Why Bitcoin and Ethereum May Not Be as Fair as You Think

Table of Links Abstract/Zusammenfassung Publications Acknowledgements CHAPTER 1: INTRODUCTION Introduction 1.1 Overview of thesis contributions 1.2 Thesis outline CHAPTER 2: BACKGROUND 2.1 Blockchains & smart contracts 2.2 Transaction prioritization norms 2.3 Transaction prioritization and contention transparency 2.4 Decentralized governance 2.5 Blockchain Scalability with Layer 2.0 Solutions CHAPTER 3. TRANSACTION PRIORITIZATION NORMS Transaction Prioritization Norms 3.1 Methodology 3.2 Analyzing norm adherence 3.3 Investigating norm violations 3.4 Dark-fee transactions 3.5 Concluding remarks CHAPTER 4. TRANSACTION PRIORITIZATION AND CONTENTION TRANSPARENCY Transaction Prioritization and Contention Transparency 4.1 Methodology 4.2 On contention transparency 4.3 On prioritization transparency 4.4 Concluding remarks CHAPTER 5. DECENTRALIZED GOVERNANCE Decentralized Governance 5.1 Methodology 5.2 Attacks on governance 5.3 Compound’s governance 5.4 Concluding remarks CHAPTER 6. RELATED WORK 6.1 Transaction prioritization norms 6.2 Transaction prioritization and contention transparency 6.3 Decentralized governance CHAPTER 7. DISCUSSION, LIMITATIONS & FUTURE WORK 7.1 Transaction ordering 7.2 Transaction transparency 7.3 Voting power distribution to amend smart contracts Conclusion Appendices APPENDIX A: Additional Analysis of Transactions Prioritization Norms APPENDIX B: Additional analysis of transactions prioritization and contention transparency APPENDIX C: Additional Analysis of Distribution of Voting Power Bibliography In this chapter, we discuss some consequential points that follow from the prior chapters, mention the limitations of our work, and explore avenues for future work. 7.1 Transaction ordering Our findings have significant implications for both bitcoin users and miners. Bitcoin users (using their wallet software) typically assume complete transparency regarding the fees associated with competing transactions when setting fees for their own transactions. However, our results challenge this common assumption. Similarly, the practice of transactions having different confirmation fees for different miners raises notable fairness concerns. Furthermore, our findings also call for a community-wide debate on defining transaction prioritization norms and enforcing them transparently. Specifically, we highlight three challenging questions that need to be addressed for the future. What are the desired transaction prioritization norms in public proof-of-work blockchains? What aspects of transactions besides fee rate should miners be allowed to consider when ordering them? For instance, should the waiting time of transactions also be considered to avoid indefinitely delaying some transactions? Should the transaction value (i.e., amount of bitcoins transferred between different accounts) be a factor in ordering, as fee rate based ordering favors larger value over smaller value transactions? Similarly, while we did not find evidence of miners decelerating or censoring (i.e., refusing to mine) transactions, the current protocols do not disallow such discriminatory behaviors by miners. Should prioritization norms also explicitly disallow discriminating transactions based on certain transaction features like sending or receiving wallet addresses? Such norms would be analogous to network neutrality norms for Internet Service Providers (ISPs) that disallow flows from being treated differently based on their source/destination addresses or payload. How can we ensure that the distributed miners are adhering to desired and defined norms? Miners in public proof-of-work blockchains, such as Bitcoin and Ethereum, operate in a distributed manner, over a P2P network. This model of operation results in different miners potentially having distinct, typically different, views of the state of the system (e.g., set of outstanding transactions). Given these differences, are there mechanisms (say, based on statistical tests (Asayag et al., 2018; Lev-Ari et al., 2020; Orda and Rottenstreich, 2019)) that any third-party observer could use to verify that a miner adheres to the established norm(s)? How can we model and analyze the impact of selfish, non-transparent, collusive behaviors of miners? While the above themes align well with a long-term vision of defining and enforcing well-defined ordering norms in blockchains, in the short term one could focus on examining the implications of the norm violations in today’s blockchains. Specifically, how can we characterize the ordering that would result from different miners following different prioritization norms, especially given an estimate of miners’ hashing or mining powers (i.e., their likelihood of mining a block). Such a characterization has crucial implications, for example, for Bitcoin users. 