The Breakdown - The First MEV-Related Arrest

Episode Date: May 17, 2024

The US Department of Justice is getting significantly more sophisticated in its crypto criminal prosecution, as witness by the recent arrest in an MEV-related case. Today's Show Brought To You By Ledger - 5% to Bitcoin Developers When You Buy https://shop.ledger.com/pages/bitcoin-hardware-wallet Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Thursday, May 16th, and today we are talking the latest crypto crackdown arrests. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link of the show notes or go to bit.ly slash breakdown pod. Well, we have a set of topics today, some shorter than others, and we have to kick off with

a follow-up from yesterday, specifically talking about CPI. Consumer price inflation softened slightly in April, giving a glimmer of hope that the U.S. economy will avoid heading into another inflationary pulse. Headline CPI rose by 0.3% for the month, coming in below estimates for the first time since January. On a 12-month basis, headline CPI inflation came in at 3.4% in line with expectations. That's a slight drop from the 3.5% reading from March. Shelter and gasoline accounted for 70% of the increase, while core inflation, which strips out food and energy, also fell slightly. Core inflation was down to 3.6% compared to 3.8% in March. The month-over-month rise in core inflation was the smallest so far this year, and the annualized

figure was the lowest since April 2021. While this data only shows a marginal decline in inflation, even a marginal decline is significantly better than the string of hot prints we've had over the recent months. In fact, this is the first month-on-month decline in CPI since October. importantly, the Fed has signaled that they don't need to see inflation all the way back down before they begin cutting rates. They're simply looking for solid confirmation that inflation is falling sustainably. FOMC rate projections showed that committee members were comfortable delivering the first few rate cuts as soon as progress on inflation is evident. March projections had penciled in three rate cuts by the end of the year, with core PCE still running at 2.6%. Bloomberg Economists wrote,

The report will probably add a bit to Fed confidence about disinflation progress, but they're likely still less confident than they were entering 2024. At least April CPI should keep the chances of a July rate cut alive for now. Dan North, senior economist at Allian's Trade North America, said, we think it's September at the earliest that they're going to cut. Their mind seems to be that, we're not in any hurry to cut rates, inflation is not near 2%. The economy is okay, we're not doing anything for months. Kathy Jones, chief fixed income strategist at Charles Schwab, said, it does open the door to a potential rate cut later in the year. It will take a few more readings indicating that inflation is coming down for the Fed to act. Beyond the inflation data,

Wednesday also saw the release of the retail sales advance estimate, which showed a collapse in spending. Retail sales were flat month over month, a huge miss from the 0.4% forecast. That data also featured a downwards revision for March sales. Separate data showed that wages grew just 0.2% for the month when adjusted for inflation. In other words, workers are still keeping up, but the cracks are beginning to show in the consumer economy. Markets jump at the first sign of easing inflation. We're not all the way to a July rate cut being priced in, but the chances of a September cut have increased dramatically. The base case is now two rate cuts by the end of the year, but there's a lot of uncertainty in the pricing of those odds. Markets are now pricing just a 5% chance that we

get to the end of the year without a rate cut, down from as much as 27% at the beginning of this month. Risk markets took the opportunity to break higher. The S&P 500 made a new all-time high, rising by 1.2%. The NASDAQ also hit all-time highs up 1.5%. And Bitcoin hit 66,000 for the first time in over three weeks. It was up more than 7% for the day, its strongest day since March. As always, we will continue to watch the macro, especially where it intersects with crypto. And speaking of crypto, a pair of brothers have been arrested in what looks to be the most complicated crypto prosecution to date. The pair are charged with conspiracy to commit wire fraud and conspiracy to commit money laundering in relation to an April 2023 exploit. They face a maximum

sentence of 20 years. The DOJ alleged the brothers tried to, quote, exploit the very integrity of the Ethereum blockchain to fraudulently obtain approximately $25 million worth of cryptocurrency within approximately 12 seconds. The case deals with MEV, or maximum extractable value, a term that refers to the practice of front-running public blockchain transactions to extract value. MEV bots will see transactions with high slippage waiting in the mempool and move the price by executing ahead of the user. You'll sometimes hear this referred to as a sandwich attack, which involves backrunning the transaction as well. MEV is believed to be an unavoidable feature of blockchains with public mempools.

