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The Constitution DAOwner and the Winner’s Curse

I had never watched a Sotheby’s auction live so I really didn’t know what I was getting myself into, but boy was this exciting. So, long story short – a bunch of crypto enthusiasts created a thing called Constitution DAO. A DAO is a Decentralized Autonomous Organization. Basically, it is a decentralized organization that operates on the blockchain to achieve some specified purpose. In this case the purpose was to buy one of the only privately owned copies of the Constitution which was going to be auctioned at Sotheby’s. It’s kind of a weird thing because this DAO doesn’t give anyone ownership to the Constitution. It would just give you some say in where it would go and stuff like that. For instance, if Joe Schmo contributed $1,000 he could vote to have the Constitution come by his house on Thursday night for Thanksgiving turkey. Could there be anything more American than that? Kind of cool I guess, but the financial upside was fairly limited.

Anyhow, this DAO crowdfunds over $40MM. Yes, $40 MILLION. An impressive feat.

Now, the estimated sales price was $15-20MM. Probably low-balled, but still. If you’re the Crypto people you’ve gotta think you have this one in the bag. The problem was, given the transparency of the DAO’s structure, the other bidders essentially knew their max bid. I am not a game theory or auction expert, but I would imagine that walking into an auction and screaming “HEY, I HAVE $40MM TO BLOW ON THIS ONE ITEM, LET’S PARTY!” is a bad strategy.

And it turns out that was exactly the case because Ken Griffin apparently already had a guaranteed bid on the item. You know, billionaire Ken Griffin of Citadel. That little firm known for payment for order flow and seeing everyone’s orders before they hit. That guy wanted the Constitution also. And he knew the max bid from the opponent he was bidding against. You can watch all the drama go down here. Spoiler alert – the DAO lost because that’s what happens at an auction when everyone knows your max bid and you’re bidding against someone who has oodles of f*$k you money.

The worst part about this whole thing is that there’s apparently all sorts of problems with the refunds being issued to all the contributors to the DAO. The fees on the crypto network are so huge that smaller contributors aren’t getting any money back. And because it’s a DAO the contributions aren’t even tax deductible. It’s all kind of sad, but at least a bunch of hilarious memes came out of it.

There’s all sorts of interesting backstories here about crypto. On the one hand it’s amazing that they crowdsourced $40MM in a handful of weeks to nearly purchase one of the most important historical artifacts in American history. And that’s the ultimate upside of all this – to be part of something bigger than yourself. As Matt Levine loves to say, modern finance (as in 2021 finance) is less about making fundamental sense about things and more so about being part of some online club (like GameStop, Tesla, AMC, Dogecoin, etc). On the other hand, the transparency, organizational inefficiency and fees raise all sorts of questions and makes you wonder why we’re creating all these online clubs and bidding up assets when they don’t actually achieve the meaningful and efficient social goals that are often claimed to be associated with them? Don’t get me wrong. The memes are great, but we’re all gonna get bored at some point and wake up, right? RIGHT?

I could write a million pages on all of that, but I am more interested in the many ways in which this whole process exaggerated the Winners Curse. The Winners Curse, in short, is the way in which the winning bidder at an auction can succumb to various behavioral biases that lead them to overbid on an item thereby cursing them with the win. A classic example is tech IPOs in late 1999.

This case is particularly interesting because Griffin had already guaranteed the auction. In other words, he was gonna bid here no matter what. The question was how high he was willing to go. And then you had this decentralized organization broadcasting their fund raising effort and publicizing their max bid. So you had a bottomless pocket bidder bidding against a brainless entity who had not only increased the demand for the auction, but had basically set a floor on the pricing. I know why Sothetby’s got into the NFT business – they’re the ultimate winner in all of this as the high fee centralized market maker playing the decentralized against the centralized….

I’m sure part of Griffin was excited to crush the hopes and dreams of crypto people while internally raging at the fact that he was being forced to bid much higher than he otherwise would have. It’s interesting that the DAO was designed to overbid for the item, but they also forced Griffin to overbid for the item. A Pyrrhic victory of sorts, I guess. Then again, the financial world is so silly these days I wonder if Constitution DAO could just do Constitution DAO Redux, raise a second round and go to Griffin and offer to buy the Constitution for an even higher price. Nothing would surprise me at this point.

In a world where financial asset prices seem to only go up it makes one wonder if the Winner’s Curse is even a thing anymore. But of course, the fact that I am even thinking that means that the Winner’s Curse is very much a thing and we just don’t know who the real losers of this cycle are. Yet.

 

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