A Guide to Blockchain Auctions
Table of Contents
Have you ever experienced the disappointment of losing an auction for an item you really wanted? It can sting. It might feel even more bitter if you think that the auction wasn’t fair in some way.
In the digital age, online auctions have become a popular way for sellers to get rid of their items and for bidders to get those items at a value they deem appropriate for themselves. Centralized auctions sites like eBay are incredibly popular, but users often worry that they aren’t paying a fair price and that the auction has been rigged.
Being a centralized site, eBay also takes a hefty commission for allowing you a platform and simple way to auction your items online. So as a seller you have to pay part of your profits to the site. There’s also the risk of the buyer not paying you (but you won’t be charged fees in this case), as well as the risk of the platform being hacked and sensitive data being shared.
What if there was a solution to all of these issues? Well in the new digital age, there is. Imagine a decentralized eBay, where no one entity owns the bidding platform, and all information about the auction is stored publicly on an immutable blockchain. OpenBazaar was said to be just this, and was expected to be the decentralized opponent to eBay.
Unfortunately, OpenBazaar didn’t succeed despite being backed by notable investors like Andreessen Horowitz and Union Square Ventures. The co-founder himself denotes this to several factors such as the market used bitcoin, which went from being a currency alternative to a store of value, as well as Ethereum took over the market for dApps.
Other factors played against them as well such as the newness and volatility of crypto. At the time, people were just too afraid to use crypto because they could lose money. He also said that the blockchain auction model better suits digital goods rather than physical goods.
That being said, in the years that have passed the crypto and blockchain sphere has made leaps and bounds, and Blockchain auctions are the future of online auctions, and we’re going to explain why in this article.
If you’re already a blockchain auction expert, use this table of contents to help you navigate to the part of the article that interests you. But if you’re new to this concept, stay tuned and we’ll explain it to you in great detail.
- What are Blockchain Auctions?
- Centralized vs. Decentralized Auctions
- Auction Formats
- NFT Auctions
- Polkadot and Kusama Parachain Auctions
What are Blockchain Auctions?
Plain and simple, blockchain auctions are auctions held on the blockchain that use smart contracts to match buyers and sellers. If we think about our decentralized eBay example again, the entire auction process would be handled automatically by smart contracts. There would be no need to hire an auctioneer or pay commissions to and give your information to a third-party auction hosting site.
The smart contract works as the auctioneer or like the auction site. There are different types of auctions, so the way the smart contract executes the auction depends on what type you choose. But we’ll first use the example of the most popular type, the English auction — which is the format typically shown in movies.
In this case, the seller creates a smart contract that details what is being held for auction, how long the auction will be held for, and the minimum price the seller will accept as the bid. Bidders can submit their bids and when data supplied by a trusted timer oracle is received letting the smart contract know that the bidding period has ended, the smart contract is then executed.
The crypto that the bidder locked in the smart contract is delivered to the seller, and any crypto locked by those who lost is returned to them. What was held for auction, as long as it’s a digital-only good, is also simultaneously delivered to the highest bidder. None of this requires any third parties, it’s all handled by code.
For real-world physical items, there’s a higher chance of fraud on both the buyer’s and seller’s end. Which is why for those kinds of sales, escrow services and a third-party moderator are used. Essentially, the crypto is locked in a 2-of-3 multisig address, where the buyer, seller, and moderator all have a key. Once the product is delivered to the buyer and all is well, both the buyer and seller put their keys in and the crypto is released to the seller. If there are any disputes or problems, this is where the moderator steps in, and can get the funds released to the correct party.
Centralized vs. Decentralized Auctions
Since decentralization is such a relatively new concept, it can be confusing to understand how it differs from a centralized platform, as well as its draws and benefits. There are a few differences between the two, but the main difference is who you trust to hold your information.
Who Holds Your Data?
A centralized platform holds all of your information. This means that if the platform is hacked, your sensitive data can fall into the wrong hands. And on a more pessimistic note, the platform could sell your data to other parties as well.
With a decentralized platform, you own your data, only sharing what is necessary to execute the transaction. People can see what wallet sent the crypto to the smart contract, which wallet received the crypto, how much it was, and what was auctioned, but no other data is necessary to execute the transaction.
And since the blockchain can’t be changed, it’s basically written in digital stone who now owns the item. A copy of that is then stored on every single computer that runs that blockchain. So there’s no worry that any information will be tampered with.
When you use a centralized platform, whether online or a regular in-person auction house, you pay a fee as the seller to auction your items, sometimes as high as 15–20% of your item price. Buyers also end up paying a fee to the host of the auction most of the time as well. They host the auction and settle the transaction, therefore they can take whatever they want in order for you to be able to use their services.
A decentralized auction tends to cost less because you only pay what is needed for transaction fees and the operating cost. For example, if you decided to use a smart contract on the Ethereum blockchain, the only fees you would pay are the gas fees to execute the transaction and a fee to the platform. In general, the cost is lower because you aren’t paying the high cost to maintain servers or the massive tech and customer service teams needed to run a centralized platform.
One concern you see with centralized bidding platforms is that the seller might have artificially inflated the bid price on their item. Shill bidding, which is placing a phantom bid to artificially inflate the price is an issue on centralized platforms like eBay. All the seller has to do is make a fake account and make bids with it and boom, the price increases.
With a decentralized platform, there is no incentive for the seller to artificially inflate the price.
For one, you can see which wallet bid what, meaning if the seller themselves inserted a bid to inflate the price, you would notice the same wallet address.
