🎙️ 74 - The History of Electronic Markets | Tarun Chitra

welcome to bankless where we explore the frontier internet money and internet finance this is how to get started how to get better and how to front run the opportunity i'm ryan sean adams i'm here with david hoffman and we're here to help you become more bankless david great episode today tarun chitra on the podcast he is a polymath he's got he he spans so many different ideas such a big brain but this episode we really drew his attention to the history of the

markets in particular the history of the electronic markets what did we cover today yeah really the the concept or story being told here is that the internet as we all know changed everything and it especially changed how markets are structured and so as soon as the internet started to invade the world of financial markets an interesting story is told and so tyrone has delineated these uh the growth and this story into three phases phase one two and three of the growth of electronic markets where we stopped

yelling at each other inside of the pits about what trades we wanted to make and instead we just started typing our trades into computers and that has gone from people order routing into various exchanges in the 80s and 90s to consolidation to brokerages like your charles schwab and your e-trades online in the 90s and early thousands to where we are today with d5 markets and crypto exchanges and each one of these phases has similar story or similar themes throughout each one there's themes of

what happens when a financial crisis crisis happens because we're talking about market infrastructure the way that the market infrastructure is built impacts the nature of the financial crisis we have the stories of how regulators came in to each phase and impacted the story of the development of each phase and the way that um the communication and computational abilities of the infrastructure or the hardware of the world impacted the accessibility and centralization or decentralization of the markets uh and so this is uh these themes are

reoccurring throughout history this is a definitely definitely a podcast about you know history doesn't repeat but it definitely does rhyme and there are lessons to be learned about electronic markets that we are trying to apply to defy so that when these events unfold in d5 which tarun thinks that they definitely will we will be prepared for them yeah absolutely i think one of the three lines of this episode is just in every phase of the electronic markets you know eras there was increased access for individuals right and i guess this

is the story of markets from from the very beginning the first you know joint stock companies the first uh you know stock markets um and that that was kind of reserved for sort of the the elites and um like the uber wealthy and and kind of like uh you know mercantile class and that sort of thing um just that the markets are opening up more and more over time and it's very interesting to see like defy as the third phase of this where you've got all of that but at warp speed like anybody

anywhere with an internet connection can open a marketplace can create an asset can even if they have the skills create a new financial product and that's something like we've never seen before i mean i know there are corollaries to to what this looked like turin says in in the 1980s with with the first era but i also feel like this is uh uncharted water uncharted territory yet it feels it fits this trajectory of markets are becoming more and more open and um like everything is is kind of

becoming uh like i guess i don't know if i'd call it hyper capitalism because it has some negative connotations but i hyper marketization if that's the word but that's kind of what we're seeing here and it's a good thing because it means more financial inclusion for for the world and more capital coordination absolutely we often talk about how crypto and defi is the wild west well you can imagine what the world is like before the internet when trades are being made by people yelling at each other on pit floors and doing hand signals to make their trades uh reminds

me of the movie from ferris bueller's day off um and but uh all of a sudden the internet comes and instead of you know yelling at each other and doing hand signals we're inputting uh you know our trades into a computer and the structure of the entire market absolutely changed that was the absolute wild west back then too this is not the first time financial markets have gone through their wild west moments like the first wild west moment happened in the 80s uh turin tells a story about this one guy that had like 10 of all trading volume going through his server in his garage it was just

some random dude and there's a lot of interesting correlates between what we see now in crypto where you know just one rogue developer builds this brand new financial product and all of a sudden like half the world is using it or whatever half of d5 is using it similar stories similar themes uh you know history definitely rhymes and i love where this ends where we we go through um the lens and we sort of apply the lessons learned from previous eras to the current era to try to map out what the future looks like because look man the the future of krypto and d5 is uh is so uncertain in terms of like

we know long term this is going to be successful because this is unstoppable but um what might we see in the interim in the in the in the short to medium run and this gives us a framework for starting to project this i especially liked turin's description of risk that we might see in d5 both the you know the plus side of this where we've opened financial system so we can maybe see these risks more easily before they emerge but also how risk has been kind of not the downfall but an issue with every single electronic uh

era previous so exciting episode make sure you guys tune in to the end of this episode before we begin we want to thank the sponsors that made this possible living a bankless life requires taking control of your own private keys not your keys not your crypto that's why so many in the bankless nation already have their ledger hardware wallets which makes proper private key management a breeze but the ledger ecosystem is more than just a secure hardware wallet ledger is the combination of the ledger hardware wallet and the ledger live app

