6: Digital technologies impact financial market behaviours

Contents

• Introduction
• 1: Growth or “slowth”
• 2: Digital technology is transforming production and labour
• 3: Digital technology is transforming consumption
• 4: Digital technology is transforming trade
• 5: Digital technology is transforming the nature of ownership and expectations of value generation
• 6: Digital technologies impact financial market behaviours
• 7: Digital technology blurs the interpretive function of key macroeconomic indicators
• 8: Digital technologies impact official data and macroeconomic policy tools
• Acknowledgments

Digital technologies impact financial market behaviours

Digital technologies will motivate change in financial market behaviours across many channels and spark a range of activities that can affect market volatility. Speed will be a key driver for price discovery, either for many market participants or a select few. This will either level the playing field or create further schisms—even by milliseconds—between those who have information and those still waiting for it. Digital technologies may continue to privilege large, incumbent firms, such as through high-frequency trading. Conversely, quickly evolving technologies may trickle through to smaller players, thereby creating “fairness” in the timing of financial trading. Finally, traditional credit-providing vehicles may become disrupted, resulting in a disconnect between borrowers and lenders.

Market stability and volatility reexamined

Digital technologies such as artificial intelligence and data analytics could either exacerbate the advantages enjoyed by large, incumbent firms, or level the playing field by allowing all investors to identify and accurately price risk at the same speed. In one scenario, digital technologies could amplify volatility and system risk, destabilizing markets. Robo-trading, high-frequency trading,¹ and automated platforms for wealth management could lead to bubbles and “flash” crashes that rapidly create and destroy value. For example, the volatile fluctuation in the value of Bitcoin could only have occurred with digital technologies. Automated systems make up to 80 percent of all Bitcoin trades, allowing arbitrage trading across multiple platforms at near-zero transactional cost.² Technology that continues to favour high-frequency trading can create even larger moves in market values. It provides an advantage to big players with the means to develop those technologies. Financial volatility may produce higher returns, but can also erase value. The net result could be more unequal or irregular growth of gross domestic product, which itself could reduce long-term growth.

In another scenario, digital technologies could contribute to enhanced market stability and efficiency, reducing the high-frequency trader advantage. Enhanced market stability could help investors gain certainty about asset valuation and make more informed decisions about those investments. The transparency surrounding better-performing investments could increase demand through corporate reinvestment or the increased purchasing power of shareholders. Conversely, sustained volatility and increased transparency could serve to lower prices for assets that had previously been inflated.

Digital technologies affect credit underwriting and availability

Digital technologies are increasingly used to evaluate credit extended to borrowers, replacing the traditional “know your customer” metrics. A protracted period of low interest rates has resulted in lower savings rates and riskier investments as people and firms seek more risk in search of higher returns. The “know your customer” metrics have been designed to help lenders better evaluate credit risk to borrowers. Individuals and corporations find higher returns in riskier equities and inflated housing markets. Easier access to credit through new digital platforms increases borrowing and reduces accountability. This, along with historically low rates, has led to new levels of household debt in Canada.³

In one scenario, digital platforms erode the connection between borrowers and lenders and provide easier access to equity markets through discount online brokerages that do not provide any advisory services to a trader using them. These digital technologies further elevate credit risk by increasing the volume of inexperienced traders.

In another scenario, the availability of credit secured by digital currencies and other cryptocurrencies provides enhanced transactional security between entities that do not know each other in transparent markets. The underlying distributed ledger provides members with a platform to form their own community, removed from the traditional regulated financial institution. The role of existing trusted intermediary is transferred from institutions such as banks to the distributed membership that makes up the blockchain.

In either scenario, the arrival of a single digital provider such as Apple into financial markets could transform credit markets. The company’s 1.4 billion active users are poised to benefit from instantaneous access to credit with no fees and low-interest lending rates, online financial planning, and cash back on purchases.⁴ This “bank of the future” may shake up credit markets. It would effectively integrate ownership, from device to capital, so that cash can be recycled within an Apple ecosystem.

