3.0: The Final Version
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
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'.
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
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
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
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.
@ dot market
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
Mutual trust is the glue that binds markets together. Regulation
engenders trust, and the setting and enforcement of market standards
of behaviour and propriety are the essence of successful regulation.
At the dawn of markets -- Market 1.0 -- this trust was based
upon self-regulation: upon subjective judgments by one individual
of another, backed by a fundamental regulatory concept -- 'mutual
Mutual reference essentially consists of the collective experience
of the market community in respect of their dealings with each
other. Any individual who offended against accepted standards
of market behaviour, and was thereby in breach of trust, would
be judged by his peers and subject to penalties up to and including
exclusion from the market -- if not to a grimmer fate under
the harsher laws of those times.
Intermediation and centralisation have led to centralised markets
-- Market 2.0 -- and to centralised regulation, exemplified
by Regulation 2.0 regulators such as the SEC/CFTC and the FSA.
In the UK the advent of self-regulatory organisations in 1987
-- such as the AFBD and TSA -- was remarkably successful in
raising the standards of UK exchanges and financial intermediaries.
This was because prior to that point no-one was looking at what
the intermediaries were doing. That, on a global basis, is the
position to which we have returned -- the 'Sumitomo Gap' --
no-one is looking at what the customers are doing.
Centralised national regulation -- Regulation 2.0 -- can go
no further. There is no access to global market data; there
are no global market standards; and even if there were, no-one
has the ability to enforce them. A new architecture is required.
Regulation 3.0 is a return to self-regulation, but this time
by market participants themselves in the form of an ITA. An
ITA will set market standards:
* the crucial market standard jurisdiction;
* standard contract terms (cf. ISDA, ISMA);
* standards of behaviour;
* standards of 'fitness and properness';
* standards of transparency.
regulatory 'teeth' derive from the fact that anyone suspended
or expelled from an ITA has no access to the market, becoming
an 'outlaw' consigned to the 'outer darkness'.
Perhaps the most important regulatory tool in internet markets
is the 'mutual reference' function. A good example of this function
in action was, until 1995, the London Stock Exchange's 'Mutual
Reference Society'. This was essentially a database of customer
identities kept in card index files which LSE members were obliged
to check when opening a new client account. While this was primarily
aimed at clients who had defaulted in payment (whose card would
be flagged appropriately), not all undesirable clients are unable
or unwilling to pay, as the regulatory requirement for anti-money
laundering 'due diligence' makes clear. Nevertheless, LSE closed
down the mutual reference service, apparently on cost and data
protection grounds and in view of the perceived prohibitive
cost of automation.
However, the function, which is little more than the operation
of a database to be maintained by brokers themselves, is perfect
as an internet application and mutualreference.com was therefore
set up in 1999 to meet the continuing regulatory requirement
for due diligence by brokers.
One example will suffice of mutual reference in practice: where
a proprietary 'e-marketplace' has evolved, by way of quality
control, a form of genuine and effective self-regulation into
its business model. eBay is a retail auction-based marketplace
connecting individuals to a centralised server-based marketplace:
in essence, a cross between an automated electronic car boot
sale and an auction. There are literally millions of auctions,
in every conceivable kind of goods, being operated by eBay at
a given point in time, each probably lasting several days. In
fact thousands of businesses, particularly in areas such as
antiques and collectibles, operate exclusively on eBay.
As the business evolved it became apparent that there were some
serious 'conduct of business' issues involved:
* were the goods actually the property of the seller?
* even if they were the seller's goods, were they what he/she
said they were?
* did the buyer have the money to pay for the goods?
* was he/she in a position to take delivery?
Beyond these issues were questions of public policy in relation
to the nature of the items for sale, such as the offer for sale
of securities, or firearms.
The regulatory model developed by eBay was based upon 'feedback
forums' whereby buyers and sellers would post positive or negative
feedback in respect of their dealings on eBay. This in turn
has led to 'star ratings' whereby regular eBay users acquire
a rating based upon the aggregate of feedback received, where
+1 is a positive; 0 is neutral; and --1 denotes negative feedback.
eBay then awards star ratings banded by the number of points
In addition actual feedback, in terms of comments, may be posted
by buyers, sellers or both and these comments may be made publicly
available with the consent of the person in receipt of the relevant
comments. eBay actively encourages such disclosure. The outcome
of this model can be fairly draconian in practice: miscreants
are given short thrift by their peers.