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taroun chitra he comes from one of the most rich and complex corners of ethereum he is a big brain i don't know can't even keep track of all the things tyrone is doing he's the co-founder of gauntlet that provides economic simulation to d5 protocols to help them harden their economics super important stuff he's also a co-founder of robot ventures where he invests alongside robert lester who's been on the podcast several times in d5 he's also a frequent guest of the zero knowledge podcast so

you will appreciate his audio uh he's also a leading thinker on mev that is maximum extractable value and so many other topics today we're going to talk about his concept for electronic markets and the third era of electronic markets that we find ourselves in today tarun how's it going man how are you doing great how are you thanks for having me on oh we are doing great you know what man i love that background you gotta you gotta tell us is this like an nft or

like what is this background it's super colorful your glasses seem to kind of match the the ambiance of it what's uh what's the story here so i love um kind of weird niche math things that have very pretty pictures and so this thing behind me is something called uh penrose tiling um oh i know this one get david to explain it then if david knows it explained if i'm right then i could be wrong but this is uh penrose tiling uh is like the

basis of a pattern if you color it right the coloring i think is very uh important and it could be wrong um but like the it's a pattern that never ever repeats and so it's an infinitely recursive pattern and you will never find the same tiling pattern ever again as the and it's an infinitely recursive pattern so it can go into infinity but you will never find the same pattern twice is that right yeah basically yeah basically it's it's it's sort of uh yeah infinite tiling with no no repeated there's a

certain weird way in which the no repeated units is defined but people make very pretty pictures like this one of them so that is super cool that's going to be uh that's going to be great this entire podcast enjoying looking at that but let's get to the topic because today we are here to explore the topic of electronic markets i think tyrone you have this idea that there have been three eras three stages of electronic markets the first to second and now we are entering the third and when dave and

i heard about this this concept you have this mental model you had we knew we absolutely had to unpack it here on bankless because uh i think it's an important mental model for us all to understand so let's start with some definitions and scope here when we're looking at electronic markets from a satellite view what do you mean uh by the term electronic markets and what does that mean more generally yeah for sure um i think you know

if we if we kind of take a step back prior to electronic markets what what were markets they were you know you you think kind of it from history class like hey it's like in the center of a city there's like a bazaar and there's like a bunch of people who have stalls and and that's like the the earliest form of market but every new form of technology uh that has been invented inevitably finds its first usage and adoption in in financial markets so you know when when people uh

sort of had the telegraph the telegraph became sort of this b2b um business to business uh device that was used for different businesses and in different towns to kind of like send messages about the weather or whether like a shipment wouldn't make it or sort of commercial details and and that was sort of the original sort of starting point of the telegraph uh but then as kind of time evolved and everyone got electricity uh you know we had telephones and then the masses started using effectively the

same communication technology and that led to a lot of uh sort of new markets uh in the sense that people could buy things over the phone people could uh find new customers uh via telemarketing which of course now is viewed as antiquated and annoying but i think at the time uh you know sort of post world war one was sort of like the heyday of like going into kind of the the golden 20s that there there was actually kind of viewed as probably the way we view like

instagram ads today as like much more in culture kind of in vogue type of advertising versus uh those ads and so but these were all very uh markets that were very peer-to-peer and i i mean peer-to-peer more in the bad way like you you know you have to do a lot of work to find a buyer or seller um when you're one of when you're the opposite you have to go manually kind of like figure out how to put the dots together there's not like a central place or a central kind of source of

