Sean Park Portrait
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Articles tagged 'Exchanges'

Are (traditional) financial markets broken?

I don’t have much invested in traditional public equity markets, just a handful of relatively small positions in my (self-directed) pension fund. I haven’t done any robust analysis but my intuition tells me that my average holding period for these positions is probably around 2-3 years, with perhaps a bit of trading (lightening up or adding to existing positions) one or twice a year. And watching the markets from the sidelines over the past month or so certainly hasn’t made me regret this modest, passive allocation. When massive, mature companies trade up and down by 10 or 20% in a period of days – with no or little company specific news, confidence in the market’s ability to set prices in an orderly fashion clearly goes out the window. Indeed, the (public) equity markets are dangerously close to losing their ability to provide one of their key benefits: price discovery. And if/when this comes to pass, there will be serious knock-on effects on their other prime (and beneficial) function of capital allocation (and providing access to capital to companies and access to companies to investors.)

The risk is that a tipping point is reached at which the traditional public equity markets cease to be relevant venues for raising capital or investing. As many people have recently remarked (Kill the Quants Before They Kill Us, Beat high-frequency trading machines by not playing their game, etc.) possibly the key driver of this trend is the relentless increase in algorithmically-driven machine trading (high-frenquency or otherwise.) Now don’t get me wrong, I am neither a luddite, nor am I fundamentally opposed to these trading strategies; rather all other things being equal I would probably consider myself a proponent. In moderation, these types of trading strategies add both liquidity and heterogeneity to the market and as such help create a more robust trading ecosystem. But recently, the equilibrium of this system has come unstuck. Anecdotally, it is now assumed that upwards of 60% of trading volumes on the main public stock exchanges are accounted for by algorithmic/machine-directed trading. On some days and in some stocks, I understand that this can be as much as 80+%.

And most of these strategies don’t involve any judgement as to the valuation per se of a company; basically, as the Onion put it so brilliantly many years ago: they are just “trading” a “blue line”.

Blue Line Price History

NEW YORK–Excitement swept the financial world Monday, when a blue line jumped more than 11 percent, passing four black horizontal lines as it rose from 367.22 to 408.85.

So nobody is actually setting the price! (…or more accurately, the “price-setters” in the markets are mostly being overwhelmed by the trend-trading machines.) This does have the side effect of creating real trading and investment opportunities for on the one hand a small number of smart nimble day traders and on the other hand a small number of very long term investors (who have the luxury of having deep pockets and patience) but for the vast majority of investors (professional or private) the market dynamics and extreme short term volatility make participation more and more painful. This is particularly the case in a low-return environment such as today. Clearly execution (entry and exit points) have always been important, even to long term investors, but never have they been make or break like they have been in August: who cares if you have a carefully crafted investment thesis that predicts a 20-40% appreciation over 2-3 years in Company A when depending on the day of the week on which you entered the position, the thesis is rendered somewhat moot by a 20% swing in the share price.

And it’s no wonder that strong, growing private companies are often loathe to have their shares listed: what right-thinking CEO wants to deal with that insanity???

So what’s the solution? I don’t pretend to have an answer, but I do have a couple suggestions that perhaps point in the right direction for smarter people than I to develop into actionable plans:

  • design structural dampeners (through exchange rules and regulations) that limit the volume of algorithmic trading to some maximum proportion (to be A/B tested to find the optimal point – 40? 50? 60? percent?); this could also be a dynamic number, for example increasing or decreasing with intraday volatility to damp same
  • encourage the continued development of private secondary markets (SharesPost, SecondMarket and others) and help to develop them as real alternatives (and complements) to traditional public equity markets.

It’s really important that our global capital markets operate robustly and efficiently. In fact it’s never been more important. I believe that reasonable, robust solutions exist (or can be developed.) But I fear that the inertia and prejudices of entrenched incumbents (exchanges, banks, regulators, governments and investors) will make finding these solutions exceedingly difficult. I hope I’m wrong. Until then, be careful out there (and think about re-allocating some of your capital to the private markets; you’ll sleep better at night!)

