How financial systems work, how they came to be and how they evolved.
Financial technology is concerned with those systems which model, assess and process financial products such as stocks, bonds, contracts and currencies. Financial systems have much in common with the traditional commercial, military or gaming systems.
For instance, they incorporate trading systems to allow the sale and purchase of financial products in the same time and in different markets.
The financial technology is based on standard protocols for secure communication between market participants and the exchange, the provision of market data, news on public and private networks.
They are subject to rules and control by government agencies that deal to ensure that transactions are carried out in a clean market, free of illegal actions. Mathematical, statistical, computational and economic models are massively used.
The main difference between a financial system and a traditional commercial system is in the type of products that are modeled, valued and traded.
Generally, products exchanged in a traditional commercial systems are things we eat, drink or consume as energy resources. Products exchanged in a financial system are more intangible and change over time, such as credit, property, contracts, bonds, stocks and shares.
In Financial market, buyers and sellers make money betting on price movement and risk management. A financial exchange has several advantages compared to a commercial system:
- Fair price: technology used by the exchange guarantees that the prices are not illegally manipulated
- Stability of prices based on standard agreements
- Differentiation of Products: it is essential to reduce the exposure risk.
Historically, the first exchange was the Amsterdam Stock Exchange, founded in 1608. Only the Dutch East India Company’s shares were traded. Moreover, the first protocol for transactions was a simply handshake. The so called handshake protocol for trading was discussed in the 1688 essay by trader Joseph de la Vega:
A member of the Exchange opens his hand and another takes it, and thus sells a number of shares at a fixed price, which is confirmed by a second handshake. With a new handshake a further item is offered, and then there follows a bid. The hands redden from the blows.
Communications between agents and brokers must not be ambiguous. The most important characteristics of such unambiguous peer-to-peer communication are:
Reliability: There is an acknowledgment for each message between participants so that if a message is not acknowledged by the listener, the speaker communicates the message again;
Error correction: Any mistakes made in communication should be detectable and correct wherever possible.
####Financial Terms Many financial terms are metonyms, i.e., words derived from associations. Wall Street, a short street in lower Manhattan, is used as an alias for the entire U.S. financial system because it is the place the New York Stock Exchange is located. Similarly, The City is used frequently as an alias for the financial district in London and therefore the financial interests of the British economy. Other financial terms are derived from Latin, old English, or slang (American or British). For example, bread (short for bread and honey)is Cockney rhyming slang for money. Other terms are eponyms (names that become identified with an object or activity) or synecdoches (a kind of metonymy in which a part of something is used for the whole).
####Juno Moneta In antiquity, temples were the “central banks” of ours day. Because temples were centrally located and well guarded, they became the natural places for storing money and other objects for safekeeping. In pre-Augustan Rome, the Temple of Juno Moneta (Moneta is a nickname, meaning she who warns) was used as the location for financial transactions. Moneta became an eponym for mint, monetary, and money.
####Clearing e Settiling Many financial transactions use intermediaries called agents or brokers, whom buy and sell on behalf of their customers. Customers’ trades are generally characterized by a location, buy or sell. Netting (or clearing) refers to the process where an agent creates a single trade (or position) from a set of individual trades. He basically merges the different trades in a single order. The opposite process is called settlement, means an agent has to fill a customer order starting from the offers.
####Financial Market Participants The participants of the financial market are traders, dealers, brokers and market makers. The bid price is the price that someone is willing to pay to buy something, while the ask price is the price that someone is willing to accept to sell something. A quote for a given product contain both bid price/volume and ask price/volume. The dealers make money from the spread between bid and ask price, while the brokers (who are agents) make money matching buyers and sellers.
Introduction to Financial Technology, by Roy S. Freedman