What is the Internet black market?

In order to understand the Internet black market, it is important to first define the Surface Web, Deep Web, and Dark Net.  The Surface Web is comprised of content on the Internet that can be found using a search engine.  If Google, Bing, or Yahoo can find certain information, it exists on the Surface Web.  Surface Web information is both accessible and indexed.  The Deep Web consists of information that is un-searchable by a search engine, information that is indexed but not accessible.  For example, if you buy something online on Amazon, someone cannot search for your credit card information via Google.  Amazon utilizes this private information and does not make it available for public use.  Organizations such as public libraries, local governments, and businesses such as online retailers manage a great deal of data in the Deep Web.  Information on the Deep Web is estimated to be hundreds, if not thousands of times larger than information on the Surface Web.  The Dark Net is a small subset of the Deep Web, it contains information that is restricted and non-indexed.  Activity on the Dark Net that has to do with exchange is done using the Tor network.

deep-web

The Tor, The Onion Router, network enables anonymous communication and transactions.  It is decentralized and cannot be shut down from an administrative location, the routing system prohibits law enforcement’s ability to identify specific users.  The information sent via Tor is encrypted.  It then travels through numerous nodes in the network.  When information travels through the Tor network, messages are ‘bounced’ between nodes which makes them virtually untraceable.  Tor is similar to mix-networks because messages are wrapped in layers of encryption.  This encrypted information contains keys of all the intermediate nodes (relays) that the information will reach before it reaches its final destination.  When the information reaches each node a layer of encryption is lost and the information continues traveling randomly throughout the network, losing layers of encryption as it goes.

This network allows for anonymous and untraceable communication because there is no correspondence between incoming and outgoing messages from each node the information travels through.  This is the most prominent form of anonymous communication, the robustness of its security lies in the diffusion of trust all through the system.  Platform providers can use various code bases to make marketplaces within the dark net, sellers then advertise their goods on these different sites.  Some sites are open to anyone, others require a referral.  Sellers utilize various technique in order to attract buyers.  The use of logos, community bonding through forums, and reputation through repeated interaction creates a more transparent and user-friendly community.  Various sites rank their members based on their tenure and the trust they have built up on their site.

tor

Because Bitcoin is the most popular and widely adopted anonymous crypto currency, it is used as a medium of exchange on Tor.  A Bitcoin is technically a solution to a mathematical equation with a fixed set of solutions.  They are able to be stored in a virtual “wallet”, similar to cash, and are exchanged with low transaction fees through anonymous virtual transactions.  This is a peer-to-peer currency that does not require verification from a central third party (Christin, 2012).  Bitcoin uses the Blockchain which is a transparent public ledger distributed by a peer-to-peer network.  This Blockchain technology prevents ‘double spending’ of Bitcoins by certifying that the same Bitcoins haven’t already been used in a transaction.  Thus, exchanges made using Bitcoins over the Tor network are extremely difficult, if not impossible, to trace.

 

Advertisements

Making Sense of Ticket Scalping

 

Version 2

March 22nd had been marked on my calendar for about a solid month.  That was the day that Lollapalooza (a music festival in Chicago) tickets were going on sale.  Ok, ok, you might be thinking that this is ridiculous, “why does she have to buy them that day?”, “why is it that big of a deal?!”  All valid questions to be sure.  However, as anyone who has tried to buy festival tickets or popular Broadway show tickets will know, these things sell out fast.

I got to my computer a few minutes before they were going on sale to increase my chances of getting one of those highly coveted tickets.  I have had similar experiences trying to buy other concert tickets and knew that if you are not able to buy them for face value on the site, your options dwindle to much more expensive tickets on secondary markets.  The tickets became available and I clicked “buy”.  I was taken to this “waiting” screen that noted that “with a high number of customers, our system is still processing your request”.  I was talking to a few friends who had gotten through and were purchasing tickets but my screen was stuck in this perpetual waiting mode.  I tried different browsers but to no avail.  The screen eventually notified me (after about 30 minutes) that the tickets were sold out!

