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Sunday
Jan182009

What are alternative markets and what elements tie them together?

 

Peer-to-Peer lending markets, local stock exchanges, prediction markets, direct buyer-seller community markets…Innovative re-inventions of the traditional marketplace, all made possible by web technology.

 

While the current financial crisis shakes the confidence of many free market believers, there glows a series of alternative market movements still enthusiastically embracing the core market essentials. These markets connect buyer to seller while rejecting the opacity and complication that characterizes much of our current financial framework. Their missions are generally simple and focused, encouraging participants to be knowledgeable of the market dynamics, with the end goal of fair and efficient trades between individuals and better information. These alternative markets can be classified into four major types:

  1. Peer-to-Peer (aka Social) Lending Markets.  This concept is a type of financial transaction where two parties can enter into a borrowing/lending agreement without the intermediation of a traditional financial services provider. See: Prosper, Lending Club, Kiva.

  2. Prediction Markets.  With the marketplace able to tap into the “wisdom of crowds”, prediction markets have emerged as a venue for speculating about the future. See: Intrade, Betfair, Futarchy.

  3. Community Markets.These sites allow buyers to get to know and interact with their sellers and buy from them directly. See: Etsy.

  4. Local Markets.  As the stock marketplace has moved increasingly global over the years, local investing enables individuals to instead invest in community companies that they know and trust. See: Locavesting.

Utilizing the efficiency of the market for the traditional purpose of exchanging goods, services, and information, these emerging concepts spin the concept to meet their niche purposes. The rise of alternative markets indicates some interesting trends of our society that have implications well beyond the marketplace.

First, there is a clear desire by market participants to introduce a level of transparency in financial dealings. Each of the social lending services works on a peer-to-peer basis, so you as an individual loaner know who is receiving your loan. This is a very different operating model than giving your money to a black box financial services company that makes decisions on your behalf. As we have seen, that model does not always make the decisions that are in the best interest of the lender. Similarly, with locavesting, rather than invest in a large corporation where you have no insights into its inner dealings (e.g., Enron, Worldcom, Global Crossing), you can invest in a neighborhood store or local company where you may actually know the management, see the customers, and build a more rounded perspective of the entity’s value.


This leads to a second trend, a lack of faith in experts.  Recent events point to the danger of trusting an individual (e.g., Bernie Madoff) while past events warn of ascribing too much faith to a group (e.g., the whiz kids of Long Term Capital Management). With economic experts and pundits of all stripes constantly pontificating their chosen strategies and predictions, it is hard to sort through the noise. This challenge was perhaps best illustrated during the November election when news agencies released daily polls accompanied by salient expert analysis that were often contradictory, repetitive, or incoherent. One of the best and simplest resources to get to the bottom of the single question, “Who will win in November?” was the prediction market Intrade, which harnessed the collective knowledge of its users to produce a startling accurate prediction of the final results (prediction of Democrats-Republicans 365-173 versus actual results of 364-174). The concept of futarchy takes faith in this concept a step further and suggests that prediction markets can be used to guide public policy decisions. Social lending services also indicate a desire for individuals to take control of their financial decisions rather than relying on the recommendations of experts. There you can manage the risk, evaluating potential lenders (or investments) yourself.


While alternative market participants personally gain from increased transparency and better informed decisions, all of the markets also demonstrate a commitment to building a community. Some peer-to-peer lending service operate under a “family and friends” model and all of them stress that the investment is not just a personal investment for return, but also a way to help fellow market community members achieve their financial objectives. Similarly, the direct artist-consumer model integrates social networking to make purchases more of an experience where you can get to know the person you choose to buy from, and in the process strengthen the artist community. Locavesting is at its core investment choices that support and sustain the local community.


Emerging market movements indicate that even in a time of bailouts and stimulus packages, capitalism is still alive and growing. Markets are evolving and individuals are having a say in that evolution. Many of these markets are now facing challenging times, however, and their future will say a lot about how our society and government value the marketplace.

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