Transaction Fee Mechanism Design (with and without MEV)

Co-authors: Maryam Bahrani and Pranav Garimidi

Abstract
The incentive-compatibility (IC) properties of blockchain transaction fee mechanisms (TFMs) 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, value derived from the application layer). The block producer surplus in our model can be interpreted as a common interpretation of the phrase “maximal extractable value (MEV).” We prove that TFM design is fundamentally more difficult with active block producers than with passive ones: With active block producers, no non-trivial or approximately welfare maximizing TFM can be IC for both users and block producers. These impossibility results can be interpreted as a mathematical justification for augmenting TFMs with additional components. We proceed to a more fine-grained model inspired by current practice, in which we distinguish the roles of “searchers” (who identify opportunities for value extraction) and “proposers” (who participate directly in consensus and choose the final published block). Here, we first consider a TFM that resembles the block production process in practice where each transaction is effectively sold to a searcher in a first-price auction. We then explore the design space more generally and design a mechanism that circumvents our previous impossibility results. Our mechanism (“SAKA”) is deterministic, IC (for users, searchers, and the block producer), sybil-proof, and 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 IC, sybil-proof, and deterministic TFM can guarantee more than 50% of the maximum-possible welfare.