The Viability of Blockchain Markets under Discrete Clearing and Paid Priority

TL;DR

This paper models blockchain markets with discrete clearing and paid priority, revealing that these features hinder price discovery, reduce liquidity, and can cause market shutdowns, especially with longer block times.

Contribution

It introduces a model analyzing how discrete clearing and paid priority fees impact market viability, liquidity, and price discovery in blockchain environments.

Findings

Paid priority induces endogenous participation cutoff.

Longer block times can lead to market shutdowns.

Market bias and liquidity issues increase with competition.

Abstract

This paper develops a model to evaluate the viability of blockchain markets as the sole venue for price formation. Blockchains clear at discrete intervals called block time, and transactions are executed sequentially according to priority fees paid by traders who compete for queue position. We show that these features undermine the viability of markets. Paid-priority ordering induces endogenous selection, where only traders with sufficiently high valuations participate. The participation cutoff rises with competition, which intensifies with lower information costs or higher liquidity demand. This hinders price discovery and biases prices. It also impairs liquidity: the cutoff concentrates trading among aggressive traders and increases adverse selection that liquidity suppliers absorb in a single clearing round. Although longer block times enhance consensus security, they amplify these effects and can cause markets to shut down.