funds and trading um but what happened once we had the internet was sort of in the very earliest parts of the internet so internet created sort of by defense agencies in the 70s but in the early 80s people in finance realized the internet was a really good way to price assets that you know that sort of disintermediated um you know large entities who

who uh kind of controlled most trading so if you think about stocks in the 1970s and 80s only institutions could really buy them like you could buy a mutual fund who could buy shares and stocks but you yourself couldn't really realistically do that and you would have to go through an intermediary like a bank now what people really don't even do that in the in the 1970s 80s like most listeners are kind of detached from that so you have to like schedule an appointment with a banker to go like with the broker

okay yeah to go buy your mutual fund yeah to go buy shares in the mutual fund and the mutual fund would go invest in and and stocks for you um i i don't know if you've ever like i feel like i've always seen this in sort of smaller towns in the us but there are like these like physical broker branches like there's a charles schwab that actually exists as a you know i've never walked into them i don't know what they do there it's certainly made for like yeah it's definitely made for a more geriatric audience i think

in a lot of ways but but that's the vestige of that time where like in order to buy stocks you would like go to a physical venue you would pay someone like five percent to execute the trade uh if you're lucky uh and then it would go through a series of middlemen and then it would go to banks and banks were the only ones who kind of dealt with the stock exchange for you so there was this like huge chain of intermediaries what happened once people this was a time where we had markets but we didn't have the electronic part of it right it

was just markets yes full of intermediaries not very peer-to-peer from an electronic perspective yes exactly exactly like the the the the phrase electronic markets i think really refers to the idea of replacing a lot of the middlemen with compute and communication via the internet and also via like being able to use a lot of compute power and people in the 80s realize that you you know you could actually do that quite efficiently and get rid rid of a lot of um middlemen

um in in banking uh and that sort of started this trend that obviously went to today where you have robinhood and you can go buy socks on your own you don't pay anything you know you can do your own research stuff like that you know i think we the earliest part of the electronic market revolution was getting rid of intermediaries and brick and mortar entities automating a lot of the execution and settlement and storage of stock so you know stocks for even

though you you might not know that you still could request this there is actually a physical certificate sitting at bank of new york mellon that represents like the share that you bought but you know you're trading when you're trading on robin hood or interactive brokers or charles schwab there everyone is holding ious for those shares and you're really only trading the ious no one's actually physically usually moving the stock the the the brokers kind of net settle every day of like hey i bought

for all my customers 500 shares of apple and i sold 600 shares of gamestop uh so you know the two counterparts execute that trade but sorry we're getting a little away from the definition of electronic markets but i think the definition is uh any sort of form of marketplace interaction where you can aggregate buyers and sellers and they can transact autonomously without needing white-listed trusted parties

so just to to ground the listener tarun is is uh much more of an expert than us on the the history and progression of electronic markets and so we definitely want to pick his brain about how these things came to be like how did we go from you know the telegraph and and the telephone into where we are today which is you know trading on robin hood and you know while the listener of this podcast and the bankless nation are beyond trading on robin hood they are you know trading on defy and using defy apps uh defy is really just the next

logical continuation of the emergence of electronic markets and so uh i think it's really important to understand the history of these things uh as a concept uh and then and then we can talk about how defy is a continuation of electronic markets with new things with uh the old things uh and a couple of you know weird kinks here and there as well um but tyrone help help the help ground the listener what would you say are the common themes and through lines and um just like reoccurring elements of each

wave of uh each you know emerging electronic market what are we going to continually revisit over and over and over again in this conversation yeah for sure i think uh the number one thing is there's always a boom and bust cycle hidden somewhere in each of these waves another thing that happens in each wave is that there is a new technology or and or regulation introduced that causes sort of a seismic shift in terms of market microstructure and and how people

interact with these systems um and then the third uh thing is i think like there's a kind of gradual disintermediation of uh third parties at each step um and uh i guess the final thing is that each new wave of technology makes the market more competitive which lowers prices usually for in aggregate for people okay so we're gonna see these themes i guess reflected in each of these uh each of

