High Frequency Trading

If you’ve read about High Frequency Trading (HFT) then you may know that it’s all about bad things such free markets, ruthless trading, Wall Street, banksters, greed, and profits.

Or else, you may have read that it’s about good things like the American can-do spirit, ingenuity, technology, and improving markets to the betterment of all.

Both HFT’s detractors and its defenders are missing the point. It’s an exploit of a system that is grossly distorted by regulation. I don’t refer to the old-fashioned kind of regulation, such as requiring a doctor to show he is competent before doing open-heart surgery. I refer to the modern kind, in its full malignant glory of cronyism.

Richard Christopher Whalen makes the case in this article. Our markets are fragmented. They’re kept in this state, constantly on the verge of breaking, by 600 pages of regulation enacted in 2007, Regulation National Market System (Reg NMS).

Only a crony could love Reg NMS. To build a robust, realtime transaction server that is going to be used and abused by so many market participants is complicated. I know, my old company DiamondWare built one for real time voice communications.

Many times, we had engineering meetings that would last for hours, passionately arguing about a point so abstract and so specific that no one outside the room would have been able to grasp it, even if we tried to explain. Those complicated and technical little points were the difference between scalable and non-scalable, or secure vs. non-secure. They could be the difference between Facebook and Second Life. The former has become a large public company. The latter seemed to be on that path, but some software compromises caused them great pain later.

At DiamondWare, we would often get to a temporary impasse, with one or more engineers arguing on both sides of an issue. One time, I tried to lighten the mood and said hey, it could be worse.

“We’re unregulated. This room has just a handful of engineers in it. We all understand the problem. We know what’s at stake and we care passionately about it. We all understand the ramifications of the solution. Just imagine if we had adversarial parties in here: regulators, competitors, and hackers. Each of them brought their lawyers, business people, and engineers. Each has conflicting goals. You think you’re frustrated now? Just imagine how you’d feel if a hacker deliberately misstated your idea and proposed one of his own. His proposal creates a subtle but serious vulnerability.”

Of course, in that scenario your competitors are taking good notes. They’re all planning to exploit the hacker’s deliberate flaw. The regulator smiles at the hacker, and you are now forced to design the flaw into your architecture. Next year, you read the news that the regulator now has a multi-million dollar salary working for the hacker.

Is this fiction? It doesn’t happen in voice servers. But even back in my voice server days, I suspected it was happening in stock market servers. Whalen has researched it and gives us a glimpse of how incomprehensible regulations governing a complex area work. They are openly gamed by well-connected cronies.

More regulations cannot fix a problem caused by regulation in the first place.

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