With the help of Derek Robertson and Ryan Heath
On Friday, I wrote about one unusual aspect of the crypto financial crisis: in side effects so that everything is played out on public blockchains.
But there is another, much less understood part of blockchain networks that can also are of great importance in times of crisis.
It’s called the mempool, and regulators will want to look into it as the market crash plays out, because it’s where a lot of under-researched market scams take place.
“Memory” is short for “memory,” and mempool is the place where each network node stores a list of pending cryptocurrency transactions. It is often compared to a “waiting room” – a place where transactions are waiting to be processed by a miner or validator, and then crystallized into a new block of data in the blockchain.
Like the blockchain itself, the mempool is a hallmark of the crypto universe. If I buy or sell, say, bitcoin, the transaction is not just cleared by the central clearing house, as is the case with traditional stock trading. Any node on the network can verify that the proposed transaction is valid and any miner can process it. But before it can be processed, it must wait for its turn – in the mempool.
Once a node confirms that the proposed transaction is valid, it relays it to other nodes, which add it to their mempools. Miners extract transactions from the mempool and add them to the next block in the block chain, leading the network to agree on which transactions occurred.
Most of the time, this process of queuing to enter the blockchain is relatively predictable and straightforward. You can pay to get the transaction done as soon as possible, but that’s part of the system. People who want to make sure their transaction is processed quickly offer higher “tips” to miners who prioritize their transactions. People who are slow offer smaller tips and they may wait longer before their transaction is included in a valid block.
But in the world of decentralized finance, or DeFi, in which loan agreements are encoded on blockchains, people make or lose a lot of money depending on the exact order in which transactions are processed.
And it is in this “pre-strike” part of the process, which includes the mempool, that juggling becomes faster and freer..
In this environment, the waiting room becomes more like a skirmish and experienced players have an advantage. “There are all sorts of predators lurking in the mempool,” said Matt Cutler, CEO of Blocknative, which specializes in pre-chain data.
For example, traders can look into mempools to see what transactions are pending and then trigger transactions based on expected price movement.
During a crisis like the one we’ve seen in recent weeks, mempool manipulation could have broader implications.
For example, in DeFi, smart contracts allow borrowers to place cryptocurrencies as collateral to secure their loans. If the price of this cryptocurrency starts to fall sharply, then the value of the placed collateral may fall so much that the smart contract will automatically make it suitable for liquidation. Cutler explained that this could lead to a race between the borrower (trying to post more collateral and keeping the loan active) and the liquidator (trying to liquidate to get some of the collateral) to get their transaction included in the next block.
In some cases, a savvy liquidator may pay additional fees to miners to ensure that their transaction is listed ahead of the borrower in the same block.
In the wild world of DeFi, this collateral could have been borrowed from retail investors who thought they were depositing their cryptocurrency into something like a high-yielding checking account from which they could withdraw their deposit at any time. Obviously, depositors cannot receive their crypto if the borrower has deposited it as collateral and then lost it. This is the dilemma faced by Celsius, which offered high yields on crypto deposits to retail investors but froze withdrawals last week as the market watched to see if the massive DeFi loan it had taken out would be liquidated.
Or a sharp fall in the price of cryptocurrencies could trigger a series of liquidations — a chain reaction that would further tug the market on. Whether that happens may depend on who wins the fight for the right place in the queue.
In some ways, these problems are similar to those that regulators have struggled with in traditional financial markets. It is prohibited for brokers to conduct transactions with shares ahead of time. The SEC fined operators of “dark pools” – private securities exchanges that often favored high-frequency traders – for misleading investors and failing to disclose information.
Regulators could try to play a similar scenario here by banning certain tactics — liquidators paying for a specific block position, for example — or by requiring off-chain trades between traders and miners to be disclosed in order to accommodate transactions.
But in places the mechanics of crypto markets are also different. Although, for example, only a small number of experts have access to and can comprehend the information in the mempool, this information is not confidential.
Thus, regulators may have to wait for a crisis – or several – to fully turn around to find out what all the new risks in the cryptocurrency markets and decentralized finance are. Once the post-mortems are written, there is a good chance they will delve into the depths of the mempool to find out exactly what happened.
“What happens in a chain is simply the result of an action,” Cutler said. “This is action.”
What if the future of cryptography is precisely opposite what do many of its most ardent supporters want – not a break with our existing institutions, but a tool to support them?
Bank for International Settlements – Bank of Central Banks – posted a report today it states that blockchain technology can become a powerful tool for financial markets, but only in the hands of central banks themselves.
“There are some useful features, but cryptocurrencies have built them into a very imperfect structure,” said Hyun Sung-shin, economic adviser and head of research at BIS. said Bjarke Smith-Meyer of POLITICO. “The whole building depends on the sale of coins to speculators.”
The value of these coins has, of course, decreased slightly in recent weeks. The current market downturn has shown that they have not been as useful as a hedge against inflation as many proponents have claimed, and it turns out that when things go awry, the boring old institutions begin to seem much more attractive than they are otherwise. – Derek Robertson
Canada’s largest tech conference and become the scene of major disputes over cryptocurrencies. The 35,000-strong Collision Conference, which fled to Toronto from New Orleans in 2019 after a dispute between conference organizers and the Trump administration’s immigration policy, began with an attack on tech titan Bill Gates.
At the first plenary session on Monday, Roham Garogozlow, CEO of blockchain gaming company Dapper Labs, accused Gates of criticizing crypto and NFTs.
“It’s very typical that people who have created a lot of value and created a lot of value in previous technology shifts tend to miss out on future technology shifts.” Garogozlu quipped, “I don’t worry too much about people who don’t see the future. I spend a lot of time with people who see the future, because these are the people who are building the future.”
Gates believes that these digital assets “100 percent based on the greater fool theory.” Bitcoin has lost about two-thirds of its value since November. 2021, and about 25% of its value in the last week.
The head of the Collision Conference, Paddy Cosgrove, said that many crypto speakers were unable to join the conference due to unrest in the sector, including Celsius, where $12 billion of client funds currently frozen. “It’s going down, very fast. There is a huge interest in understanding what is going on,” Cosgrove said.
“It’s a fundamentally unsound business model,” Tezos co-founder Kathleen Brightman said of Celsius during a discussion on cryptocurrencies, blaming that lender’s collapse on the “crypto can only grow” mindset: “That’s the culture that led to it. “ – Ryan Heath
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Stay in touch with the entire team: Ben Schrekinger ([email protected]); Derek Robertson[email protected]); Konstantin Kakaes (ur.[email protected]); and Heidi Vogt ([email protected]). Follow us on Twitter @DigitalFuture.
Ben Schrekinger writes for POLITICO on technology, finance and politics; he is a cryptocurrency investor.