Surreal illustration of DeFi market manipulation.

DeFi Under Scrutiny: Unmasking Market Manipulation in the Decentralized World

Mira Elwood in Business & Economy August 2025 • 3 min read.

"Explore how blockchain's unique features breed new forms of misconduct and what regulators can do to protect investors in the DeFi space."

Financial innovation, driven by technological advancements, has reshaped traditional finance, with blockchain and Decentralized Finance (DeFi) at the forefront. While DeFi offers unprecedented opportunities, it also introduces new forms of market misconduct that remain largely unregulated.

The bZx incident in February 2020 served as a wake-up call, demonstrating how DeFi innovations like flash loans can be exploited for malicious gain. This event highlighted the urgent need for regulatory frameworks to address the risks associated with DeFi.

In response, the UK HM Treasury (HMT) and the U.S. Department of the Treasury have initiated consultations and reports on crypto-assets and DeFi, respectively. These efforts aim to establish consistent regulatory outcomes and mitigate risks like money laundering and terrorist financing. Despite these early responses, a regulatory gap persists, leaving DeFi users vulnerable to various forms of market misconduct.

Understanding DeFi Market Misconduct

Surreal illustration of DeFi market manipulation.

DeFi market misconduct encompasses actions that exploit vulnerabilities within the DeFi system to undermine market efficiency and fairness, posing risks to DeFi security. This includes activities that distort prices, create artificial demand or supply, or spread false information, hindering the market's ability to establish fair prices and impairing decision-making.

Market efficiency in DeFi is undermined by manipulating prices, creating artificial demand or supply, or spreading false information. These actions disrupt resource allocation and impair decision-making processes.

Fairness: Ensuring equal access to information and safeguarding against unfair advantages.
Security: Protecting user assets and the integrity of the underlying blockchain system.

Intentional actions targeting the DeFi infrastructure layer that do not directly affect market efficiency or fairness are not classified as DeFi market misconduct. For example, attacks on blockchain consensus, while disruptive, are excluded if they don't directly influence the DeFi market.

The Path Forward

DeFi’s ascent underscores the transformative power of technology in finance, yet it also casts a spotlight on the potential for misconduct. As regulators navigate this evolving landscape, it’s essential to strike a balance between fostering innovation and safeguarding market integrity. By addressing the unique challenges presented by DeFi, regulators can pave the way for a more secure, transparent, and equitable financial ecosystem.

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2311.17715,

Title: Market Misconduct In Decentralized Finance (Defi): Analysis, Regulatory Challenges And Policy Implications

Subject: q-fin.cp

Authors: Xihan Xiong, Zhipeng Wang, Tianxiang Cui, William Knottenbelt, Michael Huth

Published: 29-11-2023

Everything You Need To Know

What is DeFi market misconduct?

DeFi market misconduct involves actions that exploit vulnerabilities within the DeFi system. These actions undermine market efficiency and fairness, thus posing risks to DeFi security. This includes manipulating prices, creating artificial demand or supply, or spreading false information, all of which hinder the market's ability to establish fair prices and impair decision-making.

How does market manipulation affect fairness and security in DeFi?

Market manipulation in DeFi directly undermines both fairness and security. It affects fairness by denying equal access to information and creating unfair advantages. Security is compromised because manipulating the market can lead to users' assets being at risk due to price distortions or vulnerabilities in the system. Safeguarding both elements is critical for a healthy DeFi ecosystem.

What role do regulators play in addressing the risks of DeFi?

Regulators, such as the UK HM Treasury (HMT) and the U.S. Department of the Treasury, are crucial in navigating the evolving landscape of DeFi. They aim to create regulatory frameworks that foster innovation while safeguarding market integrity. Their efforts include consultations and reports on crypto-assets and DeFi to mitigate risks like money laundering, terrorist financing, and market misconduct, ensuring a more secure, transparent, and equitable financial ecosystem.

Can you provide an example of DeFi market misconduct?

The bZx incident in February 2020 serves as an example. This event demonstrated how DeFi innovations, such as flash loans, can be exploited for malicious gain. This underscored the need for regulatory frameworks to address the risks associated with DeFi and prevent such events from happening again by establishing clearer rules and oversight.

Why are attacks on blockchain consensus not classified as DeFi market misconduct?

Attacks on blockchain consensus, while disruptive, are excluded from the classification of DeFi market misconduct if they do not directly influence the DeFi market. The focus of DeFi market misconduct is on actions that exploit vulnerabilities within the DeFi system to undermine market efficiency and fairness, posing risks to DeFi security. Attacks on the blockchain itself, if they don't directly distort prices or spread misinformation within the DeFi market, are categorized differently, highlighting the specific focus on actions that directly impact DeFi trading and user trust.