In-depth analysis of candle auction: Why is it the most suitable form of blockchain auction?

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The candle auction format can alleviate the inefficiency, low bidding income and low efficiency of weak bidders caused by preemptive transactions.

Original Title: “Research Update: “Candle Auctions” Case”
Written by: Web3 Foundation Translation: Polkadot Chinese Platform

Parachain auctions are the core feature of Kusama and Polkadot. The results of the auction determine which projects can obtain Parachain slots and the number of tokens that need to be locked. For the health of the ecosystem, it is important to allocate scarce slots to projects that can make the most of them. As we all know, auctions are usually an excellent way to achieve this goal, because—in addition to bilateral negotiations—the team therefore needs to value the auction in advance. [1]

Both Kusama and Polkadot use candle auction “Candle Auction” to allocate parachain slots. There are many good cases that explain how this mechanism works in practice. [2] Nevertheless, the candle format “Candle Auction” is a very unusual way of auction. In addition, the scale and scope of parachain auctions do not happen on the blockchain every day. This article will discuss the following basic issues in this regard:

  1. Why does auction work better on-chain than off-chain?
  2. What is the special reason for using candle auction “Candle Auction”?

To answer these questions, we will first delve into the tragic story of Gian Vincenzo Pinelli (1535-1601), a Paduan scholar, avid collector and Galileo mentor. The sale of his estate was completed through the candle auction “Candle Auction”, but it ended in failure. We believe that the reason for this failure precisely reflects the advantages of on-chain auctions.

Then we will discuss again why the candle auction “Candle Auction” is the most suitable form of blockchain auction.

Before that, let’s briefly review the recent research done by the Web3 Foundation.

Pinelli’s legacy

Pinelli, who has Neapolitan aristocratic descent, has collected almost all academic-related collections, from fossils to coins, from minerals to historical portraits, from astronomical instruments to maps. [3] However, the most famous part of his legacy is his huge library. In addition to a large number of books, it also contains more than 700 manuscripts, including many rare items, such as fragments of illustrations by Homer in the 4th century and miniatures of Dante in 1355.

After his death, Pinelli’s library was packed and shipped to the heir in Naples. The library consists of approximately 130 boxes, which require three ships to transport. One of the ships was taken by pirates, and Pinelli’s heir died shortly after the rest of the library reached its destination. After many years, more books were lost due to negligence, and the library was auctioned off in 1608 by the widow of Pinelli’s heir.

According to the custom at the time, the auction format was a candle auction: the auctioneer lights a candle in front of interested bidders, and then they bid until the candle goes out. When the candle goes out, the highest bidder wins the item and pays his bid. Pineelli auction is one of the earliest candle auctions with detailed historical records. Candle auctions were used in France in the Middle Ages (records date back to at least 1368), mainly to resolve inheritance disputes. Other records include British ships and fur auctions.

Candle auctions are only used for a relatively short period of time. (They were eventually replaced by auctions, and the auctioneer tapped the baton three times to announce the end, as we know today.) The reason they disappeared is that they are very problematic to operate. Specifically, most of the candle auctions at that time faced the following three problems.

First, people quickly began to engage in what is today called sniping: “Malicious [cancelled] bidding until the candle [was] completely burned, and as a result the legacy [almost] was never sold for real value.[4]

Second, repeatedly try to manipulate the end time, such as coughing to make the candle go out.

Third, once the candle is extinguished, it is often difficult to accurately determine the winner, which may lead to heated debates. For example, Samuel Pepys wrote in his diary while observing a candle auction in the UK that he was shocked when he saw it: “When the candle goes out, how do they cry and argue is Who made the bid first.”[5]

Advantages of blockchain technology

Therefore, the early candle auctions, especially the Pinelli Library auction, were a disaster. At what level can blockchain technology help?

