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Mechanism Design for Automated Market Makers

Authors T-H. Hubert Chan , Ke Wu , Elaine Shi

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ACM Subject Classification
  • Theory of computation → Algorithmic mechanism design
  • Theory of computation → Algorithmic game theory
Keywords
  • Mechanism design
  • game theory
  • strategy proof
  • blockchain

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Abstract

Blockchains have popularized automated market makers (AMMs), applications that run on a blockchain, maintain a pool of crypto-assets, and execute trades with users governed by some pricing function. AMMs have also introduced a significant challenge known as the Miner Extractable Value (MEV). Specifically, miners who control the contents and sequencing of transactions in a block can extract value by front-running and back-running users' transactions, creating arbitrage opportunities that guarantee them risk-free returns. MEV not only harms ordinary users, but more critically, encourages miners to auction off favorable transaction placements to users and arbitragers. This has fostered a more centralized off-chain eco-system, departing from the decentralized equilibrium originally envisioned for the blockchain infrastructure layer. 
In this paper, we consider how to design AMM mechanisms that eliminate MEV opportunities. Specifically, we propose a new AMM mechanism that processes all transactions contained within a block according to some pre-defined rules, ensuring that some constant potential function is maintained after processing the batch. We show that our new mechanism satisfies two tiers of guarantees. First, for legacy blockchains where each block is proposed by a single (possibly rotating) miner, we prove that our mechanism satisfies arbitrage resilience, i.e., a miner cannot gain risk-free profit. Second, for blockchains where the block proposal process is decentralized and offers sequencing-fairness, we prove a strictly stronger notion called strategy proofness - roughly speaking, we guarantee that any individual user’s best response is to follow the honest strategy. 
Our results complement prior works on MEV resilience in the following senses. First, prior works have shown impossibilities to address MEV entirely at the consensus level. Our work demonstrates a new paradigm of mechanism design at the application (i.e., smart contract) layer to ensure provable guarantees of strategy proofness. Second, many works have attempted to augment the underlying consensus protocol with extra properties such as sequencing fairness. While most previous works heuristically argued why these extra properties help to mitigate MEV, our work demonstrates in a mathematically formal manner how to leverage such consensus-level properties to aid the design of strategy-proof mechanisms.

Cite As Get BibTex

T-H. Hubert Chan, Ke Wu, and Elaine Shi. Mechanism Design for Automated Market Makers. In 7th Conference on Advances in Financial Technologies (AFT 2025). Leibniz International Proceedings in Informatics (LIPIcs), Volume 354, pp. 7:1-7:22, Schloss Dagstuhl – Leibniz-Zentrum für Informatik (2025) https://doi.org/10.4230/LIPIcs.AFT.2025.7

Author Details

T-H. Hubert Chan
  • University of Hong Kong, Hong Kong
Ke Wu
  • University of Michigan, Ann Arbor, MI, USA
  • Carnegie Mellon University, Pittsburgh, PA, USA
Elaine Shi
  • Carnegie Mellon University, Pittsburgh, PA, USA

Funding

  • Chan, T-H. Hubert: T-H. Hubert Chan was partially supported by the Hong Kong RGC grants 17203122 and 17202121.
  • Wu, Ke: Ke contributed to this work while she was a Ph.D. student at CMU. See the grant acknowledgements of Elaine Shi.
  • Shi, Elaine: This work is in part supported by NSF awards 2212746, 2044679, 1704788, a Packard Fellowship, a generous gift from the late Nikolai Mushegian, a gift from Google, and an ACE center grant from Algorand Foundation.

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