Decentralized Payment Clearing using Blockchain and Optimal Bidding

TL;DR

This paper proposes a decentralized blockchain-based clearing mechanism for obligations, analyzing default contagion, optimal bidding strategies, and systemic risk implications in a network of smart contracts.

Contribution

It introduces a novel blockchain clearing algorithm with guaranteed verification, explores equilibrium bidding strategies, and analyzes systemic risk impacts.

Findings

Guarantees payment verification and miner fees in blockchain clearing

Proves existence and uniqueness of equilibrium in unbounded capacity blocks

Identifies optimal bidding strategies and systemic risk effects

Abstract

In this paper, we construct a decentralized clearing mechanism which endogenously and automatically provides a claims resolution procedure. This mechanism can be used to clear a network of obligations through blockchain. In particular, we investigate default contagion in a network of smart contracts cleared through blockchain. In so doing, we provide an algorithm which constructs the blockchain so as to guarantee the payments can be verified and the miners earn a fee. We, additionally, consider the special case in which the blocks have unbounded capacity to provide a simple equilibrium clearing condition for the terminal net worths; existence and uniqueness are proven for this system. Finally, we consider the optimal bidding strategies for each firm in the network so that all firms are utility maximizers with respect to their terminal wealths. We first look for a mixed Nash equilibrium bidding strategies, and then also consider Pareto optimal bidding strategies. The implications of these strategies, and more broadly blockchain, on systemic risk are considered.