ELI5: Auctions

FLOAT token relies on alterations of its supply to stabilise its price. These alterations of supply can come in the form of expansions (where new FLOAT tokens are minted) or contractions (where FLOAT tokens are burned). Expansions occur when the market price of FLOAT is greater than the target price. Contractions occur when the market price of FLOAT is below the target price. And thus by the nature of supply and demand the FLOAT price can be stabilised.

The adjustments of the supply of FLOAT are carried out via Dutch Auctions with the Protocol.

What Are Dutch Auctions

Dutch Auctions are a special kind of auction. In a typical traditional (English) auction that many of us are used to, the auctioneer starts the auction at a low price and participants bid for goods at ever increasing values with the goods going to the highest bidder. In theory this could mean that the auction could go on forever as long as there is someone willing to pay a higher price than the last bid. Therefore to stop the auction going on forever there is normally a deadline by which it must end. The danger of this, especially in a blockchain context, is that people are likely to not bid until the last few seconds (or block) of the auction known as auction sniping. This practice is often deemed unfair to other bidders as they don’t have the time to evaluate the latest bid and respond.

In a Dutch Auction, the auctioneer starts the auction at a very high price, and slowly decreases the price until the goods are sold to a bidder willing to pay the price offered by the auctioneer. This leads to a very efficient auction mechanism as it has a finite length in both time and monetary value - the highest price is the starting price (rather than infinity in the traditional auction) and the lowest price is zero. Also, auction participants are likely to pay the highest price they can afford to pay for the goods in a quicker time frame. This is because as an auctioneer decreases the price for the goods, the deal becomes more favourable for more auction participants. Thus there is competition to take the earliest bid one can afford, otherwise, being cheeky and waiting for a cheaper deal may cost you the goods to be claimed by another participant. Therefore this results in a very efficient system in both capital and time.

How does Float Protocol use Dutch Auctions

Float Protocol uses Dutch Auctions to control the supply of FLOAT. To understand this, it is best demonstrated via examples.

In the event that the market price of FLOAT is greater than the target price, more FLOAT needs to be minted and sold to the market, i.e. the supply of FLOAT needs to undergo an expansion.

In this environment the Protocol offers newly minted FLOAT for sale via a Dutch Auction. The newly minted FLOAT is offered at a price discounted to the market price and participants in the Dutch Auction are required to pay with WETH (and sometimes BANK). The Dutch Auction starts with the sale price for FLOAT at market price [1] and slowly the sale price is decreased each block until the sale price matches the target price. Thus, the Dutch Auction sale price becomes more favourable to participants as the Dutch Auction proceeds, enabling auction participants to purchase FLOAT from the Protocol at a discount and sell it on the market for profit while also helping return the market price to the target price of FLOAT.

In the reverse case where the market price of FLOAT is lower than the target price, FLOAT needs to be purchased from the market and burned, i.e. the supply of FLOAT needs to undergo a contraction.

In this environment the Protocol offers to purchase FLOAT via a Dutch Auction. You may ask how does the Protocol purchase FLOAT? It does this by using WETH from the Basket (and sometimes newly minted BANK). The Dutch Auction in this case kind of works in reverse. Rather than starting at a high price and then gradually decreasing over time, it starts at a lower price and gradually increases over time. To walk through it: The Protocol offers to purchase FLOAT at the market price* and then slowly offers to purchase FLOAT at higher prices each block of the auction until the target price. Therefore, auction participants can purchase FLOAT from the market and sell it to the Protocol at a higher price thus making a profit - they will receive WETH (and sometimes newly minted BANK). The FLOAT that the auction participant sells to the Protocol is burned. Hence the supply of FLOAT is reduced on the overall market and the market price of FLOAT is pushed towards the target price due to the nature of supply and demand.

What are the key advantages of Float Protocol’s Dutch Auctions

Float Protocol’s Dutch Auctions have many advantages not only that they are capital efficient due to the natural competitive nature of Dutch auction but also:

1. They are instant settlement - When you participate in the Float Protocol Dutch Auctions and you make trade with the Protocol you receive the goods instantly once the transaction has been mined. Many other Dutch Auctions for example Sushiswap’s Miso distribute the goods to participants once the Auction has finally concluded. Requiring users to return to the Auction page and claim their goods.

2. They are slippage free - By trading with the Protocol during a Dutch Auction participants don’t need to be worried about slippage on their trade as it is a direct transaction. Thus if participants want to acquire FLOAT/ETH and holds the opposite token the Dutch Auction may be the most efficient way to get it as well as at a discount to market price. Moreover, due to the nature of the Dutch Auction the profitability for late-comers only gets better and better as the auction proceeds.

3. They are flash-loanable - Calling all bots and bot builders out there. Participants can use flash-loans to trade with the Protocol during a Dutch Auction. A strategy may be: in an expansion Dutch Auction, a participant flash-borrows ETH, purchases FLOAT from the Protocol at a discount to market, then sells that FLOAT for ETH on the market, returns their original ETH flash-loan and keeps the rest as pure profit all in one block.💸

[1] The Dutch Auctions actually start at a price a little bit higher than the market price in an expansion, and a little bit lower than the market price in a contraction. This is known as the fool’s price and it is there as an additional protection against oracle manipulation. More details can be read about this in the Litepaper.