so features have been built within the Ethereum ecosystem to make MEV more fair. One of the most striking things about this indictment is that it includes a very technically accurate description of MEV, far beyond anything we've seen before from the DOJ. The brothers are accused of taking advantage of MEV bots by essentially laying traps using large high slippage transactions for illiquid tokens. Once the MEV bots took the bait, the brothers would front-run the bots, beating them at their own game. At the time of the exploit, the community treated the brothers somewhat like folk heroes by getting one over on the MEV bots. This led to a lot of confusion around why the DOJ would charge the brothers, rather than the

MEV bots if their activity is substantially the same. The DOJ's case highlights the difference between taking advantage of publicly known Mempool information and exploiting MEV mitigation systems to uncover private information. A DOJ press release claimed the pair, quote, manipulated and tampered with the process and protocols by which transactions are validated and added to the Ethereum blockchain. In doing so, they fraudulently gained access to pending private transactions and use that access to alter certain transactions and obtain their victim's cryptocurrency. Prosecutors alleged that the brothers concealed their identities using shell corporations and private crypto addresses. They are further alleged to have searched the internet for information on how to

circumvent K.YC, avoid extradition, and hire a top crypto lawyer. The case is basically entirely unique in dealing with the intricate complexity of on-chain trading. Head U.S. attorney Damien Williams said, this alleged scheme was novel and has never before been charged. But as the indictment makes clear, no matter how sophisticated the fraud or how new the techniques used to accomplish it, the career prosecutors of this office will be relentless in pursuing people who attack the integrity of all financial systems. Mohamed Fowda of Alliance Dow remarked on the unprecedented case. He tweeted,

The indictment from the DOJ for the traders who baited MEV bots is mind-blowing. It dives into every detail of how the Ethereum block building works and draws analogies to tradfai. This is both, one, a recognition of the power of Ethereum to settle financial transactions. Two, a trap to pull every operator on Ethereum into a web of legal compliance requirements. This case is a unique precedent and will have long-lasting impacts. The positive thing is that it recognizes Ethereum as an established way to settle transactions and that attacking this network is an issue that affects the network users.

The catastrophic thing is that, intentionally or not, legitimizes the harmful behavior of sandwich attacks and front-running. It deals with it as a fact and completely normal behavior. A trader sees an opportunity and acts on it to make a profit with no care whatsoever to the affected party. At this point, there's a lot of confusion on why the DOJ would go after this pair instead of MEV bots more generally, with the logic being that MEV bots prey on regular users, while these brothers were something closer to an on-chain Robin Hood. Key, though, is private versus public data.

MEPBots are only taking advantage of public data available in the mempool. Like it or not, that's generally accepted as legal behavior in financial markets. What these brothers did required an exploit of Ethereum relays to disclose private block-building information by presenting a false signature. That behavior, the argument goes, is much closer to traditional forms of market manipulation and fraud. Hello, breakers. Today's episode is sponsored by Ledger.

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the show notes. 5% of all sales of the Bitcoin Ledger Nano go to support Bitcoin Development. Thanks once again to Ledger for supporting the breakdown. While a lot of the community were trying to parse through and figure out what made the brothers' behavior different than MEVBOTs in general, there were others who had a slightly cleaner and clearer take. Taylor Monaghan, for example, tweeted, If you steal and launder $25 million, you should expect to go to prison for a long time. If that's a shocking notion, please get off Twitter and call your mom and tell her you just stole $25 million and see how she reacts. Beanie Maxi said something similar, writing,

