There are many components to understand when entering the world of cryptocurrency. From how to buy it, where to store it, and even what to call, there are plenty of terms that may be unfamiliar to the newcomers in the industry.
Let’s discuss some of the key terms and processes involved to help you better understand the ins and outs of the crypto business. Having a baseline knowledge about such processes can assist you in making smart decisions with your vast investing options.
Table of Contents
What Is a Dutch Auction?
Let’s first understand precisely what this style of the auction process is. A dutch auction works in a way rather opposite way than one thinks of when they hear the word auction.
The term auction springs to mind images of bidders, waving arms and pointing fingers to place higher and higher prices to “win” the privilege of paying top dollar for the item being auctioned off in the first place.
This style is considered an English auction.
The English Auction
The English auction process is one more people are likely familiar with when operating in the buying business. Let’s take a look at the popular online auction platform eBay to further understand this more traditional model.
Awarding the Highest Bidder
In the English auction, a more traditional form of business buyers are familiar with, bidders enter an auction and state a price they are willing to pay. On eBay, for example, let’s assume a rare collectible trading card is up for auction.
The auction process on eBay operates in the English model. Bidders pay top dollar, placing a bid price, stating the highest price they are willing to pay. Bids are typically timed, with a predetermined end time. Bidders can enter a bid price until the time runs out.
In the end, the winning bid is awarded the card, paying the highest price they offered during the auction. Prices in an English auction process rise until the time runs out or the bids taper off to a conclusion.
If it is not timed, an auction can also end when no further bids are coming in and bid prices taper off. In this example, the winning bidder again is simply the highest price offered in the end.
Timed vs. Live Auction
There are two main ways an English auction can proceed. In a timed auction, bidders may come and go as they please. A time is predetermined for the auction’s end, and bidders may, until that exact moment, come in and place a bid.
Whether it is done in person or online, aloud or privately, the core value of the process remains the same. Bids will be made until the auction closes, at which time the offer for the highest bid wins the item.
If the auction is intended to end with the highest bidder, regardless of time, the auction must be a “live” auction. This does not require the bidders to be present in real life but does require bidders (or their proxy) to be present online, via telephone, or in some way communicate in real-time a bid.
In both cases, the results end with the individual at the close of the auction holding the winning bid. The highest price offered will be awarded the item.
The process only differs in the conclusion when discussing English auctions. Either the winning bid will be the final highest offer at the end of a live auction, or it will be whoever is winning after a predetermined length of time.
The Dutch Are Not English
If the term “dutch” springs to mind tulips and clogs, your viewpoint may be altered very soon. In terms of auctions, the nationality differs greatly from the English. Much like the two country’s traditions and people are unique, so too are the two unique types of auctions.
In a Dutch Auction, the entire process traditionally considered an auction (or that of the English variety anyhow) is flipped on its head. The style of bidding is completely different from the dutch process.
The Dutch Auction Process
The Dutch Auction process begins oppositely from the English process. A Dutch Auction begins with the highest price and declines from there. A price decline model first takes into consideration the assets of those entering the bidding process before lowering the price.
This bidding technique considers all bids for the asset at hand before landing on a price point. Think of the process as a way to sort of “test the waters” to see what ballpark bidders are willing to pay for an asset.
The descending price auction takes into consideration all bids before a final price is set. A Dutch auction is a type of market structure in which the price of something offered is determined after taking in all bids to arrive at the highest price at which the total offering can be sold.
In this type of auction, investors place a bid for the amount they are willing to buy in terms of quantity and price. This process helps to then determine the end price for the asset.
A Descending Price Auction
In a methodology almost opposite of the typical auction, the dutch auction process operates with a descending price auction process. Instead of starting at zero and working its way up, a price is determined by everyone that wishes to bid by pitching in their price point.
Those bids are collected, and the price begins to go down from the top until all assets are sold. Once that price is determined (the worth or value of the asset), the sale of the crypto can then be distributed.
In other words, the dutch auction is a price discovery process in which the auctioneer starts with the highest asking price and lowers it, top-down. This is done until it reaches a price level where the bids received will cover the entire offered quantity of assets (for the sake of our conversation, crypto).
By Any Other Name
To add to some confusion about these types of auctions, hailing from the land of Holland isn’t its only namesake. A Dutch auction is also known as a descending price auction or a uniform price auction in some circles.
The bottom line is these are all the same style but under different names. Nothing like adding confusion to the already complicated process, right?
An Example of a Dutch Auction
Sometimes it is easiest to comprehend a concept by examining an example. In terms of the world of crypto, a Dutch auction is often used to determine a price point for a given token. After all, when you start a new form of crypto or token, it can be difficult to know where the fixed price should fall.
Countless considerations can be weighed when setting a new price for new crypto. The Dutch Auction Process can be a systematic way to determine the value of something new. Dutch auctions compared all bids as they come in, and then decide what value an asset may have.
Let’s say a new coin is invented. Let’s call it the Coin. The Coin is new. It has no “value” until investors determine that it has worth. To decide what that worth is, the inventors of The Coin decide to hold a Dutch auction.