7.2 Transaction transparency In this section, we discuss the implications of transactions prioritization and contention transparency in blockchains. Initially, we highlight the importance of incorporating these aspects into blockchain design to fulfill the overarching goal of transparency. Subsequently, we explore the implications for publicly mined transactions. Then, we delve into the implications for privately mined transactions. Lastly, we emphasize that our implications hold both for before or after the introduction of two major improvements to blockchains: EIP-1559 and the Merge. Our results show that with private mining and accelerated transactions, the promise of the public decentralized blockchain does not hold. First, through the Bitcoin active experiment, we show that mining pools with combined hash rates of over 50% are colluding with each other, showing a centralization in the system. Further, these accelerated transactions are highly prioritized by the miners and included mostly on top of their blocks. This enables miners to also censor certain transactions, breaking the ethos of decentralized public blockchains with no central authority. Second, it breaks the assumption that all activities in the blockchain are transparent. Although this is true for transactions included in the blockchain, prioritization of transactions is becoming more opaque with the rise of private mining and off-chain fees. Hence, we make the case that to fulfill the transparency promise of public blockchains, prioritization of transactions should be transparent as well. Third, with private mining in Ethereum, Flashbots is increasingly being used for malicious and predatory activities such as sandwich attacks, which essentially levies a tax on users interacting with financial institutions on the blockchain (e.g., in DEX). These concerns need to be addressed if public blockchains are going to live up to their promises. Implications for publicly mined transactions. Most wallet software and cryptoexchanges today rely on reconstructing the current public Mempool state in order to suggest a suitable fee to transaction issuers. With the lack of contention and prioritization transparency, transaction issuers can no longer accurately recreate the current Mempool state for different miners. Consequently, they cannot reliably estimate the fees transactions need to pay for their desired prioritization. Worse, as the fraction of privately mined and accelerated transactions keeps rising, the transaction fees will become less (reliably) predictable in the future. Implications for privately mined transactions. The problem of reliable fee estimation for a desired level of prioritization is even worse for privately mined transactions that are announced on private relay networks. When transaction issuers announce on a private relay network today, they are often unsure what fraction of total network power is controlled by the miners listening to the private relay network. Hence, it is important to estimate the network power controlled by private mining pools to estimate the commit (waiting) times for transactions. Furthermore, transaction issuers on private relay networks are completely blind to other competing transactions. This opacity allows miners offering private mining and transaction acceleration services to overcharge and demand exorbitant fees to commit transactions. For example, in the Ethereum blockchain, users are observed to be overcharged by miners for having their transactions confirmed with high priority through Flashbots bundles (Weintraub et al., 2022). Relevance of findings in light of EIP-1559 and the Ethereum Merge. Our observations about the lack of transparency and their implications are fundamental to the current blockchain architectures and hold both before and after the recent major improvements to blockchains, e.g., EIP-1559 and the Ethereum Merge. While EIP-1559 attempts to improve the estimation of transaction fees that need to be offered, it does not address the problems associated with the lack of transaction contention and prioritization transparency. Similarly, after the Ethereum Merge, validators that stake a certain amount of Ether (ETH) rather than miners would be responsible for selecting and validating transactions to include in the next block (Ethereum Foundation, 2022a). Our observations about private mining would still hold for private validation and the implications would still be valid after the Merge. 7.3 Voting power distribution to amend smart contracts An inherent concern in the governance of blockchain networks revolves around the concentration of governance tokens among a select group of participants. This situation can potentially pose a threat to the protocol and compromise its integrity, especially if the voting power or authority to make important changes is proportional to the amount of tokens held by each participant. This issue was highlighted in the case of Balancer, a decentralized exchange (DEX) built on top of Ethereum. In this example, a user with a significant amount of governance tokens voted for decisions that were beneficial to the user but detrimental to the protocol (Haig, 2022). Therefore, this scenario of a minority holding a significant amount of tokens can lead to a centralization of decision-making power, which is contrary to the goal of decentralizing governance protocols. While governance protocols in blockchains aim to eliminate (or at least minimize) centralized decision-making, our work reveals that Compound is not effectively achieving its intended goal. The distribution of tokens, which corresponds to voting power, plays a crucial role in determining the level of decentralization in a protocol. Our work highlights the importance of measuring and analyzing governance protocols to ensure that they are working as intended. In addition, this work motivates