these eras but you have a kind of a framework of eras that we want to go through and maybe high level i'll kind of say what they are and we can maybe start with the first one um but the first is like electronic markets 1.0 and that was really the genesis of electronic markets we had these analog markets now we're making them electronic that started in the 1980s i think lasted into the 90s then we had electronic markets 2.0 which started in sort of the the 2000s i kind of think of this as like the the e-trade

era at the at the start of it and that lasts into the present era now um maybe maybe robin hood is kind of a you know transitory um thing into partially one foot in era two and one foot in era three that started in the 2000s and uh up to this point and then we have electronic markets 3.0 which is kind of the the crypto and wall street bets type era maybe that tart started in 2015 2016 or so and it overlaps with era too so these

are the three eras that we're going to talk about so take us to the first roon let's talk about this electronic markets era 1.0 the genesis of electronic markets take us all the way back to the early 1980s um what was the technology that really enabled this and um like uh where did it start and where where did electronic markets start arriving on the scene and um take us through the timeline yeah so um i know many people have probably seen

in movies like these pictures of these guys at like the stock exchange or the commodities trading exchange like raising their hands and like doing all sort types of hand signals to say like hey i want to buy like 500 cows or i want to sell you know 500 shares of disney that was what was happening in the 70s so there was you know the new york stock exchange the physical location was filled with people from banks and sort of brokerage and trading firms and they were the only ones who were officially allowed to trade stock

um and what happened in the 80s is you know actually sort of in this 1970s something that we don't really see right now right now when you think of stock exchanges as as just an individual you think of the new york stock exchange you think of nasdaq you think of maybe the chicago mercantile exchange maybe the london stock exchange maybe the tokyo stock exchange you know like there's always like one or a few in

each country but you don't think of like many but in the 1970s every city in the us had their own stock exchange so there was much more regionalized stock trading so you might be at the philadelphia stock exchange and comcast would be listed there instead of in new york so there wasn't bizarre why why is that is that just because like every all the companies in that region would sort of aggregate to their local city stock exchange yeah so the idea is that like you know

maybe people in philadelphia the companies that are ipo'ing there are a little smaller than the ones in new york but the buyers and sellers had to meet physically to actually buy the stock so the buyers in philadelphia tended to have less either less money and the sellers have less lower valuations to sell so they just met geographically in the kind of like the their local they represented their community as finance this was like pre-globalization right like it's just like hey like i'm going to invest in the

company down the street from me rather than exactly i'm going to like send my order to new york yes exactly exactly and so uh what happened there was a little bit of of consolidation but the consolidation wasn't in due to technology the consolidation was just like the new york stock exchange bought the philadelphia stock exchange and so they're the same brand but they they and they would net settle for you so if i lived in philadelphia i wanted to buy a stock in new york i'd go to the philadelphia stock exchange and then

they would relay it and there'd be fees on relaying so the problem with that is that's extremely expensive because a i'm paying locally for the relayer and then b i have to pay on the other end like when the trade actually gets executed so what happened when the internet came out was people realized they could get rid of this relaying system and this kind of net settlement a few days later so like if i was in philadelphia and that was my stock in chicago uh i wouldn't even be guaranteed my execution would happen within a day it

might take like two to three days they might not be able to actually fulfill it they might not find sellers it was very inefficient and like very it was almost like going to the mall and like going to each store and like looking for like the one share that you're looking for that you want right there was no liquidity you place your bid and then any time between one and three days later it might get filled is that kind of the yeah exactly and it and there's no there was no way to like find the liquidity it wasn't easy to figure out like who wanted to sell who who versus who wanted

to buy and that's why i needed to like cast your line right you would cast your line and just hope that somebody nibbles on the hook right is that why they're all shouting at each other that way they're so loud and like arms waving shouting is because exactly they're casting their line lines and making a scene so that someone hears their bid yes exactly that that's it's called it's called open outcry that's like the pit where people would do that and it literally is self-descriptive like people are in the open crying out like

