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Who Will Regulate Online Exchanges?

November 20, 2000|ESTHER DYSON

A couple of columns ago, I wrote that the next big business model for online market-makers could be, surprisingly, regulation--third-party regulators offering "government"-style functions such as dispute resolution, reputation systems and contract enforcement. Their aim would be to keep the players within each market honest.

But what's to keep the markets themselves honest? The online markets--let's call them exchanges for clarity--make up a bigger market in which they themselves are only players.

For example, a variety of stock markets--the New York Stock Exchange and Nasdaq in the U.S., the German Neuer Markt and the Britain-based AIM--all compete for companies and investors.

There are two answers to the question of how to place constraints on the markets themselves.

One is government action--everything from oversight of a particular exchange's regulations to antitrust actions if an exchange seems to be getting too large and abusing its power. Of course, many online exchanges operate across jurisdictions or outside of jurisdictions, and governments might have a hard time regulating them. Companies or market-makers big enough to pose antitrust problems, however, are probably big enough to be vulnerable to government action in major markets.

The second, and usually better, answer is competition from other exchanges. That is, a market of markets.

To use the example above, if the rules of any of the stock exchanges get too lax, leading to unhappy investors, or too tight, leading to unhappy companies, those exchanges stand to lose business to another exchange.

The challenge is how to make that happen across all markets, not just the uniquely fluid stock markets.

Each market-maker, of course, wants to make its own Internet exchange "sticky": It wants to attract potential customers and keep them--to make it easy for them to enter and difficult for them to go elsewhere. That notion, in fact, is behind many failed business-to-business models: Come in for free, and we'll start charging you transaction fees later.

Many such exchanges probably will collapse when they start charging fees, discovering that their loyal customers are not that loyal. That's good for the market overall, but not necessarily good for the exchanges within it!

On the other hand, many successful exchanges might benefit from economies of scale and become the only player in a particular online marketplace. Though participants within the marketplace will have the benefits of visibility, competition and all the other benefits the market-maker provides, the market-maker might end up with too much control and the ability to set fees or make rules without the constraints of competition.

The business opportunity here is for third parties to sell software that makes it easy for participants to operate in a variety of different exchanges, and that indeed is happening. North Systems Inc. of San Francisco ( provides e-commerce applications to suppliers who want to sell into a variety of exchanges and buyers' procurement sites. Every buyer wants to help suppliers sign up for its procurement site, but it has no interest in helping those suppliers sell to other buyers.

The sellers, by contrast, have a problem trying to configure their systems and catalogs for each of the buyers' particular requirements. And the buyers usually have the leverage to set the standards.

North Systems comes to the rescue by offering software that lets users hook up to a variety of proprietary exchanges and to the major market-software packages such as Ariba ( and Commerce One (

One North Systems customer, Viking Components, uses its software to trade in leading semiconductor and electronics exchanges such as E2open and Ehitex, as well as other customers' Ariba- and Commerce One-based procurement systems.

On the consumer side is EBay: As the leading consumer auction site, it has already attracted a variety of . . . call them parasites or call them market-openers. Showcase from Auctiva, based in Oakland, offers an alternative site where sellers can set links to their own listings on EBay and other markets. That follows attempts by other companies that linked to or used EBay and other sites with less discretion.

Making the links at the option of the sellers, Auctiva ( evidently hopes, will limit the target sites' ability to stop them. But EBay is attempting to deter its users from making such multiple listings. Stay tuned. The market-makers welcome this--with reservations. Of course they all want to be maximally accessible to all players (except for ones rejected for "bad" behavior); they just don't want competing exchanges to be accessible. The initial reaction, of course, is for powerful market players to have proprietary software, but that keeps new customers out as well as keeping existing ones in. And customers don't like feeling trapped.

The result is that exchanges are going to have to compete not on the basis of proprietary software but on the basis of genuine advantages: honest (enforcement of) rules, better services and ultimately better quality--that is, the people they keep out to keep quality standards high.

Though the promise of the Internet is its openness to all comers, the promise of the new exchanges is that they are not open to all comers but instead keep the bad guys out. On the other hand, competition from competing exchanges should keep them from acting arbitrarily and abusing their authority; they need their own regulators--not necessarily in the form of governments, but in the form of yet other market-makers who ease movement out of markets as well as into them.


Esther Dyson edits the technology newsletter Release 1.0 and is the author of the bestseller "Release 2.0." She is also chairwoman of the Internet Corp. for Assigned Names and Numbers. Send comments to

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