Ibox building in Paris, headquarters of ESMA. Image by Gecina via wikimedia. License: Creative Commons BY-SA 4.0 Deed

After regulation comes regulation: In the course of MiCA, the European Financial Markets Authority EMSA now wants to sanction an important element of staking Ethereum and other cryptocurrencies.

The EU is once again living up to its claim to be the international regulatory champion.

In a new submission, ESMA lists its requirements for specifying the technical standards under MiCA, which for us means that we will be drowning in acronyms and regulatory jargon — but the affair is too important to avoid: It is more or less about whether, how and under what circumstances the staking of cryptocurrencies, such as Ethereum, will be allowed in Europe.


The starting point is that – please don’t be alarmed – MiCA is asking ESMA to develop a series of RTS. Let’s start at this point to untangle the tangle:

MiCA is the “Regulation on Markets in Crypto-Assets”, more or less the heart of European crypto regulation. ESMA, on the other hand, is the “European Securities and Markets Authority”, i.e. the European financial regulator. RTS, finally, stands for “Regulatory Technical Standards”.

But it goes further: An article in the MiCA regulation expects PPAETs to introduce effective methods and procedures to detect and prevent market abuse. PPAETs are “Persons Professionally Arranging or Executing Transactions” with crypto assets, which is an interesting but also tricky new term that could make you liable even if you only “arrange” transactions.

These PPAETs must complete and submit a STOR to a competent authority. STOR stands for a “Suspicious Transaction and Order Report” – a report on suspicious transactions or offers to trade.

Yes, it’s complicated, it’s full of acronyms. But once you get past the technocratic slang, it’s actually pretty simple: crypto companies have to report transactions if they suspect that they’re manipulating the market.

So far, so understandable. But the devil is in the details. One could also say: the rotten egg lies in the RTS, as ESMA formulates it.

How stakers earn a bonus with MEV

As ordered by MiCA, ESMA has published a document proposing regulatory technical standards. In it, it lists various scenarios and circumstances of market manipulation in crypto assets, including – and this is where we get to the problem – the “well-known Maximum Extractable Value (MEV), where a miner or validator takes advantage of its ability to arbitrarily reorder transactions and profits by front-running specific transactions.”

MEV is a well-known plague in Ethereum and all EVM-based blockchains. It means the maximum value that can be extracted from block production, beyond the pure reward and fees from transactions. Validators or block producers have the advantage of having a small window of time in which they can reorder transactions in their favor, which is an advantage in a blockchain that not only transfers but also trades, borrows, auctions and liquidations, and which clever stakers translate into hard cash.

The Ethereum Foundation lists different variations of MEV: You can earn money through arbitrage by exploiting the price differences between different decentralized exchanges. You can push ahead in auctions that lending protocols use to liquidate collateral. And you can use “sandwiching” to quickly buy the corresponding assets before a large purchase on decentralized exchanges and then resell them to the buyer at a profit (due to slippage).

There is no need to go into detail here. What is important is that stakers reorder transactions in blocks and add their own in order to receive a small bonus to the block reward. This is, as ESMA rightly points out, a type of market abuse that is almost unavoidable in DeFi-enabled blockchains.

But how great is the damage caused by MEV?

There are several MEV overview pages and some dashboards on Dune Analytics. They don’t match exactly in detail, but they give a broadly consistent picture of the magnitude of MEV.

In total, Ethereum miners have earned around $700 million through MEV, with arbitrage and sandwich trading clearly predominating. On most days over the past two to three months, MEV revenues have been in the low five to mid six figures, rarely below $30,000 and rarely above $300,000. There have been isolated days over the past year when MEV has soared to a low million amount, which was common during times of feverish, turbulent activity, such as during the DeFi summer of 2021.

However, even without MEV, stakers earn around 13,000 ETH per day, which is almost 40 million dollars, of which 500 ETH comes from transaction fees alone and even 20 ETH from Uncle Rewards, an esoteric concept of Ethereum. Compared to the other income, MEV is therefore largely irrelevant under normal circumstances.

The problem with ESMA

Despite the moderate size, staking pools cannot do without MEV. Not only because it makes them slightly more lucrative, but also because stakers are reluctant to miss out on the chance to win high MEV prizes at a peak, like in a lottery. A staking pool that does not offer MEV is probably not competitive.

When ESMA calls MEV a market abuse, it is not wrong. What else could it be if a staker pushes his own transactions and arbitrarily changes the order in order to make a profit?

The problem, however, is that the effect is manageable, whereas the damage potentially resulting from the ESMA requirement is gigantic.

On the one hand, this brings a common practice on Web3 close to criminalization. Is it still legal to put your Ether into a staking pool that uses MEV – in other words, into any staking pool? And what if you send the ETH you earn through staking to an exchange in the Eurozone? Don’t they naturally bear the traces of MEV? And can exchanges in the EU still offer staking as a service, as is usual? Can you trade “liquid staking tokens” if the pool issuing them earns MEV?

Patrick Hansen, lobbyist for Circle (USDC), one of the most competent crypto and Web3 voices in Brussels, explains: “Almost every regulated crypto company in the EU (exchanges, brokers, etc.) has to detect MEV incidents and report them through complex STORs. ESMA’s template for STOR alone is six pages long.”

Patrick Hansen then asks: “How could it be feasible in practice if literally every single incident of MEV has to be reported? In addition, ESMA proposes that authorities should even cooperate with those outside the EU to sanction market abuse. This could make actors involved in MEV the target of investigations and lawsuits.” So things are getting more and more colorful.

Another punch against the industry

For companies within the EU, ESMA’s wishes would be yet another act in the regulatory nightmare that is their reality day and night. It would be another blow to an industry that is already struggling.

The market within the EU is already dominated by providers from outside, such as Binance, Coinbase and so on. The EU simply no longer has the access to regulate the global market. Taking action against MEV would not only create a further competitive disadvantage, but would also cause an entire industry – the staking pools of all MEV-capable blockchains – to more or less disappear from the EU.

Of course, this is only a draft so far, explains Patrick Hansen, which will be finalized in the next few months. ESMA is calling on stakeholders to submit feedback by June 25. So there may still be a chance that the plan will be overturned.

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Source: https://bitcoinblog.de/2024/06/07/eu-plant-staking-mev-als-marktmissbrauch-zu-ahnden/

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