Buyer and seller settling transactions under the digital tree?

July 30th, 2006

I recently read a journal article suggests that markets of buyers and sellers will come “full circle”. Thousands of years ago, “transactions” between buyers and sellers were negotiated “under a tree” and face to face. As markets became larger and global, industry constructed proprietary and closed systems to match buyers and sellers.  In an era of the internet, much of this infrastructure is redundant. A global internet displaces regional and proprietary communications systems. The internet will significantly impact many industries. We are likely to return to negotiating “under a digital tree”. The internet and the emerging “semantic” web will bring the people together in the global market place.

The journal article which inspired these thoughts is Whither Financial Markets on the Net?, Ariadne Capital journal, Duncan Goldie-Scot 2005. An extract of the key points is provided below.

Extract:

“The economist Ronald Coase explained that firms, and banks, only exist because of what he called ‘transaction costs’. All this really means is that firms have economies of scale. It is easier for a bank to match borrowers and lenders than it is for each of us to do it on our own. The optimum size of a bank, following Coase, is determined by those info rmation costs. Banks were at their biggest and most powerful when info rmation costs were very high. As the internet leads to plummeting information costs, banks will get much smaller – and may even be completely unnecessary. It is not just the Zopa model (www.zopa.com) of matching borrowers and lenders via a website but something much more revolutionary that follows from this.”

“Payment systems are big business. According to the Boston Consulting Group banks around the world are taking out fees of some $228 billion dollars a year just for sending money from one database to another over their networks. In the US about 5% of the value of an average purchase is eaten up in payment costs. In the UK money transmission amounts to almost 1% of GDP or £4.5 billion.”

“So, I see four distinct phases of trading, clearing and settlement. The transition from each phase to the next has been caused by an order of magnitude or more reduction in the total cost of trading, clearing and settlement.”

“In phase 1, the bearer phase, traders would sit under the buttonwood tree on Wall Street and swap bearer certificates for cash. Trading, clearing and settlement is a single and costless transaction.”

“In phase 2, the advent of the telegraph means that Wall Street has to cope with long distance orders. A regulator/clearing house has to arbitrate disputes. Trading, clearing and settlement become three distinct operations. The cost of sending my Securicor van to your cage, and vice versa, is offset by the liquidity of the marketplace.”

“In phase 3, the mainframe computer means that we can immobilise and then dematerialise stock into book entries in a database. Trading, clearing and settlement remain separate operations, partly out of habit and partly because the clunkiness of the bank payment mechanisms. Clearing and settlement in computerised databases is cheaper than physical delivery but is neither cheap nor simple: multiple message formats have to be processed in a steep hierarchy of connections between participating institutions.”

“In phase 4, the invention of financial cryptography and the dominance of the internet, as a universal network, means that database entries, and immobilised documents, can be represented in digital bearer form on the internet. Digital cash can be exchanged for digital equity in real time in a costless transaction. The processing can be distributed on client devices meaning that there are very limited hardware overheads. Trading, clearing and settlement merge again into a single transaction.”

“We have established that the banking cartel exercises its power today over the money transmission network – extracting $228 billion a year in fees. We can look forward to new models, such as Paypal, mobile phone payment methods and many others, killing the cartel.”

“Finally, I contend that we will return to bearer markets on the net – digital bearer markets overturning all of our financial structure. Because it can happen, because it will be massively cheaper, and because there is money to be made by making it happen, it is only a matter of time.”

Entry Filed under: Online networks vs. industries, Economic development