RediSwap: MEV Redistribution Mechanism for CFMMs (2410.18434v1)

Abstract: Automated Market Makers (AMMs) are essential to decentralized finance, offering continuous liquidity and enabling intermediary-free trading on blockchains. However, participants in AMMs are vulnerable to Maximal Extractable Value (MEV) exploitation. Users face threats such as front-running, back-running, and sandwich attacks, while liquidity providers (LPs) incur the loss-versus-rebalancing (LVR). In this paper, we introduce RediSwap, a novel AMM designed to capture MEV at the application level and refund it fairly among users and liquidity providers. At its core, RediSwap features an MEV-redistribution mechanism that manages arbitrage opportunities within the AMM pool. We formalize the mechanism design problem and the desired game-theoretical properties. A central insight underpinning our mechanism is the interpretation of the maximal MEV value as the sum of LVR and individual user losses. We prove that our mechanism is incentive-compatible and Sybil-proof, and demonstrate that it is easy for arbitrageurs to participate. We empirically compared RediSwap with existing solutions by replaying historical AMM trades. Our results suggest that RediSwap can achieve better execution than UniswapX in 89% of trades and reduce LPs' loss to under 0.5% of the original LVR in most cases.

• The paper proposes a novel MEV redistribution mechanism that precisely quantifies LVR and trade losses to enhance fairness in Automated Market Makers.
• It employs mechanism design principles, including incentive compatibility and Sybil-proofing, and uses a second-price auction model for arbitrage participation.
• Empirical results show an 89% improvement in execution prices and LP exposure reductions below 0.5%, validating RediSwap's effectiveness.

An Overview of "RediSwap: MEV Redistribution Mechanism for CFMMs"

The paper "RediSwap: MEV Redistribution Mechanism for CFMMs" introduces a novel approach designed to address the challenges posed by Maximal Extractable Value (MEV) in the context of Automated Market Makers (AMMs) in decentralized finance (DeFi). The authors focus on devising a fair mechanism for the redistribution of MEV within Constant Function Market Makers (CFMMs), ensuring equitable benefits to liquidity providers (LPs) and users.

Motivation

AMMs have revolutionized DeFi by enabling seamless token exchanges without needing an intermediary. However, they are susceptible to MEV exploitation, which refers to the excess value that intermediaries can capture through manipulating transaction sequencing. This generates multiple concerns:

• Users may encounter detrimental trade executions due to strategies like front-running and sandwich attacks.
• Liquidity Providers face Loss-Versus-Rebalancing (LVR), which undermines profitability.

Existing solutions to mitigate MEV, such as MEV-Share and MEV Blocker, focus on refunding a portion of the extracted value downstream in the transaction flow but often fall short of comprehensiveness and fairness.

RediSwap Mechanism

RediSwap proposes a mechanism that operates at the application level, directly integrating with the CFMM:

• It interprets MEV as the collective sum of LVR and user trade losses, allowing a precise quantification of value extraction.
• The authors employ mechanism design principles to ensure that the system is incentive-compatible and Sybil-proof, minimizing opportunities for gaming by strategic users.

Key Components and Process

1. Bundle Generation: During a transaction, RediSwap constructs a transaction bundle, determining an optimal set of trades that maximizes MEV while maintaining fairness. The process ensures that MEV captured is proportional to each trade's loss within the bundle.
2. Payment and Refund: The mechanism incorporates a second-price auction model. It collects payments from arbitrageurs based on their reported price beliefs and redistributes these funds proportionately to users and LPs.
3. Arbitrage Participation: The system permits straightforward engagement for arbitrageurs, who can participate without complex strategies, mainly providing their price expectations.

Results and Evaluation

Empirical assessments were conducted by replaying historical trades against existing protocols like UniswapX and CoWSwap. The outcomes illustrated that:

• RediSwap achieves superior execution prices in 89% of cases compared to UniswapX.
• LPs' exposure to LVR is significantly reduced, often to less than 0.5% in the considered scenarios.

Theoretical Implications

The theoretical framework ensures that the mechanism adheres to essential game theory principles:

• Truthfulness: Encourages accurate reporting of valuations by arbitrageurs.
• Sybil-Proofness: Protects against false-user proliferation and collusion.

Practical Implications and Future Directions

RediSwap's integration into DeFi protocols promises improved fairness in MEV distribution, enhancing usability and trust. Future aspirations for RediSwap and similar mechanisms could include:

• Extending the model to other DeFi infrastructures such as lending platforms and cross-protocol interactions.
• Exploiting cryptographic advancements for secure implementation, potentially leveraging Trusted Execution Environments (TEEs) for private computation.
• Investigating solver behaviors in broader contexts to further refine and align incentives toward holistic user-beneficial outcomes.

The RediSwap mechanism presents a promising advancement in DeFi, harnessing mechanism design and empirical validation to tackle pervasive MEV challenges effectively.