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Auctions with Tokens: Monetary Policy as a Mechanism Design Choice

Andrea Canidio

TL;DR

The paper analyzes a finite-horizon auction where bidders can pay with a token created by the designer, and the token supply is governed by a monetary policy. It shows that, in expectation, the present value of revenues is invariant to whether payments are in dollars or tokens, but token-based mechanisms can front-load revenues and reduce volatility, especially when tokens are burned. The equivalence with a dollar-based auction extends to the frictionless benchmark where the token-based mechanism is replicable by issuing equity, yet introducing non-contractible effort and revenue misappropriation creates a trade-off: tokens dominate under limited contracting, while dollar-based auctions with contingent securities perform better under richer contracting environments. The findings provide a theoretical justification for token burning in blockchain auctions, clarify when tokens should be viewed as securities, and highlight how monetary-policy design interacts with mechanism design to shape incentives and revenue risk.

Abstract

I study a repeated auction in which payments are made with a blockchain token created and initially owned by the auction designer. Unlike the ``virtual money'' previously examined in mechanism design, such tokens can be saved and traded outside the mechanism. I show that the present-discounted value of expected revenues equals that of a conventional dollar auction, but revenues accrue earlier and are less volatile. The optimal monetary policy burns the tokens used for payment, a practice common in blockchain-based protocols. I also show that the same outcome can be reproduced in a dollar auction if the auctioneer issues a suitable dollar-denominated security. This equivalence breaks down with moral hazard and contracting frictions: with severe contracting frictions the token auction dominates, whereas with mild contracting frictions the dollar auction combined with a dollar-denominated financial instrument is preferred.

Auctions with Tokens: Monetary Policy as a Mechanism Design Choice

TL;DR

The paper analyzes a finite-horizon auction where bidders can pay with a token created by the designer, and the token supply is governed by a monetary policy. It shows that, in expectation, the present value of revenues is invariant to whether payments are in dollars or tokens, but token-based mechanisms can front-load revenues and reduce volatility, especially when tokens are burned. The equivalence with a dollar-based auction extends to the frictionless benchmark where the token-based mechanism is replicable by issuing equity, yet introducing non-contractible effort and revenue misappropriation creates a trade-off: tokens dominate under limited contracting, while dollar-based auctions with contingent securities perform better under richer contracting environments. The findings provide a theoretical justification for token burning in blockchain auctions, clarify when tokens should be viewed as securities, and highlight how monetary-policy design interacts with mechanism design to shape incentives and revenue risk.

Abstract

I study a repeated auction in which payments are made with a blockchain token created and initially owned by the auction designer. Unlike the ``virtual money'' previously examined in mechanism design, such tokens can be saved and traded outside the mechanism. I show that the present-discounted value of expected revenues equals that of a conventional dollar auction, but revenues accrue earlier and are less volatile. The optimal monetary policy burns the tokens used for payment, a practice common in blockchain-based protocols. I also show that the same outcome can be reproduced in a dollar auction if the auctioneer issues a suitable dollar-denominated security. This equivalence breaks down with moral hazard and contracting frictions: with severe contracting frictions the token auction dominates, whereas with mild contracting frictions the dollar auction combined with a dollar-denominated financial instrument is preferred.
Paper Structure (13 sections, 7 theorems, 43 equations)

This paper contains 13 sections, 7 theorems, 43 equations.

Table of Contents

  1. Introduction
  2. The model
  3. Equilibrium
  4. Auction with dollars
  5. Auction with Tokens
  6. Discussion: Traditional Financial Instruments
  7. Extension: pledging an object vs. pledging cash
  8. First best
  9. Auction with dollars and outside investors.
  10. Auction with tokens
  11. Discussion
  12. Conclusions
  13. Mathematical derivations

Key Result

Lemma 1

Consider a given auction format, an initial asset level $w_1 \geq 0$, and realized period-1 revenues $\sum_{i=1}^n b_{i,1}$. Define $\{w_2^*, \dots, w_T^*\}$ as the unconstrained optimal sequence of asset holdings in the absence of risk, that is, Then, where the expectation is taken over the realization of period-1 revenues $\sum_{i=1}^n b_{i,1}$. The inequality is strict if $U(\cdot)$ is strict

Theorems & Definitions (10)

  • Lemma 1
  • Lemma 2
  • Proposition 1: Expected Revenues
  • Proposition 2: Revenues when $\sigma_t = -1$ for all $t \leq T$
  • Corollary 1
  • Lemma 3
  • Proposition 3
  • proof : Proof of Lemma \ref{['lem: initial']}
  • proof : Proof of Proposition \ref{['prop:revenues']}
  • proof : Proof of Lemma \ref{['lem:effort']}