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The end of [financial exchange] history.

I haven’t had much time to write in the last few months, part of the unavoidable occupational hazards of building a business and a company, but I felt almost obliged to comment on the latest round of major financial exchange consolidation as the author of the 2005 “Amazonbay” video

So what was my initial reaction? Completely underwhelmed. The question that immediately popped into my head was: “Is that it???” Is that the most exciting, most optimal path to future growth that these management teams and their armies of advisors could come up with? And if so, what next? Even theoretically, only one more iteration of the global consolidation game exists and I’m not sure anyone would really advocate for a monolithic NYSEEuronextDBCMESGXetc… So the question that still will haunt the new, bigger boardrooms is not answered but only postponed: whither future growth in an increasingly commoditized business??

Don’t get me wrong, it’s a hard question. I don’t have an answer either. But you won’t be surprised if I suggest that it is probably to be found in thinking about post-consolidation de-consolidation aimed at creating new companies focused on various horizontal layers in the stack. Indeed, if the only path possible to get to a very small handful of global core exchange platforms was this flurry of mergers, then perhaps it was not all in vain. I would accept that in this layer of the “exchange stack” there is truly economies of scale, much as for instance with core communication infrastructure.

But then I would suggest that management of these platforms then needs to focus intensely on dis-investing themselves of other layers of the stack where economies of scale are less in evidence or absent completely. I don’t want to be cynical but giving the combination of normal 20th century management dynamics (bigger is better) and the particular emotio-political aspects of the exchange business, I would be very surprised to see anything like this happen. If I were a shareholder of any of these companies my fear would be that any of the advantages that arise from these combinations are ultimately subsumed by the disadvantages engendered by complexity (in every dimension.)

Giant financial exchanges – like the giant banks – aren’t going to disappear overnight. Possibly never. But to frame the debate in this “new” vs “old” / “mammal” vs “dinosaur” context is to miss the point. There are dozens of good (and some less good) reasons why these incumbents will be very hard to dislodge, and to focus on this – while potentially entertaining – skirts around the really interesting question which is to ask: where (and by whom) will value be created in digital transaction execution and management over the the next decade or two?

I don’t envy the management teams that lead these exchanges – they are forced to operate in a highly constrained political and cultural space and having fairly recently lived through the golden age for their traditional business model would seem – at least in the short term – to have huge asymmetrical downside in terms of the world’s expectations for them. Not fun.

There are some very interesting opportunities for these giant trading platforms in the years ahead. I just think that things will have to get a lot worse first before the management of these firms are in a position to act on these opportunities and think laterally. Or should I say horizontally!

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AWS Chronicles

So my question is when does split its retail operations from its AWS platform business. I’d love to see these priced separately. Actually, truth be told, I suggest is actually three businesses:

  • the AWS computing platform
  • the Amazon retail and logistics platform
  • the online store(s)

At the risk of being accused of adding only ‘thin’ value, I would suggest that these three businesses run and capitalized individually would be worth more than Amazon’s current $60bn market cap. Indeed, is a perfect example of a firm that is natively adapted to the new optimal ‘industrial stack’:
The new industrial stack.

Earlier this year I suggested that AWS in particular could well be the totemic representative technology that inaugurates the sixth techno-economic paradigm:

Just as Intel’s 4004 microprocessor was the catalyst for a wave of creative destruction in the 70s and 80s, will AWS prove the same for the 00s and 10s? Probably. We’re seeing it already. And it’s going to disrupt the hell out of the mastodons of industry across most sectors of the economy. Why? Because their cultures and leaders are entirely ill-equipped to face such a fundamental paradigm shift. They know how to play by the old rules. The strategic competitive advantages they built up over decades risk suddenly – poof! – to become obsolete.

