Incentivised Bidding: The GBM Auction
A Novel Price Discovery Mechanism That Makes Ascending Auctions Work On The Blockchain
The Cryptograph platform introduces a novel auction model called the Gonnaud-Bessire-McDonaugh (“GBM”) auction, in which bidders are paid an incentive when they are outbid in real-time during the auction. In short, a person taking part in a GBM auction either wins the auction or leaves with more money than they started with. On the Cryptograph platform, bidders receive incentives up to 10% of their bid when they are outbid. Although some may find it counter-intuitive at first, the GBM auction is a transparent and fully-funded system where incentives paid are simply accumulated as debt and carried until they are settled by the final bidder (who wins the auction).
To the best of our knowledge, an auction that rewards bidders when outbid has not been introduced previously. We believe the main reasons for this are:
- Calculating incentives paid to bidders in real-time and ordering bids in a verifiable manner is only practical electronically;
- The GBM system requires bids to be fully funded, which requires a fast and reliable payment system (the blockchain solves this);
- The traditional English auction has been an adequate price discovery mechanism for centuries, thus there was no great need for a replacement.
How The GBM Auction Works
A GBM auction is a time-limited and incentivised open ascending auction. Bids must be fully funded i.e. bidders commit the full amount when placing their bid. Each new bid needs to be higher than the previous bid by a minimum step, calculated as a percentage of the previous bid. When someone is outbid, they are instantly refunded their bid, as well as an incentive. This incentive is calculated as a percentage of their bid amount, and this percentage depends on the ratio between the previous bid and their bid. The auction runs for a set time, and bids placed just before the end of the auction extend the duration of the auction (which is the technological equivalent of saying “Going once, going twice, sold!” when a new bid is placed at the end of an auction).
The highest bidder at the end of a GBM auction wins the item and their winning bid is the final price paid for the item, just like in a traditional English auction. The revenue of the GBM auction (i.e. the money collected by the seller and auction house) is equal to the winning bid, minus the sum of the incentives that were distributed to bidders during the auction.
An extension of the GBM auction can also be implemented for secondary market dynamics, whereby the seller can accept the current highest offer at any time, and the bidders are able to cancel their bid (there is a cancellation fee if you are the current highest bidder unless you are the first bidder). This system, implemented on the Cryptograph platform, combines the freedom for buyers to make and retract offers and the GBM incentive mechanism to encourage price discovery and curtail black market deals.
To take part in a GBM auction, go to the Cryptograph platform to bid on live auctions.
The Challenges Of Running Auctions On The Blockchain
One of the motivations behind developing the GBM auction was the desire to make fully on-chain ascending auctions viable. At first glance, the Ethereum blockchain seems to be a perfect candidate to run trustless and transparent auctions: it is inherently resistant to data modification, secure by design, smart contracts can automatically enforce auction rules and it even has its own currency/payment system. However, running an open ascending auction (e.g. English auction) on the blockchain is expensive. Placing a bid costs money (gas) to be processed, and the dominant strategy in an ascending auction is for the bidders to keep bidding the minimum to stay the highest bidder until it reaches their value of the item, which maximises the number of bids per auction and thus the costs. This is even more relevant currently as Ethereum’s gas costs have increased significantly since the beginning of 2020.
Because of these costs, digital collectibles have only been sold at auction in two ways until now:
- Using a Dutch auction (e.g. Cryptokitties, Etheremon, MyCryptoHeroes) which begins with a high asking price set by the seller, and the price decreases until one participant accepts the price. The first to accept the price wins the item and pays that price.
- More recently, using centralised gasless English auctions (e.g. Opensea) where the platform takes buy orders, settles the payment at the end of the auction, and then transfers the item to the winner.
Traditionally, a Dutch auction showed the advantage of speed in auction houses since a sale never requires more than one bid. On the blockchain, this means that the auction is free for almost all participants as only the winner pays money (gas) to place a bid (in cases where several bidders accept the current price in the same block, the losers may incur a small gas cost). However, the Dutch auction also has a fatal flaw: blockchain bots can front-run bidders by spotting a bid before it is processed, and placing their own identical bid with a much higher gas price so that it will be processed first (effectively stealing the win from the bidder). In addition, setting a “maximum” starting price is a complex and potentially detrimental exercise when selling one-of-a-kind assets with no real benchmark.
As per the centralised gasless English auctions, the system means that the bidder is not actually placing a bid on the blockchain, and he or she has to trust the platform to pay for the gas and send the token at the end of the auction.
GBM: On-chain Ascending Auctions on Ethereum (Even With High Gas Fees)
The GBM auction solves all the aforementioned issues and allows for on-chain, decentralised, real-time, open ascending auctions.
First, thanks to the incentive mechanism of the GBM auction, every bidder except the winner of the auction receives an incentive when he or she is outbid. Assuming a gas fee of $0.50 per bids and an incentive fee of 10%, the bidder will receive more than enough to cover the bid’s gas costs when outbid if the bid amount is over $5. As bidding increases, the incentives will be significantly larger than the gas fees.
Second, the dominant strategy changes: Unlike in an English auction, bidders are incentivised to bid higher than the minimum increment in a GBM auction. That is because the percentage calculating their incentives depends on the increases their bid represents compared to the current standing bid. As a result, the GBM model reduces the numbers of bids per auction.
Finally, because bids placed just before the end of the auction extend the duration of the auction, bots cannot front-run a collector to steal the win from them. On the Cryptograph platform, for example, every bid placed less than 10mins before the end of an auction will reset that timer to 10mins. However, the incentivised mechanism allows anyone who has power over the order of bids -i.e. blockchain miners- to theoretically take advantage of this mechanism to earn incentives by front-running bids. A miner could insert its own bid in-between the current bid and an incoming higher bid, therefore being paid an incentive instantly without committing any capital (hence without taking any risk). To solve this issue, each new submitted bid should include a reference to the value of the current standing bid at the moment the new bid is submitted. This solution is implemented in the Cryptograph auction smart contract. Effectively, this system forces miners to take a financial risk if they want to re-order bids, which removes the inherent advantage they have over other bidders. Because of this feature, some bids might bounce if several people are bidding at the same time. To mitigate this, the Cryptograph smart contract checks the validity of incoming bids before any other logic. As a result, if a bid is invalid, most of the gas cost will be refunded to the bidder.