a16z: DeFi surpasses CeFi, and predictability is key

Author | Pranav Garimidi, Joachim Neu, Max Resnick

Translation | Luffy, Foresight News

Blockchain can now confidently claim that it has the capability to compete with existing financial infrastructure. Current production systems process tens of thousands of transactions per second, with future performance expected to improve by orders of magnitude.

But beyond raw throughput, financial applications also require predictability. When a transaction is initiated—be it a trade, an auction bid, or an option exercise—reliable assurance of on-chain inclusion timing is essential for the normal operation of financial systems. If transactions face unpredictable delays, many applications become unusable. To make on-chain financial applications competitive, blockchains must provide short-term guarantees: once a valid transaction is submitted to the network, it should be assured to be packaged into a block as soon as possible.

For example, on-chain order books operate this way. An efficient order book requires market makers to continuously provide liquidity by placing buy and sell orders. The core challenge for market makers is: how to minimize bid-ask spreads while avoiding adverse selection caused by quotes diverging from the market. To do this, market makers must constantly update orders to reflect the latest market conditions. For instance, when the Federal Reserve announces a major policy change causing asset prices to fluctuate sharply, market makers need to respond immediately by updating their orders to the new prices. If the transactions used to update orders cannot be instantaneously included on-chain, arbitrageurs can trade at outdated prices, causing losses for market makers. In such cases, market makers might widen spreads to reduce risk, which diminishes the competitiveness of on-chain trading platforms.

A predictable transaction inclusion mechanism would provide reliable guarantees for market makers, enabling them to respond swiftly to off-chain events and maintain efficient on-chain markets.

Gap Between Current State and Goals

Most mainstream blockchains today only offer finality guarantees, often with confirmation times measured in seconds. Such guarantees are sufficient for payments and similar applications but fall short for most financial applications that require real-time responsiveness from market participants.

Returning to the order book example: for market makers, a “guarantee of inclusion within a few seconds” is meaningless; what matters is that their transactions can be included earlier by a more prompt block. Without strong inclusion guarantees, market makers can only hedge risks by widening spreads and offering worse quotes to users. This makes on-chain trading less attractive compared to platforms with stronger guarantees.

If blockchain is to truly realize its vision as the backbone of modern capital markets, developers must address these issues, enabling high-value applications like order books to thrive.

Why Is Achieving Predictability Difficult?

Enhancing transaction inclusion guarantees on existing blockchains to support such scenarios is highly challenging. Some protocols rely on a single node (block producer) to decide the transaction order within a specific window. While this simplifies high-performance blockchain design, it also creates a potential economic monopoly point—block producers can extract value through this control.

Typically, during the window when a node is elected as the block producer, it has full control over which transactions are included in the block.

For blockchains hosting significant financial activity, block producers hold privileged positions. If such a node refuses to include a transaction, users must wait for the next willing block producer. In permissionless networks, block producers are inherently motivated to extract value, known as MEV (Maximal Extractable Value).

MEV is far more than just sandwich attacks. Even delaying block inclusion by tens of milliseconds can generate huge profits and reduce the efficiency of underlying applications. An order book that prioritizes only certain traders’ orders creates an unfair environment for others. Worst case, malicious block producers could cause traders to abandon the platform altogether.

Suppose an interest rate hike is announced, causing ETH prices to drop 5% instantly. All market makers on the order book rush to cancel existing orders and re-list at the new prices. Meanwhile, arbitrageurs submit orders to sell ETH at outdated prices.

If the order book operates on a single block producer protocol, that node wields enormous power. It could choose to censor all cancellations by market makers, allowing arbitrageurs to profit; or delay cancellations to let arbitrage trades execute first; or even insert its own arbitrage orders to profit from price deviations.

Two core demands: censorship resistance and information hiding

In such a scenario, active participation by market makers becomes uneconomical; any price movement could be exploited. The fundamental problem stems from two privileges of block producers:

• The ability to censor others’ transactions;
• The ability to see others’ transactions and act accordingly.

Either of these issues can lead to disastrous outcomes.

An Example

Let’s illustrate this precisely with an auction scenario. Suppose two bidders, Alice and Bob, and Bob happens to be the block producer for the auction’s block. (This example can be generalized to any number of bidders.)

The auction accepts bids within a block production cycle, say from time 0 to time 1. Alice submits bid bA at time tA, Bob submits bid bB at a later time tB. Since Bob is the block producer, he can always ensure he acts last.

Both can access a continuously updated price source (e.g., a centralized exchange’s mid-price), with pₜ representing the price at time t. We assume that at any time t, both parties expect the asset’s price at auction end (t=1) to be equal to the current price pₜ. The auction rule is simple: highest bid wins and pays their bid.

Necessity of Censorship Resistance

If Bob can use his block producer privilege to censor Alice’s bid, the auction mechanism collapses. Bob can bid any low price to guarantee victory, making the auction’s revenue nearly zero.

Necessity of Information Hiding

A more complex scenario: Bob cannot directly see Alice’s bid, but can observe her bid before submitting his own. In this case, Bob can adopt a simple strategy:

• If the current price pₜ_B > bA, bid slightly above bA;
• Otherwise, abstain from bidding.

This strategy forces Alice into adverse selection: she can only win if her bid exceeds the expected asset value, which would mean a loss, prompting her to withdraw. Once all competitors exit, Bob can bid very low and win, again yielding near-zero profit.

The core conclusion: the duration of the auction doesn’t matter. As long as Bob can observe or censor Alice’s bid, the auction is doomed.

This logic applies equally to high-frequency trading scenarios, including spot, perpetual, and derivatives exchanges: if block producers have the privileges described, markets will be fundamentally broken. For on-chain products to be viable in such environments, they must not grant such privileges to block producers.

Why Haven’t These Issues Exploded in Reality?

The above analysis paints a bleak picture of permissionless protocols with single block producer nodes, yet many decentralized exchanges (DEXs) built on such protocols still see substantial trading volume. Why?

In reality, two forces mitigate these problems:

• Block producers often hold large amounts of native tokens, tightly coupled with the success of the blockchain, reducing incentives for abuse;
• Application layers have developed workarounds to reduce their vulnerability to these issues.

While these factors have allowed DeFi to operate relatively normally so far, they are insufficient for long-term competitiveness against off-chain markets.

On active public blockchains, becoming a block producer requires substantial staking. Nodes are either large token holders or trusted entities with enough reputation to be delegated by others. In either case, large node operators tend to be reputable, well-known entities. Staked assets also incentivize maintaining the health of the blockchain. As a result, outright abuse of power by nodes has not yet become widespread, but this does not mean the problem is nonexistent.

First, relying on node operators’ goodwill, social pressure, and long-term incentives is not a reliable foundation for future finance. As on-chain financial activity grows, the potential profits for nodes increase proportionally. The greater the temptation, the weaker the social pressure to prevent short-term misconduct.

Second, the degree of abuse by nodes exists on a continuum—from mild behaviors to outright market destruction. Nodes might unilaterally expand their privileges step by step for higher profits. Once someone crosses a line, others