:: The Park Paradigm ::

Markets for the Digital Generation

Like JP, I am privileged to have one foot in “the City” (Wall Street for North American readers) and one foot in “the Valley” (and am probably perceived as a bit of a black sheep in both.) I am also privileged to be Generation X, with one foot in the Baby Boomers’ world and one in the Digital Generation’s. And so I immediately saw the truth in his recent observation on how the rules of (social) engagement are so different in each. Which all too often leads to missed opportunities on both sides:

An aside. One way to understand the difference between the audience of yesterday and the audience of tomorrow is by looking at how Blackberries and Macs get used in the enterprise, at meetings and conferences. Yesterday’s generation look surreptitiously at their BlackBerries, pretending to pay attention to what is being said. For some strange reason, they think that no one will notice. Tomorrow’s generation, on the other hand, put their Macs on the table and use them to take notes, to look up references, to stay connected. And they pay attention to what is being said. While everyone else thinks they aren’t listening. So one generation pretends to listen, actually does something else, and goes around in the benighted belief that no one will notice. And the other generation pretends not to listen, knows how to multitask, and does all this in the open. Hmmmm.

I guess bridging this divide is really what I have been trying to do for the last few years and is a cornerstone of my new venture. I guess it comes down to seeing the lack of a public wi-fi network (and more importantly nobody except me even noticing let alone caring) at a major conference on financial technology as a glass half full…

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In 1971 Intel unveiled the world’s first commercial microprocessor, a technological revolution that heralded the Age of Information and Telecommunications - the fifth techno-economic paradigm since the dawn of the industrial revolution in the 18th century.* Although it is almost impossible to identify the core elements of each successive technological revolution without the distance of historical perspective, I wonder if Betfair’s recently announced Flywheel trading engine might be an analogous revolution at the dawn of the sixth paradigm - the Age of Markets. Will Moore’s Law be joined by Yu’s Law? (or Devine’s Law?):

“The number of transactions per second per $1000 of hardware increases by X every Y months…(!)”

(Remember future wikipedia contributors, you read it here first! )

To put this into context, and using Carlota Perez’ framework, let me outline some of the elements I believe will characterize the Age of Markets. Firstly, new technologies and new or redefined industries will emerge:

• truly global financial markets (including ‘developing’ countries)
• entirely new concept of risk management and insurance: “outcome” markets
• convergence of retail and wholesale risk markets
• ubiquitous worldwide realtime trading in “digital goods and services”

These will be supported by new or redefined infrastructures:

• cheap electronic exchange software
• digital transaction costs converging on free
• abundant (almost free) computing power and communication bandwidth
• worldwide dissemination of mobile networked computers (phones)
• vast social networks (breaking institutional monopoly on trust)

Indeed, unleashing the potential for ubiquitous traded markets in heretofore “inaccessible” products, services and outcomes depends on a number of foundation elements: essentially free transaction mechanisms (allowing high frequency, low value transactions), vast distributed digital communication platforms, robust and secure trust frameworks, and intuitive (ideally invisible, at least in the conscious sense) and painless trade capture and risk management interfaces. It would seem that Flywheel has the potential to meet at least the first of these requirements (from BusinessWeek):

Betfair CEO David Yu set the company’s R&D team the task of increasing throughput by 100 times for free. Project 100X took two years to develop and was run both internally and with three other partners, in what Carter calls a “bake out” - whichever team came up with the best prototype would get the investment for the rollout.

The budget for the entire project was less than £1m over two years.

In the end, the R&D team came up with a betting engine, called Flywheel, that could demonstrate a throughput of almost 100,000 transactions per second, while also reducing the cost per transaction by 200 times.

Even with a traditional betting engine, Betfair processes five million transactions per day - much more than the London Stock Exchange’s transaction processing system is capable of.

The R&D team expects one million trades per second to be possible through Flywheel, which it estimates is the equivalent of the entire combined annual global equity trading volume being processed in a matter of hours.

However, for Carter, the key achievement is the cost levels. He explained the whole system runs on two servers with an approximate cost of £25,000. This, he said, is in comparison to a high street bank with a similar throughput load that will typically use a mainframe costing many millions of pounds.

Ok, just in case you skimmed over that last bit, it probably bears repeating:

ONE MILLION TRADES PER SECOND. ON £25,ooo OF HARDWARE.

I’m talking my own book sure, but honestly who’s stock would you rather own? The NYSE Euronext? Nasdaq? how about Deutsche Borse? or OMX? or the LSE? …or Betfair???

In Amazonbay, I suggested that someone like eBay might move into financial markets, leveraging their technology and associated low transaction costs by buying a financial exchange, leading electronic agency brokers and ultimately Betfair (in the summer of 2010!) With a market capitalization of c. $44bn eBay could probably afford NYSE Euronext (at c. $21bn plus a takeover premium) but the real prize would be Betfair. By 2010 they should still be able to afford it but it’s far from clear it will be for sale and one imagines it will be a far sight more expensive than the £1.5bn valuation Softbank acheived when it took a private stake in April 2006. Speculating about big brand name corporate deals is obviously fun but risks confusing the real point.

Any business predicated on charging a significant ‘metered’ transaction fee for matching or facilitating a (digital) trade is likely to see it’s business model washed away like a sand castle at high tide and needs to be ready to compete in a world where marginal transaction costs are zero and value is derived ‘because of’ the trade, not ‘with’ the trade.

Oh, and one more thing… ONE MILLION TRADES PER SECOND. MILLION.

…this is not your father’s oldsmobile…

(* see Technological Revolutions and Financial Capital, p. 11)

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