From Block Lords to Blockchain: How Securities Dealers Make Markets

Abstract

Technology is currently bringing a decisive wave of innovation and disruption to the financial industry. There are many promises and predictions of where this will go, but the best source of information for projecting the future’s trajectory is history. History shows us that markets began decentralized, centralized from the 18th century around trading venues, and then gravitated again toward decentralization thanks to data transmission. The “gravity” that has shaped this process is broker-dealer choice. The medium in which the process has occurred is technology. Law has occasionally – but not always – played an important role. Merchant firms of varying size and specialization have traded securities largely through private networks at least from 1200, and then since about 1800 in clubs and quasi-public organizations called “exchanges”. Around 2000, major broker-dealers began to re-internalize trading into proprietary matching platforms, a return to private networks. The move to decentralization accelerated around 2015 with an intense interest in blockchain or other forms of distributed ledger technology. Securities trading has thus migrated from private networks to public forums and appears to be returning to private networks again. This evolution has been shaped by law and technology, but is driven by the interests of the broker-dealers that both design and operate the markets. As trading concentrated in exchange venues slips into history, it is important to understand what is happening. The dis-integration of securities trading, commonly understood as stimulating innovation and lowering trading costs through competition among matching platforms, is arguably reducing market quality for all other constituents, such as issuers, investors, regulators and the taxpayers who support them, while increasing control of the largest institutions over access to the market.