They could also potentially use another address, but there would be no point because they would have to lock precious crypto in a smart contract, which wouldn’t make much sense. As with anything, there are ways to cheat, but with a decentralized platform the incentive to do this is much lower as it’s a lot more work to succeed at cheating.
There are a multitude of different auction formats that can be used, we’ll go over a few but not all of them are used in blockchain auctions. Since some would require more information and more set-up operations, they would make the smart contract deployment costs more expensive.
Also known as an open-cry ascending auction or an open ascending price, this is the auction type almost everyone thinks of when they hear the word. Anytime you see one in a movie or on tv, it’s an English auction.
The format goes like this: the auction starts from a low price and gradually gets higher until only one bidder still stands. They then pay that price. Usually this kind of auction requires everyone to congregate in one place, and you can see who is placing the bid, but with the advent of the internet, users can just place their bids online whenever they want in an open ascending form, and when the time period for bidding is up, the item goes to the highest last highest bidder.
If an English auction has an open ascending price, a Dutch auction is the exact opposite. Also known as open descending price, a Dutch auction starts from a price so high presumably no bidder is willing to pay it, and is then dropped down incrementally until a willing bidder emerges. The bidding ends there and the bidder pays that price.
There is a downside with this auction though. You really need to make sure that the price you open with is truly too high, because if it’s too low, you could end up auctioning off your item at a value less than the item is actually worth.
First-price sealed bid auctions have the bidders each submit one bid privately, and then whoever bid the highest wins and pays that price. With this auction style you can’t see who is bidding and you can’t see what they are bidding. If you bid too low, you won’t win, but if you bid too high, you could end up paying more for the item than you valued it at.
Also known as a second-price sealed bid auction, Vickrey auctions work by having bidders submit bids privately, and then the highest bidder wins. But they don’t actually pay the price they bid, they end up paying the second highest bid submitted. This kind of auction incentivizes users to bid their true value for the item because if you win you’ll pay less than you valued the item for every single time… if you place a bid that really is true.
A type of auction that was popular in the 17th and 18th centuries where a candle is lit to start the auction, and the end of the auction is then signaled when the candle flame goes out. This way, no one knows for sure when the auction will end and can make a last-minute bid. This auction type has been amended for the digital age, but we’ll explain how a little later in the article.
Non-fungible tokens (NFTs) have taken the digital art world by storm, and NFT auction sites are currently popping up left and right to support the explosive growth of the industry. They also happen to be a great real-world example of how blockchain auctions work.
On an NFT auction site, you are able to place bids on digital artwork that you would like to buy in the form of a non-fungible token, meaning that there is only one of it in existence and once the smart contract is executed, you will be the sole owner of the NFT as proven by the blockchain.
How they work is you place a bid on the auction site and the ETH is extracted from your wallet. You’ll need to make sure that you have enough ETH to pay for gas fees. If your bid is the last bid standing, then the smart contract is executed automatically and the NFT will be transferred to you.
If you are outbid, your ETH will automatically be returned to your wallet. If time remains on the auction and you really want the token, you can bid again and the process we described above will repeat itself.
Ethereum is an incredibly popular blockchain to host auctions on, and just a popular blockchain in general. Due to this gas fees are often high, which could lead to an auction being more expensive than you’d like because you have to cover astronomical gas fees. Wrapped ETH (WETH) is now an alternative being used on auction platforms like OpenSea to combat high gas fees, but still use the Ethereum blockchain.
Polkadot and Kusama Parachain Auctions
If you’ve followed our project for a while, you know that we are built on the Polkadot blockchain. Polkadot is a blockchain ecosystem built around two types of blockchains: a relay chain and parachains.
The relay chain is the main network where transactions are finalized. Parachains are custom blockchains that are anchored to the relay chain. If you would like to find out more about parachains and how they work, check out our guide on parachains and parathreads.
Polkadot, along with its experimentation network (also known as a canary network) Kusama, can both support up to 100 parachains. But how does one even get their own parachain? The answer is Parachain Slot Auctions — also known as Parachain Auctions.
Remember the candle auction that we mentioned earlier? Well it’s been slightly adapted by Polkadot to fit in the digital age. An amended candle auction works by allowing a certain time period to submit bids, and then the time at which the “candle runs out” is randomly generated and retroactively applied. This type of auction is used in Polkadot and Kusama Parachain auctions.
Projects that would like to get a parachain slot participate in the auction by mobilizing their supporters to place bids on them. DOT and KSM (the respective cryptos of Polkadot and Kusama) can be bonded to support the project of the holder choice. The incentive to do this is presumably that the project provides a reward for supporting them, like airdropped tokens.
Once the candle auction is over and the time the auction finished is retroactively applied, the winner of the parachain slot is determined by whichever project had the most DOT or KSM support at that time. If the project you support loses the auction, your DOT or KSM will be returned to you. If your project wins, you can get your funds back once the project’s access to the parachin slot expires, anywhere from 6–48 weeks. Some of the first winners of Kusama parachains have even already been chosen.
Out of all the possible use cases for blockchain, secure and fair auctions are one that is already in play in the market, and we’re likely to see more blockchain auction platforms emerge in the coming years. Thanks to the advent of the smart contract, a secure and decentralized alternative has become available.
Now that’s not to say people will just stop using centralized platforms altogether, but a new option has presented itself to those who wish to utilize what the blockchain has to offer, as well as save money from not needing to pay commission fees.
Combine that with new and emerging blockchains that also offer smart contracts, the pressure can be taken off the Ethereum ecosystem as new alternatives are emerging. Pontem is a great example of a dApp platform on a scalable blockchain — Polkadot — that anyone who wants to build an auction platform on can. The future looks bright for decentralized platforms, and Pontem is no exception.