EU plans to penalize Staking-MEV as market abuse

After Regulation Comes Regulation: Following MiCA, the European Financial Market Regulator ESMA Now Intends to Sanction an Important Element of Staking in Ethereum and Other Cryptocurrencies

The EU once again lives up to its claim of being the international champion of regulation.

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

MiCA, STOR, PPAET, ESMA, ETC

The starting point is that—please don’t be alarmed—MiCA requires ESMA to develop a series of RTS. Let’s begin to untangle this knot:

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„, which is essentially the European financial market regulator. RTS stands for „Regulatory Technical Standards.“

But it goes further: An article of 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 sensitive new designation that could potentially hold someone accountable just for „arranging“ transactions.

These PPAETs must complete a STOR and submit it to a competent authority. STOR stands for „Suspicious Transaction and Order Report.“

Yes, it is complicated, and it is full of abbreviations. But actually, once you decode the technocratic slang, it becomes quite simple: Crypto companies must report transactions if they suspect the transactions are manipulating the market.

So far, so understandable. But the devil is in the details. One might also say: The rotten egg lies in the RTS, as formulated by ESMA.

How Stakers Earn a Bonus with MEV

As mandated by MiCA, ESMA has published a document in which it proposes regulatory technical standards. It mentions various scenarios and circumstances of market manipulation with crypto-assets, including—and here we reach the problem—the „well-known Maximum Extractable Value (MEV). This practice allows a miner or validator to reorder transactions arbitrarily to their own advantage, benefiting through the front-running of specific transactions.“

MEV is a well-known plague in Ethereum and all EVM-based blockchains. It refers to the maximum value that can be extracted from block production, beyond the pure reward and transaction fees. Validators, or block producers, have the advantage of a small time window in which they can reorder transactions to their benefit, which can be quite lucrative in a blockchain where not only transfers but also trades, loans, auctions, and liquidations occur.

The Ethereum Foundation mentions various forms of MEV: One can earn through arbitrage by exploiting price differences between different decentralized exchanges. One can jump ahead in auctions where lending protocols liquidate collateral. And one can engage in „sandwiching,“ buying the relevant assets just before a large purchase on decentralized exchanges and then selling them at a profit (due to slippage).

Details are not necessary here. What matters is that stakers reorder transactions in blocks and insert their own to gain a small bonus on top of the block reward. This, as ESMA rightly notes, is a form of market abuse that is almost unavoidable in DeFi-enabled blockchains.

But How Significant Is the Damage from MEV?

Several overview pages on MEV and some dashboards on Dune Analytics exist. They do not match exactly in detail but together paint a consistent picture of the magnitude of MEV.

In total, miners on Ethereum have earned approximately $700 million through MEV, with arbitrage and sandwich trading clearly prevailing. On most days in the last two to three months, MEV revenues have been in the low five to mid-six figure range, rarely falling below $30,000 or exceeding $300,000. There have been isolated days in the past year when MEV surged to small million-dollar amounts, which was common during periods of frenzied activity such as the DeFi summer of 2021.

However, stakers earn around 13,000 ETH per day without MEV, equating to nearly $40 million, with approximately 500 ETH from transaction fees and even 20 ETH from Uncle Rewards, an esoteric concept of Ethereum. Compared to other revenues, MEV is relatively insignificant under normal circumstances.

The Problem with ESMA

Despite the modest scope, staking pools cannot do without MEV—not only because it makes them marginally more lucrative, but also because stakers are reluctant to miss the lottery-like opportunity for high MEV gains. A staking pool that does not offer MEV is likely not competitive.

When ESMA labels MEV as market abuse, it is not wrong. What else could it be when a staker prioritizes their own transactions and arbitrarily changes the order to make a profit?

The problem is that the actual impact is limited, whereas the potential damage from ESMA’s mandate could be massive.

For one thing, a common practice in Web3 is being pushed towards criminalization. Is it still legal to stake your Ether in a pool that uses MEV—essentially any staking pool? And what if you send those ETH, earned through staking, to an exchange in the Eurozone? Do they not inherently bear the traces of MEV? Can exchanges in the EU still offer staking as a service as usual? Can one trade „Liquid Staking Tokens“ if the issuing pool uses MEV?

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

Then Patrick Hansen continues: „How should it be practically feasible if literally every single instance of MEV must be reported? Moreover, ESMA proposes that authorities even cooperate with those outside the EU to sanction market abuse. This means that actors involved in MEV could become targets of investigations and lawsuits.“ It keeps getting more colorful.

Another Body Blow to the Industry

For companies within the EU, ESMA’s requirements would add another act to the regulatory nightmare that is already their daily reality. It would be another body blow to an industry that is already on its last legs here.

The market within the EU is currently dominated by providers from outside, such as Binance, Coinbase, and so on. The EU simply no longer has the reach to regulate the global market. A move against MEV would not only create another competitive disadvantage but would also effectively drive an entire industry—staking pools of all MEV-capable blockchains—out of the EU.

Of course, this is currently just a draft, as Patrick Hansen explains, which will be finalized in the coming months. ESMA is calling on stakeholders to submit feedback by June 25. So, there may still be a chance to overturn this effort.