I was a little bummed that my attempts to buy a Saturday day pass Lollapalooza ticket were thwarted by a likely massive number of scalpers (with the advent of modern computing, ticket scalpers are able to submit thousands of requests for tickets at one time, often times crippling ticket sites), however, I knew that I could still get tickets (unfortunately at a much higher price) and that there was a logical economic explanation for this seemingly out-of-control market.

IMG_3050Why are these ticket sales so fast?  Why are scalpers able to effectively and repeatedly profit from this ticket re-sale market?  This rapid selling-out of tickets is something that happens yearly with Lollapalooza tickets.  The concert organizers know this, the concert attendees know this, and the scalpers know this.  But then why does it keep happening?

When I see people forming a line or rapid ticket-sales, I know that the price for the good or service is too low.  Basic supply and demand illuminates this phenomenon and tells us that if the price is below the equilibrium level, there will be more quantity demanded for that good.  $120 a day for a very popular and prominent festival is apparently much too low of a price to be selling tickets for.  This is because immediately after the tickets were sold out, they appeared on StubHub for around $250 a day and they were being sold!  People demanded these tickets even at over double the price of the original face value ticket.

So if these scalpers are consistently receiving revenues from their re-sale of tickets, why don’t the concert ticket sellers just raise the price of tickets to equilibrium levels, reap the benefits themselves, and price out the scalpers?  There are some that have tried to overcome this problem, but for the most part, concert venues and festival organizers have been relatively unsuccessful at this.  There are two main economic reasons why tickets are not initially sold at equilibrium levels, first, these festival organizers would like to preserve their reputation and secondly, they cannot effectively price discriminate.

When you picture a music festival goer who comes to mind?  I would guess that you are probably thinking of a relatively young person who likes EDM, cheap beer, and crop tops.  Festival organizers, along now with Broadway theaters, want to preserve their reputation of being affordable by providing quality entertainment that is accessible to people of diverse socio-economic statuses.  They do not want to be known as organizations that have “high” ticket prices that price out young people and people of lower income brackets from participating in their brand of entertainment.  They would like to provide, or at least appear to provide, tickets at a “reasonable” face value.

The second has to do with price discrimination.  This is when firms sell the same product for different prices to various segments of the population.  Think about student and senior discounts at the movie theater and “early bird specials” on certain products.  This allows firms to capture revenue from segments of the population that have different elasticities of demand.  Two conditions have to be met in order for a firm to successfully price discriminate.  First, the firm must be able to identify distinct market segments that are different with respect to price elasticity of demand.  Second, the firm must be able to enforce the different prices paid by the various segments of the population (there have to be few to no arbitrage opportunities).

IMG_3079Think about airline tickets, this is an industry that has been very successful in price discrimination.  Depending on when you buy the ticket, prices fluctuate dramatically.  Prices for flights far in advance are typically the cheapest and they get more expensive as the date of the flight approaches.  This is to capture the customers that have very inelastic demand just a few days before the flight, who are willing to pay much more than those who planned ahead.  Airline tickets cannot be resold because each passenger is IDed in order to just get past security and the name on their ticket is matched with their ID.

Concert organizers have not been able to successfully price discriminate with their ticket sales the way that StubHub and other secondary ticket sites have been able to.  The prices for the tickets did fluctuate on StubHub, depending on how far away the concert was, this is because the numerous sellers are very sensitive to demand changes on a weekly basis.  Scalpers, because of their access to these secondary markets, are able to discriminate based on income bracket and willingness to pay.

So why are the organizers of Lollapalooza not price discriminating?  This may have to do with the fact that the event only comes around once a year and in order to effectively price discriminate they would have to have a sophisticated system in place to sense changes in demand over time and price accordingly.  This may be prohibitively costly or might tarnish their reputation of providing affordable tickets and not price gouging.  They also would have a very difficult time fulfilling the second condition of effective price discrimination, even if they were able to identify distinct market segments, how would they enforce the different prices paid by the various segments of the population?  The line to enter the festival already took about 40 minutes, imagine the time it would take to ID everyone at the door to make sure the name on their ticket matched the name on their ID.  This could be prohibitively costly for both the festival organizers and festival attendees.

