How the Deep Web could inform tomorrow's online marketplaces

What is fascinating about Joel’s overview of illicit marketplaces on the Internet is not that there is illegal activity happening there. I suspect, even though Joel estimates the sale of illegal drugs is ten times larger than the next category of goods, that’s still a tiny fraction of the drugs sold on the street. The really interesting thing about Joel’s analysis is what it tells us about the future of open, transparent and legal markets on the Internet.

By definition, these illegal markets are unregulated. There is no government agency you can complain to when you get ripped off. You cannot take a seller to court. You are entirely on your own. These markets are, therefore, some of the most free markets in the world. Because they are illegal, the marketplaces themselves have a strong incentive to use technology efficiently. They have to limit the amount of capital required, and the number of employees, so they may also be the leanest marketplaces in existence today. So what can we learn from them that might help us refine our approach to investing in legitimate markets?

I have worried for some time that as the value of marketplaces like AirBnB and Uber soars, they become vulnerable to a new breed of competitors. No matter how efficiently they use technology, they now have another mouth to feed - the shareholder. If Uber is valued at $40bn in the latest round and the new investors expect a 3X return, the company must somehow extract enough value out of the marketplace to justify a $120bn market capitalization. Yes, established marketplaces have strong network effects, but it is possible for buyers and sellers to use more than one app, and it seems likely that they will begin to move to apps that share more value with creators in the form of lower costs, and with consumers in the form of lower prices.

It seems to me illicit markets on the dark web may offer a template for creating the next generation marketplace. At the end of his post, Joel summarizes what he found most interesting about these markets. He suggests their existence is proof it is possible to create and operate a lean, decentralized, market and lists the key requirements - low capital requirements, and an independent discovery mechanism and reputation system that spans multiple marketplaces.

The illicit markets that Joel studied apparently not only decentralize control, they disaggregate functionality. Discovery and reputation are not the only service elements that are independent, it appears that these illicit marketplaces unbundle other services like escrow, and charge for them separately. As the Internet breaks down distribution bottlenecks, we see already see unbundling threatening to disrupt media markets like cable TV. Perhaps we are seeing a hint of what’s to come with legitimate, legal marketplaces, as network effects break down.

Interestingly, the friction and latency, necessary in illegal markets to hide the identity of the participants, may not be necessary in open, transparent, legal markets. My first thought was, how cool, in a legal market you can leverage the design principles of the illegal markets but skip the overhead of encryption. But that may not be true. For a decentralized reputation system to work, you need some way of knowing that a review of a seller by a buyer is credible. The illicit markets do this by relying on the buyers private key to establish their identity. In existing legal markets, the platform manages identity and enforces the legitimacy of reviews. An existing network like Twitter or Facebook could create a truly independent and portable identity scheme if they were willing to give up collecting sensitive user data but they don’t seem to be going there. Even if you still need private keys to establish identity, you could still simplify user experience and reduce latency by eliminating the need to hide it.

All this leaves me wondering not so much if the world will move toward decentralized, and disaggregated marketplaces, but when and why. Because the activities on the dark web are largely illegal, there is no other choice. For the rest of us, we are still generally willing to depend on a centralized platform for discovery, and identity management. For the moment, we are also still willing to accept the fees, the terms of service, and the bundling, these platforms enforce. My guess is the models pioneered on the dark web will come into the light first as leaner more efficient competitors to the first generation of peer economy companies, but the question I am still struggling with is where to look. Are there legal markets where the value of a decentralized market is greater so this transition will happen sooner, or will it happen first in any market where a first generation peer economy company goes too far by economically and politically disenfranchising the value creators at the edge of their network?

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