further research in this area. For example, our empirical evidence supports recent proposals to redefine voting power based on social rewards, such as a voter’s reputation or contributions to the protocol (Guidi et al., 2021; Liu et al., 2022; Sharma et al., 2023), or the use of a quadratic voting scheme, where voting power is calculated as the square root of the number of tokens held by voters (Buterin et al., 2019b; Lalley and Weyl, 2018). In light of our findings, we argue for integrating these insights into the design of future governance protocols. There, we can effectively increase fairness and decentralization within these protocols. In addition, it would also be interesting to analyze other widely used governance protocols, such as Uniswap, to ensure that these governance protocols are truly decentralized. Author: (1) Johnnatan Messias Peixoto Afonso This paper is available on arxiv under CC BY 4.0 DEED license. Table of Links Abstract/Zusammenfassung Abstract/Zusammenfassung Publications Publications Acknowledgements Acknowledgements CHAPTER 1: INTRODUCTION CHAPTER 1: INTRODUCTION Introduction 1.1 Overview of thesis contributions 1.2 Thesis outline Introduction 1.1 Overview of thesis contributions 1.2 Thesis outline Introduction Introduction 1.1 Overview of thesis contributions 1.1 Overview of thesis contributions 1.2 Thesis outline 1.2 Thesis outline CHAPTER 2: BACKGROUND CHAPTER 2: BACKGROUND 2.1 Blockchains & smart contracts 2.1 Blockchains & smart contracts 2.2 Transaction prioritization norms 2.2 Transaction prioritization norms 2.3 Transaction prioritization and contention transparency 2.3 Transaction prioritization and contention transparency 2.4 Decentralized governance 2.4 Decentralized governance 2.5 Blockchain Scalability with Layer 2.0 Solutions 2.5 Blockchain Scalability with Layer 2.0 Solutions CHAPTER 3. TRANSACTION PRIORITIZATION NORMS CHAPTER 3. TRANSACTION PRIORITIZATION NORMS Transaction Prioritization Norms 3.1 Methodology 3.2 Analyzing norm adherence 3.3 Investigating norm violations 3.4 Dark-fee transactions 3.5 Concluding remarks Transaction Prioritization Norms 3.1 Methodology 3.2 Analyzing norm adherence 3.3 Investigating norm violations 3.4 Dark-fee transactions 3.5 Concluding remarks Transaction Prioritization Norms Transaction Prioritization Norms 3.1 Methodology 3.1 Methodology 3.2 Analyzing norm adherence 3.2 Analyzing norm adherence 3.3 Investigating norm violations 3.3 Investigating norm violations 3.4 Dark-fee transactions 3.4 Dark-fee transactions 3.5 Concluding remarks 3.5 Concluding remarks CHAPTER 4. TRANSACTION PRIORITIZATION AND CONTENTION TRANSPARENCY CHAPTER 4. TRANSACTION PRIORITIZATION AND CONTENTION TRANSPARENCY Transaction Prioritization and Contention Transparency 4.1 Methodology 4.2 On contention transparency 4.3 On prioritization transparency 4.4 Concluding remarks Transaction Prioritization and Contention Transparency 4.1 Methodology 4.2 On contention transparency 4.3 On prioritization transparency 4.4 Concluding remarks Transaction Prioritization and Contention Transparency Transaction Prioritization and Contention Transparency 4.1 Methodology 4.1 Methodology 4.2 On contention transparency 4.2 On contention transparency 4.3 On prioritization transparency 4.3 On prioritization transparency 4.4 Concluding remarks 4.4 Concluding remarks CHAPTER 5. DECENTRALIZED GOVERNANCE CHAPTER 5. DECENTRALIZED GOVERNANCE Decentralized Governance 5.1 Methodology 5.2 Attacks on governance 5.3 Compound’s governance 5.4 Concluding remarks Decentralized Governance 5.1 Methodology 5.2 Attacks on governance 5.3 Compound’s governance 5.4 Concluding remarks Decentralized Governance Decentralized Governance 5.1 Methodology 5.1 Methodology 5.2 Attacks on governance 5.2 Attacks on governance 5.3 Compound’s governance 5.3 Compound’s governance 5.4 Concluding remarks 5.4 Concluding remarks CHAPTER 6. RELATED WORK CHAPTER 6. RELATED WORK 6.1 Transaction prioritization norms 6.1 Transaction prioritization norms 6.2 Transaction prioritization and contention transparency 6.2 Transaction prioritization and contention transparency 6.3 Decentralized governance 6.3 Decentralized governance CHAPTER 7. DISCUSSION, LIMITATIONS & FUTURE WORK CHAPTER 7. DISCUSSION, LIMITATIONS & FUTURE WORK 7.1 Transaction ordering 7.1 Transaction ordering 7.2 Transaction transparency 7.2 Transaction transparency 7.3 Voting power distribution to amend smart contracts 7.3 Voting power distribution to amend smart contracts Conclusion Conclusion Appendices Appendices APPENDIX A: Additional Analysis of Transactions Prioritization Norms APPENDIX A: Additional Analysis of Transactions Prioritization Norms APPENDIX B: Additional analysis of transactions prioritization and contention transparency APPENDIX B: Additional analysis of transactions prioritization and contention transparency APPENDIX C: Additional Analysis of Distribution of Voting Power APPENDIX C: Additional Analysis of Distribution of Voting Power Bibliography Bibliography In this chapter, we discuss some consequential points that follow from the prior chapters, mention the limitations of our work, and explore avenues for future work. 7.1 Transaction ordering Our findings have significant implications for both bitcoin users and miners. Bitcoin users (using their wallet software) typically assume complete transparency regarding the