Digital technologies and financial transaction execution

Technological innovations are reshaping wholesale trade, which is based on discovery and trust in tight delivery windows. In one scenario, blockchains and their associated distributed ledger technology could make the cost of transactional trust plummet, saving billions of dollars in transactional fees. Blockchain is being used to track the chain of custody and delivery for shipments of physical goods. In the process, it eliminates many broker functions in the distribution elements of the supply chain. Demand could be reduced from intermediaries that are eliminated from payment and custody channels. In another scenario, public blockchains, such as Bitcoin, may have difficulty gaining mainstream appeal. However, existing intermediaries could adopt private blockchains that reduce their internal costs as they continue to extract high rents in transaction fees charged to investors. Consequently, the savings in transaction fees may not be passed on to consumers.

Sources of innovation

The demand-destroying or demand-creating potential of investments as sources of innovation depends on the rate of creation and market acceptance of new enterprises, which depends to some degree on corporate innovation and concentration in the marketplace. While technological innovation can still start at a small scale from the periphery, corporate giants drive research and development (R&D) and shape economic potential. The capacity of corporate giants to invest in technology development has increased significantly. Fewer than 10 percent of the world’s public companies account for more than 80 percent of global profit.⁵ They effectively decide how to allocate the vast majority of the global surplus. Eight tech firms alone spent US$96.5 billion on R&D in 2018. This outstrips R&D investments in any other industrial sector, including pharma (US$66.3 billion) and autos (US$61.2 billion).

For the start-ups, digital technology can develop new markets and transactional systems by democratizing access to capital through crowdfunding platforms. Crowdfunding may simply inflate market bubbles rather than act as an alternative mechanism for financing new products and services. Crowdfunding has grown rapidly—its global volume in 2017 was estimated at US$34 billion.⁶ However, it is vastly eclipsed by traditional capital markets—global equity trades were approximately US$21.7 trillion in the fourth quarter of 2017.⁷ The integration of digital technologies into emerging markets has increased capital flows, raising both supply and demand in these markets. For example, M-pesa allows quick and cheap transfers of money from abroad (e.g. remittances) through mobile phones to communities in Kenya, Tanzania, and South Africa. Such transactions were previously inconceivable given the lack of banking infrastructure. These transfers have accelerated economic development in Africa, particularly among women—a clear example of demand creation through technology.

Endnotes

1 Gregory Meyer, Nicole Bullock, and Joe Rennison, “How High-frequency Trading Hit a Speed Bump”, January 1, 2018, Financial Times, https://www.ft.com/content/d81f96ea-d43c-11e7-a303-9060cb1e5f44.

2 Benoit Tessier, “High-Speed Traders are Taking Over Bitcoin”, January 16, 2017, Globe and Mail, https://www.theglobeandmail.com/globe-investor/investment-ideas/high-speed-traders-are-taking-over-bitcoin/article33637923/.

3 Guy Gellatly and Elizabeth Richards, “Indebtedness and Wealth among Canadian Households”, March 26, 2019, Statistics Canada, https://www150.statcan.gc.ca/n1/pub/11-626-x/11-626-x2019003-eng.htm.

4 Kelly Fiveash, “Is Apple Card the Future of Finance or just a Fancy MasterCard?”, March 28, 2019, Wired, https://www.wired.co.uk/article/apple-credit-card-uk.

5 McKinsey Global Institute, McKinsey & Company, Playing to Win: The New Global Competition for Corporate Profits, September 2015, https://www.mckinsey.com/~/media/mckinsey/business%20functions/strategy%20and%20corporate%20finance/%20our%20insights/the%20new%20global%20competition%20for%20corporate%20profits/mgi%20global%20competition_full%20report_sep%202015.ashx.

6 “Crowding Statistics”, Fundly, accessed April 2020, https://blog.fundly.com/crowdfunding-statistics/#general.

7 Statista, 2019, “Value of Global Equity Trading Worldwide from 1st to 4th Quarter 2017”, Financial Instruments and Investments, Statista, https://www.statista.com/statistics/242745/volume-of-global-equity-trading/