Front-Running, Smart Contracts, and Candle Auctions

Abstract

Blockchain implementations of auctions have to deal with the problem of front-running: block production happens at discrete intervals, and anyone can inspect and react to the incoming bids before they are written on chain. The presence of smart contracts among bidders, a hallmark of automated blockchain environments, renders current cryptographic solutions infeasible and essentially precludes static auctions. Moreover, their transparent nature makes smart contracts susceptible to shill bidding in strategy-proof auctions more generally. As a remedy, this paper considers an ascending auction with a random ending time --- a so-called candle auction. Time is discrete and in every round, the bidders bid sequentially and in a fixed order. The bidder with the highest bid at the end of the decisive round wins the auction and pays her bid. We show that an appropriately chosen ending time distribution mitigates the main problems of front-running: low revenue, reduced utility when being front-run, and limited efficiency.

Keywords: auctions, blockchains, front-running, random ending time

JEL Classification: D44, D82, G29, C72