After two weeks of frenzied bidding, Vignesh Sundaresan probably overpaid for Beeple's Everyday's NFT when he spent 42,329 ETH ($69mm) on the most expensive NFT ever.
This isn't a criticism of splashing cash on JPEGs - but a fact based on a phenomena in auctions known as the "Winner's Curse".
The idea is that every bidder has an estimate of the fair value of the Everyday's NFT, and we would expect that the average of the estimates to be pretty close to the true value.
The winner of the auction is the person that had the highest estimate of the fair value of the item (by definition), so it is highly likely that they overpaid! Oops.
Auctions can get surprisingly complex - they have their own branch of economics called Auction Theory, which tries to predict participant behavior and invent new types of fairer, more optimal auctions.
In 2020, Stanford economists Robert Wilson and Paul Milgrom were awarded the Nobel Prize for Economics for their contributions to the field - including a novel auction design used by the FCC to sell radio frequency rights.
At SIZE, we've been researching and building out the best ways to trade large amounts of tokens.
We've found there are heaps of auction types, each with their own strategies. Is it possible to win an auction and avoid being cursed? Let's run through some auction mechanisms.
Technically known as first-price ascending auctions, English Auctions are the most common auction variant.
The price goes up as the auction progresses, and the bidder who placed the highest bid at the end of the auction wins.
So what's the ideal strategy?
Imagine - you sold the top and you're in a bidding war for a holiday house.
In English Auctions, you get to hear other bidders call out their bids, which gives you a little bit more information about their valuation.
Are they bidding urgently? Small or large amounts above the last price? Do they seem like they're giving up?
Using other people's internal valuations as part of your own strategy will help you win the auction at a fair price and avoid overpaying.
In Dutch auctions, the bidding price starts high and gets lower and lower - the opposite of English auctions.
There are a few variants depending on what is being sold but generally, once all the items have been sold the auction is cleared at the lowest price.
Dutch auctions tend to be more efficient, as the item(s) are guaranteed to be sold as soon as the bid is placed, rather than having to have a back-and-forth war with other bidders.
Unlike English auctions, you're unable to see other bidders before you bid yourself - making it harder to be stirred up into a bidding frenzy and massively overpaying.
Dutch auctions have seen adoption in crypto from NFT sales to ICOs, like in the Solana token sale ($1.7mm), Algorand token sale ($60mm), and Illuvium Land sale ($72mm).
What would be your strategy in a Dutch auction? Do you have a price target in mind? Are you desperate to guarantee some tokens, or do you want to see how much of a discount you could get?
Since you don't have any information of other bidders directly through their bids, you can only estimate what other people are willing to bid with what little information you can glean and compare this against your own valuation.
Sealed Bid Auctions
Sealed bid auctions happen in two stages. First, each bidder submits the highest possible price they are willing to pay to the auctioneer, who keeps all these bids secret (which is why it's also known as a blind auction).
The auctioneer then selects the bidder willing to pay the highest amount, who wins the auction.
Interestingly, sealed bid auctions have the same ideal strategy as Dutch auctions - since your bids do not leak any information to other participants, you have to rely on your own internal value estimate to place your bids.
This sounds great in theory - but in practice, sealed bid auctions are used less than first-price auctions because of this reason. Most bidders prefer to have some idea of other bidders valuations in an auction to avoid overpaying.
Sellers also prefer open outcry auctions because if bidders aren't allowed to see other bids, they tend to underbid due to fear of overpaying - decreasing the fees they can take from an open outcry bidding frenzy.
Vickery Auctions are similar to sealed bid auctions but with a twist - the winner of the auction only pays the second-highest price. Named after Nobel laureate William Vickery, this type of auction is praised for its fairness and optimal strategy.
The dominant strategy in Vickery auctions is to simply bid your fair valuation, since the winner is guaranteed to pay their bid or lower. The auction winner with the highest valuation will win the auction at a discounted price!
However despite their theoretical superiority, Vickery auctions haven't seen widespread adoption is suspected to be driven by two reasons: first is general concerns of cheating in sealed bid auctions, and second is because bidders are reluctant to actually bid their true valuations - which is a required assumption for the auctions to work as intended.
At SIZE, we are committed to building a platform to improve the OTC experience for whales, traders, DAOs and treasuries alike. We've iterated and debated on several auction types and arrived at a protocol we think is fair, easy to use, and will become a core mechanism of the broader DeFi ecosystem.
Subscribe and stay tuned for upcoming blog articles, where we'll go deep on the specifications of the protocol!