Paper 2024/331

Transaction Fee Mechanism Design in a Post-MEV World

Abstract

The incentive-compatibility properties of blockchain transaction fee mechanisms have been investigated with passive block producers that are motivated purely by the net rewards earned at the consensus layer. This paper introduces a model of active block producers that have their own private valuations for blocks (representing, for example, additional value derived from the application layer). The block producer surplus in our model can be interpreted as one of the more common colloquial meanings of the phrase ``maximal extractable value (MEV).'' We first prove 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 impossibility results can be interpreted as a mathematical justification for augmenting transaction fee mechanisms with additional components such as orderflow auctions, block producer competition, trusted hardware, or cryptographic techniques. We then proceed to a more fine-grained model of block production that is inspired by current practice, in which we distinguish the roles of ``searchers'' (who actively identify opportunities for value extraction from the application layer and compete for the right to take advantage of them) and ``proposers'' (who participate directly in the blockchain protocol and make the final choice of the published block). Searchers can effectively act as an ``MEV oracle'' for a transaction fee mechanism, thereby enlarging the design space. Here, we first consider a transaction fee mechanism that resembles how searchers have traditionally been incorporated into the block production process, with each transaction effectively sold off to a searcher through a first-price auction. We then explore the design space with searchers more generally, and design a mechanism that circumvents our impossibility results for mechanisms without searchers. Our mechanism (the ``SAKA'' mechanism) is deterministic, incentive-compatible (for users, searchers, and the block producer), and sybil-proof, and it guarantees roughly 50% of the maximum-possible welfare when transaction sizes are small relative to block sizes. We conclude with a matching negative result: even when transactions are small relative to blocks, no incentive-compatible, sybil proof, and deterministic transaction fee mechanism can guarantee more than 50% of the maximum-possible welfare.

Note: This paper subsumes an earlier working paper with a somewhat different title, Transaction Fee Mechanism Design with Active Block Producers, arXiv:2307.01686. The results in Section 3 appear also in that paper, while the results in Sections 4 and 5 are new to this paper.