I did eventually buy a ticket on StubHub and ended up having a wonderful time at the concert.  When I was outside the festival venue I made sure to ask some of the scalpers I ran into on the street half way through one of the days of the festival how much their tickets were going for, less than 80% of the face value ticket price!  I guess price elasticity of demand is relatively very inelastic half-way through a day of the concert because the scalpers didn’t want to be stuck with a bunch of worthless tickets the next day.

Reputation in the Internet Black Market

Modern black markets have in place numerous institutions to facilitate trade and evade law enforcement. Cash makes transactions untraceable, hierarchy delineates roles and responsibilities, and violence encourages participants to abide by norms. The advent of the Internet razes this system; entirely new institutions are required for black market trades in this environment. The increased anonymity lowers the risk of detection by law enforcement in exchange for an increase in the risk of impropriety between buyer and seller. Seller ratings are used to facilitate trade through lower transaction and information costs.Screen Shot 2016-05-03 at 3.07.38 PM

Illegal Internet activities are conducted on a portion of the Internet referred to as the Dark Net, which is a subset of the Deep Web which is estimated to be thousands of times larger than the Surface Web, the Internet we use every day.  The Dark Web is unregulated, untaxed, and hidden from a typical Internet search. It is a self-contained market place that functions under a set of informal institutions. Representative data set mined from The Silk Road, one of the most popular sites on the Deep Web, sheds light on the operation of these black-market transactions. The institution of seller reputations creates a stable trading environment among those least expected to deal honestly: criminals.

Black-market activity on the Deep Web is attractive because of the anonymity it provides. Cryptocurrencies such as Bitcoin (BTC) function like cash; they are relatively untraceable. The TOR network anonymizes web traffic. PGP encryption programs mask data within emails sent between users. These three elements form the technological base upon which Deep Web black markets build, allowing exchange at a much lower cost than previously. Before this technology, sellers and buyers in the black market relied heavily on face-to-face interaction and building a reputation through personal encounters. This shift led to a flourishing peer-to-peer underground marketplace expanding on a global scale.

But, anonymous Internet trading incurs an additional cost. Like buyers and sellers on any peer-to-peer Internet site such as eBay or Amazon, buyers and sellers on the Deep Web rarely, if ever, meet in person. This makes transactions particularly risky because there is no recourse for failure. And unlike goods on Surface Web sites, Deep Web users are buying products much more harmful than ordinary consumer purchases. The unique nature of this marketplace makes the accumulated reputation of users critical to its emergence and sustainability. Similar to Avner Greif’s work on the Maghribi Traders, these Internet traders have asymmetric information. However, unlike the Maghribi Traders, these Internet traders have no legal contract enforceability.  Analyzing this reputation component enlightens, more fully, how this market place can exist without any ability to seek recourse ex post and without any prevalence of contract enforceability.

The most important institution of the Deep Web is anonymity. Each buyer and seller is known by a unique username; their true identity is secret. Users of the Deep Web, through forums and blogs, create a wealth of information to keep users updated on the happenings of the market.  They use these ‘news outlets’ to keep users informed on frauds, scams, and imposters. Deep Web markets take a cut of each transaction to cover their operation costs and to make a profit. Buyers write and read extensive reviews on sellers and their products. Markets allow ratings from 0 to 5 stars, accompanied by a brief note explaining the rating. More extensive reviews are commonly posted on internal forums and Reddit. These jointly create the seller’s reputation. Some sellers, to differentiate, offer free samples or extra secure shipping techniques to attract positive reviews.

