https://ethresear.ch/t/mev-auction-auctioning-transaction-ordering-rights-as-a-solution-to-miner-extractable-value/6788
Special thanks to Vitalik for much of this, Phil Daian as well (& his amazing research on MEV), Barry Whitehat for also coming up with this idea 221, and Ben Jones for the rest!
Blockchain miners (also known as validators, block producers, or aggregators) are nominally rewarded for their services by some combination of block rewards and transaction fees. However, being a block producer tasked with producing a particular block gives you a lot of power within the span of that block, letting you arbitrarily reorder transactions, insert your own transactions before or after other transactions, and delay transactions outright until the next block, and it turns out that there are a lot of ways that one can earn money from this. For example, one can front-run decentralized exchanges (both Uniswap-style and the order book variety), be the first to claim whistleblower rewards, have a favorable position in ICOs, as well as many other forms of mild manipulation of applications. Recent research shows that the revenue that can be extracted from this (called “miner-extractable value 290” or MEV) is potentially significantly higher than transaction fee revenue.
Frequent batch auctions 139 are one traditional response to market manipulation by reordering. In an FBA, instead of processing transactions “as they come”, a market gathers all transactions submitted within the same time span (could be short eg. 100 ms, or a minute or longer), reorders them according to a standard algorithm that does not depend on order of submission, and then processes them in that new order. This makes micro-scale timing manipulation nearly irrelevant.
We propose a technique in a similar spirit to how FBAs remove micro-scale timing manipulation, with one major difference. In an FBA, there is only one application, and so there is one natural “optimal” order for transactions (orders): process them in order of price. In a general-purpose blockchain, there are many applications with arbitrary properties, and so coming up with a “correct” order is virtually impossible for a fixed algorithm. Instead, we simply auction off the right to reorder transactions within an N-block window to the highest bidder. That is, we create a MEV Auction (MEVA), in which the winner of the auction has the right to reorder submitted transactions and insert their own, as long as they do not delay any specific transaction by more than N blocks.
This creates a form of “managed centralization”: a single sophisticated party wins the auction and can capture all of the MEV. We call this party a “sequencer.” Having a single sequencer reduces the benefit to other block proposers of using “clever” algorithms to near-zero, thereby increasing the chance that “dumb” block proposers will be long-term viable and hence promoting decentralization at the block proposal layer. This technique can theoretically be used at layer 1, though we also show how it is a perfect fit for layer 2 systems, particularly systems such as Optimistic Rollup, zkRollup, or Plasma.
This mechanism is designed to extract MEV for the sole purpose of supporting our (inclusive) blockchain community. In fact, this mechanism could be the revenue stream for opt-in self governance built to fund the internet’s public goods. We mustn’t participate in an MEVA which funds things we don’t like!
Control over transaction ordering has become extremely profitable especially as smart contracts like Uniswap have gained popularity. There have been multiple occasions where trades on Uniswap with high slippage caused tens of thousands of dollars in free arbitrage profits.
These arbitrage opportunities are taken advantage of by arbitrage bots that watch the blockchain and participate in the gas price auction. These bots outbid each other at high frequency as long as the price they pay for the transaction is not excess of the amount of money they stand to make. Frontrun.me 312 has great information collected on these auctions happening in the background of Ethereum every day.
Counter-intuitively, the real winner of these auctions is Ethereum miners, as bots which outbid each other raise the gas price. This increased gas price increases miner fees and revenue. By introducing an MEV Auction in addition to this gas price auction we can employ the same market mechanism that extracts frontrunning fees to be directed at miners, and redirect that profit back to the community.
The auction is able to extract MEV from miners by separating two functions which are often conflated: 1) Transaction inclusion; and 2) transaction ordering. In order to implement our MEVA we can define a role for each function. Block producers which determine transaction inclusion, and sequencers which determine transaction ordering.
Block proposers are most analogous to traditional blockchain miners. It is critical that they preserve the censorship resistance that we see in blockchains today. However, instead of proposing blocks with an ordering, they simply propose a set of transactions to eventually be included before N blocks.
Sequencers are elected by a smart contract managed auction run by the block producers called the MEVA contract. This auction assigns the right to sequence the last N transactions. If, within a timeout the sequencer has not submitted an ordering which is included by block proposers, a new sequencer is elected.