Mechanism Design for Automated Market Makers

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.