This paper introduces a model of active block producers that have their own private valuations for blocks. The block producer surplus in our model can be interpreted as one of the more common colloquial meanings of the term “MEV.” The main results show that transaction fee mechanism design is fundamentally more difficult with active block producers than with passive ones: with active block producers, no non-trivial or approximately welfare-maximizing transaction fee mechanism can be incentive-compatible for both users and block producers. These results can be interpreted as a mathematical justification for the current interest in augmenting transaction fee mechanisms with additional components such as order flow auctions, block producer competition, trusted hardware, or cryptographic techniques.
A transaction fee mechanism (TFM) is the part of a blockchain protocol responsible for figuring out which transactions should be included and who should pay what. Ethereum’s EIP-1559 is an example. One minimal thing you’d really like from a TFM is good UX, meaning that bidding is easy for users (one of the original motivations for EIP-1559). This idea is encoded by a mathematical property called “DSIC.” A second requirement is a form of credibility called “BPIC,” meaning that a validator responsible for supplying the TFM’s inputs should be properly incentivized to behave as intended. DSIC+BPIC have been studied in a pre-MEV world (e.g., with EIP-1559 achieving both, as long as its base fee is not too low for the current demand).
In this paper, we model a post-MEV world via block producers with private valuations for blocks (e.g., due to application-layer value that they can extract), above and beyond whatever fees they might earn at the consensus layer. MEV changes things considerably, both theoretically and practically. For example, EIP-1559 is no longer incentive-compatible for both users and block producers (even with a correctly set base fee).
Intuitively, the issue is that, when there’s MEV, a user can’t know whether to underbid to take advantage of a block producer that might be willing to subsidize the difference. Our main result shows that the problem is fundamental and not a flaw in the EIP-1559 design: with MEV, no non-trivial or approximately welfare-maximizing TFM can be both DSIC and BPIC.
The role of an impossibility result like this is not to discourage but to illuminate, highlighting the most promising paths forward. From it, we learn that our options are constrained but already being actively explored by the community. Options include:
- Giving up on “good UX,” at least as it is expressed by the DSIC property
- Giving up on the BPIC property, presumably compensating with restrictions on block producer behavior (perhaps enforced using, e.g., trusted hardware or cryptographic techniques)
- Expand the TFM design space, for example by incorporating order flow auctions or block producer competition to expose information about a BP’s private valuation to a TFM
For details, proofs, and citations, read the paper.
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