:: The Park Paradigm ::

Markets for the Digital Generation

Paul Sloan writes in The Virtual Rockefeller in December’s Business2.0:

To understand the lucrative real estate empire Anshe Chung has created, it helps to spend some time with her “in world.” There, she might teleport you to one of her islands, on the continent she’s named Dreamland. You can stroll through the floating city she built 700 feet above a desert, walk through elegant Arabian-style homes on land she leases, strike up a conversation in Japanese amid her Asian gardens, or shop for a grand piano in one of her 600 boutiques.

It’s all virtual, of course–part of a flourishing online universe called Second Life. And if it sounds absurd, consider this: While Anshe won’t talk about how much money she’s making (”I’m careful not to stir animosity,” she says), Philip Rosedale, the founder and CEO of Linden Lab, which runs Second Life, estimates that she’s bringing in around $150,000 a year–in real, hard cash.

…

When she joined Second Life just over a year ago, she did so out of curiosity about virtual worlds–to explore how people behaved there and how the experience was different from, say, playing a videogame. “What I found were real people with real emotions and real friendships,” says Anshe, 33. “I also found the economy was very real.”

The initial reaction to stories such as these tends to be along the lines: “I can’t believe people pay real money on virtual goods. (followed by a resigned shake of the head…those crazy kids…)”

Then they pick up the phone or go online and buy a bond. Only when is the last time you’ve seen a bond? What if I told you it didn’t exist? Not in the physical sense. Only in the 0’s and 1’s in the computer systems of your bank or broker and custodian…a virtual good if there ever was one. Ah but you say - that bond can be converted to hard physical cash (let’s not get into the philisophical ‘reality’ of fiat money here!) any time, unlike the virtual real estate (or swords or gold or whatever) that Anshe has purchased…ummm but doesn’t she do just that?

Same difference.

Time to change the frame. I think.

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Last year, Thomas Schelling won the Nobel prize for his work on game theory.

Geoffrey Colvin writes a short editorial in FORTUNE exposing just how pervasive Schelling’s work has become in our lives over the last 50 years.

I think this is set to continue and increase. Success in the digital age will be helped by a sound understanding of game theory.

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from FORTUNE magazine, October 31st, 2005:

“The internet is almost the ultimate way of giving people choice. Young people use it more. Before, we were pushing media at them. Now the new generation and the generations to follow are going to be pulling out of the universe what media they want to feel relevant.”

Exactly Mr. Murdoch. The 74 year old billionaire leader of News Corp. gets it.

The same dynamics will affect the financial services industry. It may not be as obvious and immediate as with music or news or film, but the consumers of these products are the same people and the Digital Generation will have entirely different expectations of how they will want to interact with financial services firms and products.

The 40 and 50-something leaders of today’s global financial services behemoths have not yet had their epiphany. Then again they have not yet been Yahoo’ed or Google’d…

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Jennifer Hughes wrote an excellent article in the Financial Times a couple weeks back entitled: “Electronic Trading helps minis grow in stature: Smaller contracts are gaining popularity as local and prop traders realise one size does not necessarily fit all” Of course I can’t link to it as FT.com has no clue what Web2.0 is and has all their information behind a subscriber wall. The (sad) irony is that I subscribe to the paper edition of the FT but that doesn’t seem to make a difference…

Anyhow the point is not to complain about FT’s online autism, but to highlight once again the changing landscape of trading in financial assets or instruments - from large and discrete voice-brokered trading to small and continuous electronically facilitated trading. Trade sizes are going down but trade numbers are going up much much faster (think linear vs geometric.)

The CME (good exchange, poor website) launched ‘mini’ contracts on their flagship S&P Futures back in 1997 but essentially saw minimal interest until 2001 and 2002. (This is all the more surprising as the product was launched into the heart of the great day-trading-internet-bubble of the late 90’s…) Since then, average daily trading volume has quadrupled to over 800,000 contracts per day.

The NYMEX (btw very good website, CME take note) just launched two new miNY contracts (on gasoline and heating oil.) The CBOT has mini contracts on precious metals and some agricultural contracts.

The mini contracts are traded electronically on both exchanges whereas their ‘big brother’ contracts continue to be traded as open-outcry. I find it very interesting that one of the drivers of growth on the mini contracts has been from institutional traders who like the speed and flexibility available from an electronic trading platform. (From Ms Hughes’ article:)

Minis are traded electronically, which most agree has added to their success, since their development coincided with a huge shift towards electronic trading, notably by the Chicago exchanges, and a corresponding widening of the pool of investors with access to the markets.
…
[on standard vs mini gold contracts] …”The beauty is that neither has cannibalised the other, so it means each contract is in effect addressing a different segment of the market,” said Robert Ray, senior vp of the CBOT, who believes that contracts can get bigger, as well as smaller.

On one level - as long as the trading and pricing model remain static - I can agree with what Mr. Ray is saying; however wouldn’t it make alot more sense in a digital world where the cost of processing a marginal contract is tending to zero to focus liquidity in one smallest unit contract? Of course it does. But that would mean, in some cases, eliminating pit trading and more importantly changing the price structure of the exchanges so that someone wanting to trade x million of value is indifferent to whether that is 100 or 1000 contracts.

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