From Competition to Centralization: The Oligopoly in Ethereum Block Building Auctions (2412.18074v1)

Abstract: The Ethereum block production process has evolved with the introduction of an auction-based mechanism known as Proposer-Builder Separation (PBS), allowing validators to outsource block production to builders and reap Maximal Extractable Value (MEV) revenue from builder bids in a decentralized market. In this market, builders compete in MEV-Boost auctions to have their blocks selected and earn potential MEV rewards. This paper employs empirical game-theoretic analysis to explore builders' strategic bidding incentives in MEV-Boost auctions, focusing on how advantages in network latency and access to MEV opportunities affect builders' bidding behaviors and auction outcomes. Our findings confirm an oligopolistic dynamic, where a few dominant builders, leveraging their advantages in latency and MEV access, benefit from an economy of scale that reinforces their market power, leading to increased centralization and reduced auction efficiency. Our analysis highlights the importance of fair MEV distribution among builders and the ongoing challenge of enhancing decentralization in the Ethereum block building market.

• The paper demonstrates that, under uniform latency and orderflow conditions, aggressive bidding strategies promote decentralized market mechanisms.
• The paper finds that network latency differences cause moderate variations in bidding aggressiveness without drastically centralizing the auction process.
• The paper shows that disparities in private orderflow access enable dominant builders to secure disproportionate control, steering the market toward oligopolistic dynamics.

From Competition to Centralization: The Oligopoly in Ethereum Block Building Auctions

The paper "From Competition to Centralization: The Oligopoly in Ethereum Block Building Auctions" elucidates the evolving dynamics of auction-based block production within the Ethereum network, focusing on the emergent oligopolistic behaviors of dominant builders. This research explores the strategic incentives governing builders' behaviors within the framework of the Proposer-Builder Separation (PBS) mechanism, particularly through the lens of MEV-Boost auctions that aim to outsource block production, thereby enabling validators to maximize extractable value (MEV).

Context and Framework

Ethereum's adoption of PBS allows validators to delegate the task of block construction to specialized builders, facilitating competitive auctions where these builders vie for selection by proposers. Prior research has predominantly examined the centralization risks tied to MEV opportunities when resources and capabilities among validators differ substantially. This paper scrutinizes builders' bidding strategies and elucidates how factors such as network latency and access to MEV opportunities can critically affect auction dynamics and result in oligopolistic market configurations.

Methodological Approach

The authors employ an empirical game-theoretic analysis in their exploration of strategic interactions in MEV-Boost auctions. The paper introduces a model grounded in the empirical game-theoretic framework, using a meta-game approach that incorporates a broader and richer strategy space than previously considered. This allows for a more detailed understanding of how builders' strategic choices shape auction outcomes under various conditions including uniform and non-uniform distributions of latency and orderflow access.

Key Findings

1. Decentralized Market under Ideal Conditions:
   • When builders possess similar latency and orderflow access, the competitive landscape fosters aggressive strategies where builders employ a significant portion of block value for bidding. This scenario results in a decentralized market with builders enjoying equal market shares, thereby optimizing auction efficiency.
2. Impact of Network Latency:
   • The paper finds that while low-latency builders tend to have higher success rates, latency disparities alone do not significantly distort market equilibrium or centralize the auction. The aggressiveness in bidding strategies is preserved across varying latency gaps. However, real-world latency differences contribute to slight variations in auction efficiency.
3. Orderflow Access as a Centralizing Force:
   • Disparities in private orderflow access illuminate a path to market centralization. Builders with superior access to exclusive orderflows exhibit less aggressive bidding, thereby reducing proposers' MEV revenue share and decreasing auction efficiency. The market thus veers towards oligopolistic dynamics, where dominant builders secure disproportionate control over the auction landscape and enjoy enhanced profit margins.

Practical Implications

This research offers significant insights into the constraints and opportunities within Ethereum's block-building market. The findings underscore the critical need for fair MEV distribution mechanisms to counteract centralizing tendencies and maintain a competitive and decentralized auction environment. Moreover, the emergence of solutions like BuilderNet and ongoing discourse surrounding decentralized orderflow distribution offer potential avenues for minimizing the biases in orderflow access and, consequently, market centralization.

Conclusion and Future Directions

The paper draws attention to the evolving challenges within Ethereum's block-building context, pointing to vertical integration and access disparities as pivotal elements fostering centralization. Future research directions could involve the development of more sophisticated models to capture multi-stage auctions or incorporate adaptive strategies for builders. Additionally, an investigation into the effectiveness of trustless mechanisms like BuilderNet in achieving decentralization goals could further refine our understanding of efficient auction design in decentralized networks.