Katya Malinova PRO
I am an Associate Professor, Mackenzie Investments Chair in Evidence-Based Investment Management at the DeGroote School of Business, McMaster University, Canada.
Private Settlement in Blockchain Systems
Alfred Lehar & Motahhareh Moravvej-Hamedani
Discussion by Katya Malinova
DeGroote School of Business
McMaster University
Central Bank Workshop
December 2022, Sydney
Private Transaction
Comments: miner incentives and behaviour
Private settlement on the Bitcoin vs Ethereum
Bitcoin blockchain (this paper):
- 6% of transactions settle privately
- Smaller miners
- (MUCH) larger (active) users
- Private users (5-6% of total):
- at least one "private" transaction
- but only use 1.002 miner -- once private, always private?
- Lower (by 20%) and less volatile fees
Private settlement on the Bitcoin vs Ethereum
Ethereum
- E.g. Capponi, Jia, Wang (2022) "The Evolution of Blockchain: From Public to Private Mempools" (theory and empirics).
- Private pools:
- Higher overall welfare (more users submit transactions)
- But higher fees
- Higher validator welfare
- Private pools:
- Weintraub, Ferreira Torres, Nita-Rotaru, State (2022) "A Flash(bot) in the Pan: Measuring Maximal Extractable Value in Private Pools"
- Flashbots [private pool] miners (in 2022): over 99.9 % of the hashing power in the Ethereum network
- Miners: make more than x2 what they did before joining Flashbots
What problems does the private settlement solve?
Bitcoin blockchain (this paper):
- For the miners: fee volatility
- get a steady stream of "private" transactions
- willing to mine for lower fees ("certainty equivalent")
- For the users: high fees
- attractive to fee-sensitive but time-insensitive users
Comment 1: can we get a better idea of who these users are & how much are they saving?
What problems does the private settlement solve?
Ethereum
- Ordering of transactions is important
- E.g., price of a decentralized exchange (DEX) trade is determined by the funds on DEX at the time of settlement
- No time priority
- Miners have discretion over ordering within a block (typically by fees)
- \(\to\) Visibility of transactions in a public mempool is a problem
-
- E.g., can be "front-run" (by miners or other users)
- \(\to\) MEV = miner (maximal) extractable value
Detour: MEV extraction example = "sandwich attack" on a DEX trade
Buy low (goes first for $$$ fee)
Sell high (this is last: $ fee)
Front-run \(\to\) pays a higher price
\(\to\) Evil bot earns MEV
\(\to\) users are willing to pay higher fees for private settlement to avoid being "front-run" & get the "low" transaction price
Buy
Buy
Sell
Private settlement protocol on Ethereum: Flashbots protocol
- Private mempool (not a one-to-one contract arrangement)
- Any miner can join
- vetting procedure, kicked out for misbehaviour
- No exclusivity: miners that join monitor both public and private
- Users:
- Con: higher execution/timing uncertainty (fewer miners monitor the private pool)
- Pro: avoid being front-run
- \(\to\) May be willing to pay higher fees
- Miners:
- join private \(\to\) see both \(\to\) weakly higher payoff from joining (Capponi et al)
- Empirically: higher fees, all large miners join (Weintraub et al)
- \(\approx\) 50% of blocks include Flashbot transactions
Doesn't apply to BTC blockchain
This can be arranged on the BTC blockchain (?)
Any general insights that apply to private settlement across different blockchains?
Comments: miner incentives and behaviour
- (Toy) model in the paper:
- Miners that provide private settlement do not monitor public pools
- No impact on the miner size from going public to private
- No user decisions
- Can similar insights be obtained from first principles?
- Smaller miners face higher income (fee) volatility?
- Accept smaller fee to lower it (certainty equivalent type argument?)
- Alternatively - build up the model to allow more choices?
Private Transaction
Private Transaction
Comments: miner incentives and behaviour
To what extent do miners "specialize" on private vs public?
Time trends in who offers private?
Comments: miner incentives and behaviour
Extent of specialization?
- If do not have to "switch" to private, then it's "extra" income & not just risk/uncertainty reduction
- \(\to\) always willing to provide private settlement, no matter the fee
- The average private transaction fee \(\approx\) std dev (11-12 satoshi)
- Explore further how these are set?
- E.g., do fees for private transactions differ across miners?
- Across users?
- Explore further how these are set?
Comments: who are the users?
- Who are the users of private transactions?
- Conjecture: fee-sensitive, time-insensitive.
- Conjecture: layer 1 applications
- Can you tease out more information?
- E.g., exchange wallets?
- Can Cardiff University Bitcoin Database (CUBiD) help?
- What are the incentives for the less active users?
- The average for all private users is under 1.7 transaction
- < 20% have 10+ transactions
- How easy is it to find private settlement for just 1-2 transactions? Worth it?
- Why would a miner offer a discount for a one-off transaction?
- Back-of-the-envelope fee savings computation?
- The average for all private users is under 1.7 transaction
Comments: who are the users?
- Do these settle exclusively privately or only occasionally?
- Implications for security/single point of failure
- "Bulk discounts"
- agreements when the user must send everything?
- akin to payment for order flow
- Do active vs occasional users pay different fees for privately settled transactions?
- Do private users have transactions with miners?
- Curious if they may provider services to miners (loans?) and receive lower fees in exchange for these services?
@katyamalinova
malinovk@mcmaster.ca
slides.com/kmalinova
https://sites.google.com/site/katyamalinova/
Central Bank Conference Sydney Discussion
By Katya Malinova
Central Bank Conference Sydney Discussion
Central Bank Workshop on Microstructure: Discussion
