The Impact of the Internet on financial markets The Internet's impact as an enhancement large variety of items ranging from printed information to of existing processes general software goods to music, pictures, video, and movies Many, if not most, of the effects of the Internet are enhance- in digitized form. ments of existing processes and markets. However, even for those, often the extent of improvement can be so significant Such delivery can be faster, more efficient, and cheaper as to have profound consequences for market structure. A than traditional distribution. Moreover, content in digitized typical example of an improvement of an existing process is form is searchable for words and patterns, so it is arguably of the elimination of the middleman(broker) in sending orders to enhanced value. An interesting example of distribution of financial markets. Before the Internet, this was possible by ital goods on the Internet is Napster. By leveraging the dual using the telephone. But the Internet allows it to be done nature of computers as clients and servers, as well as the geo- much more efficiently through a direct connection to an elec- metric expansion of network effects, Napster tronic system. And, the Internet brings a wide availability of extremely successful in facilitating peer-to-peer transfers information both about current prices and past performance music among computer users. Irrespective of the legality of as well as various tools to analyze it. the transfers it is evident that distribution of music over the Internet can be very efficient and may, over time, replace tra. ditional distribution methods process Tools that were available only in trading rooms now are very widely available. To the shrewd and wise trader, these Another example of an interaction that is made possible by are very valuable and level the playing field. For the foolish or the Internet is multi-party, text-based chat functionality with the informed- but not-knowledgeable trader, the Internet the possible combination of interactive drawing and speaking makes it easier to lose money. Overall, it is worth noting that The creation of communities based on common interests and he wide availability of rapid action trading technology has the possibility of rapid interaction among members of the increased market volatility. ommunity worldwide is a profound social and political change brought on by the Internet, although at this point its In another interesting example of a drastic enhancement of effect on financial markets is uncertai an existing process, the Internet has created tremendous pressure on eliminating price discrimination based on geogra- The Internet as a facilitator of a winner- phy or national borders, as well as in increasing price compe- takes-most world tition among providers of standardized goods. Toll-free calling The Internet like most networks, tends to create a"winner and mail order had already created such pressures. But the takes. most" world where one firm has a lion 's share of the Internet's ability to allow for the collection of pricing informa- activity in a market. A market structure of small, but equal. tion from dozens of sellers reduces search costs immensely. firms or small, but equal, market exchanges is less likely to intensifies price competition among different providers, and survive in a post-Internet world. Small advantages tend to be all but eliminates geographically-based price discrimination magnified and to become more prominent as the Internet by the same provider. smoothes out flows and removes frictions that used to sup- port early egalitarian market structures. The Internet's impact as a creator processes and interactions Markets with network effects lead to a The Internet also creates processes, goods, and interaction winner-takes-most world that were not possible before. For example, digital goods can A market exhibits network effects(or network externalities) be delivered over the Internet Digital goods when the value to a buyer of an extra unit is higher when moreThe Internet’s impact as an enhancement of existing processes Many, if not most, of the effects of the Internet are enhance￾ments of existing processes and markets. However, even for those, often the extent of improvement can be so significant as to have profound consequences for market structure. A typical example of an improvement of an existing process is the elimination of the middleman (broker) in sending orders to financial markets. Before the Internet, this was possible by using the telephone. But the Internet allows it to be done much more efficiently through a direct connection to an elec￾tronic system. And, the Internet brings a wide availability of information both about current prices and past performance as well as various tools to analyze it. This has been called the “democratization of trading process.” Tools that were available only in trading rooms now are very widely available. To the shrewd and wise trader, these are very valuable and level the playing field. For the foolish or the informed- but not-knowledgeable trader, the Internet makes it easier to lose money. Overall, it is worth noting that the wide availability of rapid action trading technology has increased market volatility. In another interesting example of a drastic enhancement of an existing process, the Internet has created tremendous pressure on eliminating price discrimination based on geogra￾phy or national borders, as well as in increasing price compe￾tition among providers of standardized goods. Toll-free calling and mail order had already created such pressures. But the Internet’s ability to allow for the collection of pricing informa￾tion from dozens of sellers reduces search costs immensely, intensifies price competition among different providers, and all but eliminates geographically-based price discrimination by the same provider. The Internet’s impact as a creator of new processes and interactions The Internet also creates processes, goods, and interaction that were not possible before. For example, digital goods can be delivered over the Internet. Digital goods encompass a large variety of items ranging from printed information to general software goods to music, pictures, video, and movies in digitized form. Such delivery can be faster, more efficient, and cheaper than traditional distribution. Moreover, content in digitized form is searchable for words and patterns, so it is arguably of enhanced value. An interesting example of distribution of dig￾ital goods on the Internet is Napster. By leveraging the dual nature of computers as clients and servers, as well as the geo￾metric expansion of network effects, Napster has been extremely successful in facilitating peer-to-peer transfers of music among computer users. Irrespective of the legality of the transfers, it is evident that distribution of music over the Internet can be very efficient and may, over time, replace tra￾ditional distribution methods. Another example of an interaction that is made possible by the Internet is multi-party, text-based chat functionality with the possible combination of interactive drawing and speaking. The creation of communities based on common interests and the possibility of rapid interaction among members of the community worldwide is a profound social and political change brought on by the Internet, although at this point its effect on financial markets is uncertain. The Internet as a facilitator of a “winner￾takes-most” world The Internet, like most networks, tends to create a “winner￾takes-most” world, where one firm has a lion’s share of the activity in a market. A market structure of small, but equal, firms or small, but equal, market exchanges is less likely to survive in a post-Internet world. Small advantages tend to be magnified and to become more prominent as the Internet smoothes out flows and removes frictions that used to sup￾port early egalitarian market structures. Markets with network effects lead to a “winner-takes-most” world A market exhibits network effects (or network externalities) when the value to a buyer of an extra unit is higher when more The Impact of the Internet on financial markets 9