Solana, a blockchain favored by many finance pros, when they overloaded it by sending more than 2 million transactions a second. And back in September, Solana was taken completely offline for 17 hours by bot activity.
Solana isn’t alone seeing an influx of computerized traders. Polygon, Avalanche and Binance Smart Chain are also getting swarmed. Flashbots, which makes software that bot traders use, estimates that more than 25% of MEV — crypto-jargon for much of this trading — now takes place on blockchains other than Ethereum.
Luring these kinds of automated traders — a cohort who helped make Ethereum the second-largest cryptocurrency — is a sign decentralized finance, or DeFi, is expanding beyond that realm, bringing the bots with them. But the troubles the bots have caused signal the industry has a long way to go before their underlying infrastructure meets the needs of professionals.
“Outages on a decentralized blockchain are always concerning,” said Avi Felman, a portfolio manager at BlockTower. “Solana’s recent troubles should remind everyone that new consensus mechanisms are inherently untested, and are very much still as experimental as they are exciting.”
Much of what bots do in crypto is make money off something crypto players call MEV — which originally stood for “miner extractable value” but then the term morphed into “maximal extractable value” or “maximum extractable value.” Some of these strategies have parallels in conventional markets, like arbitrage. Or take sandwich trading, in which a bot spots that another user has placed a trade on a decentralized exchange that’s likely to move prices. Because of how blockchains work, the sandwich-seeking bot can actually buy the asset first — meaning the original person gets a worse price — and then sell it after prices move.
Thousands of these software programs, some run by crypto developers out of their bedrooms, have long been a blessing and a curse for Ethereum. They’ve pushed up transaction fees while poaching trades, but also deepened liquidity and supported a slew of lending and borrowing apps. Ethereum’s infrastructure can now largely handle all this volume. But the DeFi movement is branching out to other blockchains, and they’re not holding up nearly as well. “A blockchain isn’t really battle tested until there are millions of dollars at stake and it’s been hammered by MEV bots seeking any edge they can get,” Flashbots’ Robert Miller tweeted last month.
Bots gave that a go on Solana in late January. “Liquidator bots started spamming the network,” Solana co-founder Anatoly Yakovenko tweeted on Jan. 26. That exposed a software bug in Solana, slowing down the network.
In early January, a bot on blockchain Polygon PoS did about 1.5 million transactions to mint pickaxes in crop-planting game Sunflower Farmers. Bot activity eventually shut down the game and drove transaction fees on Polygon to as much as 10 cents from a fraction of a cent. “When you have bot activity, the average player suffers,” Sandeep Nailwal, co-founder of Polygon, said in an interview.
Take the bots’ proliferation as a sign that these young blockchains have arrived. As they attract more DeFi applications, ranging from exchanges to lending services, that spells more money-making opportunities for the bots. DeFi apps on Polygon now have about $3.4 billion in total funds locked — a crypto-industry measure that essential amounts to how much money is invested in a given blockchain’s ecosystem — up from $130 million a year ago, according to DappRadar. Binance Smart Chain is up to $9.6 billion from less than $400 million. These are dwarfed by the $91 billion locked into Ethereum, but they’re growing fast.
“What I am seeing is whenever there’s more DeFi activity in a specific blockchain, it automatically means there’s more bot opportunities and more people will try to exploit those opportunities,” said Jonas Pfannschmidt, principal blockchain engineer at Blockdaemon, which manages blockchain infrastructure.
There are other reasons for the bots’ migration as well: Last year, more bots piled into Ethereum, making operating on the network more expensive and competitive, so some of them are now “moving to greener pastures,” Alex Obadia of Flashbots said in a Jan. 13 YouTube presentation watched in real time by several dozen developers. Some long-time bot operators are simply hedging their bets, particularly as Ethereum is expected to undergo a dramatic technical overhaul this year called Ethereum 2.0. The very foundation of Ethereum — how it orders transactions — is being redesigned, which some bot operators worry could disrupt how they do business.
“If they don’t get it right, they risk losing a lot of the DeFi marketshare to other chains, which have sacrificed decentralization for user experience,” said Nathan Worsley, who runs bots on Ethereum as well as other blockchains to hedge his bets.
©2022 Bloomberg L.P.