A post-mortem: how market manipulation left Synthetix stakers with over $1m in debt

Decentralized Finance (DeFi) startup Synthetix received criticism recently after a market participant accused it of turning a blind eye to a series of market manipulating-trades between November 30 and December 26, 2019. 

According to a blog post published on Monday, several suspicious addresses seemingly manipulated the MKR market on decentralized exchange Uniswap, which provides price feed to Synthetix, a platform that allows users to create synthetic tokens that open long and short positions on different assets. Some of these addresses then took advantage of the MKR price swing by building correlated derivatives exposure on Synthetix, leading to around $2.5 million user fund loss, the blog post claimed. 

“This operation continued for 26 days, going unnoticed, though being a very significant volume outlier on the platform. There was no urgency in analysing the impact of the operation, and stopping it, when bringing it to the attention of the team on the 23rd of Dec. There was no public disclosure of the impact of this operation, or a postmortem,” the blog post stated. 

Although the Synthetix team has yet to publish a post-mortem, The Block performed an independent investigation to unveil the scheme and talked to Synthetix founder Kain Warwick about the measures they have taken and will take to prevent future exploits. 

The scheme

The Block found only one instance of confirmed market manipulation on December 25, with the rest not as decisively linked to the scheme. 

In this particular case, someone with an address beginning with 0x054c repeatedly manipulated MKR price on Uniswap. This user extracted about 52 sMKR from the strategy, valued at about $26,000 at the time of the incident. This incident was mentioned by The Block in early January 2020.

The scheme, which is rather straightforward, took advantage of the fact that MKR is largely an illiquid asset and its primary market is decentralized exchange Uniswap, which Synthetix receives part of its price feed from. 

To perform the exploit, 0x054c first opened an MKR long position on Synthetix by purchasing sMKR, the synthetic MKR long token, then bought a large amount of MKR on Uniswap to drive up the reference price artificially. The trader exchanged the MKR long position for a short position by trading their sMKR in for iMKR, realizing a paper profit in the process. He then proceeded to dump the acquired MKR back onto Uniswap to force down the price, again earning a profit from the price drop. The address repeated this process several times, The Block found. 

Unlike 0x054c, the other addresses did not perform the manipulation scheme in its entirety. Instead, eight of these addresses interacted with the Synthetix contracts, but did not perform the oracle manipulation performed by interacting with the underlying markets. The other two performed repeated buys and sells on Uniswap. All of these transactions happened prior to 0x054c. 

Warwick believed that there was no collusion between these addresses. Instead, those addresses that interact with the Synthetix contracts belong to “independent actors seeing these transactions and responding to them,” Warwick said. 

“There are significant risks with listing crypto assets on sX but we believe that this is the best approach to bootstrap interest in the exchange ahead of listing other asset classes like equities,” said Warwick. 

The loss 

According to the blog post and The Block’s research, the eleven addresses in question managed to extract roughly 2926 sMKR from Synthetix. At the market price of 503.99 USD per MKR on December 13, these ten addresses resulted in a total loss of about $1.47 million, different from the $2.5 million figure the blog post stated. 

This is due to the different MKR reference prices the blog author and The Block used - while The Block used MKR price around that time period, the blog author used the current MKR price. Meanwhile, the $1.47 million loss was socialized among all SNX stakers, who underwrite all system debt on a pro-rata basis. 

The fix

Synthetix decided to shut down the sMKR market to prevent further manipulation after the evident exploit on December 25. However, the blog author accused the team for not taking more proactive actions, as he raised his concerns to the Synthetix team on December 23. 

“I think I should not have needed to bring it to their attention, as there should be some awareness of what's happening in your own platform,” the blog post author told The Block. 

When asked why the team did not halt sMKR trading earlier, Warwick said that when the incident was flagged to the team by the blog author, there were extensive discussions on what precautions should be taken.  And after the last, and the only confirmed market manipulation incident occurred on December 25, the platform finally decided to halt the MKR market. 

“We could tell that there was a potential for it to be quite profitable, but it was not 100% clear the extent of what they would be able to achieve," Warwick said. "It took about 24 hours to review the transactions before the community achieved consensus… to whether we should switch it [the MKR pair] off.”

“At the time my position was initially that we should monitor the situation as delisting an asset was not something we had done previously and it was potentially a large precedent to set. In fact we actually saw some other traders start to counter trade this trader increasing liquidity in Uniswap significantly, but in the end a decision was made by the community to delist MKR, which was the right decision,” he added. 

Notably, the blog author disclosed that he copy traded the scheme and made a profit during the same time period the alleged manipulation was happening, while also trading MKR on the spot market for profit. 

[I have] an incentive for this operation to continue,” he wrote in the post. 

In the short term, MKR may be too illiquid to be listed again on Syntheix, according to Warwick. However, the firm is working with Delphi Digital on an asset listing and monitoring framework to address issues the liquidity issues. 

“The reality is, it was not the lack of response that was the issue, it was probably the lack of a robust framework for monitoring liquidity,” said Warwick.