Understanding Order Flow Auctions

An introduction to Order Flow Auctions: What they are, how they work, and the levels on which they’re implemented.

In a recent presentation, we took a deep-dive into the specifics of Order Flow Auctions (OFA) in the Ethereum ecosystem. In this article, we summarize the insights and findings we’ve gathered from developing two Order Flow Auctions across different stacks within the Ethereum transaction supply chain.

What is an Order Flow Auction?

Order Flow Auctions (OFAs) are mechanisms designed to optimize transaction settlements. The key feature of OFAs is a competitive bidding system that relies on third parties. This ensures that users capture as much value from each transaction as possible and don’t fall prey to Maximal Extractable Value (MEV).

The Order Flow Auction Process Explained

OFAs involve a multi-step process:

• Gathering Orders: Initially, orders from multiple users are collected and grouped
• Auction Initiation: These orders are then presented to the auctioneer, initiating the auction
• Bid Optimization: Bidders assess the orders within the auction and optimize their execution based on specified criteria
• Selecting Winning Bids: The auctioneer selects the winning bids based on the defined objectives
• On-Chain Settlement: The winning bids are pushed on-chain, along with all the orders included in the auction, moving on to the next stage of the supply chain

Factors Considered in an Order Flow Auction

Order Flow Auctions must consider several crucial factors:

• Types of Orders: Distinguishing between intents and actual transactions is critical. Intents are fully composable, allowing for optimization and flexibility. Transactions, on the other hand, don’t allow any additional optimizations
• Settlement Rights: Deciding who has settlement rights — public, permissioned, or private — affects the auction’s dynamics
• Bid Objectives: Determining whether the auction aims to maximize or minimize MEV plays a pivotal role in how it takes place
• Information Sharing: The degree of information sharing with bidders — full access, partial, or obfuscated — may impact the auction’s integrity

3 Levels of Order Flow Auctions in the Ethereum Stack

OFAs can take place at various levels of the Ethereum stack

OFAs can be analyzed at three distinct implementation levels:

• The dApp
• The Builder
• The Validator

Each presents unique opportunities for optimizations.

The dApp stage is where users interact with the blockchain for the first time. Thus, it represents the first opportunity for OFAs to take place. This stage holds significant potential for improving the outcomes of transactions significantly in advance of them going on-chain.

The builder stage represents the second stage of potential implementation. Here, a private mempool can be set up that protects transactions from potential value losses. This stage focuses on concrete goals, such as application-oriented targets, or maximizing user benefits.

The final level is the validator stage. Here, there is an opportunity for validators to auction off the entire block to builders with the hopes of including the most profitable transactions. This stage optimizes for transaction value, rather than the goals of particular users or applications.

Types of Order Flow Auctions

There are three primary types of Order Flow Auctions:

• RFQ (Request for Quote) Auctions: RFQs are optimized for price discovery, so they are particularly suited to market makers offering quotes for swaps. These auctions help facilitate price discovery through a system of bidders quoting swaps and market makers using private inventory to offer better prices than automated market makers (AMMs)
• Frequent Batch Auctions: A combination of price discovery, price optimization, and settlement path, Frequent Batch Auctions enable multi-dimensional intent matching. This, in turn, allows for trade optimizations not available through other mechanisms and complete protection from MEV thanks to peer-to-peer trading
• Block Space Aggregator Auctions: Unlike other auctions that focus on price discovery and execution, Block Space Aggregator Auctions provide value to the user through post-trade rebates. These rebates come from capturing value that likely would have leaked out at the last stage of the supply chain

Let’s take a look at two well-known implementations of Order Flow Auctions developed by CoW DAO.

MEV Blocker RPC: Enhancing privacy and fairness at the block builder level

MEV Blocker is an RPC endpoint that facilitates an Order Flow Auction at the builder level. Its primary objectives are to provide privacy, expedite transaction inclusion, and offer protection from MEV. MEV Blocker protects user transactions from the worst types of MEV, but it goes a step further by capturing backrunning opportunities and providing rebates. Users receive up to 90% of the value of any backrunning opportunity they create before MEV bots can take it for themselves.

MEV Blocker offers several versions of its RPC endpoint, catering to different user-bases

MEV Blocker offers three main endpoints:

• Fast: Focuses on fast transaction inclusion with the possibility of a backrunning rebate
• No Reverts: Guarantees transaction execution without reverts, prioritizing security over speed
• No Rebates: Maximizes privacy and speed but does not provide rebates

Just 6 months after launch, MEV Blocker has already protected 387,000 users, 7 million transactions, and $21 billion in DEX volume.

CoW Swap: Better execution through intents and batch auctions at the dApp level

CoW Swap is an Order Flow Auction operating at the dApp level. It relies on intents, which hardcode transaction outputs, in order to prevent MEV exploits. CoW Swap aims to protect users from MEV, enhance liquidity, offer fair pricing, and optimize fee consumption.

A timeline of an order on CoW Swap:

• Users express an intent to trade
• Intents are registered in the orderbook
• The protocol initiates a batch auction
• Solvers optimize the trades within the batch auction
• The protocol selects the winning solvers
• Transactions are pushed on-chain, and users receive their tokens

CoW Swap’s efficiency lies in bundling multiple transactions into one which reduces block congestion and requires less gas. It also ensures uniform clearing prices for liquidity pools, promoting fairness and balanced liquidity.

The Future of Order Flow Auctions

Order Flow Auctions have the potential to benefit Ethereum users through better price discovery, lower transaction costs, more liquidity, and fewer opportunities for exploitation. The key features of OFAs are transparency and a competition mechanism that ensures only the best outcomes prevail.

CoW DAO is showcasing the power of OFAs through MEV Blocker and CoW Swap, two products that protect users from MEV and optimize block space usage.

The Impact of MEV Blocker and CoW Swap

So far, these products have had a profound impact.

MEV Blocker has protected over $21 billion in trading volume across 387,000 users from MEV and has returned over 475 ETH in rebates (for an updated version of these stats, check out the MEV Blocker Dune dashboard.)

CoW Swap, meanwhile, has optimized and protected around $29 billion in trading volume across 747,000 users, returning over $136M in surplus (for an updated version of these stats, make sure to check the CoW Swap Dune dashboard).

These figures highlight the essential role that OFAs play in enhancing the Ethereum ecosystem.

In conclusion, as the blockchain space continues to evolve, Order Flow Auctions are emerging as a crucial tool for achieving fairness, efficiency, and transparency. CoW DAO’s innovative solutions offer promising glimpses into a future where users can trade with confidence in a secure and friendly environment.