To find a fair price, the auction will ask future owners what they are willing to pay for one “Coin.” Joe offers via the dutch auction, to pay $100 for a single Coin token. However, as more and more bids come in for the Coin, the price falls to around $5.
So, will Joe pay $100 for a single coin? No. He will be awarded the number of Coins to total the value of his top bid. For this example, Joe would be given 20 Coins if the price point was set at $5.
Should the results of the auction be that the Coin is worth $10, Joe would win 10 of the Coins. All bidders in the process will get their “fair share” of the Coin. Bidders compete in an English-style auction to “win” the asset at hand. However, in the example of a dutch auction, all bidders who enter a successful bid will be rewarded a portion of the new cryptocurrency up for sale.
Dutch Auction IPO
One of the common uses of the Dutch auction process is in the IPO or initial public offering process. Initial public offerings are not to be confused with ICO (yes, one whole letter difference), which is an initial coin offering.
An ICO is where a company sells a new cryptocurrency to raise money. The aforementioned “example” of Joe and The Coin would be an ICO process.
However, the IPO, or initial public offering, is a process in which a private company sells crypto assets of its business to the public in new issuance. Yes, this seems only a slight play on words difference, right?
IPO vs. ICO
The main difference between an IPO and an ICO comes down to the subject of control. The primary difference between an ICO and an IPO of stock or crypto is that investing in an ICO doesn’t secure you an ownership stake in the crypto project or company. Any ICO participants are technically gambling that a currency, which is a worthless currency, to begin with, will later increase in value above its original purchase price.
Like most investments, nothing has value unless buyers believe it to be true. Without diving into an existential world of questioning the existence of all matter, it is something to consider. Even “money” doesn’t have any value. It is a piece of paper, after all.
But, if a society decides that piece of paper can be used to purchase goods and services, then that scrap suddenly becomes valuable.
IPO and ICO both handle new crypto and are usually ways a new business is creating value or assets where once value did not previously exist. However, if you are purchasing crypto in an ICO, you are not going to have ownership.
In less technical terms, an ICO is usually a method used by newer, less experienced companies without the benefit of an established reputation. An IPO is typically done by businesses with a longer history of established and trusted practices.
Why ‘Go Dutch’ With an IPO
Using a dutch auction in the process of an IPO offers a few unique benefits. From adding value to saving money, there are plenty of reasons this style is being utilized by more and more businesses.
Transparency in Business
For example, the process itself is a democratization of the public offerings. In other words, bringing an IPO into a business not only brings in funding but also transparency.
As we know, much of the entire crypto concept is based on a pillar of decentralization. From the technical science to the mental and emotional connections, many of the key takeaways from the world of crypto rest on this central concept: no central authority.
The Dutch Auction works in complete contrast to that of traditional IPOs. There, the investors bidding are part of an “exclusive and institutionalized group,” typically investment banks. These groups determine the price.
However, in a Dutch Auction, a business can allow smaller party investors to place bids and play a part in setting the price. This takes the centralized power away from the more traditional banks, supporting the values of the crypto space, not to mention giving others a chance to get into the game.
The Dutch option in an IPO is also preferred by many businesses as it can lower the costs involved. In a traditional IPO, investment banks have to be involved. This means they will do some of the legwork, but also will charge a fee.
Less Investment Banks Involved
The investment banks set the IPO price in that case, but in a dutch auction IPO, the involvement of those same investment banks can be far less involved. With less involvement of underwriters, there is less cost for transactions to be made.
Another win for the Dutch auction IPO is that favoritism is cut out of the equation. In a traditional IPO, shares are often sold to favored investors in the business. However, when the Dutch auction IPO is used, shares will go to the highest bidder, whether that is a known investor or not.
This takes the selection process out of the IPO, and the “backroom shady deals” along with it. Winning bids take the place of favored investors, making the term “fair price” even more true.
Does a Dutch Auction Work?
As an auction ends, does the dutch auction price fetch businesses the same price as a traditional, English-style auction? In the crypto space, bidders pay top dollar at times, and other times the lowest price is rock bottom. But, is it the type of auction or other factors that may weigh in on this chance to submit bids?
Factors in Determining Values
When entering an auction, the bidder accepts the consequences of a bid. Whether that bid is the highest in the case of an English model, or the lowest, in the example of a dutch auction, the winner must pay out that bid.
A bid is a promise of sorts, and a winning bid is a winning bid, meaning that once accepted, the successful bidder will be awarded the asset at stake.
Besides a bid style, what other factors weigh in on what new crypto is worth?
The Business’ Reputation
One of the top early determinants of a new crypto’s value is the reputation of the company offering the currency. Whether a business seeks the highest bids or determines a given price based on an auction where a price is gradually lowered, the result is likely to be similar due to the business offering the funds.
Faith in a business, or a proven track record in other products, will greatly impact the going price for a new cryptocurrency. Potential investors are far more likely to become involved, and thus higher bids will be seen, if a company offering the asset for sale can be trusted for the long haul.
Newer companies with small investors will see fewer bids. If you recall basic high school economics, with fewer bidders and fewer bids, there is less likelihood of success. The issuing company often has far more to do with the winning bid and sale price than the style of auction.