Because markets are by definition open, there are important
issues in relation to the enforcement and disciplinary process
which may not apply to a proprietary system where someone unfairly
excluded may perhaps take his business elsewhere. Clearly, ITAs
would therefore have to take care in drafting their rules/user
agreement to meet appropriate regulatory standards of fairness
We have seen how two distinct consortia comprise Market 3.0.
How is it possible to link them together into a seamless enterprise
with a viable business model?
Virtually all markets were until relatively recently run by
cartels of intermediaries (i.e. exchanges) in their own interests.
They were typically constituted as not for profit or mutual
entities which would return any surplus of income over expenditure
to members. The recent trend among exchanges in response to
the threat posed by ATSs has been demutualisation into for profit
entities; the reasons being:
* the requirement for capital to fund development of the exchange's
own dealing systems and networks;
* more flexible management, free of the factionalism that plagues
* the prospect for executives and shareholders alike of mouthwatering
returns on their investment from exploitation of a dominant
A moment's reflection
on the latter leads to the conclusion that the 'shareholder
value' thereby generated has to be at someone's expense, i.e.
the constituency of customers, now including the ex-members.
In other words, the flaw (which is a fundamental flaw of capitalism
itself, excused by the fact that alternatives have to date proven
to be worse) lies in the divergence of interest between the
providers of this capital and the users. At this point, an innovation
is proposed which may square the circle. The 'open corporate'
entity suggested is not rooted in the UK body of Companies Act
legislation, but rather in the unintended potential of a recent
innovation in UK Partnership Law. It has been possible in the
UK since 1907 for a partner to introduce capital and limit his
liability but at the price of being unable to participate in
management. The key UK legislation in the creation of the open
corporate was the Limited Liability Partnerships Act 2000 which
came into effect on April 6, 2001. This Act effectively enables
partnerships, typically of professional firms such as accountants
and lawyers, to protect the assets of the individual partners
in the event of insolvency -- itself increasingly likely in
the face of massive claims of compensation. It reflects similar
US Limited Liability Partnerships (LLPs).
A UK LLP is a corporate body with members/partners who may be
individual or corporate (or a mix of the two). It is governed
by a member agreement which sets out the rights and obligations
of the members inter se. However, it is doubtful that the use
to which it may now be put was ever conceived when the Act was
A Market Corporation will be a UK (or possibly for tax
reasons Jersey) LLP.
Members of Market Corporation LLP will own proportional shares
in the value of the enterprise rather than the shares in a for
profit joint stock company, which are created and issued with
a nominal value -- typically £1.
Such proportional shares are infinitely divisible: a partner
with a half share therefore has 500 thousandths or 500,000 millionths
and so on, and the value of such a share may be determined at
any time as a proportion of the value of the enterprise. The
member agreement of Market Corporation LLP will allow such proportional
shares to be freely tradeable between members or constituencies
of members. New members will be invited to contribute capital
or services in return for shares. Most revolutionary of all,
it will be possible to raise additional capital without relinquishing
control by lending or pledging shares.
This will be accomplished through the use of the 'repo' agreement
-- the sale and repurchase of shares. Repos -- which are relatively
little known for a multi-trillion pound industry -- allow institutional
investors to generate an income by lending shares to each other
for a period of time. The Repo price would reflect a benchmark
cost of money plus a risk premium. A default gives rise to a
very simple outcome, which is that the financier would automatically
acquire full ownership of the shares. The outcome is that the
utility cash-flow received by the Market Corporation from its
ITA members and remitted to its MSP members may thereby be simply
and effectively securitised. In an open corporation, debt is
equity traded forward.
Market 3.0 is based upon a simple market architecture where,
for example, members of the International Petroleum Trade Associationwould
access the oil market, using whatever proprietary trading software
they wish, @ dot oil. They would receive market data, news and
intelligence from their preferred sources via the Oil Channel.
The oil market transaction and title repositories, connected
by clearing and settlement software, would provide paperless
straight-through processing generating massive savings for IPTA
Members. If a guarantee is required in respect of a contract
then this will be available.
The IPTA members would be partners, with the Oil Market Services
consortium providing this oil market infrastructure, in Oil
Corporation LLP-- an Open Corporation which is neither mutual
nor for profit, but rather 'for value'.
This article was originally published in the 2002 Compaq