On-Chain Auctions with Deposits

TL;DR

This paper analyzes how deposit visibility in on-chain second-price auctions influences bidding strategies, leading to inefficiencies like over-depositing and entry deterrence, which affect optimal allocation.

Contribution

It introduces a strategic model of on-chain auctions with deposits, highlighting the impact of deposit visibility on bidding behavior and auction efficiency.

Findings

High deposits can lead to over-bidding and inefficiencies.

Deposit visibility enables costly signaling and entry deterrence.

Pooling equilibria can prevent the highest valuation bidder from winning.

Abstract

Second-price auctions with deposits are frequently used in blockchain environments. An auction takes place on-chain: bidders deposit an amount that fully covers their bid (but possibly exceeds it) in a smart contract. The deposit is used as insurance against bidders not honoring their bid if they win. The deposit, but not the bid, is publicly observed during the bidding phase of the auction. The visibility of deposits can fundamentally change the strategic structure of the auction if bidding happens sequentially: Bidding is costly since deposit are costly to make. Thus, deposits can be used as a costly signal for a high valuation. This is the source of multiple inefficiencies: To engage in costly signalling, a bidder who bids first and has a high valuation will generally over-deposit in equilibrium, i.e.~deposit more than he will bid. If high valuations are likely there can, moreover, be entry deterrence through high deposits: a bidder who bids first can deter subsequent bidders from entering the auction. Pooling can happen in equilibrium, where bidders of different valuations deposit the same amount. The auction fails to allocate the item to the bidder with the highest valuation.