Ethereum, darkish forests and the bounds of transparency
"The Mempool is a dark forest," proclaimed Ryan Sean Adams, author of the Bankless newsletter. And he paints a picture of a dangerous place full of predators – arbitrage bots, front runners and the like:
“They're hiding in the mempool, waiting to be attacked. They monitor all transactions with the intention of exploiting them. When profitable opportunities arise? You rush. "
Frances Coppola, a CoinDesk columnist, is a freelance banking, finance, and business speaker and writer. Her book "The Case for People's Quantitative Easing" explains how modern money creation and quantitative easing work and advocates "helicopter money" to help economies out of recession.
Creepy stuff. There's only one problem. What Adams describes is not a dark forest. It's a floodlit level.
By definition, crypto markets are illuminated markets. This is how predators can see the prey coming. The prey can see them too – but the prey cannot escape. When you send an Ethereum transaction, it has to wait in this mempool until a miner picks it up. There is nowhere else to go. In order to coin a sentence, it is a "sitting duck". Any predator in the pool can see it. It will inevitably get replicated, run from scratch, or otherwise stolen. The wonder is that legitimate transactions are ever verified.
Perhaps we should think of the Mempool as a desert instead of a dark forest. The sun shines relentlessly on it and there is no place to hide. And it's full of snakes. A recent documentary released by the BBC filmed baby iguanas emerging from their eggs into the blinding light of the desert floor and then walking the glove of a multitude of snakes.
Although they managed to escape the snakes, few managed: they were constantly ambushed, and one wrong or faltering step was fatal. Few made it to the top of the hill that the snakes could not reach. The miracle is that anyone did it at all.
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In my opinion this is more similar to the mempool. A desert, dazzlingly lit and full of predators. However, unlike baby iguanas, Ethereum transactions cannot escape the snakes.
You might think if baby iguanas – or Ethereum transactions – can't escape the snakes, they don't deserve to survive. It's the survival of the strongest, isn't it? No doubt that is how the snakes see it. After all, they are only interested in a free lunch. They would love to kill and eat all of the iguanas.
But that's not intelligent. Smart snakes would understand that some of the iguanas need to survive, not because iguanas are important, but because snakes do. When the surviving iguanas grow up, they will return to this location to lay their eggs, ensuring a future supply of free lunches for snakes and their offspring.
The crypto world avoided trust in favor of transparency. However, transparency does not solve the problem of unreliability in financial markets.
If some Ethereum transactions run successfully without being redone, copied, or stolen, then Ethereum transactions will still be issued. But if the snakes kill and eat all of the iguanas, there will be no adults to lay eggs. And when the Mempool predators devour all or almost all of the Ethereum transactions, people will stop using Ethereum. There are no more free lunches. All snakes that have left to eat are one another.
Every human system replicates the natural world in some way, and crypto is no exception. Unrelenting transparency makes markets inefficient and socially unproductive because legitimate investors are crowded out by speculators. Legitimate investors need to find ways to hide from or escape the speculators. If it doesn't, there will ultimately be no legitimate investors, just arbitrageurs trying to overtake each other. The ecosystem will feed itself.
So there is a need for “safe spaces”. Dark places, protected from the eyes of predators. Small creatures hide in the safety of their dark burrows when the falcon flies. Mammals and marsupials create inner safe spaces for their young. Birds create safe spaces in their nests. Reptiles create safe spaces by burying their eggs. Security is in the dark. Lighted places are dangerous places.
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Yet dark places are also dangerous. Predators in lighted markets have to be very quick to escape their prey. But predators in dark markets don't need speed. All they have to do is hide in the shadows and wait for a tasty meal to find its way. A dark market for predators to enter is not a safe place for legitimate investors.
When conventional “lighted” markets were crowded with HFT bots, investment banks offered large investors “dark pools” in which they could trade with one another without the risk of being led by algae. But Barclays allowed HFT bots into its dark pool, where they happily led unsuspecting investors who thought they were safe. Eventually Barclays was caught and forced to empty its dark pool. A $ 70 million fine was fined for fraud in 2016. It wasn't the only big bank that took money from big investors to protect them from HFT bots and money from HFT traders to give them access to the investors they were supposed to protect.
Crypto's transparency should eliminate the need for trusted third parties like Barclays. However, if transactions cannot clear the mempool without being re-executed, copied, or stolen, users will inevitably try to find ways to escape from the mempool. And these avenues are likely to involve trusted third parties – though perhaps not investment banks.
In “Ethereum is a dark forest”, DeFi investors Dan Robinson and Georgios Konstantopoulos describe how they tried to escape the snakes in the mempool. Unfortunately, they only managed to draw attention to the money they were trying to claim, which of course hadn't been claimed by anyone else because everyone knew the snakes would get there first.
Robinson and Konstantopoulos had some useful advice for would-be iguanas, particularly "snakes are real" (although they call them "monsters") and "stick to the plan". But it was this paragraph that caught my eye:
"Better still, if you happen to know a miner (we didn't) you could get him to put the transaction straight into a block and skip the mempool – and monsters – entirely."
A trusted third party could throw their iguana straight onto the rocks.
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There is clearly a profit opportunity here for miners. Some are no doubt already taking advantage of it. But those who would rely on the helping hands of seemingly friendly miners might want to remember what happened to the investors who trusted Barclays.
After all, it is the survival of the fittest in the crypto world. And no one will prosecute a miner for fraud if you pay them to pick up your trade early, but they'll just delay until they're on top. In the crypto world, even more than in conventional markets, there is no “trustworthy third party”. If you trust someone, you are likely to get ripped off.
The crypto world avoided trust in favor of transparency. However, transparency does not solve the problem of unreliability in financial markets. Trusted third parties may not exist in fully lit markets, but there is also no protection from predators. Now the crypto world seems to be swinging towards trust again. But in a world where dogs eat dog or snakes eat iguana, who can you really count on?