fees associated with competing transactions when setting fees for their own transactions. However, our results challenge this common assumption. Similarly, the practice of transactions having different confirmation fees for different miners raises notable fairness concerns. Furthermore, our findings also call for a community-wide debate on defining transaction prioritization norms and enforcing them transparently. Specifically, we highlight three challenging questions that need to be addressed for the future. What are the desired transaction prioritization norms in public proof-of-work blockchains? What aspects of transactions besides fee rate should miners be allowed to consider when ordering them? For instance, should the waiting time of transactions also be considered to avoid indefinitely delaying some transactions? Should the transaction value (i.e., amount of bitcoins transferred between different accounts) be a factor in ordering, as fee rate based ordering favors larger value over smaller value transactions? Similarly, while we did not find evidence of miners decelerating or censoring (i.e., refusing to mine) transactions, the current protocols do not disallow such discriminatory behaviors by miners. Should prioritization norms also explicitly disallow discriminating transactions based on certain transaction features like sending or receiving wallet addresses? Such norms would be analogous to network neutrality norms for Internet Service Providers (ISPs) that disallow flows from being treated differently based on their source/destination addresses or payload. What are the desired transaction prioritization norms in public proof-of-work blockchains? What are the desired transaction prioritization norms in public proof-of-work blockchains? How can we ensure that the distributed miners are adhering to desired and defined norms? Miners in public proof-of-work blockchains, such as Bitcoin and Ethereum, operate in a distributed manner, over a P2P network. This model of operation results in different miners potentially having distinct, typically different, views of the state of the system (e.g., set of outstanding transactions). Given these differences, are there mechanisms (say, based on statistical tests (Asayag et al., 2018; Lev-Ari et al., 2020; Orda and Rottenstreich, 2019)) that any third-party observer could use to verify that a miner adheres to the established norm(s)? How can we ensure that the distributed miners are adhering to desired and defined norms? How can we ensure that the distributed miners are adhering to desired and defined norms? How can we model and analyze the impact of selfish, non-transparent, collusive behaviors of miners? While the above themes align well with a long-term vision of defining and enforcing well-defined ordering norms in blockchains, in the short term one could focus on examining the implications of the norm violations in today’s blockchains. Specifically, how can we characterize the ordering that would result from different miners following different prioritization norms, especially given an estimate of miners’ hashing or mining powers (i.e., their likelihood of mining a block). Such a characterization has crucial implications, for example, for Bitcoin users. How can we model and analyze the impact of selfish, non-transparent, collusive behaviors of miners? How can we model and analyze the impact of selfish, non-transparent, collusive behaviors of miners? 7.2 Transaction transparency In this section, we discuss the implications of transactions prioritization and contention transparency in blockchains. Initially, we highlight the importance of incorporating these aspects into blockchain design to fulfill the overarching goal of transparency. Subsequently, we explore the implications for publicly mined transactions. Then, we delve into the implications for privately mined transactions. Lastly, we emphasize that our implications hold both for before or after the introduction of two major improvements to blockchains: EIP-1559 and the Merge. Our results show that with private mining and accelerated transactions, the promise of the public decentralized blockchain does not hold. First, through the Bitcoin active experiment, we show that mining pools with combined hash rates of over 50% are colluding with each other, showing a centralization in the system. Further, these accelerated transactions are highly prioritized by the miners and included mostly on top of their blocks. This enables miners to also censor certain transactions, breaking the ethos of decentralized public blockchains with no central authority. Second, it breaks the assumption that all activities in the blockchain are transparent. Although this is true for transactions included in the blockchain, prioritization of transactions is becoming more opaque with the rise of private mining and off-chain fees. Hence, we make the case that to fulfill the transparency promise of public blockchains, prioritization of transactions should be transparent as well. Third, with private mining in Ethereum, Flashbots is increasingly being used for malicious and predatory activities such as sandwich attacks, which essentially levies a tax on users interacting with financial institutions on the blockchain (e.g., in DEX). These concerns need to be addressed if public blockchains are going to live up to their