Inside the ‘mempool,’ where crypto risks hide- POLITICO


With the help of Derek Robertson and Ryan Heath

On Friday, I wrote about an unusual aspect of the crypto-financial crisis: o side effects that everything unfolds in publicly visible blockchains.

But there is another part, much less understood, of blockchain networks that can too to acquire enormous importance in a crisis.

It’s called “mempool” and it’s something regulators will want to become familiar with as the market merger unfolds, because it’s the place where many unscrupulous market machinations fall.

“Mem” is the abbreviation for memory, and mempool is where each node in the network maintains a list of pending cryptographic transactions. It is often compared to a “waiting room”: the place where transactions wait to be processed by a miner or validator, and then crystallized into a new block of data in the blockchain.

Like the blockchain itself, mempool is a distinctive feature of the cryptographic universe. If I buy or sell, say, Bitcoin, the transaction is not only settled by a centralized clearing house, as it does in a traditional stock trading. Any node in the network can verify that a proposed transaction is valid and any miner can process it. But before you can process it, you have to wait your turn, in the mempool.

After a node verifies that a proposed transaction is valid, it passes it to other nodes, which add it to their mempools. Miners pull transactions from one mempool and add them to the next block in the blockchain, making the network agree which transactions occurred.

Most of the time, this process of queuing to enter the blockchain is relatively predictable and simple. You can pay to complete your transaction as soon as possible, but this is a widely understood part of the system. People who want to make sure their transaction is processed quickly offer higher “advice” to miners, who prioritize their transactions. People who are in no hurry offer a small tip and can wait longer to see their transaction included in a valid block.

But in the world of decentralized finance, or DeFi, where loan agreements are coded in blockchains, people make or lose a lot of money depending on the exact order in which transactions are processed.

And it is in this part of the “pre-chain” process, which includes the mempool, where the game becomes faster and freer..

In this environment, the waiting room becomes more like a scrum and sophisticated 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 could look in the mempools to see what transactions are pending, and then direct the transactions based on the expected price movement.

In a crisis, like the one we’ve seen in recent weeks, the game of mempool can also have far-reaching consequences.

For example, in DeFi, “smart contracts” allow borrowers to issue cryptocurrencies as collateral to secure their loans. If the price of that cryptocurrency starts to plummet, then the value of the published collateral could drop enough for the smart contract to automatically be eligible for settlement. That could create a rift between the borrower (who is trying to issue more collateral and keep the loan active) and the liquidator (who is trying to settle to get some of the collateral), to include his transaction in the next block, Cutler explained.

In some cases, an experienced liquidator might pay miners an additional fee to make sure their transaction is listed before the borrower in the same block.

In the wild world of DeFi, that guarantee could have been borrowed from retail investors, who thought they were depositing their cryptocurrency into a high-yield checking account, from which they could withdraw their deposit at any time. Obviously, depositors cannot withdraw their encryption if the borrower has released it as collateral and then lost it. That’s the dilemma Celsius faces, which offered retail investors high returns on cryptocurrencies, but froze withdrawals last week as the market watched whether a large DeFi loan it took would be settled.

Or the plummeting prices of cryptocurrencies could lead to a rash of settlements, a chain reaction that further melts the market. If this happens, it may depend on who wins the game to find the right place in the row.

In a way, these problems are similar to those faced by regulators in traditional financial markets. Stock trading was prohibited by brokers. The SEC has fined operators of “dark pools” – private stock exchanges that often favored high-frequency traders – for misleading investors and not making revelations.

Regulators may try to apply a similar manual here, banning certain tactics, such as liquidators paying for a specific position within a bloc, or requiring out-of-chain agreements between traders and miners to place transactions for disclosure.

But in some places the mechanics of cryptographic markets also differ. Although only a small number of experts are equipped to access and make sense of the information in the mempool, for example, that information is not private.

Therefore, regulators may have to wait for a crisis (or several) to fully develop to find out where all the new risks lie in the crypto markets and decentralized finance. When autopsies are written, there is a good chance that they will explore the depths of the mempool to find out exactly what happened.

“What goes into jail is just the result of the action,” Cutler said. “This is the action.”

And if the future of crypto is exactly the opposite what many of their most ardent supporters want: not a break with our existing institutions, but a tool to strengthen them?

The Bank for International Settlements – the bank of central banks – published a report today that says blockchain technology could be a powerful tool for financial markets, but only in the hands of the central banks themselves.

“There are some useful features, but cryptography incorporates it into a very flawed structure,” said Hyun Song Shin, economic adviser and head of BIS research. told Bjarke Smith-Meyer of POLITICO. “The whole building depends on selling coins to speculators.”

That value of those coins, of course, has meant a bit of a dip in recent weeks. The current market slowdown has shown that they were not as useful as a hedge against inflation as many proponents have claimed, and it turns out that when things start to go wrong, old institutions start to look boring. much more attractive than they would otherwise. – Derek Robertson

Canada’s largest technology conference is underway and becoming the scene of major cryptocurrency disputes. The 35,000-person Collision Conference, which fled Toronto from New Orleans in 2019 following a dispute between conference organizers and the Trump administration’s immigration policies, opened with an attack on tech titan Bill Gates.

At Monday’s opening plenary session, Roham Gharogozlou, CEO of blockchain gaming company Dapper Labs, turned to Gates for criticizing crypto and NFT.

“It’s very typical that people who have created a lot of value and created a lot of value in previous technological changes, tend to miss out on future technological changes.” Gharogozlou snapped and added, “I don’t care too much about people who don’t see the future. I spend a lot of time with people who see the future, because those are the people who build the future.”

Gates thinks those digital assets are “100 percent based on the biggest madman theory.” Bitcoin has lost about two-thirds of its value since November 2021 and about 25 percent of its value in the last week.

Collision Conference chief Paddy Cosgrove said many cryptographic speakers were unable to join the conference due to turbulence in the industry, including Celsius, where $ 12 billion in customer funds are currently frozen. “It’s going down, going down really fast. There’s a lot of interest in understanding what’s going on,” Cosgrove said.

“It’s a fundamentally inadequate business model,” Tezos CEO Kathleen Breitman said of Celsius during a panel on cryptocurrencies, blaming the collapse of this loan on the mentality of raising only cryptocurrencies: “This is the culture that led to this. … “ Ryan Heath

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Keep in touch with the whole team: Ben Schreckinger ([email protected]); Derek Robertson ([email protected]); Konstantin Kakaes ([email protected]); and Heidi Vogt ([email protected]). Follow us on Twitter @FuturoDigital.

Ben Schreckinger covers technology, finance and politics for POLITICO; is an investor in cryptocurrency.

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