A deep dive in NFT launch mechanisms
The end of 2021 was euphoric for web3 games and NFT collections. NFT launches during that time were sold-outs, many times in seconds. Most projects put zero effort into structuring their NFT sale, slapping a price, and going along with the current. That is how our story begins.
No-effort sold-outs abruptly ended in the spring when market conditions worsened. Gaming and NFT projects suddenly became interested in “the best launch mechanism.” We are here to examine the mechanisms that have been explored and those that are uncharted waters.
As auction theory suggests, game studios need to balance three things:
Maximize value for themselves (Revenue Maximization),
By treating all bidders as equal (Fairness),
And ensuring a fair allocation (whoever values the NFT more will be the one to mint it, Allocation Efficiency)
They would also need to consider the transaction cost, but that is mainly up to the underlying chain, and since that is a piece by itself, we won’t go there. Remember, auction theory is an entire applied branch of economics and cannot be covered in this piece’s length.
We will take these as the three pillars of our auction mechanisms. So let’s dive in; what has been tested so far?
Fixed Price Sale
Allocation efficiency - Everyone takes up the same price, so it’s up to gas fees, whitelist process, and luck whether the ones valuing it more will end up getting it.
Revenue Maximization - It doesn’t maximize revenue but offers certainty in the estimated sales revenue. Calculating the optimal price beforehand would require substantial data that projects in alpha and pre-alpha stages will certainly not have.
Fairness - It gives everyone a fair shot if it has a reasonable price range.
Prominent examples: Crypto Unicorns, Shrapnel, Metasoccer, PlanetQuest.
Dutch Auction
Allocation efficiency - Yes, the assets will end up with those who value them the most, as they will be the ones to bid first since they are the most certain of their value.
Revenue Maximization - It’s all about the starting and minimum price where the auction ends. Usually, the starting price is outrageous, so the sellers can maximize their revenue from those that jump the gun and overpay for their NFTs. The minimum price is also vital, so speculators willing to wait for a price drop must join in or be left out eventually. If the minimum price is too low, the sellers will bleed revenue, but again if the minimum price is too high, the collection might not sell out.
Fairness - It’s a community-friendly auction. If the amount of game assets matches the demand, everyone can get the same chances at one, at the price they are comfortable with. If you are patient enough, that price will likely be better than in a fixed-price sale.
Prominent examples: Illuvium’s Land Sale.
Fair Auction
Fair Auction uses the same mechanism as a Dutch Auction; the price gradually drops from an initial starting point until it meets a bid. The differentiator here is that bidders do not pay their offer. They pay the minimum bid that will be offered in the entire auction; thus, everyone comes at the same “fair price” at the end. Those that have bidded higher than the “fair price” have the excessive funds returned.
Allocation efficiency - The first bidders aren’t harmed from the price dropping later in the auction. That drives individuals who do not value the NFTs as much to bid early without hesitation, meaning that the assets won’t necessarily end up with those that value them the most.
Revenue Maximization - It doesn’t maximize in ideal market conditions. The collection will likely sell near the starting price, making it a fixed-price sale. In bad market conditions, the “fair price” hit is great, as the price will close near the minimum. Studios do set a minimum price, so the “fair price hit” is relatively under control.
Fairness - The auction is more than fair as it sets the minimum price paid in the auction as the price for everyone, making all bidders equal.
Prominent examples: RagnarokMeta, and Nyan Heroes.
Free Mint
Unlike the first three auction mechanisms, free mints weren’t used last year and only took center stage later this year.
Allocation efficiency - Free mints attract more traffic because, well, they are free. Without a well-structured whitelist, speculators will run rampant, and the assets won’t go to those valuing them the most.
Revenue Maximization - As the name states, there is no revenue. The price is determined in the marketplaces, and if there is strong demand, the royalties can balance the missed revenue, even outweigh them.
Fairness - Free mint is arguably the fairest mechanism, as it doesn’t deal with the price restrictions of all the others.
Prominent examples: Gossamer, Civitas, and the most recent one from DigiDaigaku.
There have also been hybrid NFT launches, where projects combine multiple mechanisms. A fixed-price sale followed by a free mint for holders of the initial mint is common. A couple of examples are “Champions Ascension” and “Aradena: Battlegrounds.”
Are there more auction mechanisms that could be tested? Certainly.
Would they fit in the web3 gaming scene? Let’s take a look.
English auctions
Participants make increasingly higher bids until no participant is prepared to make a higher bid; the highest bidder wins the auction at the final amount bid. Sometimes the lot is sold only if the bidding reaches a reserve price set by the seller.
Allocation efficiency - The one that values the game asset the most could get it if we assume they can afford the bidding war.
Revenue Maximization - It does maximize revenue for the game studios, as there is no upper limit, and higher bids are heavily encouraged.
Fairness - It doesn’t level the playfield for all participants, it doesn’t save them any funds in a high-demand environment, and whales are the apparent beneficiaries.
In a low-demand environment, the participants would still have to pay the starting price, similar to a fixed-price sale.
Great for studios and whales, not so for community members. It would apply best to very rare select NFTs.
First Price Sealed Bid
In this form of auction, each bidder submits a bid without knowing what the other bidders have bid. The bidders are anonymous to each other. The bidder’s best choice always appears to be to select the highest price. (alternatively: Second Price Sealed Bid, the highest bidder wins but pays the second highest bid)
Allocation efficiency - The game asset will not necessarily end up with the one that values it more. That person might consider an asset valuable, but they might underestimate its demand and try to bid lower to save funds, while if they knew the biddings, they would go higher. On the other hand, Second Price Sealed Bid overcomes that issue because bidders only pay the second highest offer, so they can bid their honest valuation.
Revenue Maximization - It’s a coin toss; in a phase of euphoria, everyone could come up with crazy bids, not fearing if they overpaid. But during unfavorable periods, fear might hold bidders even more constrained since they can’t know what others bid.
Fairness - It will usually favor whales, but on rare occasions, someone could snatch an asset if whales underestimate the other bidders or undervalue the asset.
Second Price Sealed Bid would make the auction even fairer, but it would likely curb revenue maximization.
Yankee Auction
It is a variation of the Dutch Auction where successful bidders pay what they bid as opposed to paying the price determined by the lowest qualified bidder (as in a Dutch Auction). In this format, when the auction closes, the highest bidders win the available merchandise at their bid price.
NOTE! Yankee Auction is a BATCH Auction, and gaming projects are unlikely to sell their game assets in batches as they seek to spread them among many gamers.
Allocation efficiency - The person that values the game assets more is less likely to be able to afford the whole batch compared to other auction mechanisms.
Revenue Maximization - The batch auction will likely lead to lower prices, as bidders would often be called to spend far more than the number of assets they wanted, thus leading to lower revenues.
Fairness - Less fair to the bidders that want a limited amount of assets, whether they are a whale, a dolphin, or a regular gamer.
To sum up, every auction mechanism has strengths and weaknesses, and there isn’t a definitive answer on which one is best. Web3 games and NFT collections will need to take a closer look and structure their NFT launches according to what they are trying to achieve.