Sellers are capable of distorting auctions away from their most efficient form, either because of a desire to reduce price uncertainty, to extract more gain for themselves at buyers’ expense, or to control what types of buyers will ultimately win the auction.
One of the more common ways in which sellers can influence auction outcomes is by setting a reserve price — a minimum price that any bid must meet (or exceed) in order to be considered. By setting a reserve price equal to their own valuation for an item, a seller can ensure that they are not forced to sell at a price so low that they would have been better off just keeping it, rather than putting it up for auction.
Of course, the reserve price doesn’t need to equal the seller’s valuation — sellers are free to set reserve prices at whatever level they want. This allows them to potentially capture a portion of the auction surplus that would otherwise be retained by the buyer.
Sellers may also demand entry fees, paid by all participants whether they win or lose an auction, as a way to extract revenues from buyers. And in some cases sellers may try to provide special preferences to certain types of bidders — often driven by altruism, as in the case of government set-asides and subsidies for underrepresented minority groups or military veterans.
However, poorly designed set-aside strategies can create unintended consequences. In 1994, the Federal Communications Commission auctioned a band of spectrum for Personal Communications Services. In addition to the basic goals of allocating spectrum efficiently and maximizing revenues, the FCC wanted to ensure that the spectrum sales reflected a diverse set of owners. To that end, they created special rules for bidders designated as “entrepreneurs,” as “regional companies” and as “female/minority owned firms,” giving them 25% bid credit (and thus making their bids worth more relative to other bidders), requiring very low initial deposits and offering generous installment plans for full payment. The outcome of this crude application of targeting: Many purchasers from these groups simply chose to flip their spectrum to large establishment players, while others defaulted on their payment plans when spectrum proved to be worth less than they bid.
All of the above represent wholly legal ways in which sellers can introduce distortionary effects into auctions. But sellers also sometimes manipulate auctions in more illicit fashion. One common means of doing so is “shill bidding,” which is when sellers make bids on their own auctions, by themselves or through agents, to drive up prices. This is a common risk of online auctions, where bidding from multiple accounts is relatively easy and challenging to unmask.
There are complicated tradeoffs that exist when trying to optimize auctions. Do you choose to maximize seller revenue, buyer satisfaction or overall utility? Do you emphasize prevention of collusion or speed of process? Ultimately, there are a range of different priorities that auctions providers must assess in designing auctions — while also determining the best means to make them profitable, efficient and scalable.
That’s especially true when the items being auctioned are unfamiliar, valuations are uncertain, supply and demand are wildly volatile and buyers and sellers have a wide range of different risk profiles — all things that are true about today’s NFT market.
Want to learn more about sell side factors in auctions? Read our in-depth article here.