Last week, Gavin Verhey posted an excellent article detailing a number of pervasive myths regarding Magic. Myth #6, which spawned the most debate in the forums, was that "Mythic rares make Standard decks significantly more expensive" and referenced my analysis here on ManaNation.com a few weeks ago. Needless to say, not everyone in the forums agreed with this analysis, with the most trenchant and intriguing criticism being the prevalence of "shark" traders in the post-Medina (et. al.) era. What I would like to do here is move away from the ethics issues—because there are definitely acceptable and unacceptable ways of trading for value—and instead focus on some of the economics of trading. I am going to argue that, however distasteful some of their methods are (and these methods should be policed), the emergence of competitive trading on the whole is a positive development for Magic. I look forward to your flames, but please read the article before flaming!

In order to have this discussion, we need to focus on the core two questions in economic theory. First: What is a market? Second: What are the key characteristics of market actors? To answer these questions, and to explain the function of competitive training, I will be drawing in part on a landmark essay in economics by F. A. Hayek entitled "The Use of Knowledge in Society." If you have any interest in economics, I highly recommend reading this article. Hayek may be a bit extreme in making his case at times, but the fundamental argument has a great deal of merit.

Question 1: What Is a Market?

In economic theory, the market is a social construct that exists to solve problems of imperfect information. In Hayek's words, the core problem of constructing a rational system of economic distribution is "a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge that is not given to anyone in its totality."

In other words, the problem is that no one individual possesses all the information necessary to ensure an efficient allocation of goods. The solution to this problem is the market, a network of decentralized transactions that communicates pricing data to all the relevant actors, ensuring that everyone knows what their resources are worth. This information enables each actor to make an informed decision on what goods to buy or sell at a given time.

The "Law of One Price"

The most relevant aspect of this concept to the problem of Magic trading is that it tells us that, at any one time, there are a number of different available prices within the market for a good (or card), but that any good does have a true/correct "price"—if one has all of the relevant information. Given a larger number of market transactions, the speed at which information is transmitted increases, and the variation in each individual price decreases as information spreads. The more transactions, the closer to the true price we get.

Question 2: What Are the Key Characteristics of Market Actors?

The core assumption of economic theory is that each individual market actor is a rational individual whose goal is to maximize the fulfillment of his or her own preferences. In the case of most Magic players, we can safely assume that their main preference is to acquire the cards they want to play in their relevant format, while other preferences would include "pimping" their cards and making money (or at least not losing money) on trading. Market actors will also have limited information about changes in the overall market, but will have intimate knowledge about items that are important to them or are routine aspects of their immediate surroundings.

If we assume that most actors will be most familiar with the prices of the cards they are interested in—that is, Legacy players will best know the prices of Legacy cards, casual players will best know the prices of EDH cards, and so forth—we are left with a number of different price groupings where players in each grouping will be familiar with the price of one type of card but less familiar with the prices of other types of cards (obviously, cross-format staples will overlap). This is one example of the way in which multiple prices for one particular card will be available in a market.

A second reason different prices may be available is because of the isolation of different physical sources of goods and, therefore, data about the supply and price of a particular good/card. In the case of Magic, this is most relevant when it comes to the enclaves of trading groups that exist, particularly at one store's weekly FNM. Because of the intimate knowledge most players attending one store will have of the price of cards at that store, they will associate their "home" store's price with the market price of the card. This was broadly how trading worked before the advent of Internet pricing via eBay and major online retailers like Star City Games, TCG Player, ChannelFireball, and Cool Stuff, Inc. It would be naïve to suggest that this phenomenon has completely disappeared, but its prevalence has diminished substantially over the past few years.

The problem with using a local store as your price guide is that your store will price goods based on the demand for a particular card in its core market—you and your fellow players at the store—and will not be reflective of the overall market price of the card. What this means is that many of the cards you would trade to get the cards you want will be undervalued at your local FNM, while the card you want will be overvalued. Effectively, although you are unaware of the fact, you will be ripping yourself off in a large number of the trades you make.

(Aside: This will come up later, but savvy traders will note that in the older days of multiple stores with different prices, there was substantial value to be made by exploiting the different values at which people would trade cards at different stores. So, intentional rip-offs could occur, so long as one was willing to put in the legwork. Medina himself has pointed out that this is how he first started making money on Magic trading.)

Economic Utility of the Sharks

Along with all of the basic profiles I detailed above, there is one more profile—that of the competitive trader, someone whose focus is on leveraging information to make money on Magic trades. Much-maligned as sharks, these individuals, perhaps more accurately called arbitrageurs, after the economic concept of arbitrage (more below), actually perform a useful economic function. Hayek agrees, arguing that despite the general contempt with which they are met, individuals with specialized knowledge perform a useful market function: They transmit specialized knowledge, simply through acting on that knowledge in a rational and self-interested manner, to other individuals who lacked access to that knowledge, inadvertently providing a benefit to all.

The core problem of organizing a market (and, incidentally, the reason communism failed), according to Hayek, is the lack of a centralized mechanism to ensure each individual has perfect pricing data at all times. I think it is worth quoting Hayek here at length:

It is a curious fact that this sort of knowledge should today be generally regarded with a kind of contempt and that anyone who by such knowledge gains an advantage over somebody better equipped with theoretical or technical knowledge is thought to have acted almost disreputably. . . . The common idea now seems to be that all such knowledge should as a matter of course be readily at the command of everybody, and the reproach of irrationality leveled against the existing economic order is frequently based on the fact that it is not so available. This view disregards the fact that the method by which such knowledge can be made as widely available as possible is precisely the problem to which we have to find an answer.