First, the behavior of the auctioneer after the sale points out the main problem of any off-chain auction: the auctioneer’s lack of commitment. Even with the best legal system, the seller can at least delay the transaction of goods for sale in the event of a sudden change of mind after the auction. Of course, if the bidders in the auction anticipate this behavior, then they will not bid as seriously as others, resulting in lower bids. In contrast, if the auctioned and sold items are on the blockchain, smart contracts can easily solve this problem. Once the winning bidder is determined, it will trigger the transfer of auction items.

Next, turn to candle auctions more specifically, and consider the issue of sniping. The reason for using candles is to make the auction end time random: no one knows when the auction ends, which can encourage early bidding. This sounds like a good idea, but the chance that the auction will end early is almost zero.

In contrast, modern computers allow for a more dispersed end time distribution, which increases the likelihood of an auction ending prematurely. The possibility of an early end time means that sniping is indeed no longer a problem, because bidders are under pressure to bid seriously from the beginning.

However, modern computers alone cannot solve the second problem of candle auctions: the manipulability of the end time. In particular, the auctioneer acting on behalf of the seller must still convince the bidder that the announced ending was indeed randomly generated. After all, because bids increase over time, sellers always prefer to participate in the auction later rather than earlier. Fortunately, the latest advances in cryptography allow immutable randomness and can be verified by everyone in the network. [6] Therefore, in the blockchain candle auction, bidders cannot arbitrarily suspend the auction, nor can the auctioneer misrepresent the end time.

The third problem with candle auctions is that their execution process is usually very busy, resulting in endless quarrels about who bids when and how much. In modern auctions (online and offline), the exact order of bids is recorded, which should reduce such disputes. Nevertheless, there are still problems with the secret operation of such records. Especially in complex online auctions, allegations of fraud are not uncommon. [7] Therefore, participation in such auctions is always based on trust in the auctioneer. Of course, this is in contrast to blockchain auctions: if bids are recorded on the chain, then everyone can verify the number and time of all bids without trust at all.

Candle auction case

Now we know that candle auctions are implemented on the blockchain and can be improved compared to earlier offline implementations, but the question still remains: Why use candle auctions in priority?

It is believed that candle auctions can help solve the two main problems that blockchain auctions usually face: preemptive transactions and the existence of smart contracts between bidders.

Preemptive transactions (taking actions before others based on privileges or inside information) will appear on the blockchain because the upcoming transactions are known to participants before they go on the chain. [8] For the auction implementation process on the blockchain, some bidders can see and react to the bids of other bidders before they take effect.

For example, in a first-price auction (an auction where the winning bidder pays the highest bid), this makes it possible for technically savvy bidders to bid more than other bidders at will. However, what is worrisome is that the existence of preemptive transactions makes some bidders feel less involved, thus inhibiting the overall bidding, and then reducing the auction revenue. In addition, auction efficiency may also be affected, because the goods sold go to the most technologically advanced bidders rather than the most highly valued bidders.

As discussed by Jeff Burdges and Luca de Feo in the Web 3 Foundation’s research, there are currently encryption solutions to solve front-end operational problems. However, they are either very computationally intensive or require bidders to take multiple actions. But most importantly, if the bid itself is executed through a smart contract, then the encryption solution will not work properly. The reason is that smart contracts correspond to publicly visible code. Therefore, their valuation of the goods for sale and their strategies have been made public before the auction. In view of the widespread use of smart contracts, there is a high probability that smart contracts between potential bidders will exist in any auction implemented on the blockchain.

Smart contract bidders also face transparency issues. If the valuation of the smart contract is known in advance, it is possible for the auctioneer to register a trumpet and conduct a so-called shill bid (a bid that aims to increase the price paid by the winner). This is especially problematic in second-price auctions (i.e., auctions where the winning bidder pays the second highest bid). In such an auction, everyone must bid honestly. Therefore, the auctioneer may deceive the smart contract in the auction (by submitting a bid slightly lower than the value of the smart contract). But smart contracts that foresee such behavior are likely to be hesitant to participate in it from the beginning. This again leads to efficiency issues, because the smart contract that decides not to participate is likely to be the contract with the highest valuation.

In short, preemptive auctions basically exclude static auctions where bidders submit a bid at the same time, and the transparency of smart contracts excludes auctions that use the second price payment rule.

