Vickrey Auction, an essential mechanism for DeFi product
To fellow crypto enthusiasts,
In this post, you will discover a brand-new protocol that allows for issuing a stable coin and a leveraged token in a brilliant way.
Today, you will learn about the auction mechanism implemented in this protocol.
The protocol regularly holds an auction for SBT, a token that backs up the value of a stable coin implemented in the protocol, making the auction process a vital part of the protocol. This is different from the MakerDAO protocol in which its CDP auction process might not play as important a role within the protocol because it is held only when the price of ETH goes down significantly.
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To give you a better idea on what the auction mechanism might look like, let’s look at an auction process on eBay as an example. Suppose that the start date and expiration date/time of the auction are June 1, 2020 and 23:59 on June 30, 2020, respectively, and the current date is June 15, 2020. Here, even though more than two weeks have gone by since the auction was announced, it’s actually quite common to see the lowest bid price staying at $1 and no higher bids made on the platform. This totally makes sense since there is no incentive for people to place a bid early; they’d rather keep their bid prices secret until the last minute while waiting for other participants to place their bids so they can get a better sense of how much other people are willing to pay.
In fact, you often see bidders suddenly start placing their bids just 10 minutes or so before the auction expires. As you can see, it would be extremely impractical to implement this type of auction on the Ethereum network, where the amount of information that can be processed within each block is strictly limited. Given this, it’s important to ensure that people have the same odds of winning an auction regardless of when they place their bids by making sure that they cannot see the bid prices provided by other participants. One simple way of achieving this would be to use a hash commitment scheme where the bid is committed using a hash function.
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On the other hand, there is a problem with the model where a bid price is not disclosed to other people participating in an auction. That is, if an auction winner has to pay the highest bid price that he placed himself, people might end up in a “guessing game”. Some people might be willing to pay $110 but place a bid at $101, thinking that the highest price others are willing to pay is somewhere around $100, while others might be thinking the same way and propose a bid price of $102. At the same time, someone may come along and, anticipating this move, place a $103 bid, etc.
In order to eliminate this complexity involved in price discovery, you need to have a mechanism whereby the final bid price ends up being cheaper than the highest bid price. This can be implemented with an auction format called “second price auction”, which most of you might be familiar with. Essentially, this is an auction mechanism in which the highest bidder can win an auction at the second highest price put forward by another auction participant. This way, people can safely place an honest bid whose price they are truly willing to pay and they don’t have to engage in the guessing loop mentioned above. Here, the bid will be committed as a hash value.
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Note that the actual implementation of the protocol will adopt the “Vickrey auction” format, which is an advanced version of the second price auction format, as the auctions within this protocol deal with divisible tokens (a.k.a fungible tokens) instead of non-fungible goods like artworks that you often see listed in a normal auction. To learn more about how this auction mechanism works, check out the whitepaper!
White paper: http://lien.finance/pdf/iDOLWP_v1.pdf
Website: http://lien.finance/
Twitter (Follow and get update): https://twitter.com/lienfinance
Telegram Group: https://t.me/lien_finance
