Sei for market makers and MEV: batch auctions on an on-chain orderbook
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Explains how Sei's native CLOB, parallel order matching, optimistic block processing and frequent batch auctions aim to reduce HFT stale-order picking and MEV, and why Sei plans Flashbots-style auctions for value accrual.
Key claims
Frequent batch auctions reduce the value of tiny speed advantages and limit front-running
Sei plans a Flashbots-style private auction so bribes converge to opportunity value
A chain with sub-penny fees has no path to token value accrual without capturing MEV
0/ @SeiNetwork is a highly anticipated general purpose L1 launching in 2023 & primed to enable next-gen apps. Its built-in features will change the #DEX game forever 馃寠
a 馃У on how $SEI is optimized for market makers & MEV in the context of on-chain #orderbook DEXes 馃殺
(0/31)馃憞
1/ if you're not familiar with @SeiNetwork yet, make sure to check out my deep dive thread below 馃憞
x.com/expctchaos/status/1672271431684751367
2/ @SeiNetwork is bringing on-chain orderbooks back into the spotlight. Compared to the relatively simple smart contracts behind AMMs, building on-chain #orderbooks is challenging
3/ unlike off-chain #orderbooks, recording every executed transaction and order on-chain leads to congestion, slower transactions, and higher fees. @SeiNetwork, a permissioned #L1 blockchain optimized for #DeFi, aims to address these challenges
4/ while it has garnered interest from #AMMs and #NFT marketplaces, its central limit order book (CLOB) makes it particularly suitable for orderbook #DEXs
5/ unlike order-book #DEXs built on generic purpose blockchains like #Serum and #Solana, @SeiNetwork's orderbook (natively integrated in the L1) is built from scratch, allowing for customization of consensus mechanisms & order sequencing to optimize trading
6/ while this is not a game-changer in itself, it opens up novel possibilities for addressing the nuanced issues of #HFTs and #MEV in a more effective manner
7/ in this 馃У we will dive into these optimizations for market makers & #MEV
let's get started with the market maker side of things 馃憞
8/ In order for both centralized and #decentralized order books to function effectively, liquidity is crucial. The majority of this liquidity is provided by high-frequency traders (HFTs), who serve as market makers
9/ #HFTs utilize sophisticated algorithms to analyze vast amounts of data across various markets and swiftly execute a significant number of orders within seconds
10/ high-frequency traders (#HFTs) play an important role in driving market liquidity
a typical scenario: #HFTs, using sophisticated algorithms, analyze massive amounts of data across markets, executing vast orders within seconds, capitalizing on price discrepancies
11/ HFTs' speed is crucial for profit. To get an edge, they invest in advanced technologies like microwave towers and FPGAs, enabling them to execute trades in nanoseconds. They play a significant role in market stability by filling price gaps and balancing markets
12/ however, #HFTs play a dual role. They provide liquidity, beneficial for markets, and engage in stale order picking - not so beneficial and potentially harmful to end users
13/ enter $SEI order processing mechanism which incentives liquidity while eliminating the harmful aspects
14/ existing blockchains struggle to match the high throughput needed for Continuous Double Action (CDA) used by centralized exchanges. These chains use sequential execution, limiting throughput, leading to high gas fees, especially when network usage spikes
15/ this is where parallel processing comes into play. @SeiNetwork employs parallelism to cater to #DeFi use-cases, boosting throughput by allowing order matching for different markets to run simultaneously, also adopting optimistic block processing to decrease block latency
16/ in typical #Tendermint Core, validators execute state changes after the precommit message is sent, which can increase latency. $SEI overcomes this by processing state changes optimistically, applying them to a temporary state, thus enhancing throughput and reducing latency
17/ next, let's discuss the impact of wider spreads on continuous time limit-order books
in such markets, there's a race to respond to any news event that is publicly and symmetrically observable. The speed here can have significant implications on the market
18/ now imagine you're an #HFT with a resting order above the current market price
a significant price surge could render your order stale. In a continuous market, other #HFTs might rush to pick off your quote. This risk results in wider bid-ask spreads
19/ @SeiNetwork's solution? Frequent Batch Auctions (FBA). Here, orders are batched and accepted over a discrete period of time
20/ orders aren't published to the #orderbook until after the batch auction, eliminating front-running opportunities. The benefit? It reduces the value of tiny speed advantages
21/ @SeiNetwork's use of FBA also disincentivizes the unnecessary competition of buying up advanced tech for speed advantages. Competition now drives the price to its new correct level. Thus, Sei optimizes its order processing for deep liquidity provision on its orderbook (CLOB)
22/ now that we understand the optimizations on the market maker side, let's move on to Maximal Extractable Value (MEV), which refers to the multi-billion dollar market for transaction inclusion, prioritisation, reordering, and bundling 馃憞
23/ #MEV exploitation can lead to 'frontrunning', where transactions with higher gas prices get mined before pending ones
24/ #MEV can also lead to 'sandwich attacks', which result in increased slippage and worse execution for victim traders. MEV extraction is becoming increasingly centralized, going against the core principles of blockchain - permissionlessness and decentralisation
25/ while Frequent Batch Auctions partially address MEV, they don't entirely eliminate the problems between blocks. If the #MEV in one block exceeds the standard block reward, validators may be incentivized to reorganize blocks, causing consensus instability
26/ @SeiNetwork aims to manage #MEV for the benefit of users and investors. They plan to use a Flashbots style auction where transactions are privately submitted, leading to a more democratised and transparent process. They aim to redirect the revenue flows to better places
27/ most chains rely on transaction fees and most #DEXs rely on trading fees. But as fees will eventually converge to zero, a chain with sub-penny transaction fees for organic users has no path to meaningful value accrual for token holders. That's where $SEI plans to be different
28/ @SeiNetwork's model would see more opportunities become well-known and more searchers compete for the same opportunity. As a result, the price of the bribe converges to the price of the opportunity, allowing validators/delegators to capture more of the total #MEV revenue
29/ in summary, @SeiNetwork's unique appeal lies in how it orders and processes transactions to optimize liquidity and fees. Their Central Limit Order Book allows transaction processing and ordering mechanisms to narrow spreads, maximize liquidity, and effectively manage #MEV
30/ while discussions on democratizing consumer finance are compelling, fundamental technological innovation is the real driver of change. With mechanisms like Frequent Batch Auctions, @SeiNetwork has the potential to crack the liquidity vs. revenue puzzle that all #DEXs face
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