FCA has published a research note entitled ‘Review of Maximal Extractable value (MEV) and Blockchain Oracles’ in collaboration with Futuresight Business Intelligence Ltd, the Financial Industry Regulatory Authority and University College London.
Although FCA takes a technologically neutral approach to its regulatory responsibilities it acknowledges that there are certain specific issues intrinsic to some technological advancements, such as decentralised finance or DeFi, including the adoption of blockchain.
The research note focuses on the risks and opportunities posed by MEV and blockchain oracles in particular.
MEV is a metric of value derived from a phenomenon specific to blockchains where transactions can be ordered in such a way as to maximise the value extracted from block creation. This can involve including additional transactions, excluding transactions by pushing them out of a block or altering the order of transactions in the block production process. The high degree of visibility associated with transactions that take place on the blockchain has created opportunities for market participants to explore new strategies to maximise the economic gain from each block.
FCA notes that this behaviour can be viewed as helping to optimise blockchain networks and maximise profit for those responsible for ordering the transactions, but also raises concerns over the externalities it imposes on the wider network and users. These could include increased network congestion, higher costs for users, information asymmetries and in some cases, user exploitation and potential manipulation.
Therefore, FCA is of the view that certain issues which may have market abuse and best execution implications need serious consideration:
• What factors should be considered when assessing whether a particular MEV related
action is malicious or not, should it be solely outcome based? Would the
creation of a MEV taxonomy, differentiating between malicious and benign MEV,
prove beneficial to market participants?
• How does the ecosystem best engage to assess and remedy the risks presented
• How will the landscape for MEV evolve in the future? What are the consequences
of other types of innovations that interact with the fundamental execution and
consensus layer (for example, staking delivery channels and re-staking)?
• Does MEV impact what execution factors are most relevant to the best execution
of cryptoasset orders (such as price, costs, speed, likelihood of execution and
settlement, size, nature, or any other relevant considerations)?
Blockchain oracles are data feed services that allow information to enter a blockchain system or to be transferred between blockchain networks and consumed by external systems. They are important infrastructure components that are responsible for facilitating the transfer of data that is required for the operation of decentralised applications such as decentralised lending platforms.
Due to their privileged role within DeFi networks, FCA is of the view that their are certain considerations which must be addressed in relation to the way in which blockchain oracles should be treated by future regulatory framework:
• What are best practices that will reduce the risks presented by blockchain oracles,
given their role in smart contract functionality and interoperability between
multiple blockchain networks?
• How, or through what methods, can blockchain oracles be designed and deployed
to mitigate against the risks they present?
• What are the potential roles of blockchain oracles in the future, and how will they
develop alongside the wider ecosystem, including new innovations?