Transaction Fee Mechanism Design
This work addresses the critical issue of transaction selection in blockchains like Ethereum, providing theoretical validation for a major protocol change and offering new designs to enhance security and efficiency, though it is incremental in building on existing mechanism design principles.
The paper tackles the problem of designing blockchain transaction fee mechanisms to select transactions for inclusion on-chain, introducing new incentive-compatibility conditions (MMIC and OCA-proofness) to protect against miner deviations and off-chain collusion. It proves that Ethereum's EIP-1559 mechanism satisfies these conditions and is dominant-strategy incentive compatible except during demand spikes, and proposes an alternative 'tipless mechanism' with different guarantees.
Demand for blockchains such as Bitcoin and Ethereum is far larger than supply, necessitating a mechanism that selects a subset of transactions to include "on-chain" from the pool of all pending transactions. This paper investigates the problem of designing a blockchain transaction fee mechanism through the lens of mechanism design. We introduce two new forms of incentive-compatibility that capture some of the idiosyncrasies of the blockchain setting, one (MMIC) that protects against deviations by profit-maximizing miners and one (OCA-proofness) that protects against off-chain collusion between miners and users. This study is immediately applicable to a recent (August 5, 2021) and major change to Ethereum's transaction fee mechanism, based on a proposal called "EIP-1559." Historically, Ethereum's transaction fee mechanism was a first-price (pay-as-bid) auction. EIP-1559 suggested making several tightly coupled changes, including the introduction of variable-size blocks, a history-dependent reserve price, and the burning of a significant portion of the transaction fees. We prove that this new mechanism earns an impressive report card: it satisfies the MMIC and OCA-proofness conditions, and is also dominant-strategy incentive compatible (DSIC) except when there is a sudden demand spike. We also introduce an alternative design, the "tipless mechanism," which offers an incomparable slate of incentive-compatibility guarantees -- it is MMIC and DSIC, and OCA-proof unless in the midst of a demand spike.