Headline: Different types of auctions
Date: 4/14/2022
Body: So many of us are used to the image of an auction. A richly paneled room with hundreds of well-dressed men and women, each armed with a paddle. The price goes up and up and up until there is no other higher bid. This is one type of auction, but there are so many other types, and I since cryptocurrencies, NFTs and other digital assets are so often placed into an auction, I thought that reviewing the major types of auctions that there are would be a productive use of time. (Lest you think this is an outdated, uninteresting part of the dismal science, the most recent Nobel Prize in Economics went to a man who did work on different styles of auctions.)
What Is an Auction?
An auction is a sales event where there is a process of “price discovery.” The price changes up or down, until there is one person with the highest bid. It is popular with both sellers and buyers because they both believe that this format of price discovery will lead to a fair value. (I know that some of these auctions can lead to seemingly ludicrously high values for some assets, but really, that winning bid is evidence of “what the market will bear.”) In the largest level, they can either be closed (where individual bidders don’t know about competition) or open (like at a classic car auction, where the owners are aware of the competition.
Are there different types of auctions?
Yes, as mentioned above, there are open and closed format auctions. Beyond that, there are a few more to be aware of.
Government Auctions
Sometimes, assets come into possession of the federal or municipal governments, and to get some cash, they will auction these items. As an example, I have a friend, Scott. Scott has always wanted to own a Ferrari. He did his homework and decided exactly what he wanted. He scanned the government auction lists, and one week, he found one that had been seized in a legal proceeding. He got a great price, the government got a little money, and everybody was happy. Except for the miscreant who originally purchased the Ferrari.
Traditional (English) Auctions
In a traditional-style auction, as explained above, the starting point is usually pretty low, then works its way up, until there is no bidding. The winner is the last bid.
Dutch Auction
Most often, this refers to an auction that starts at a very high value. The price of the item drops gradually, until there is one bid.
Silent Auction
In my limited experience, this is most often a sort of fund raiser activity for a non-profit entity. I belong to an organization called the American Nystagmus Network, and they have a conference every 2 years. At that conference, they have a printed program with advertisements. In recompense for printing an ad in the program, many vendors will donate a prize (e.g. a spa package or perhaps a gift card.) These prizes will be placed on a long table, and a sheet of paper under each one. If interested in an item, you write your name below, and the amount you are willing to donate to the organization and to hopefully win the item. It is a great way to make money for a good organization.
Double Auction
In this type of auction, both buyers and sellers publish prices they are willing to pay or accept. They are matched, and then a transaction occurs under the watchful eye of a 3rd party. OK, this one is most often within the financial markets, so it is very applicable here. Picture the NYSE circa 1992. There is paper flying everywhere, and people wearing different color jackets are running around the exchange floor. Hand gestures flash faster than gang signs in Compton. When a seller finds a matching buyer, the exchange is done and the records are updated for both parties.
There is one other wrinkle that I know of…
When growing up, there was a development across the street, of about 20 lots. The original developer went bankrupt, and there was an auction held right in the midst of these lots. (I remember this well.) What I most remember is what happened at the end. Each lot was auctioned off serially, one at a time. But, at the end, the auctioneer added up the value of all successful bids for the 20 lots, and gave everybody one last shot to bid higher on the whole collection of 20. This detail caught my eye, as I was not used to it.
Advantages and Disadvantages of Auctions
Advantages
| You can often find rare items at an auction. |
| Buyers can often get bargains at an auction. |
| At an auction, the seller is in control the whole time. |
Disadvantages
| Some potential buyers might pass up the auction due to the competitive nature of the event. |
| The fees to have an auction can be very high. (For instance, there has to be a venue, and rental expense could be high. There is also the auctioneer who has to be paid.) |
Are there legalities that I should be aware of?
There are a couple.
- When you enter a bid at an auction, it is considered entering into a legally binding contract. Once you make that bid, if you back out, you can be sued.
- Collusion is possible at an auction, and in some countries, this type of bidding is illegal. Check your local listings…
- If nobody bids on an item, negotiations can be executed between buyer and seller.
The Verdict
Auctions are so well-engrained in our capitalist system that is difficult to imagine our world without them. And the tradition of auctions is not limited to the American system. In many portions of the world, it is just expected that negotiations will take place, and people seem almost disappointed if you do not use an auction-like negotiating tactic. The trick here, seems to be that you have to know the rules and customs of business before you take part.
REFERENCES
https://www.econport.org/content/handbook/auctions/commntypes.html
https://onlinelibrary.wiley.com/doi/pdf/10.1002/9781119205098.app4
Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice. Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.