Make Blockchain Work (Ch 5): Price discovery
In this Make Blockchain Work series, I discuss how blockchain technology could be best applied to financing and investment in nine chapters. It is from these reflections that we devised the world’s first marketplace for tokenized real-world assets, IdeaFeX. I prefer not to touch on ideological or debatable subjects, because a strong business model must be built on resources, including technologies, available now while thriving on agility to adapt to future developments. In this series, I will insert some of the posters that we have published on our social media platforms.
Price discovery
In the previous four chapters, I have covered openness and navigability as qualities that would make blockchain work better for financing and investment. In the next three chapters, I will cover efficiency. A primal point of efficiency that has so far been acutely missing is a simple, market-driven price discovery mechanism.
While market forces are imperfect, they are in general efficient in reaching equilibria. Given that liquidity brings many benefits to assets meant for investment, and that for the purpose of investment the ultimate goal is to sell the assets on (which is to say that price needs to be supported by the market after all), correct valuation from the start by market forces is highly attractive to investors. Granted, many would prefer to buy undervalued assets and profit from arbitrage; this “ideal” situation does not truly contradict market-driven price discovery: Unless the investment opportunity is highly exclusive (which means that many investors who would value the asset higher simply are excluded), for an asset to be undervalued investors in the market must on average undervalue it. Thus, the “ideal” situation is but a case of diverging valuations among investors — the ultimate force that makes a market work to begin with.
In secondary markets, especially ones supported by sufficient liquidity, the market is usually quite efficient. However, price discovery in primary markets tend to be much opaquer. Among crypto assets, this problem with valuation is exacerbated: Due to (i) generally low liquidity, (ii) extremely concentrated ownership, (iii) largely unregulated exchanges, and (iv) peculiar acceptance of unscrupulous (and sometimes criminal) behaviors, even the secondary market is highly inefficient. Prices swing wildly, with strong signs of manipulation (the perpetrators of which goes unpunished and exceedingly emboldened). In primary markets, things are no less worrisome, as many hidden “discounts” are given to “private investors” who purchase tokens independent of the public sale.
At IdeaFeX, we see both the problem that exists today in crypto assets and the opportunity that an efficient market pricing mechanism can bring. We have, therefore, designed the IdeaFeX marketplace with market-driven price discovery in mind.
For the primary market, we have devised a unique auction method that allows numerous investors to bid together in determining the final price of the asset. Unlike auctions for unique items, large quantities of asset tokens can be efficiently bid on, while all winning bidders still pay the same price. Unlike auctions in IPOs, bidders can update their bids in response to others’ inputs. Overall, this auction method secures a list of commanding advantages over existing alternatives:
1. There is absolutely no limit on the number of bidders that can participate, and winning in the auction requires solely the bidder to be willing to pay a sufficiently high unit price.
2. There is an unusually low capital requirement to participate: a bidder does not need to be able to afford the entire asset.
3. All bidders can interact together during the bidding window. All their individual valuations are pooled in a manner that reflect the overall valuation by the market.
4. The fundraiser is assured of fair valuation and maximal investor exposure.
To know more about how this works, I encourage you to read our Token White Paper.
For the secondary market, we leverage (I) broad access, easy navigation, and efficient matching to boost liquidity, (II) broad access combined with our unique auction system to allow for decentralized ownership, and (III) transparency and high standards to protect our users from unscrupulous behaviors. These measures serve to protect the market and to allow it to function properly.
This article is written by the CEO of IdeaFeX, Dr Jiulin Teng. You can follow him on Twitter or LinkedIn.