And then a couple of weeks ago, Amazon announces spot instances on EC2. Amazon’s CTO Werner Vogel explains:

The central concept in this new option is that of the Spot Price, which we determine based on current supply and demand and will fluctuate periodically. If the maximum price a customer has bid exceeds the current Spot Price then their instances will be run, priced at the current Spot Price. If the Spot Price rises above the customer’s bid, their instances will be terminated and restarted (if the customer wants it restarted at all) when the Spot Price falls below the customer’s bid. This gives customers exact control over the maximum cost they are incurring for their workloads, and often will provide them with substantial savings. It is important to note that customers will pay only the existing Spot Price; the maximum price just specifies how much a customer is willing to pay for capacity as the Spot Price changes.

Spot Instances are ideal for Amazon EC2 customers who have workloads that are flexible as to when its tasks are run. These can be incidental tasks, such as the analysis of a particular dataset, or tasks where the amount of work to be done is almost never finished, such as media conversion from a Hollywood’s studio’s movie vault, or web crawling for a search indexing company. For most of these tasks their completion is not time critical and as such they are ideal targets for additional cost savings.

Before I go any further, let’s just say it’s pretty exciting to see vision become reality even if in this case I’m only a distant spectator. Markets in anything. Digital markets. Themes that go back to the founding mission statement of the Park Paradigm:

(December 2005) The technology of the digital age is driving an unprecedented explosion in the ability to create markets in anything. Trade anything. Not just physical goods. Not just financial instruments. But ideas. Events. Outcomes.
The emergence of these kinds of markets will – over time – impact how we view and interact with the world in all aspects of our personal and professional lives. They will fundamentally alter the current world economic and social paradigm.

Chris Swan calls them virtual resource markets and correctly points out that, at least for now, the market is “closed” – ie users cannot trade their capacity amongst themselves, however I suspect that it is just a matter of time before such a market is organized. But what would be even more useful (and exciting) than a closed market on Amazon EC2 resources, would be an open marketplace for on-demand spot computing resources. ie A marketplace which is agnostic as to where the compute resource comes from, so long as it is a robust and more or less uniform resource.* However for this to be useful for the end consumers of this computing commodity, the ability to switch automatically and seamlessly from one cloud computing source to another based on price and/or availability would be crucial. Indeed this would be the key value driver for anyone hoping to operate a compute resource exchange. Sure the price discovery and transaction mechanisms would be necessary but these are relatively trivial to build and hard (in isolation) to monetize. The real value creator for any exchange (just ask the CME) lies in clearing and settlements. (For the non-financial amongst my readers this is the back-end of the trade, fulfillment essentially.)**

James Urquhart makes this point strongly in his review of spot instances:

Note, however, that this feature is not market-based pricing. Amazon determines the spot price and can raise that price enough to gain back capacity at will, at no real cost to itself. There is no competition. There is no commoditization. There is just consumption of what is not being used.

The truth is, real commoditization of infrastructure services–or any other cloud service, for that matter–isn’t in the best interest of Amazon or any other service provider.

Regardless, commoditization can’t happen without open standards that allow easy portability and interoperability of data and code, as well as security, control, service-level assurance and compliance systems. Those standards are coming, but it is impossible to predict when they will arrive. I only hope Amazon embraces them when they do.

I’m not sure I agree with his view however that commoditization isn’t in the best interest of Amazon. The underlying asset is ultimately relatively undifferentiated (a compute cycle is a compute cycle is a compute cycle) which is in fact the definition of a commodity. If you are a provider of a commodity – unless you can maintain a monopoly or a cartel – it is in your interest to create as big and vibrant a marketplace as possible. Supply creating demand. And particularly if you fancy yourself the most efficient, large scale producer of said commodity (as I’m sure Amazon does), all the more reason to want a big, liquid market of consumers. It is the exchange and clearer that want to create lock-in, not the producers. To be fair, for the moment AWS is both and indeed this is the point James is making I think, but I would be surprised if they had the intention (hubris?) to think this is anything but a transitionary arrangement.

