Chris Cook on a structure for Market 3.0, part one

Chris Cook on Why Market 3.0?:

The first generation of markets — Market 1.0 — was decentralised but disconnected, and ‘market presence’ required the physical presence of buyer and seller, typically in local and regional exchanges.

Market 2.0, which has now reached its zenith, is centralised but connected, with market presence through intermediaries such as Exchanges or proprietary Alternative Trading Systems (ATSs).

Market 3.0 represents the final evolution of markets: decentralised but connected, with market presence being through a ‘network presence’ on a dedicated market network. Understanding Market 3.0 requires consideration of the architecture of the Internet itself and how this relates to the communications, security, technological and legal infrastructure of markets.

The Internet is nothing more — and nothing less — than a network of connected networks. Every ‘client’ device which accesses the Internet is allocated an Internet Protocol (IP) address which may be fixed or ‘dynamic’, i.e. temporarily allocated for the duration of the connection to the Internet.

At the core of the Internet are root servers specific to top level domains such as ‘dot com’. These are powerful computers whose function it is to enable users to be routed to the destination device. They do so by comparing the dot com name requested with a list of IP addresses of the server(s) upon which the relevant website is maintained.

A key event in the evolution of the Internet was the arrival of instant messaging (IM) services such as Microsoft Messenger. This works through the maintenance of a ‘virtual network’, comprising all users registered at a given moment in time with the instant messaging system server as ‘present on the network’. This is accomplished through an agreed protocol/methodology whereby users’ devices report to the system server when they establish or break their connection. Such direct connection of device to device is known as ‘peer to peer’ networking. All the IM server does is reconcile the registered identity of the user with the IP address of the device being used to access the Internet.

A further revolutionary step in the evolution of the Internet was Napster: the music-sharing system which within 18 months acquired some 60 million users. The Napster architecture was also ‘peer to peer’, allowing Napster users seeking music MP3 data files to be connected to other users who held these files and then to access and download them free of any charge other than the cost of the connection.

The Market 3.0 network will be an instant market messaging network. Market messages largely consist of market ‘chat’, and standardised message forms such as bids, offers, requests for quote; trade details, settlement details and payment details. There will be a dedicated market server which exists to relate the market IDs of the individuals and/or their corporate backers, with their IP addresses.

The final step will be the establishment of a private market-specific domain, accessible exclusively to market users who have downloaded a tiny addition to the Internet browser software on their access device thereby creating ‘dot market’. Market channels

The dot market network allows market participants to access and take part in the market through a direct connection with each other. Note that it is a simple matter to suppress or reveal the market identities of participants at any stage of the trading cycle. Furthermore, ‘intelligent agent’ software programs now exist whose function it is to interrogate the other devices in the market network and even to negotiate with them according to the parameters set by the trader.

However, in order to make trading decisions, participants require access to market data, news, research and analysis. This data, particularly the provision of ‘streamed’ video, consumes vast amounts of network capacity — ‘bandwidth’. Worse, delivery of the data through the Internet is subject to a fundamental architectural constraint. If ten users on a network request data via the Internet then it can only arrive in ten separate ‘unicast’ streams of data: essentially data with a delivery IP address attached to it. The result is that ten users will use ten times as much network capacity as one: exemplified by a large City-based bank whose traders recently accessed a somewhat risqué source of streamed video and crashed the network.

Data broadcast by satellite, wireless or digital TV, on the other hand, has no delivery IP address attached to it. In practical terms, such data can be received by and then delivered within a network by ‘multicasting’ it, which allows an unlimited number of users to access the same data with no increase on the original bandwidth requirement. It is possible to encrypt such data and provide the user with a ‘key’ allowing him to decode it. This technique enables the business model of broadcasters such as BskyB.

However, the further revolutionary step that makes a ‘market channel’ possible is the transmission of the decryption key via the Internet. The result is an interactive ‘peer to peer’ market network with a ‘one-to-many’ broadcast market channel overlay.

