MEV Capture Through Time-Advantaged Arbitrage (2410.10797v2)

Abstract: As blockchains begin processing significant economic activity, the ability to include and order transactions inevitably becomes highly valuable, a concept known as Maximal Extractable Value (MEV). This makes effective mechanisms for transaction inclusion and ordering, and thereby the extraction of MEV, a key aspect of blockchain design. Beyond traditional approaches such as ordering in a first-come-first-serve manner or using priority fees, a recent proposal suggests auctioning off a time advantage for transaction inclusion. In this paper, we investigate this time advantage mechanism, focusing specifically on arbitrage opportunities on Automated Market Makers (AMMs), one of the largest sources of MEV today. We analyze the optimal strategy for a time-advantaged arbitrageur and compare the profits generated by various MEV extraction methods. Finally, we explore how AMMs can be adapted in the time advantage setting to capture a portion of the MEV.

• The paper introduces the Timeboost mechanism that grants exclusive temporal advantages for arbitrage, enhancing MEV extraction efficiency.
• It employs dynamic programming and empirical simulations under geometric Brownian motion to identify optimal trading strategies amid different sequencing policies.
• The study demonstrates that innovative transaction ordering can boost arbitrage profits and inform better rollup design in decentralized finance.

Analytical Perspectives on MEV Capture Through Time-Advantaged Arbitrage

The paper "MEV Capture Through Time-Advantaged Arbitrage" presented by Fritsch et al. addresses the complexities and strategies associated with Maximal Extractable Value (MEV) in the context of blockchain transaction ordering. Specifically, it focuses on the impact of time-advantaged arbitrage opportunities, particularly within Automated Market Makers (AMMs) which constitute significant sources of MEV. The paper is grounded within the operational frameworks of emerging Layer 2 (L2) scaling solutions, with a particular emphasis on rollups, where trading dynamics and transaction ordering policies play a crucial role in MEV extraction.

Transaction Sequencing Policies

The authors present a sophisticated exploration of transaction sequencing policies, contrasting three primary mechanisms: First-Come-First-Serve (FCFS), Priority Gas Auctions (PGAs), and the proposed Timeboost mechanism that incorporates a time advantage. FCFS allows transactions in the order of reception by the centralized sequencer, while PGAs rely on priority fees to determine transaction order. Both have implications on who benefits from MEV extraction, with FCFS potentially leading to latency races. In contrast, the Timeboost mechanism introduces an auction for temporal advantage, granting a single bidder prioritized transaction inclusion for a set period.

Modeling and Strategy Analysis

The theoretical model developed in the paper rigorously evaluates the scenario where an arbitrageur has a time advantage over competitors. The authors derive optimal strategies for exploiting arbitrage opportunities by balancing immediate versus delayed actions. Their analysis underpins the strategic choice faced by an arbitrageur with the time advantage—whether to act promptly or to wait for potentially larger returns within their exclusive execution window.

The paper outlines the conditions under which different strategies are optimal, utilizing dynamic programming and empirical pricing distributions from liquidity pools. Notably, under assumptions such as geometric Brownian motion of asset prices, the model shows that waiting until the end of the time advantage interval can be the optimal strategy, and the authors provide simulations to evaluate this claim across different trading scenarios.

Simulations and Practical Implications

Through extensive simulations incorporating historical price data, the paper assesses arbitrage profits under FCFS, PGA, and Timeboost mechanisms. Results reveal that Timeboost can lead to higher arbitrage profits compared to FCFS or PGA, particularly in volatile or low-fee trading environments. This highlights the transformative potential of transaction sequencing policies on MEV distribution and the market structure itself.

However, the paper also recognizes the complexity introduced by factors like mean reversion in prices, which can affect the relative profitability of waiting strategies under Timeboost. Simulations also confirm that parameters such as block times or time advantages significantly influence the extractable MEV, offering rollup designers insights into optimizing policy settings for different economic objectives.

Future Prospects and Conclusions

The paper concludes by proposing mechanisms for capturing arbitrage profits directly within AMM pools, attempting to return MEV to liquidity providers by adjusting fees and market-making functions for time-advantaged transactions. This approach underscores a broader implication: the need for evolving blockchain protocols and market structures that more equitably distribute MEV, enhancing the efficiency and fairness of decentralized finance ecosystems.

Fritsch et al. contribute a nuanced understanding of how time advantages in transaction ordering could reshape MEV landscapes. The paper sets the stage for subsequent work on dynamic sequencing policies and MEV redistribution schemes, marking an important step towards more robust and equitable blockchain environments. The insights from this research are pivotal for practitioners endeavoring to refine the interplay between transaction timing, arbitrage dynamics, and overall network efficiency in the ever-evolving field of decentralized finance.