In the study of Häfner and Stewart in 2021, we proved that the candle auction method is a good choice. To illustrate our point, we analyzed a candle auction between two bidders. In each round, two bidders move in a fixed order. In other words, one bidder is always ahead of another bidder. The bid price must increase over time. In the decisive round, the bidder with the highest bid wins and pays the bid.

The results show that, with a proper selection of the end time distribution, for the first bidder, it is best for the first bidder to make more bids over time, while for the second bidder, when she is When the price of the product is higher, it only needs to match the current bid. Therefore, candle auctions provide some security measures to defend against sinister bidding attacks: in order to raise the price above the equilibrium price, the auctioneer must submit a higher winning bid in an earlier round. But the price of this is that if the auction ends within this period of time, one of the bidders will pay a sum in advance.

In addition, random end times are more attractive to bidders than fixed end times. At a fixed end time, two bidders may wait until the final period. On the other hand, the random ending time brings pressure to bidders to bid in advance. In particular, because early bidders match the current highest bid when their valuation is high, early bidders can gain an advantage by submitting increased bids over time. This allows him to fine-tune bids based on new information, thereby obtaining higher expected utility.

We found that random ending time has a higher bid winning rate than fixed ending time. Because bidders submit higher and higher bids over time, the random end rule means that sometimes auctioneers must also accept lower bids from previous rounds. However, the magic of the random end time makes the overall bid of the bidders higher, resulting in a higher average winning price.

Finally, we found that under a uniform ending time distribution and a large number of rounds, the result will be close to the second price auction. This means that the expected payment of the bidder and the expected income of the auctioneer are equal to the income in the second-price auction. This is an important result, because second-price auctions are one of the most ideal auctions—that is, those that generate the highest revenue. This also means-the result Polkadot most wants to pursue-the bidder with the highest estimate wins the auction!

In summary, the candle auction format can alleviate all three problems caused by preemptive transactions: (1) the inefficiency of weak bidders; (2) low auction revenue; (3) low efficiency. In view of these characteristics, we should expect candle auctions to become the standard mechanism for all auctions on the blockchain.

In the last tragic turning point in Pinelli’s book sales, the cost of shipping the books to Milan was higher than expected, so most of the books were disposed of on the way. In the end, only 35 boxes (out of the original 130 boxes) were delivered to Biblioteca Ambrosiana in Milan, and they are still there today.

references

  • Bulow, Jeremy, and Paul Klemperer. 1996. “Auctions Versus Negotiations.” The American Economic Review, 86(1), 180-194.

  • Burdges, Jeffrey, and Luca De Feo. 2020. “Delay Encryption.” Working Paper.

  • Daian, Philip, Steven Goldfeder, Tyler Kell, Yunqi Li, Xueyuan Zhao, Iddo Bentov, Lorenz Breidenbach, and Ari Juels. 2019. Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges.

  • Häfner, Samuel, and Alistair Stewart. 2021. Blockchains, Front-Running, and Candle Auctions. 」Working Paper.

  • Hobson, Anthony. 1971. “A Sale by Candle in 1608.” The Library 5 (3): 215-233.

  • Micali, Silvio, Michael Rabin, and Salil Vadhan. 1999. “Verifiable Random Functions.” 40th annual symposium on foundations of computer science (cat. No. 99CB37039), 120-130.

  • Pepys, Samuel. The Diary of Samuel Pepys.

  • [1] See the seminal work by Bulow and Klemperer (1996).

  • [2] For a general overview, cf. the Polkadot wiki article. The Polkadot decoded talk by Shawn Tabrizi is also very informative.

  • [3] The accounts given in this and the next section largely follow Hobson (1971).

  • [4] Hobson (1971, 223).

  • [5] Pepys (1662, Wed. 3 September).

  • [6] See, eg, Micali, Rabin, and Vadhan (1999).

  • [7] For example, see this story on MarketWatch about the manipulation accusations of Daily Mail against Google

  • [8] See, eg, Daian et al. (2019).

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