Because of the nature of the goods sold in the Deep Web, on the Silk Road in particular, sellers are anonymous to buyers and buyers are anonymous to sellers. Before a first transaction, they have no personal knowledge of another’s personality and no formal enforcement mechanism if a transaction goes awry. The characteristics of this particular marketplace pose risks to the traders involved. The buyer could refuse to pay the seller after their items have been received, or, if the buyer pays first, the seller could fail to send the purchased items because they received the payment upfront. There is no way to recoup lost BTCs or products once the transaction is finalized. This marketplace exists due to the importance of a bilateral reputation mechanism that instills confidence in the traders and facilitates repeated transactions.

Collecting as much data as possible on the other party is necessary to making a smart and calculated transaction. Initially, buyers and sellers are dependent upon previous users’ feedback for information on the legitimacy of their potential trade. Recognizing this potential risk, traders utilize forums such as Reddit and the Silk Road itself for feedback, bringing attention to fraudulent behavior and informing traders of transaction malfeasance.

The codification of buyer and seller feedback makes up each party’s user profile.  A user’s feedback profile in this marketplace is made up of the comments and ratings left on the Silk Road site as well as other feedback forums. This feedback is both comments and a number rating. The collection of this user feedback on other users makes up the reputation of the trader in the marketplace. Due to the anonymity aspects of The Silk Road, buyer information is not formally posted like seller information and feedback is on the site. Unlike Surface Web marketplaces, if a buyer leaves a comment and/or rating, an individual identifier is not attached to their message. The reason for this is to protect buyer anonymity. The only information that we can glean about the buyer in particular is that they did in fact make a purchase; buyers cannot leave feedback on a product they did not buy.

Potential buyers utilize this feedback about sellers. They can read comments about previous buyer’s experiences, whether or not the buyer received the items, and view the seller’s 30-day and 60-day and overall rating score. This score is an average of past reviews and it is out of five possible points. Sellers, however, do not have access to this information about potential buyers. Repeated trade will reveal buyer reputation, but the first is made with little information. The promise of future trade can incentivize honest behavior from the beginning; sellers can cease trade with dishonest buyers.

Discovery of a dishonest buyer can have positive externalities for other sellers. But, sellers’ outlets for relaying the information that they have learned from buyers are limited. Because buyers do not have publically available profiles, the seller must seek alternative forms of feedback. They can leave feedback on the internal Silk Road forums or various forums on the Surface Web, but cannot add to a collected reputation buyer profile because they do not exist.

Gambetta, identifies that criminals need both a costly signal of the trader’s credentials and a costless arbitrary group signal in order for this type of market place to run smoothly underground.  The components necessary for a successful reputation signal must be easily observable and that they also must be costly for cheaters to signal a stellar reputation and fairly inexpensive for honest users to signal that they are authentic.

Applying these characteristics to the Silk Road marketplace, the seller feedback mechanisms of readily observable ratings, comments, and thus reputation fit these criteria and send a signal that the seller is honest or dishonest. It would be difficult for a repeatedly dishonest seller to trick its buyers to leave positive reviews and ratings even though the products and services were a sham. On the other hand, if an honest seller provides their customers with quality products in a timely manner, it will be relatively easy to receive truthful positive reviews about the seller’s quality performance. This dovetails very nicely with what we know about the Silk Road community from studying Silk Road forums: the community is very active at giving feedback. These criteria, easily observable signaling and costly signaling for cheaters, do not necessarily apply to the buyers in this marketplace. This failure of buyer feedback to meet the strong signal criteria proposes that buyer signals could contain a great deal of noise and potential for misread signals. For the purposes of this paper, we will analyze the impact of seller’s reputation as a signal.

However imperfect these feedback mechanisms may be, they provide users information on reputation. Reputation is crucial in this market because it acts as a signal to other users that they are honest and credible individuals. This signal works to differentiate between honest and dishonest users to ensure that honest users are not driven out of the marketplace by dishonest users that are not properly identified. The traders’ identities work to reduce social distance in the marketplace. Deep Web traders do not have an identity in the traditional sense; however, they foster an identity through their online reputation. People cheat because they have higher discount rates than their cooperators. Their gains from future exchange are more heavily discounted, thus they invest less because it is more costly for them.

