Dutch auction

The Dutch auction is a supply management mechanism using descending-price auctions where newly minted tokens start at a high price and decrease over time until demand meets supply. Think of it as letting the market discover the fair price through a controlled price descent rather than guessing the right price upfront.

When the issuer mints tokens after acquiring an asset, instead of offering them at a fixed acquisition price, the tokens enter a Dutch auction. The price starts high (potentially above the acquisition price) and decreases according to a predetermined schedule. Buyers can purchase at any point during the descent—the earlier they buy, the higher the price they pay. The auction continues until all tokens are sold or the price reaches the current pool price, at which point any remaining tokens are added as sell liquidity at that price.

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Why Dutch auctions matter

Dutch auctions address several challenges in token distribution:

Fair price discovery

Without a Dutch auction, the issuer must guess the right price:

• Too high: Tokens don't sell, creating execution risk
• Too low: Issuer leaves money on the table, existing holders face unnecessary dilution

With a Dutch auction, the market discovers the fair price:

• Buyers reveal their true valuations through purchase timing
• Price naturally finds the level where demand meets supply
• No guessing required—the market tells you the answer

Prevents gas wars and front-running

In fixed-price sales, especially for high-demand assets:

• Buyers compete on transaction speed, not price
• Gas wars drive up transaction costs
• Front-runners extract value from slower participants

In Dutch auctions:

• Buyers compete on price tolerance, not speed
• Early buyers pay premium for certainty
• Patient buyers get better prices but risk missing out
• No advantage to front-running—everyone sees the same descending price

Transparent and accessible

Dutch auctions create a level playing field:

• All participants see the same price at the same time
• No hidden information or insider advantages
• Transparent price descent schedule
• Democratic distribution based on willingness to pay

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Formal structure

Let:

• $t_0$: auction start time
• $t_{\text{end}}$: auction end time (or when all tokens sell)
• $p_{\text{start}}$: starting price (high)
• $p_{\text{pool}}$: current pool price (auction stops here if not sold out)
• $p_{\text{floor}}$: minimum price floor (typically $= p_{\text{pool}}$ or acquisition price, whichever is higher)
• $m$: total tokens available in auction
• $\tau = t_{\text{end}} - t_0$: auction duration

Price function: The price decreases over time according to a schedule:

$$p(t) = p_{\text{floor}} + (p_{\text{start}} - p_{\text{floor}}) \cdot \left(1 - \frac{t - t_0}{\tau}\right)^\gamma$$

where $\gamma$ controls the descent rate:

• $\gamma = 1$: linear descent
• $\gamma > 1$: convex descent (slower initially, faster later)
• $\gamma < 1$: concave descent (faster initially, slower later)

Auction termination: The auction ends when either:

1. All tokens are sold, or
2. Price reaches $p_{\text{pool}}$ (current pool price)

Any unsold tokens at termination are added as sell liquidity at $p_{\text{pool}}$.

Purchase mechanics: At any time $t$, a buyer can purchase quantity $q$ at price $p(t)$:

$$\text{Cost} = q \cdot p(t)$$

Auction termination: The auction ends when:

1. All $m$ tokens are sold, OR
2. Time reaches $t_{\text{end}}$, OR
3. Price reaches $p_{\text{floor}}$ and remains unsold

Remaining tokens: Any unsold tokens at auction end can be:

• Retained by issuer for future sale
• Burned to reduce supply
• Offered at floor price indefinitely
• Subject to other mechanisms (hold period, release curve)

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Worked example

Setup

• Current pool price: $p_t = 5{,}000$ USDC per token
• Acquisition price: $p^{\text{acq}} = 4{,}200$ USDC per token
• Newly minted tokens: $m = 1{,}000$
• Tokens for auction: 800 (80% of supply)
• Auction duration: $\tau = 7$ days
• Starting price: $p_{\text{start}} = 6{,}000$ USDC (20% above pool price)
• Floor price: $p_{\text{floor}} = 4{,}200$ USDC (acquisition price)
• Descent curve: $\gamma = 2$ (convex)

Price schedule

Day 0 (auction start):

$$p(0) = 4{,}200 + (6{,}000 - 4{,}200) \cdot (1 - 0)^2 = 6{,}000 \text{ USDC}$$

Day 1:

$$p(1) = 4{,}200 + 1{,}800 \cdot \left(1 - \frac{1}{7}\right)^2 = 4{,}200 + 1{,}800 \cdot 0.735 = 5{,}523 \text{ USDC}$$

Day 3:

$$p(3) = 4{,}200 + 1{,}800 \cdot \left(1 - \frac{3}{7}\right)^2 = 4{,}200 + 1{,}800 \cdot 0.327 = 4{,}789 \text{ USDC}$$

Day 5:

$$p(5) = 4{,}200 + 1{,}800 \cdot \left(1 - \frac{5}{7}\right)^2 = 4{,}200 + 1{,}800 \cdot 0.082 = 4{,}348 \text{ USDC}$$

