MEV Capture and Decentralization in Execution Tickets (2408.11255v1)

Abstract: We provide an economic model of Execution Tickets and use it to study the ability of the Ethereum protocol to capture MEV from block construction. We demonstrate that Execution Tickets extract all MEV when all buyers are homogeneous, risk neutral and face no capital costs. We also show that MEV capture decreases with risk aversion and capital costs. Moreover, when buyers are heterogeneous, MEV capture can be especially low and a single dominant buyer can extract much of the MEV. This adverse effect can be partially mitigated by the presence of a Proposer Builder Separation (PBS) mechanism, which gives ET buyers access to a market of specialized builders, but in practice centralization vectors still persist. With PBS, ETs are concentrated among those with the highest ex-ante MEV extraction ability and lowest cost of capital. We show how it is possible that large investors that are not builders but have substantial advantage in capital cost can come to dominate the ET market.

• The paper introduces an economic model showing that under ideal conditions, risk-neutral and homogeneous buyers enable full MEV capture with decentralized ET distribution.
• It demonstrates that risk aversion and capital costs reduce MEV capture, while still maintaining decentralized holdings among buyers.
• The study reveals that buyer heterogeneity can lead to centralization and that PBS mechanisms mitigate, but do not eliminate, centralization risks.

MEV Capture and Decentralization in Execution Tickets: An Economic Model

The paper "MEV Capture and Decentralization in Execution Tickets" by Jonah Burian, Davide Crapis, and Fahad Saleh, presents an economic model for evaluating the effectiveness of Execution Tickets (ETs) in the Ethereum blockchain protocol for capturing Maximal Extractable Value (MEV). By leveraging a well-structured equilibrium analysis, the authors investigate the nuances of ETs, both in isolation and with the presence of Proposer Builder Separation (PBS) mechanisms. This work provides crucial insights into the efficiency and decentralization implications of ETs in MEV capture, addressing key factors such as risk aversion, capital costs, and buyer heterogeneity.

Key Findings

Total MEV Capture with Homogeneous Buyers

The authors first consider a scenario where buyers are homogeneous, risk-neutral, and face no capital costs. Under these assumptions, the model achieves full MEV capture. Specifically:

• Result: The protocol extracts all MEV, leading to $\chi = 1$, where $\chi$ is the long-run proportion of MEV captured by the protocol.
• Decentralization: ET holdings are evenly distributed among all buyers, with $k_b = \frac{N}{B}$ for each buyer $b$ within the set $\mathcal{B}$.

This result highlights the ideal conditions under which ETs can fully capture MEV without leading to centralization, as homogeneity among buyers eliminates any competitive edge that could otherwise skew the distribution of ET holdings.

Partial MEV Capture with Homogeneous But Risk-Averse Buyers

When the model accounts for risk aversion and non-zero capital costs among homogeneously skilled buyers, MEV capture diminishes:

• Result: MEV capture is partial ($\chi < 1$) due to the buyers' risk-adjusted discounted valuations of ETs being less than the expected MEV per block.
• Decentralization: Despite the reduction in MEV capture, ET holdings remain decentralized among buyers.

Risk aversion and capital costs introduce a discrepancy between the expected MEV and the buyers' valuation of ETs, leading to suboptimal MEV capture.

Low MEV Capture with Heterogeneous Buyers

In scenarios where buyers are heterogeneous, either in terms of risk aversion, capital costs, or MEV extraction abilities, the model indicates a significant drop in MEV capture:

• Result: MEV capture $\chi$ decreases, and a single dominant buyer may extract much of the MEV. For risk-neutral, heterogeneous buyers in MEV extraction abilities:
  • $$\chi = \frac{\mathbb{E}[R_{2,t}]}{\mathbb{E}[R_{1,t}]} < 1$$, where $\mathbb{E}[R_{1,t}]$ and $\mathbb{E}[R_{2,t}]$ are the expected MEV for the top two buyers.
• Centralization: ET holdings become centralized with the buyer having the highest valuation, primarily due to better MEV extraction abilities or lower capital costs.

This result underscores the risk of market centralization and lower MEV capture when there is significant heterogeneity among buyers.

Impact of PBS Mechanisms

PBS mechanisms, designed to separate the block construction role from the block proposing role, are examined to determine their effect on ET effectiveness:

• Result: PBS can mitigate but not eliminate centralization. Buyers with the highest valuation, considering both MEV extraction ability and capital costs, dominate the ET market.
• Large Investors: With sufficiently low capital costs, large investors with minimal MEV extraction ability may dominate the ET market, relying on PBS to outsource block construction tasks.

This indicates that while PBS can introduce a more competitive environment, the underlying differentiation in capital costs remains a significant factor influencing the distribution of ET holdings.

Practical Implications and Future Developments

Allocation Efficiency

ETs have the potential to capture more MEV compared to the current system, which fails to capture MEV effectively. This suggests that ETs can improve resource allocation within the Ethereum protocol by distributing MEV proceeds more equitably among participants.

Centralization Concerns

ETs introduce new centralization vectors, primarily driven by the cost of capital and MEV extraction abilities. Although PBS mechanisms help distribute block-building tasks among capable participants, financial advantages among select buyers may counterbalance these gains, leading to potential centralization. Future research should further explore the optimal design and implementation of ETs, potentially integrating adaptive mechanisms to balance centralization risks.

Conclusion

The analysis presented in "MEV Capture and Decentralization in Execution Tickets" provides a rigorous and insightful examination of ETs as an economic model for MEV capture within the Ethereum protocol. The findings highlight the potential efficiency gains from ETs while acknowledging the challenges posed by buyer heterogeneity and the effective role of PBS mechanisms. Moving forward, addressing capital cost disparities and refining ET implementation mechanisms will be crucial in maximizing their benefits while mitigating centralization risks.