You shouldn't be surprised they exploited a software. Exploiting software for gain is always illegal. Code isn't law lots of precedents here. There is another part of the conversation, which I thought was interesting, that was summed up by Flowhorse, which is the changing tide for where things might be going in the crypto industry. Flowhorse writes, You guys see the DOJ and Damien Williams going after things like this and still feel

safe shilling low-cap garbage, pump and dumps and rugs? Methink's some large accounts are going to have some trouble down the line. All right, our third story today is going to be half of a story that we'll pick up tomorrow, and that is, of course, about the SAB-121 vote. where the bill to repeal this controversial SEC accounting guidance was scheduled for a vote in the Senate today after being passed in the House last Wednesday. As a quick refresher, this bill deals with SEC Staff Accounting Bulletin 121, which was guidance that required crypto custodians to hold customers assets on their own balance sheets. This prevents custodians from making the assets bankruptcy

remote and functionally bans commercial banks from offering custody altogether due to capital requirements. Commentary from across the crypto and banking industries generally suggested that it was a bad idea that would make crypto custody less safe. In November, the government accountability office found that the guidance was so substantial that it should have gone through the proper rulemaking process, that finding opened Sab 121 to congressional review, which ultimately led to this legislation to revoke the guidance. Last Wednesday, you might remember, the White House took the incredibly aggressive step of threatening to veto the bill before it even went to a vote in the House. That vote saw 21 Democrats break ranks to vote with the Republican

majority to rescind Sab 121. The Senate vote was originally scheduled to take place on Wednesday, but was pushed back until today. Democrat House member Wiley Nicol was a co-sponsor of the bill and spent yesterday making a case for repealing the guidance. He penned a joint op-ed with a Republican co-sponsor Mike Flood, which was published by Blockworks. The article criticized the SEC for both the contents of Saab 121, as well as the process that allowed the agency to circumvent standard rulemaking procedure. The congressman wrote, If Chair Gensler wishes to protect retail investors, he should take this problem seriously. Whether you love crypto or hate crypto, digital assets are here to stay. We need to ensure

American investors receive the same protections they would with any other asset class. Nickel also wrote a letter to the SEC calling on the agency to voluntarily retract Sab 121 before it can be passed by the Senate. He was very clear that the bill has bipartisan support and will inevitably end up on the president's desk. Nickle noted that he had reached out to the SEC after last week's House vote, but had received no response. He argued crypto becoming a hot-button partisan issue was now harming the Democrat election campaign, writing, The SEC's open hostility towards the digital assets industry isn't serving President Biden's best interests. The SEC is turning cryptocurrency regulation into a political football and forcing

President Biden to choose sides on an issue that matters to many Americans. This is, of course, the core issue. By standing behind this nonsensical rule, the SEC has forced President Biden to pick a side heading into a tight election race. The fact that this congressman was unable to get an SEC meeting to discuss this issue really says it all about how stubborn this fight has become. Misari's CEO Ryan Selkis has become deeply involved in organizing crypto support for a Trump presidency. He has been keeping a close eye on this vote as it snowballed in importance, becoming a way to signal crypto support for dissenting Democrats. Last week, he suggested that the presidential veto might be used to allow Democrat senators to signal crypto support knowing that the bill won't become law. However, Selkis warned that there

will be no participation trophies if the bill ends up being vetoed by Biden, tweeting, we'll go 10 times harder after Senate Democrats aside from Senator Gillibran, who vote for the SEB-121 repeal tomorrow as a mere stunt. Call your president. Sab 121 is regulatory overreach. If Biden follows through on his veto, no cookies for make-believe. Senator Gillibrand, meanwhile, made an appearance at a panel on Wednesday as this controversy was swirling. She could not have been more clear on her stance, stating that, quote, Saab 121 is a very destructive rule, and it's trying to eliminate the ability of cryptocurrencies to participate in the marketplace.

Gillibrand believed that more than 50 senators would vote to repeal Saab 112 today, and that, quote, creates momentum. Crypto market structure legislation is coming up for a House vote next week, and stablecoin legislation is also potentially on the agenda for this year. It's entirely possible that the momentum around SAB-121 could carry over into these other crypto bills. Now, just as I was recording this, the vote had come in, Natalia appeared to be 60 to 38 in favor of repealing this. So tomorrow morning, first thing, we will pick up the story with all the commentary, all the discourse, and all the fallout, and what it looks like President Biden is going to do

now. For today, however, that is going to do it for today's breakdown. Big thanks to my sponsor for today's show. Check out the Ledger Bitcoin Orange Nano. Five percent of sales will go to support Bitcoin development. Until next time, be safe and take care of each other. Peace.