The Order of Bidders
Much like the reputation of a business, how many bidders decide to enter a sale will also greatly impact how much a currency is sold for in the end. The first bidder in a traditional auction can set the bar for all others’ bids.
For example, if the public offering opens, and a bidder sees that the current price (or bid) is top dollar, they may be discouraged from entering. This will drive the price down, and fewer bidders will submit a price if the current level is a higher price than they are willing to pay.
In the case of a Dutch Auction, the going price will not be known until the end of the process. More bidders are willing to enter if the first bid posted doesn’t price them out of the auction altogether.
A business may reach a more optimal price with a Dutch auction because the original bid doesn’t matter quite so much. There is no need to bid higher because the price will work its way down.
Dutch auctions can be a way to get more bidders, which can mean higher price points, simply because no one is excluded from the get-go.
A Rich History
You may be curious by now why the name? Despite the newfound use in the crypto world, this concept is not as new as the currency being sold in its name. The type of sale was first done in the 1600s.
Around this time, the tulip bulb was just being introduced to the country. Holland, as is evident from its picturesque scenic and flowering landscapes, took to the blossoms with fervor, and created a booming market in doing so.
Suddenly, a product that did not previously exist, was quickly growing in demand. Everyone wanted the flower for themselves. So, how would the market handle this new asset? And how could they do it quickly?
While the desire for more tulips was rapidly growing, the ability to mass-produce them was limited by Mother Nature. Tulip bulbs take 7 to 12 to form from a seed, and the bulb is the traded asset. So, what is an entrepreneur to do?
A Small Window
Besides a lengthy seed-to-bulb growth cycle, tulips are only in bloom about two to three months out of the year. How could sellers get products to owners when there is just a short window to enjoy the flower itself?
The Birth of ‘Futures’
Instead of being limited by the small bloom window, sellers decided to offer contracts to sell tulips. The modern-day “futures market” was formed as a result. Instead of waiting and trying to push sales only in the blooming summer months, vendors decided to offer the sale of future promised flowers, instead.
The vendor would work with a buyer and set that for a set price, X number of tulips would be delivered. So, while the tulip was only blooming two or three months a year, sales could go on all year long. It would only be those warmer summer months that would create the delivery window, not the sales time.
Another unlikely father of invention and economic Panic in Holland forced its government to allow for futures to be altered. No, it didn’t involve a time machine.
To curb the panic of its residents, the Parliament stated that all futures contracts could be canceled at any point if the buyer paid the seller 3.5 percent of the overall contract price.
A contract that can be canceled at any point with only a fixed price paid to the seller for the right to cancel gives plenty of options (i.e. “outs”).
Enter the Auction
With such chaotic terms of business, coupled with the business of a bustling marketplace, vendors of tulips needed a better way to do sales. They wanted to get the best price possible, but have the least process involved.
A traditional Dutch Auction gave the desired attributes to the tulip salesmen.
Optimal Auctions explains: “It started at an artificially high price, where demand is known (or believed) to be 0. At publicly known time intervals, the price ticks down in publicly known price increments. The price continues to tick down until the first bid is received. At this point, the auction ends immediately, and the bidder wins the product at the price when he placed his bid.”
The process fits the needs of tulip sales. Few (even only one if they wanted) bids needed to be placed. The price could be close to what a predicted sales price would later be. Coupled with short time intervals an auction goes by quickly but yields a high asking price.
The auction also would help the seller. Economic benefits to the seller showed in the results. A final price would be the same price as often seen in a sealed-bid auction (where each bidder submits bids in an envelope, and the high bidder wins at the price they bid). The price is equal no matter the process creating an aggressive bidding scenario, where all could benefit.
Though the process worked better for the sellers, the buyers too reaped benefits by resulting in fair prices.
From Tulips to Crypto
It is hard to imagine that a process from some flowers in the 1600s would later be applied to an imaginary form of digital currency, but here we are.
Public offerings still exist. There is still a need to host auctions. There is still a desire to include a fair price, an allowance for small investors, and also get a currency sold out in a public space.
Using a dutch auction, those creating new forms of crypto can include those same values that the tulip sellers of Holland established hundreds of years ago.
The Future of the Dutch Auction
The world of winning bids is not likely to fall to the wayside anytime soon. When you can find a system that benefits both a buyer and a seller, you’ve found a winning solution that many can get behind.
Amazingly, a step back in time can result in a fair process for digital crypto! The industry of cryptocurrency may be in the infancy stages of its “life,” but it certainly has a rich history of “ancestors.”
How these applications will continue to be used in the space of cryptocurrency remains to be seen. But, one thing is for sure, this ever-changing and volatile space certainly can benefit by taking historic lessons from yesteryear.
No matter the style of sale, the crypto involved, or the company behind it, one thing is for sure. You will constantly need to learn, adapt, and stay informed in this crazy market. Having the helpful hands of well-researched and informative resources such as FLOLio, you can ensure you are getting the lower price for purchase, maximizing your investments, and understanding the space of crypto.