Day 7 (auction end):

$$p(7) = 4{,}200 + 1{,}800 \cdot (1 - 1)^2 = 4{,}200 \text{ USDC}$$

Purchase scenarios

Scenario 1: Early buyer (Day 1)

• Price: $5,523 per token
• Purchase: 100 tokens
• Cost: $100 \times 5{,}523 = 552{,}300$ USDC
• Premium paid: $1,323 per token above floor (31% premium)
• Benefit: Certainty of acquisition, no risk of missing out

Scenario 2: Patient buyer (Day 5)

• Price: $4,348 per token
• Purchase: 200 tokens
• Cost: $200 \times 4{,}348 = 869{,}600$ USDC
• Premium paid: $148 per token above floor (3.5% premium)
• Risk: Auction might sell out before Day 5

Scenario 3: Floor buyer (Day 7)

• Price: $4,200 per token (floor)
• Purchase: 500 tokens (if still available)
• Cost: $500 \times 4{,}200 = 2{,}100{,}000$ USDC
• Premium paid: $0 (at floor)
• Risk: High chance auction sold out before reaching floor

Outcome analysis

If demand is strong:

• Most tokens sell in days 1-3 at prices above $5,000
• Surplus above acquisition price is distributed via profit-sharing
• Early buyers secure allocation but pay premium
• Auction validates high valuation

If demand is moderate:

• Tokens sell gradually across days 1-7
• Average price around $4,500-5,000
• Mix of early and patient buyers
• Price discovery reflects true market demand

If demand is weak:

• Auction reaches pool price (floor) with unsold tokens
• Sold tokens execute at various prices during descent
• Remaining unsold tokens become sell liquidity at pool price
• Market signals lower valuation than expected

Profit distribution

When tokens sell above acquisition price, the surplus is distributed according to the protocol's profit-sharing structure outlined in Coordinated supply management. This rewards both good acquisitions by issuers and participation by market participants (specific distribution strategy to be determined).

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Outcome

Advantages

Price discovery:

• Market reveals true valuation through purchase timing
• No need to guess the right price upfront
• Transparent process visible to all participants

Fairness:

• All participants see the same price schedule
• Competition based on price tolerance, not speed
• No front-running or gas war advantages

Flexibility:

• Buyers choose their price/risk tradeoff
• Early buyers pay premium for certainty
• Patient buyers get better prices but risk missing out

Issuer benefits:

• Potential to capture premium above acquisition price
• Clear market signal about demand
• Reduced execution risk (auction finds clearing price)

Disadvantages

Complexity:

• More complex than fixed-price offerings
• Requires understanding of auction mechanics
• Potential for buyer confusion

Uncertainty:

• Buyers don't know final clearing price
• Risk of overpaying (early buyers) or missing out (late buyers)
• Difficult to optimize purchase timing

Execution risk:

• Auction might not sell all tokens
• May need fallback mechanisms for unsold tokens
• Requires sufficient market attention during auction period

Price impact:

• Large early purchases can signal strong demand, influencing later buyers
• Conversely, lack of early purchases can signal weak demand
• Strategic behavior can distort price discovery

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Why it works

The Dutch auction transforms price discovery from a guessing game into a revelation mechanism. Instead of the issuer trying to predict the right price, the market reveals it through purchase timing. Buyers with high valuations buy early (paying premium for certainty), while buyers with lower valuations wait (accepting risk for better prices).

This creates a natural sorting where tokens flow to those who value them most, while the issuer captures value through the premium paid by early buyers. The transparent, time-based descent prevents manipulation and ensures all participants have equal information.

Trade-offs vs. other mechanisms

vs. Fixed price:

• Dutch auction: Better price discovery, but more complex
• Fixed price: Simpler, but risk of mispricing

vs. Release curve:

• Dutch auction: Price descends, quantity constant
• Release curve: Price fixed, quantity increases over time

vs. Open interest:

• Dutch auction: Buyers compete on timing
• Open interest: Buyers commit capital in advance

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Configuration

Dutch auction parameters are configurable per collection:

• Starting price ($p_{\text{start}}$): How high to start (e.g., 20% above pool price)
• Floor price ($p_{\text{floor}}$): Minimum price (typically acquisition price)
• Duration ($\tau$): How long the auction runs (e.g., 7 days)
• Descent curve ($\gamma$): Linear, convex, or concave descent
• Minimum purchase: Prevents spam bids
• Maximum purchase: Prevents single buyer domination

These parameters can be adjusted based on:

• Asset class: More volatile assets may need wider price ranges
• Market conditions: Stressed markets may need longer durations
• Collection size: Larger collections may need longer auctions

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Related reading

• Price dynamics and risks for detailed Case B analysis
• Release curve mechanism for alternative supply management
• Bonded minting mechanism for collateral-backed minting
• Open interest mechanism for demand signals