2025-11-05

Financial Markets 2

12 observations and opinions on financial markets

This post draws insights from a previous post: Financial Markets.

Many of these insights are well-understood by finance practitioners but are still worth re-iterating.

  1. The success of an exchange is a function of the number of interesting assets available to trade and how much people want to trade on them.

Exchange success = (assets) * (volume) + (selling data)

  1. The success of a brokerage is a function of how much money people deposit onto the platform and how much people want to trade on them.

Brokerage success = (assets under management) * (volume)

  1. Liquidity network effects are stronger than social network effects.

Liquidity network effects enable easier price discovery when everything is in the same centralized venue. Additionally, exchanges accrue technical debt and impose increasingly higher switching costs for integrators.

User preferences are constantly changing, putting significant pressure on the social network effect of brokerages. Furthermore, regulation is designed to incite competition among brokerages.

  1. Consumers are generally very well-protected and oversight is quite robust.

Regulatory capture operates through complexity. The separation of exchanges and brokerages and surrounding regulatory network creates high barriers to entry. The distinction between insiders and outsiders requires years of networking and vetting, creating a cartel-esque system similar to that of doctors and lawyers. Unlike credential-based gatekeeping, finance screens through social and operational complexity.

  1. Demand for the dollar is much higher than demand for yield.

The neobank winners (Revolut, Monzo, N26, Chime, NuBank) prove this: they succeeded by providing easy access to the dollar, not because of high yields.

Stablecoins are further evidence of demand for dollars, not yield. Over $250B in USDT and USDC exists despite zero yield. Users pay fees for synthetic dollars, accepting negative real rates.

  1. PFOF, implemented correctly, increases user welfare.

Robinhood is not fucking their users.

  1. Asian countries electing unified exchanges and brokerages was the correct decision.

Asian countries benefited from second-mover advantage as they implemented their electronic systems years after their Western counterparts. Because of this, many were state-driven single exchange projects, enabling better centralized oversight and capital controls. Furthermore, this approach was attractive for bootstrapping new financial markets as it unified liquidity on a single order book. Small, elite teams could more easily coordinate to build optimal exchanges given the talent and resources available.

  1. Bid-ask spreads exist for market makers to make a profit and not get run over.

  2. The present construction of exchanges has effectively outlawed innovation, so talent is shuffled into trading or building new brokerages.

Instead of questioning whether the market rules are correct, the smartest minds choose to either exploit existing market rules or build compliant wrapper products.

This directly incentivizes talent to either trade given existing rules on exchanges or build new brokerages. The smartest minds don't build better markets; they build compliant wrapper products. Every fintech is a form of arbitrage: neobanks (partner bank charter arbitrage), BNPL (lending regulation arbitrage), crypto (everything arbitrage).

  1. The goal of DeFi should be building a financial system where risk management and transfer between parties occur non-custodially, without counterparty risk.

  2. The exchange / brokerage distinction is naturally emerging in crypto.

Early crypto finance products bundled both functions under one team and brand. Specialization and increased competition are now splitting the stack. Aggregators now serve as brokerages, providing user interfaces and order routing, while exchanges become backend liquidity venues that plug into aggregator APIs. This mirrors the traditional separation between exchanges and brokerages.

  1. Finance at 7% of GDP is both surprisingly low and too high.

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