Despite the economic relevance of marketplaces, public discourse is lacking a debate on their responsibilities. In light of the current disputes, such as Spotify accusing Apple of using unfair practices in the App Store benefiting Apple Music, we hope to stimulate such a discussion. To this end, we address the importance of marketplaces to society, identify their core elements, derive their responsibilities, point out what is leading to their inherent flaws, and finally, show how smart contracts can help resolve current issues.

The Societal Relevance of Marketplaces

The internet has given rise to a multitude of digital marketplaces. 30 years after its inception, stocks, groceries, books, clothes, and insurances are increasingly traded online. In our consumer-oriented society, we engage with digital marketplaces on a regular basis. Today digital marketplaces already comprise roughly 15% of retail in the US and the trend is rising.

Their appeal to buyers and sellers is obvious. Merchants are able to reach an audience of millions of users when listing their goods. No matter how small their company or the niche they are selling to is. At the same time, merchants do not have to invest their resources into a physical store. Similarly, buyers are able to shop from anywhere, at any time, selecting from a wide variety of offers.

The 4 Elements of a Marketplace

The four elements of a marketplace are to (i) aggregate liquidity, (ii) distribute offers, (iii) match buyers with sellers, and (iv) enforce trade settlement. In the following, we are going to explain these four elements and therefrom derive the associated responsibilities applicable to all marketplaces.

I. Aggregate Liquidity

Marketplaces aggregate supply and demand, by collecting offers from buyers and sellers. The higher the supply and demand, the higher the liquidity. Liquidity in a market leads to efficient pricing and low order execution costs, to the benefit of all market participants.

On a fair market, everybody should be given access to distribute his offers. Discrimination of potential market participants counteracts the markets’ search for efficient prices.

We find that on regular marketplaces such exclusion is uncommon as increased liquidity is to the benefit of a marketplace as well.

Yet, such market exclusion is a common occurrence on stock exchanges. For example, traders who want to trade small volumes are denied direct access to marketplaces. This forces them to go through brokers, leading to price markups and additional order costs.

Responsibility 1: Marketplaces should be accessible to all.

II. Distribute Offers

The offers, aggregated by the marketplace, have to be distributed. The distribution entails two parts: for one, the listing of the offer; for another, the marketing of the offer.

All listed offers should be treated equally. Herein, the marketplace has to remain neutral. If two merchants were to sell identical products, then the distribution of their offer should only take two variables into account, (a) the price and (b) the time an order has been submitted at. It should not take into account, who has submitted the offer. Distributing offers according to the factors of, first, price and, secondly, time is called price-time-priority.

No offer should be emphasized or marketed in an earlier or more appealing way. Sponsoring of offers and preferred access to offers should be prohibited as it favors those who are able to pay the sponsoring costs or the access fee. Thereby, the market hurts other vendors and potentially financially harms buyers by driving up the price. To guarantee equal treatment of buyers, everyone should simultaneously be provided with market information, to the same extent. Otherwise, buyers and sellers with prioritized access to market data could match with favorable deals first.

Responsibility 2: Distribute orders equally.

III. Match Buyers and Sellers

Matching buyers and sellers have to follow the same principle as order distribution: price-time-priority. Imagine multiple merchants offering an identical product. A buyer should always be matched with the product that has the lowest quoted price. If multiple sellers quote the same price, the buyer should be matched with the seller who submitted his offer first.

The market stays fair, as long as the platform matches under the principle of price-time-priority. Thereby, it detains from matching users with unfavorable offers. Yet, this principle is rarely followed on exchanges. For example, certain sellers are matched with first because they are selling higher volumes or are paying for their offers to be distributed in a more appealing way.

Responsibility 3: Match orders under the principle of price-time-priority.

IV. Enforce Trade Settlement

The marketplace is responsible to ensure that the settlement, the exchange of goods between buyer and seller, takes place. Whereas this is generally not a problem in trades vis-à-vis on a physical marketplace, this becomes an issue on digital marketplaces.

In e-commerce, marketplaces generally do not control the entire chain of payment and delivery. Instead, the parties are extending their chain of trust to third-party providers, such as delivery companies and their published parcel tracking information. As there is little control over these external service providers, successful dispute resolution in trade settlement is dependent on contract frameworks and a functioning judiciary.

To create trust for buyers, marketplaces list seller reviews or do extensive KYC on sellers. To create trust for vendors, marketplaces often handle the escrow of payments. Instead of trusting each other, the market participants are trusting the marketplace and its published information. Buyers have to trust that reviews are not faked, while vendors have to trust, that they will receive the money collected by the marketplace.

Trust underlies the relationship between all market participants and the market itself. To mitigate uncertainty, it is the responsibility of digital marketplaces to ensure the security of trades, providing trust to market participants.

Responsibility 4: Create trust in trade settlements.

To summarize, a market aggregates offers, distributes these offers, matches buyers with sellers, and finally, enforces trade settlement. Thereby, his four responsibilities are to (i) ensure fair access to the market, (ii) treat offers equally when distributing them, (iii) match buyers and sellers under the principle of time-price-priority, and (iv) create trust in trade settlements.

Why Marketplaces are Failing to Meet their Responsibilities

With these four responsibilities in mind, we take a look at why current marketplaces fail to meet these responsibilities. Hereby two issues stick out. First, incentives for marketplaces are misaligned. Secondly, they are unable to create complete trust.

A. Misaligned Incentives

A marketplace commits to equality, only so long as this does not mean cutting down on profits. If there is an economic appeal, to privileging certain vendors or buyers, we can assume that the market will do so. Take for example Amazon. Amazon will offer his own products favorably or let vendors sponsor their products in order to be seen first within the first search results. The same is true for Apple, which will try to nudge users to use Apple Music instead of Spotify. On both these marketplaces, the operator is incentivized to favor his own products over competitors offers or to accept payments to preferably market others.

B. Inability to Create Complete Trust

As mentioned previously, on digital marketplaces participants always have to trust intermediaries to ensure trade settlement. If the execution of an order is not dependent on the buyer or seller it is dependent on intermediaries, such as the marketplace itself or external service providers, such as FedEx or payment providers and credit card issuers. Therefore, trust can never be completely guaranteed.

In summary, marketplaces are unable to meet their responsibilities, because (a.) they are incentivized to favor discrimination and (b.) because trust is dependent on too many parties.

What Now

Nowadays marketplaces are controlled by regulatory authorities. While controls cause exchanges to avoid illegal activities, they cannot force exchanges to act ethically.

One way for a market to guarantee that it will not deviate from a fair strategy is by fixing terms in a smart contract. Smart contracts offer the opportunity of creating platforms, guaranteeing the entire chain of trust mathematically, while making terms both fully transparent and immutable.

If an exchange subjects itself to terms that are fair in the beginning, it cannot be tempted to change the terms in his or anybody’s favor later on. The public auditability of the smart contract ensures complete transparency. Users have the ability to verify the existence of traded goods and check whether they deem the terms of trade to be fair.

At dex.blue we have built an exchange based on smart contracts. Doing this, we have made it our mission to live up to the previously defined responsibilities, avoiding the issues of misaligned incentives and trust altogether.

In doing so, we aim to follow three basic principles:

Advocate for the responsibilities we propagate. Make use of the pioneering technical solutions available today. Perform this in a way, that it is efficient.

To us, these principles should not be seen as the ideal, but as the absolute minimum criteria for establishing any marketplace today.