In a sense, money and capital markets have always been a kind of social network. Information, money and capital circulate through them. That this exchange functions reliably is anything but natural. As in other social networks, financial markets are prone to misinformation, exaggeration and abuse. The question is how to ensure that truth, reason, and fairness prevail.

On social media, we watch this process with a mix of anxiety and hope. In the case of financial markets, humanity has had more than two and a half millennia to learn how things can go wrong – and how they can work better. Out of this experience emerged rules and institutions. Central banks, stock exchanges and supervisory authorities bring a certain degree of order to the system not only through their voices, but through concrete action. They ensure markets are efficient – but also fair, transparent and stable. The contribution of central banks, for example, is stable money.

Every innovation in the financial markets raises questions. Are the rules still appropriate? What competencies must institutions have? What needs to change? Such questions are justified. Pressure to adapt and to justify authorities is healthy. It counterbalances two equally powerful forces: institutional inertia – the logic behind “this is how we’ve always done it” – and the tendency toward ever more granular, rigid regulation. We see this tension in international capital flows as well as in individual markets. Stock exchanges, central banks and supervisors alike must continuously redefine and defend their role.

Prickly guardians of the market

Before the 19th century, financial activity in Europe relied largely on informal networks of individuals acting on their own behalf. Bills of exchange, precious metals, coins, government bonds, annuities and mining shares all depended on personal credit – on personal contacts and reputation. The larger, more complex, and more dynamic these financial transactions were, the more complex, risky, and opaque they became. In major financial and trading centers, permanent institutions emerged to organise trading, pricing and clearing. These included stock exchanges in the capital markets and exchange banks and note-issuing banks in the money markets.

During the 19th century – the age of liberalism – stock exchanges and central banks became established institutions across much of the western world. Only then were markets able to operate efficiently in the modern world. As central counterparties in both credit and money markets, these institutions replaced the old world’s personal credit system with institutional credit. These institutions did not make money and capital markets immune to crises. But I am convinced they have made crises less frequent and less severe. That does not mean rules and institutions are always popular. At times, they can be prickly – like a hedgehog.

A “well-ordered” financial market rests on efficiency, stability, fairness and transparency. Efficiency means low transaction costs, high liquidity and rapid execution. Stability is about preventing systemic crises through clear rules and adequate buffers. Fairness stands for equal opportunity, while transparency stands for protection against manipulation. But how can these goals be achieved? The answer lies in striking a balance between theoretical ideals and pragmatic implementation.

The question is not whether – but how 

Key market institutions such as stock exchanges and central banks are under pressure from historic change. The financial crisis of 2008 in particular demonstrated how a lack of transparency can render markets dysfunctional. This applied to securitisations as well as to over-the-counter markets. Since then, tendencies toward fragmentation have persisted. Dark pools do not necessarily increase transparency or liquidity in securities trading. Decentralised finance platforms bypass traditional exchanges but provide neither clearing nor supervisory oversight. On the Frankfurt Stock Exchange today, algorithmic trading accounts for roughly 60 percent of the trading volume. The crypto market has enormous momentum. The impact of the increasing use of artificial intelligence in capital flows is difficult to assess.

Such market changes are affecting central banks, especially as they operate actively in markets to implement monetary policy. At the same time, crypto-assets and stablecoins are challenging the currency monopoly traditionally held by central banks.  

The historical development of the modern era brought stock exchanges and central banks into being, elevating them to the core of the financial system in the 19th century. Today, digitalisation and fragmentation in the financial system are forcing these institutions to redefine their role and significance in a new environment. The question is not whether we need them – but how we design them so they can fulfill their mandate: efficiently, effectively, and – where necessary – even with “prickles”.

Professor Joachim Nagel is President of the Deutsche Bundesbank and a member of the ECB Governing Council.