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The incentive-compatibility properties of blockchain transaction fee mechanisms have been investigated with passive block producers that are motivated purely by the net rewards earned at the consensus layer. This paper introduces a model of active block producers that have their own private valuations for blocks (representing, for example, additional value derived from the application layer). The block producer surplus in our model can be interpreted as one of the more common colloquial meanings of the phrase "maximal extractable value (MEV)." We first prove that transaction fee mechanism design is fundamentally more difficult with active block producers than with passive ones: With active block producers, no non-trivial or approximately welfare-maximizing transaction fee mechanism can be incentive-compatible for both users and block producers. These results can be interpreted as a mathematical justification for augmenting transaction fee mechanisms with additional components such as order flow auctions, block producer competition, trusted hardware, or cryptographic techniques. We then consider a more fine-grained model of block production that more accurately reflects current practice, in which we distinguish the roles of "searchers" (who actively identify opportunities for value extraction from the application layer and compete for the right to take advantage of them) and "proposers" (who participate directly in the blockchain protocol and make the final choice of the published block). Searchers can effectively act as an "MEV oracle" for a transaction fee mechanism, thereby enlarging the design space. Here, we first consider a TFM that is inspired by how searchers have traditionally been incorporated into the block production process, with each transaction effectively sold off to a searcher through a first-price auction. We then explore the TFM design space with searchers more generally, and design a mechanism that circumvents our impossibility results for TFMs without searchers. Our mechanism (the "SAKA" mechanism) is incentive-compatible (for users, searchers, and the block producer), sybil-proof, and guarantees roughly 50% of the maximum-possible welfare when transaction sizes are small relative to block sizes. We conclude with a matching negative result: even when transaction sizes are small, no DSIC and sybil-proof deterministic TFM can guarantee more than 50% of the maximum-possible welfare.

In a typical decentralized autonomous organization (DAO), people organize themselves into a group that is programmatically managed. DAOs can act as bidders in auctions (with ConstitutionDAO being one notable example), with a DAO’s bid typically treated by the auctioneer as if it had been submitted by an individual, without regard to any details of the internal DAO dynamics. The goal of this paper is to study auctions in which the bidders are DAOs. More precisely, we consider the design of two-level auctions in which the "participants" are groups of bidders rather than individuals. Bidders form DAOs to pool resources, but must then also negotiate the terms by which the DAO’s winnings are shared. We model the outcome of a DAO’s negotiations through an aggregation function (which aggregates DAO members' bids into a single group bid) and a budget-balanced cost-sharing mechanism (that determines DAO members' access to the DAO’s allocation and distributes the aggregate payment demanded from the DAO to its members). DAOs' bids are processed by a direct-revelation mechanism that has no knowledge of the DAO structure (and thus treats each DAO as an individual). Within this framework, we pursue two-level mechanisms that are incentive-compatible (with truthful bidding a dominant strategy for each member of each DAO) and approximately welfare-optimal. We prove that, even in the case of a single-item auction, the DAO dynamics hidden from the outer mechanism preclude incentive-compatible welfare maximization: No matter what the outer mechanism and the cost-sharing mechanisms used by DAOs, the welfare of the resulting two-level mechanism can be a ≈ ln n factor less than the optimal welfare (in the worst case over DAOs and valuation profiles). We complement this lower bound with a natural two-level mechanism that achieves a matching approximate welfare guarantee. This upper bound also extends to multi-item auctions in which individuals have additive valuations. Finally, we show that our positive results cannot be extended much further: Even in multi-item settings in which bidders have unit-demand valuations, truthful two-level mechanisms form a highly restricted class and as a consequence cannot guarantee any non-trivial approximation of the maximum social welfare.