Transaction Fee Mechanism Design

TL;DR

This paper designs and analyzes blockchain transaction fee mechanisms, introducing new incentive-compatibility concepts and evaluating Ethereum's EIP-1559 proposal, demonstrating its robustness and proposing an alternative tipless mechanism.

Contribution

It introduces two new incentive-compatibility notions for blockchain fee mechanisms and proves EIP-1559's effectiveness under these criteria, also proposing a novel tipless mechanism.

Findings

EIP-1559 satisfies MMIC and OCA-proofness, and is DSIC except during demand spikes.

The tipless mechanism is MMIC, DSIC, and OCA-proof except during demand spikes.

Ethereum's EIP-1559 mechanism is robust under the new incentive criteria.

Abstract

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.