Whether you’re actor Kevin Bacon, a page on the world wide web, or a bank, we are all connected…and connected in very similar ways. A Power-law is a type of relationship between the size of events and their frequency. Several studies of payments networks have found the node-degree distribution to follow power laws. The sizes of human settlements, the intensity of wars, the size of meteorites, income and wealth, the size of files sent over the Internet and natural phenomena such as rainfall, hurricanes and earthquakes all appear to follow a Power-law. In the interbank market we take the banks to be the nodes of a network, and if two banks exchange payments they share a link. Interbank networks have the same topology as other networks: most banks have few links, while a few banks have a large number of links. Links do not form randomly, but instead a new node is much more likely to link itself to an existing node that already has a high number of links. Such networks are efficient but vulnerable to failure of a single highly connected node. Can you say “systemically important”?
Download chapter 12, What is the topology of your payment network?, here.