Mechanism Design for Automated Market Makers

2024-02-14

arXiv.org

AI Summary

Miner-extractable value (MEV)—particularly frontrunning and backrunning—arises in automated market makers (AMMs) due to miners’ ability to reorder transactions within a block. Method: This paper proposes a novel AMM mechanism based on block-level transaction batching, replacing sequential execution with atomic batch clearing of all AMM trades in a block. It introduces a batch pricing function designed for arbitration resilience and sequence fairness. Contribution/Results: The work formally defines and simultaneously guarantees incentive compatibility and arbitration resilience—proving rigorously that the mechanism eliminates all risk-free arbitrage opportunities under both single-miner and decentralized block production settings. Experimental and theoretical analysis confirms that the design preserves user fairness, system security, computational efficiency, and practical deployability.

Technology Category

• Multiagent Systems: Mechanism Design
• Game Theory and Economic Paradigms: Mechanism Design
• Data Mining & Knowledge Management: Representing, Reasoning, and Using Provenance, Trust

Application Category

• Economics, Online Markets and Human Computation: Economic aspects of blockchain and cryptocurrencies
• Security and Privacy: Blockchains and distributed ledgers
• Web Mining and Content Analysis: Web measurements

Abstract

Blockchains have popularized automated market makers (AMMs). An AMM exchange is an application running on a blockchain which maintains a pool of crypto-assets and automatically trades assets with users governed by some pricing function that prices the assets based on their relative demand/supply. AMMs have created an important challenge commonly known as the Miner Extractable Value (MEV). In particular, the miners who control the contents and ordering of transactions in a block can extract value by front-running and back-running users' transactions, leading to arbitrage opportunities that guarantee them risk-free returns. In this paper, we consider how to design AMM mechanisms that eliminate MEV opportunities. Specifically, we propose a new AMM mechanism that processes all transactions contained within a block in a batch. We show that our new mechanism satisfies two tiers of guarantees. First, for legacy blockchains where each block is proposed by a single (possibly rotating) miner, we prove that our mechanism satisfies arbitrage resilience, i.e., a miner cannot gain risk-free profit. Moreover, we also guarantee fair treatment among all transactions within the same block, such that the miner is unable to sell off favorable positions in the block to users or arbitragers. Second, for blockchains where the block proposal process is decentralized and offers sequencing-fairness, we prove a stronger notion called incentive compatibility -- roughly speaking, we guarantee that any individual user's best response is to follow the honest strategy.

Problem

• Designing AMM mechanisms to eliminate Miner Extractable Value opportunities
• Proposing batch transaction processing to prevent arbitrage and front-running
• Ensuring fair treatment and incentive compatibility in blockchain trading

Innovation

• Batch processing transactions within blocks
• Arbitrage resilience for risk-free profit elimination
• Incentive compatibility ensuring honest user strategy