okay so open outcry exchanges are kind of these old school ones um and so what happened was when the internet even just the idea of the internet came out you know darpa like late 60s early 70s people who were traders were like hey i could replace this whole relaying system and communicate information about bids and offers between the different stock exchanges without actually having to do this physical relay thing right and and now all of a sudden people were able to compete on price uh across

different stock exchanges and that was sort of the first glimpse of hey uh the this idea of like hey really fast communication networks and a lot of compute power can replace the system of like hundreds of people and like very uncertain execution like you don't know when you're going to get filled stuff like that so is this kind of like the emergence of the we use the phrase liquidity begins liquidity and while that usually is pertaining to specific assets as in like

uh the uh us dollar is liquid and it tracks a bunch of liquidity but right now uh we are seeing like perhaps uh you know running on the example of the philadelphia stock exchange perhaps there is like an internet connection the fir one of the first earliest internet connections between the philadelphia stock exchange in the new york stock exchange and now those two liquidity pools all of the people shouting in philadelphia can also technically also be heard in new york and so these two liquidity pools are now collapsed they same into the same they merge into

the same like liquidity pool of the stock exchange uh and is that kind of what we're talking about yeah in the same way that like now like vcs and like silicon valley people love talking about aggregation effects this was the first aggregation effect due to the internet it's literally aggregating liquidity across different stock exchanges um and so there was there was still people shouting in the pits but now the people were connected to more cities right yes i mean so so people shouting in the pits

let's say i shouted uh in philadelphia prior to the internet let's say i want to buy five shares of disney and i knew there were only like three brokers who had disney i would go like hey you broker one i want five shares of disney broker two i want five shows disney broker three i want five shirts this thing how much can you sell to me for it what's your offer and prior to the internet they were literally like getting on the phone calling someone in new york saying hey can you shout in new york and tell me who actually has disney then that person

in new york would go you know what i mean like that part got turned into like query and so like slowly but surely the internet started replacing but there were jobs there were physical like people whose jobs were literally to just like sit and pick up the phone and that their jobs were kind of replaced by the by basically the the computers those are the relayers those are kind of like the bridges between blockchains yeah like order routers like there's people who look like they're order routing right you know like switchboard routers like

phone ones it's like basically like that they were basically doing everything like that prior to the internet right so and we also have like in the in the crypto world we have like dex aggregators right they're going and finding offers at all the different dexes are these like the original exchange like well i'll find you the best rates by calling up all the different brokerages and all the different exchanges and i'll sell you the best one same kind of deal same deal except extremely slow extremely with huge fees with huge fees so this had to be true when this came

about uh electronic markets started showing up in the 1980s this had to be hugely transformative for the financial industry give us a sense of um how quickly this happened yeah so you would think it happened really quickly but kind of a little bit like defy it took place it kind of really started with the more esoteric and new assets first rather than the older assets so options um so like the right to buy a

stock in the future or the right to sell a stock in the future we're sort of uh done kind of only by legal contract um prior to maybe like the late 70s there are two reasons for that one is economists only sort of figured out the math for options to some extent in the 1970s for how you should think about how much an option is worth given how much the stock is worth but the other thing is that uh well that math is quite

computationally intensive uh and so you needed a lot of compute power to actually compute what you should think you know compute a price to quote for an option and so options had this double-edged sword where they needed both a lot of compute and a lot of like communication about liquidity how where the bids and nas are and so they were a natural fit to be the first uh electronically traded asset because a you need a computer to even

figure out what the price is and b you also needed that you have this problem of like open outcry just doesn't work for for options very well right uh correct me if i'm wrong but options in order to really be a competitive product they need more participants than the typical like bid asks of you know spot markets is that correct yeah to some extent so so one of the reasons is options trade at every price that theoretically they trade at every possible price like i can buy an option to buy apple stock at one cent i mean