Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges (1904.05234v1)

Abstract: Blockchains, and specifically smart contracts, have promised to create fair and transparent trading ecosystems. Unfortunately, we show that this promise has not been met. We document and quantify the widespread and rising deployment of arbitrage bots in blockchain systems, specifically in decentralized exchanges (or "DEXes"). Like high-frequency traders on Wall Street, these bots exploit inefficiencies in DEXes, paying high transaction fees and optimizing network latency to frontrun, i.e., anticipate and exploit, ordinary users' DEX trades. We study the breadth of DEX arbitrage bots in a subset of transactions that yield quantifiable revenue to these bots. We also study bots' profit-making strategies, with a focus on blockchain-specific elements. We observe bots engage in what we call priority gas auctions (PGAs), competitively bidding up transaction fees in order to obtain priority ordering, i.e., early block position and execution, for their transactions. PGAs present an interesting and complex new continuous-time, partial-information, game-theoretic model that we formalize and study. We release an interactive web portal, http://frontrun.me/, to provide the community with real-time data on PGAs. We additionally show that high fees paid for priority transaction ordering poses a systemic risk to consensus-layer security. We explain that such fees are just one form of a general phenomenon in DEXes and beyond---what we call miner extractable value (MEV)---that poses concrete, measurable, consensus-layer security risks. We show empirically that MEV poses a realistic threat to Ethereum today. Our work highlights the large, complex risks created by transaction-ordering dependencies in smart contracts and the ways in which traditional forms of financial-market exploitation are adapting to and penetrating blockchain economies.

• The paper demonstrates that arbitrage bots exploit decentralized exchanges via priority gas auctions to secure transactions, yielding over USD 6 million in profits.
• It introduces a game-theoretic model for priority gas auctions, revealing how competitive bidding drives up transaction fees in bot-dominated environments.
• The study reveals that miner-extractable value destabilizes blockchain consensus, highlighting the need for enhanced security protocols against transaction reordering attacks.

Overview of "Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges"

The paper "Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges" offers an analytical dissertation on the challenges posed by arbitrage bots within decentralized exchanges (DEXes) on blockchain systems, with a focused examination of the Ethereum network. This paper elucidates the adaptative behaviors of traditional financial exploitation mechanisms in the decentralized smart-contract ecosystems and highlights systemic risks to the underlying blockchain infrastructure.

Key Insights from the Paper

1. Arbitrage Bots and Performance Metrics: The research demonstrates the prevalence of arbitrage bots within DEXes that seize inefficiencies to conduct frontrunning trades. These bots engage in priority gas auctions (PGAs) to secure favorable transaction times and positions in the block order, ultimately generating substantial revenue. Empirical data from the paper estimates a minimum economy size of USD 6 million in arbitrage profits, indicating significant financial activity influenced by these bots.
2. Priority Gas Auctions (PGAs): The authors introduce a game-theoretic model to conceptualize PGAs, where bots essentially outbid each other by increasing transaction fees, effectively prioritizing their transaction orders during block validation. This competitive behavior underscores a dynamic environment where the rapid bidding up of gas prices leads to complex auction scenarios.
3. Miner-Extractable Value (MEV): A novel concept discussed is the concept of MEV, which describes the potential gains miners can extract from manipulating transaction orders or selectively including and excluding transactions for their advantage. The research details how MEV contributes to increased transaction costs and disrupts consensus-layer security, posing threats to blockchain stability.
4. Security Risks and Financial Stability: The paper extrapolates the systemic vulnerabilities including fee-based forking attacks and time-bandit attacks. Fee-based forking attacks are incentivized by ordering optimization (OO) fees, while time-bandit attacks involve miners rewriting blockchain history for financial gain, both highlighting significant concerns for blockchain's consensus efficacy.
5. Empirical Observations and Theoretical Implications: By measuring and modeling the actions of arbitrage bots, this research delineates the economic ramifications of DEX flaws and outlines systemic risks such as transaction-order dependencies inherent in smart contract designs. From a theoretical perspective, this research challenges the assumed economic security models traditionally applied to blockchain protocols, emphasizing a need for improved design considerations that mitigate exploitation risks.

Implications and Future Directions

This paper puts forth substantive implications for blockchain technology and its application in decentralized trading protocols. Practically, the findings necessitate the blockchain community's focus on developing robust transaction ordering protocols that balance efficiency and fairness while safeguarding consensus from exploitation. Theoretically, the paper advances the understanding of blockchain economics by integrating the nuances of smart contract transactions, which have hitherto been oversimplified within the paradigms applied to traditional electronic payment systems like Bitcoin.

Looking forward, further research into mitigating MEV and improving consensus-layer security in blockchain architectures is crucial. There's room for exploration into advanced cryptographic methods and consensus algorithms that inherently protect against transaction reordering and financial exploits. As second-layer solutions and cross-chain technologies mature, their integration into existing systems must be carefully strategized to avoid inadvertently expanding attack vectors as highlighted by the research findings on Ethereum.

In conclusion, this paper underscores the evolving dynamics within decentralized financial systems and serves as a foundation for continued discourse and development of secure, equitable trading mechanisms in the blockchain domain.