Of course, as a traded market in this critical 21st century resource develops over the next decade and beyond, the business opportunities abound. Better yet, many of them are well known and can quickly be adapted (from other asset markets) to apply to the compute resource market. It’s not a business yet, but it only took a few hours before the first ticker tapes (here also) began to appear for EC2 pricing:

An entire ecosystem will surely emerge – exchanges, prime brokers, risk management derivatives, algorithmic trading… I’m sure there will also be some interesting second-order opportunities. Linking spot computing prices with spot electricity prices. Selling green compute cycles (ie powered by renewable energy sources only.) Allowing anyone to sell compute cycles into the grid (think SETI@home meets micro-generation). The mind races.

Welcome to the sixth paradigm.

* like a bond futures contract, one could imagine allowing any compute resource fitting a certain minimum specification into the “basket” of deliverable resources; typically in this scenario there would be a “cheapest-to-deliver” resource in the basket which presumably would get allocated first.

** I can’t help but wondering if the amazing technology developed by our portfolio company CohesiveFT couldn’t be adapted or re-purposed to form the core fulfillment engine of a compute resource exchange. The fact that they are Chicago based and their CEO/Founder is ex-O’Connor makes me wonder even more!

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(Still) more on markets for tickets.

As a result of some of my recent thoughts on how markets for (live event) tickets should work, I was pointed in the direction of a new start-up called yoonew:

yoonew is the world’s first futures exchange for event tickets. We have created a dynamic marketplace that helps online consumers save money and time when buying and selling tickets. Our real-time trading platform gives fans, traders, and resellers a safe and transparent place to trade tickets.
We are passionate about leveling the playing field and creating a fair marketplace where everyone has equal access to tickets. Our team focuses on building new product features that will bring transparency to markets where pricing information is not universally available. We help customers make more informed purchasing decisions so they are confident that their purchase or sale concluded at a fair price.

TechCrunch did a write-up in early January and they got a lot of coverage in the run up to the recent Super Bowl game:

I’m not 100% convinced that they’ve nailed it but it is certainly a very interesting step in the right direction in terms of introducing modern (and useful) markets technology into the historically moribund market for live event tickets. Essentially, they are selling call options on tickets to major sporting events. Moreover they have taken an original and clever approach by – at least initially – focusing on major sporting events (like the Super Bowl) where the terminal value of the underlying is different depending on the buyer. ie If “your” team gets through to the game, the tickets are of more value to you. Of course, with a properly functioning secondary market (irrespective of whether on yoonew’s upcoming secondary exchange or another market – StubHub, etc.) financially this should be irrelevant – the ‘market’ value of the tickets depends only on the clearing price of the event once the participants are known. (ie Super Bowl tickets on balance will be worth more if two teams with big, passionate fan bases are playing as opposed to two teams from smaller markets; NY v New England more valuable than Kansas City vs Detroit for example.) So a ‘rational’ trader would try to buy the cheapest options – not necessarily the option on his team, especially if you could re-sell the option before delivery. (I’m not sure this is allowed, if not it should be.) Nonetheless, the (marketing) focus on ‘real’ end buyers (people that hope to take delivery, rather than just make a financial profit) is a good angle as it plays to the psychology of ‘hedging’ rather than speculating and should add heterogeneity to their risk book.

Notwithstanding the ridiculous US laws proscribing trading on sporting outcomes, there would also potentially be very interesting arbitrage and hedging opportunities (for both yoonew as the market-maker and their customers) with trading sports risk. For example (using the same teams as above) going long New England and NY to make the Super Bowl to hedge the extra cost of delivering tickets to this pairing (vs a less valuable team pairing.) Or going long the team in the host city (which would also probably be more valuable on delivery if they ended up playing.) I’m not sure if they have any plans to offer markets on European (or global) events – it would have been great for the recent Rugby World Cup, imagine if England fans could have bought (what would have been) cheap options on the final in Paris – but if they did they could use Betfair to manage their price risk today.