Certain markets have a core community of liquidity providers/market-makers and ‘clearers’ who take financial responsibility for market participants’ trades. The market channel communications platform enables the instant global dissemination from this core group of ‘one-to-many’ market messages such as requests for quote and/or bids/offers, inviting participants to submit bids or offers in response. Such a ‘broadcast market’ model is particularly relevant to the global benchmark/ settlement price-setting auction mechanisms such as the London bullion ‘fix’ or London Metal Exchange ‘rings’. Security

The principal reason for the relatively slow growth of the Internet for ‘e-commerce’ is that users, quite rightly, just do not trust it. The solution lies in the integration of two complementary communications layers into one.

Firstly, it is necessary, wherever possible, to segregate the transmission of encrypted data from the transmission of the key. So encrypted data may be broadcast, with the key transmitted on the terrestrial Internet; or conversely, encrypted data may be transmitted via the Internet, while the key is communicated by wireless or other means.

Secondly, it is necessary to strengthen the authentication of the user’s ID. In a world of digital money, crime will involve the ‘theft of identity’ — exemplified by the epidemic of ‘cloned’ credit cards. Here the key lies with geo-location. Individuals commit crime, and individuals cannot be in more than one geographical location. This means that the geo-location capability always available using satellite technology and now becoming standard in wireless communications will, when combined with the introduction of geo-location into IP addressing (planned for the next generation of browser software), give rise to very powerful authentication.

It will be seen therefore that this overlay of complementary communications networks, linked by geo-located individuals and ground stations (which is all that a ‘set top box’ is), will provide the level of market security which the Internet is structurally unable to provide.

Essentially, there are two generic market functions:

* contract formation — which defines a market;

* exchange of value — which underpins a market.

In a spot transaction the two functions take place contemporaneously and the exchange of value is conditional: if I don’t have the shares, I can’t offer them for sale, and if I don’t have the money, I can’t bid for the shares.

The consequence of this is that for true real-time settlement of a spot transaction, there is no requirement for a risk intermediary such as a central counterparty because there is no risk. Where there is an element of time between the conclusion of the contract and its settlement, then this introduces the requirement for risk management, and the interpolation of a risk intermediary such as a central counterparty or insurer.

The requirement for Market 3.0 is for what has been termed a ‘shared transaction repository’ and a ‘shared title repository’. In other words, a market-specific transaction registry database, and a market-specific title database. Note that these databases will not be held at a centralised point in some monstrous mainframe or cluster of servers, but will consist of a distributed network of the connected databases of market participants themselves — in technical terms, a ‘filespace’.

It is possible to connect the disparate market databases through the use of market-specific versions of the technical protocol XML. This means that the market messages travelling through the market network find their way from and to the individual users’ databases of origin and destination.

Equally, Market 3.0 may be characterised as an ‘exchange of exchanges’ or meta-exchange incorporating, in addition to exchanges, all proprietary mechanisms (alternative trading systems — ATSs) by which contracts may be legally concluded. Here the requirement is for a global legal protocol — a market user agreement — incorporating a market standard jurisdiction enabling users to transcend the disparate jurisdictions incorporated in national exchange contracts, or proprietary ATS-generated contracts. So in the same way that exchange members are bound legally in respect of disparate individual listed contract terms, so will Market 3.0 users be bound in respect of listed exchange or proprietary ATS contract terms. The outcome of shared market title and transaction repositories @ dot market is to create what is to all intents and purposes an open market ‘general ledger’. Dot market structure

There is a paradox at the heart of Internet market development:

* initiatives by neutral service providers lack liquidity;

* initiatives by liquidity providers lack neutrality.

The result to date has been fragmentation into competing proprietary networks, with consequent adverse effects upon market liquidity.

True neutrality in the global market trading platform denominated Market 3.0 can only arise if it is operated, and is seen to be operated, for and on behalf of all market participants equally. So a market may be divided into two constituencies: those who provide market services and those who utilise them.

The former consortium may be described as ‘market service provider’ or MSP. An MSP will provide via the Internet all of the services market participants require: market access; market data; trading, settlement and payment; training and education; risk management and accounting services; dispute resolution and so on. An example of such an MSP in embryo is Camelot, which is essentially a consortium of providers of technology, communications and expertise serving a national gaming market via a proprietary network

Any market is defined by those who enter into contracts in it: here the market user agreement — the global legal protocol linking market members together creates the potential for the formation of international trade associations (ITAs). ITAs form the basis for a new decentralised regulatory regime — Regulation 3.0.

Tomorrow: Regulation 3.0

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