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Sandwich Trading

Sandwich Trading

Intermediate

Sandwich trading, also known as sandwich attacks or sandwiching, is a trading strategy or manipulation technique in the cryptocurrency markets. 

It’s used to exploit token price movements caused by transactions on decentralized exchanges (DEXs) to gain profits at the expense of unsuspecting traders. 

How Sandwich Trading Works

Before understanding sandwich trading, let’s first review how DEXs work. In a Constant Product Market Maker (CPMM) model, a liquidity pool consisting of token X and token Y follows this formula: X * Y = K, where K always remains constant. 
Trades submitted to DEXs are not executed immediately but are instead sent to the mempool, where traders can see all the pending transactions. This creates opportunities for sandwich attackers to exploit profit opportunities for themselves at the expense of unsuspecting traders.  
Let’s say trader A submits a transaction trading 10 token X for token Y with 1% slippage tolerance (willing to accept up to a 1% difference in the final value trader A receives) and 0.3% gas fee in a pool holding 100 tokens X and 100 tokens Y. 

Based on these parameters, trader A is expected to receive 9.066 token Y. 

However, a sandwich attacker strategically places two transactions, one in front of trader A’s transaction and one after, to profit from the price fluctuations. 

First, the attacker purchases 0.524 token Y with 0.529 token X with a higher gas fee. This “front order” raises the price of token Y because of how the CPMM model works. 

As a result, trader A’s trade only buys 8.975 tokens Y at a higher price than expected. To be precise, trader A receives exactly 1% fewer token Y than anticipated, the maximum slippage trader A indicates that trader A would tolerate. 

The sandwich attacker then sells 0.524 token Y at a higher price (“back order”), which was pushed up further after trader A’s transaction is completed, and receives 0.635 token X. 

The sandwich attacker makes a profit of 0.106 token X (0.635-0.529=0.106) from this attack. 

Generally, the profitability of sandwich attacks increases with the victim’s transaction size and slippage tolerance. 

Impact of Sandwich Trading

Sandwich trading, when used for manipulative purposes, can have several negative impacts on decentralized exchanges (DEXs) and the broader cryptocurrency ecosystem. 

1. Market Manipulation

Sandwich trading is a form of market manipulation. It exploits price discrepancies to profit at the expense of other traders. This behavior undermines trust in the market and can deter legitimate participants.

2. Loss of Funds

Sandwich victims can suffer financial losses due to the price manipulation. This can lead to dissatisfaction and distrust within the cryptocurrency community.

3. Reduced Liquidity 

Repeated sandwich attacks can deter liquidity providers from participating in DEXs, reducing the overall liquidity in the market. 

How to Protect Yourself from Sandwich Attacks 

You can consider the following ways to protect your trades from sandwich attacks. 

1. Use Limit Orders 

Consider using limit orders instead of market orders whenever possible. While many DEXs don’t provide this order type, some DEXs do have this option. You can consider using DEXs with limit orders, which allow you to specify the price at which you are willing to buy or sell an asset. 

2. Use low slippage

You can keep your slippage tolerance relatively lower, which should reduce the potential rewards sandwich attackers can gain from manipulating your trades. Many DEXs, however, use auto-slippage settings now. Setting your slippage too low could also make your trades take longer to process. 

3. Break your large trades apart

A single large trade is the ideal target for sandwich attackers. Breaking them into smaller ones could help mitigate potential slippage. 

How DEXs Can Mitigate Sandwich Trading

Here are some strategies that can be potentially implemented by DEXs to mitigate sandwich trading’s negative effects:

1. Anti-front running measures 

DEXs can implement measures to detect and prevent front-running and sandwich trading. This may include order execution delays, randomization of order execution times, and improved matching algorithms.

2. Transaction Analysis Tools

DEXs can develop or integrate tools that analyze transactions for suspicious trading patterns. These tools can identify and flag potential sandwich attacks for further review.

3. Algorithmic Trading Policies 

DEXs can establish clear policies and guidelines for algorithmic trading and high-frequency trading. This helps ensure that trading bots and algorithms operate within acceptable boundaries.

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