Longer term, ideally you would hope that sports teams and leagues would embrace this kind of market to help manage their own pricing risk. Instead of just selling tickets (in the primary market), they could sell options on tickets and use secondary markets to dynamically hedge their risk. For a team that didn’t sell out systematically, it would be a good way to monetize potentially empty seats and even for teams that sold out perennially it would allow them to be more aggressive in finding the ‘true’ equilibrium clearing price for a given seat. For investors it would be another potential (uncorrelated) asset class to trade and invest in. I wonder what the implied volatility curve on the NY Giants season would look like? Gamma trading based on the weekly game results anyone? The question is do the owners and managers of these teams understand how this could work to everyone’s benefit or will they stick to the old model of static seat prices and unoptimized revenue management?

I hope yoonew succeeds and helps to develop a more enlightened and efficient market for tickets in live events. One to watch.

All About Alpha has a look at yoonew.

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Learning from less.

Several mobile phones
Image via Wikipedia

I am fascinated by the application of modern information and communications technologies to help improve the lives of some of the world’s poorest and ‘infrastructurally challenged’ (don’t know if this term has been used before but seems to encompass the fundamental problem that holds back the people in developing countries from improving their economic prospects.) To be able to succeed (in providing meaningful, affordable, services) in such challenging environments to my mind offers great insights into how improvements can be made to how services are designed and sold in any environment – including the developed and wealthy western markets. A variation on the New York, NY theme of – ‘if you can make it here, you can make it anywhere’…

While I have written previously on the impact of mobile telephony on the developing world, and I will try not to repeat myself too blatantly, I thought it was worth highlighting a few more initiatives that have caught my attention over the last few weeks.

Bruno (a prolific source of new and interesting people and ideas) in reporting on the recent TED 2007 conference pointed me in the direction of Jan Chipchase’s post on the Village Phone initiative in Uganda:

the Village Phone extends regular base station cellular coverage from around 15 kilometers to around 30 kilometers through the use of a village phone kit – an antenna and ten meter cable (shown above) and a coupler (shown below) connected to a regular Nokia 1100 mobile phone plus of course, a micro-finance loan. The net result? In a number of cases it provides the first convenient, reliable and affordable connectivity to the outside world for many rural communities as well as providing a stable income for the local entrepreneur that takes out the loan.

He also goes on to mention the development of essential services facilitated by access to mobile communications:

One example of the benefits of connectivity? Sente – the transfer of money via mobile phone that essentially also extends regular banking services such as the remittance of cash to these communities.

Another exciting initiative I stumbled accross (at the excellent Timbuktu Chronicles) is Sevak Solutions “commitment of developing the product specifications, business plans, and financial requirements to create an open architecture transaction system [for microfinance institutions.]” Rather than paraphrase, Sevak Solutions describe themselves as follows:

Sevak Solutions is a start-up initiative that has emerged from a consortium of microfinance institutions seeking to understand the role technology could play in scaling microfinance. Early work demonstrated a need for alternative, low-cost transaction solutions and business models that addressed the needs of microfinance institutions that do not have the client volumes required to afford, or piggy-back on, existing payment systems. Sevak Solutions is focused on interoperability, open architecture systems that can connect to cell phones, point-of-sale terminals, ATMs, or any other access devices available in the market. The company performs its own in-country research and development, supports technology innovators that are attempting to enter the market, and provides strategic and implementation consulting on a global basis. Sevak Solutions is interested in promoting a set of technologies and migratory path for microfinance institutions and microfinance banks to expand their reach to the unbanked.