promises. Implications for publicly mined transactions. Most wallet software and cryptoexchanges today rely on reconstructing the current public Mempool state in order to suggest a suitable fee to transaction issuers. With the lack of contention and prioritization transparency, transaction issuers can no longer accurately recreate the current Mempool state for different miners. Consequently, they cannot reliably estimate the fees transactions need to pay for their desired prioritization. Worse, as the fraction of privately mined and accelerated transactions keeps rising, the transaction fees will become less (reliably) predictable in the future. Implications for publicly mined transactions. Implications for publicly mined transactions. Implications for privately mined transactions. The problem of reliable fee estimation for a desired level of prioritization is even worse for privately mined transactions that are announced on private relay networks. When transaction issuers announce on a private relay network today, they are often unsure what fraction of total network power is controlled by the miners listening to the private relay network. Hence, it is important to estimate the network power controlled by private mining pools to estimate the commit (waiting) times for transactions. Furthermore, transaction issuers on private relay networks are completely blind to other competing transactions. This opacity allows miners offering private mining and transaction acceleration services to overcharge and demand exorbitant fees to commit transactions. For example, in the Ethereum blockchain, users are observed to be overcharged by miners for having their transactions confirmed with high priority through Flashbots bundles (Weintraub et al., 2022). Implications for privately mined transactions. Implications for privately mined transactions. Relevance of findings in light of EIP-1559 and the Ethereum Merge. Our observations about the lack of transparency and their implications are fundamental to the current blockchain architectures and hold both before and after the recent major improvements to blockchains, e.g., EIP-1559 and the Ethereum Merge. While EIP-1559 attempts to improve the estimation of transaction fees that need to be offered, it does not address the problems associated with the lack of transaction contention and prioritization transparency. Similarly, after the Ethereum Merge, validators that stake a certain amount of Ether (ETH) rather than miners would be responsible for selecting and validating transactions to include in the next block (Ethereum Foundation, 2022a). Our observations about private mining would still hold for private validation and the implications would still be valid after the Merge. Relevance of findings in light of EIP-1559 and the Ethereum Merge. Relevance of findings in light of EIP-1559 and the Ethereum Merge. 7.3 Voting power distribution to amend smart contracts An inherent concern in the governance of blockchain networks revolves around the concentration of governance tokens among a select group of participants. This situation can potentially pose a threat to the protocol and compromise its integrity, especially if the voting power or authority to make important changes is proportional to the amount of tokens held by each participant. This issue was highlighted in the case of Balancer, a decentralized exchange (DEX) built on top of Ethereum. In this example, a user with a significant amount of governance tokens voted for decisions that were beneficial to the user but detrimental to the protocol (Haig, 2022). Therefore, this scenario of a minority holding a significant amount of tokens can lead to a centralization of decision-making power, which is contrary to the goal of decentralizing governance protocols. While governance protocols in blockchains aim to eliminate (or at least minimize) centralized decision-making, our work reveals that Compound is not effectively achieving its intended goal. The distribution of tokens, which corresponds to voting power, plays a crucial role in determining the level of decentralization in a protocol. Our work highlights the importance of measuring and analyzing governance protocols to ensure that they are working as intended. In addition, this work motivates further research in this area. For example, our empirical evidence supports recent proposals to redefine voting power based on social rewards, such as a voter’s reputation or contributions to the protocol (Guidi et al., 2021; Liu et al., 2022; Sharma et al., 2023), or the use of a quadratic voting scheme, where voting power is calculated as the square root of the number of tokens held by voters (Buterin et al., 2019b; Lalley and Weyl, 2018). In light of our findings, we argue for integrating these insights into the design of future governance protocols. There, we can effectively increase fairness and decentralization within these protocols. In addition, it would also be interesting to analyze other widely used governance protocols, such as Uniswap, to ensure that these governance protocols are truly decentralized. Author: (1) Johnnatan Messias Peixoto Afonso Author : Author (1) Johnnatan Messias Peixoto Afonso This paper is available on arxiv under CC BY 4.0 DEED license. This paper is available on arxiv under CC BY 4.0 DEED license. available on arxiv available on arxiv