These feedback mechanisms have created an informal institutional framework within which traders exchange goods with confidence.  This marketplace demonstrates the shifting institutional structure of black markets in response to new technologies and threats. Sellers are able to charge premium prices due to their higher relative reputations, this incentivizes them to work to increase their reputation. This particular incentive structure further solidifies the theory that reputation mechanisms are effective. Good reputations allow sellers to make more money and sellers are incentivized to provide quality service to their customers so that they increase their reputation and thus, make higher profits.

The entire paper, Reputation in the Internet black market: an empirical and theoretical analysis of the Deep Web, can be found at https://www.gwern.net/docs/sr/2015-hardy.pdf

For the Strength of the Pack is the Wolf, and the Strength of the Wolf is the Pack: Order in the Jungle Book

Wolf PackA friend of mine invited me to go to new movie The Jungle Book this past Friday.  Because I had plans Friday night, we decided to go to the matinee, not fully appreciating the fact that we would be in the movie with a bunch of 4 year olds until we arrived to the theater.  Taking our seats amongst a bunch of miniature humans I went into the theater with few expectations for the movie other than expecting a nostalgic, fun loving children’s story.  Not only was the movie entertaining and charming for both children and adults, it contained numerous economic themes that I did not recall from my first exposure to the story as a child.

For example, the animals in this story are surprisingly ordered and disciplined.  The wolves that raise Mowgli adhere to a strict code of interaction which they call “The Law of the Jungle”.  Multiple times throughout the film the pack, Mowgli included, recite this creed that provides a oral contract which the wolves have agreed to live by in order to ensure peaceful relations amongst themselves and the other animals in the jungle.

Law of the Jungle (The whole law can be found at http://www.kiplingsociety.co.uk/poems_lawofjungle.htm)

Kipling presumably included this into the story to humanize the already inherent pack mentality that wolves have, in order to make it more relatable to people.  The part in the law “for the strength of the Pack is the Wolf, and the strength of the Wolf is the Pack”, functions to overcome the collective action problem that the wolves face.  These wolves are not the strongest or biggest animals in the jungle, however, because they travel and fight in packs, they are able to take on animals much more dangerous and powerful than any one of them alone.  You see this pack mentality in the movie when they collectively fight the huge tiger Shere Khan.  The leader of the wolf pack, Akela, stresses honor among his wolves and makes arrangements with other animals in the jungle to ensure peace amongst the wolves and others.

Another remarkably sophisticated institutional component that Kipling included in the story is the “Peace Rock”.  In the story, the jungle experiences an extreme drought and water is very scarce.  The water level of the communal watering hole decreases rapidly to expose parts of the bottom of the hole.  There is a rock at the bottom of the hole called the “Peace Rock”.  When the water level gets so low that it exposes the Peace Rock, a pseudo state-of-emergency in the jungle is automatically called.  These laws include the notion that any animal will be protected by the rest of the community and by “The Law of the Jungle” if they come to the watering hole to drink.  Presumably, in times of plentiful water, animals who ventured to the watering hole were on their own in terms of taking a risk of being attacked and eaten.  However, in this time of drought, to ensure relative peace and a stable population equilibrium, the animals have decided to suspend the normal rules of animal conduct in order to provide safe passage to the watering hole.

This type of state-of-emergency rule is common amongst subsistence level cultures and primitive societies.  They provide an institutional framework to prevent people from falling into extreme and perhaps inescapable poverty.  The creation and enforcement of these norms safeguards the society against an even more deleterious outcome in already challenging times.  A modern day example would be the concept of “cousinship” in Western Africa.  This is the notion that family and friends of yours and friends of friends of yours are all considered “cousins”.  When a “cousin” comes knocking on your door, you are culturally obligated to care for them, providing them with food and clothing, potentially for an extended period of time, if necessary.  This cultural constitution acts as a privately enforced social safety net in which community members care for one another in times of desperate need.

The Jungle Book

Not only is the new “The Jungle Book” entertaining and contains some impressive CGI you will definitely learn some institutional economics to boot!