In other words, if the core problem is that up-to-the-minute pricing data cannot be communicated to all market actors, instantaneously, at every market update, without relying on the market itself to communicate such data, it makes absolutely no sense at all to demonize those who use special information—which they worked hard to achieve—for using that knowledge to make a profit. Without the attached profit incentive, there would be no reason to work to gain that special information, and it would not be transmitted. To expect everyone to communicate all of this data verbally and altruistically even if it is to their disadvantage, is naïve at the very least, and quite possibly unfair to the one doing the work. More fundamentally, it would cause the information transmission function of the market to break down, leading to widespread inefficiencies in economic activity (here represented by sloppy trading).

Arbitrage: Transmitting Information across Markets

Now that I've discussed the economic function of sharks, and briefly touched on how they perform an economically useful activity, I want to discuss a little about how sharks make their money—in other words, discuss what arbitrage is—and explain what the apparent proliferation of sharks means in terms of the development of the Magic market.

The goal of arbitrage is to gain money based solely on the pricing disparity of the same good in two different markets. Thus, any arbitrage transaction requires two "legs" to be successful; the arbitrageur must buy low and sell high, and within a relatively short time frame. In financial markets, this is typically done electronically, but since Magic cards don't shift as rapidly as industrial commodities, a competitive trader can feasibly have a time frame of a week or two in unloading their cards (although this creates some "leg risk" that prices will change). Fundamentally, competitive traders in the MtG market are engaged in arbitrage; they look for places where cards are undervalued (either by people or by dealers) and look for places to unload those cards where they are overvalued (or normally valued). In a nutshell, arbitrage is just comparison shopping for profit.

The function of arbitrage in the overall market, as I've hinted at above, is to transmit pricing data to different actors, in order to reduce the inefficiency associated with imperfect information in the marketplace. How is this done? By strategically undervaluing and overvaluing cards, the arbitrageur penalizes or rewards those with correct or incorrect information. Essentially, the profit made when conducting arbitrage is like charging a cost for providing correct information, but it functions through an indirect reward/punishment mechanism. Hence, the general rule when dealing with sharks: If you feel like you are being ripped off—well, you probably are.

Given that arbitrage is more profitable to undertake with larger price gaps between markets, why is it that we didn't seem to notice savvy trading going on ten years ago? The answer is twofold. First, you probably didn't notice simply because you didn't have access to reliable pricing data outside of your local store, and therefore had no idea of your cards' values outside of the local market. Second, of course, there was a tectonic phase shift in the MtG market about eight years ago—the rise of online retail.

Online Retail and Arbitrage

A little over eight years ago, two major things happened to the MtG market. First, Star City Games took over for the Dojo, the Sideboard, and other sites as the major publisher of competitive Magic content and theory, which it coupled with a substantial online sales push. This had the function of beginning to standardize Magic prices across the United States, providing reliable price data at the click of a button. Second, in late 2002, eBay purchased PayPal, and the online auction site completed its move toward gaining mainstream acceptance. This had the function of providing a readily available market whereby MtG collectors could sell their cards for cash and be guaranteed a decent return approximating market prices. Essentially, eBay streamlined the process of finding buyers for your cards and greatly reduced the need to accept dealer buy-list prices.

As far as arbitrage is concerned, these twin changes made it both easier and more difficult to make money trading Magic cards. While it became much easier to do your research and make a sale, minimizing the legwork involved with arbitrage, it also gradually became more difficult to make a substantial profit on every trade, as people became increasingly familiar with national pricing trends. Thus, while it was easier to get started in trying to make money, the amount of money you could make was limited in scope.

The overall impact of this change was that the market as a whole traded a few large sharks—effectively dealers in their own right, maintaining large collections and making a substantial profit with minimal overhead—for a plethora of small-time sharks, each of whom is looking to make a little value on each trade. What this means for the overall market is that the market is operating much more efficiently, regardless of whether you as an individual like to play the "valuation game." Without online retailers like Star City Games, Cool Stuff, Inc., and TCG Player to provide national pricing data, and without competitive trading to regulate the market, the trading process would actually be less efficient and more cumbersome, dictated more by personal attachment to a card than by objective pricing measures.

Conclusion

Next time you are complaining about being ripped off on a trade, please do me a favor. Don't blame Jon Medina or Kelly Reid or Brian Grewe for "popularizing" competitive trading. It already existed; arbitrage exists in all markets. There were just fewer sharks because the legwork associated with arbitrage was more difficult. However, when you did get ripped off, it was a much bigger deal than it is now, because fewer people had any idea what their cards were really worth.

In general, the spread of spiky trading is due principally to the prevalence of Internet pricing data, and the fact that people generally look out for themselves while trading. What this means is that the market is becoming more efficient, so people don't trade as loosely as before. It may be that you don't like to look up pricing data, or deal with the added layer of competition, but from a strictly economic standpoint, the more competitive trading environment is desirable, as it greatly improves market efficiency.

That's right. I said it. Despite all the protestations to the contrary, the proliferation of sharks is, on the whole, a good thing.