So here is a non-profit organization focused on developing open-source solutions in order to open access to the formal global financial system to anyone, anywhere, irrespective of their wealth. Bringing banking to the unbanked. Historically one of the great impediments to economic progress has been the lack of a cost-effective and robust financial infrastructure, Sevak seems to be taking direct aim at contributing significantly to solving this problem. I hope they succeed. Will they build the equivalent of Linux or WordPress for banking/transaction processing? I hope so, I will certainly try to follow their progress and they are definitely on my ‘find out more’ list.

As if it weren’t long enough already, another initiative that bounced on to my ‘find out more’ list earlier this year when I read about it in the Economist is TradeNet, a new mobile2mobile trading platform for farmers and traders in Africa founded by Mark Davies:

TradeNet, a software company based in Accra, Ghana, will unveil a simple sort of eBay for agricultural products across a dozen countries in west Africa. It lets buyers and sellers indicate what they are after and their contact information, which is sent to all relevant subscribers as an SMS text message in one of four languages. Interested parties can then reach others directly to do a deal.


Listing offers is free, as is receiving the texts. TradeNet plans to earn revenue by putting advertisements in the messages, though it hopes the service will become so useful that recipients will eventually want to pay. For the moment, though, the company is busy signing up users and swallowing the cost of sending the messages.

I have to admit this is one of those ‘I-wish-I-had-done-that’ companies. The potential for this kind of platform seem to me to be enormous. I’ll leave it at that for now. Very exciting stuff.

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Peer to peer banking

I haven’t written about these new person to person banking exchanges before, but a recent article in the Economist is as good an excuse as any.

Zopa in the UK and the new Prosper Marketplace in the US are variations on the eBay/Betfair person-to-person business model focussed on lending and borrowing. Zopa likens their business to microfinance only using the internet to create the networks of lenders and syndication of risk needed to make this a viable and attractive proposition. Interestingly on Zopa, you can only lend (I imagine borrow as well but haven’t read the terms) if you are not a “a credit broker or lend money to other persons in the course of any business. “ I can imagine where this idea came from but over time I wonder why an exchange would want to limit or restrict the types of participants on them. Indeed, institutional players can be key liquidity providers with the long tail of individuals setting the marginal price. Betfair is a lot more robust as a marketplace for instance for having a heterogeneous base of users.

Zopa do a very interesting market update however.

Prosper Marketplace has added an additional angle which is to allow customers to form groups of affiliated borrowers that can (in theory) harness their collective trust / reliability to achieve lower borrowing rates – similar to the idea of the traditional credit union or the more modern social network (a la Friendster or LinkedIn.)

It will be interesting to see how these networks develop, but weaved into the tissue of the connected web, it is possible to imagine a day when such exchanges become ubiquitous and the preferred method of dynamically managing credit for millions or billions of users – retail and wholesale – around the world. Clearly there are many many obstacles to overcome but imagine the day when a hedge fund can trade on Betfair using leverage provided by Zopa using PayPal as a payments system…all dynamically managed in real time.

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Thain sees further exchange consolidation (from CNBC)

Reuters reports:

NEW YORK, Jan 27 (Reuters) – New York Stock Exchange Chief Executive John Thain on Friday told CNBC he expects consolidation among exchanges in the next year or two, and he thinks there could be synergies between the United States and Europe.

The NYSE is in the final stages of closing its deal to buy electronic trading company Archipelago Holdings Inc. (AX.P: Quote, Profile, Research), which will turn it into a publicly traded, for-profit company.

Thain, speaking from Davos, Switzerland, said he expected that deal to close a couple of weeks after the regulatory comment period ends on Thursday.

The deal means “we have public shareholders, and we will be responsive to them, and we will operate more efficiently,” Thain said. “But more importantly, we will have a much broader list of products, and as the world of exchanges consolidates, we will be one of the players.”

Over the next year or two, he thinks there will be consolidation in the United States and “across the ocean.”

There could be synergies between the United States and Europe, he said, as a lot of companies trade in both places and there were opportunities on the technology side to share best practices.

I wonder if he’s been watching AmazonBay?