Dear Mr. Lewis,
I recently re-read Flash Boys for the first time since its publication in 2014. I enjoyed the excerpt below describing Brad Katsuyama's struggle to attract funding for the new Investors Exchange (IEX):
“As one investor put it, behind Brad’s back, ‘I have a question about Brad: Have you figured out why he’s playing Robin Hood?'
“Brad’s first answer to that question was the thing he’d told himself: The stock market had become grotesquely unjust, and badly needed to be changed, and he’d come to see that, if he didn’t do it, no one else would. ‘That didn’t sit well,’ he recalled. ‘They’d just say, ‘That sounds like complete bullshit.’ The first couple of times it happened, it really bothered me.’ Then he got over it. If this new stock exchange flourished, its founders stood to make money – maybe a lot of money. He wasn’t a monk; he simply didn’t feel any need to make great sums of money. But he noticed, weirdly, that when he stressed how much money he himself might make from the new stock exchange, potential investors in his new business warmed to him – and so he started to stress how much money he might make. ‘We had a saying that seemed to appease everyone when they asked why we are doing this,’ he said. ‘We are long-term greedy. That worked very well…It always got a better response out of them than my first answer.’”
Amusing takes on Wall Street’s money-obsession aside, has Brad’s long-term greediness been justified by developments since the book’s publication?
Over the last 12 months, the share of US equity volume transacting on the Investors Exchange co-founded by Brad Katsuyama has been in the 2.0-2.5% range (see graph below). According to a recent interview with Brad, IEX’s share of large block trade volume is materially higher (30-40% of $5 mm+) and the exchange has been profitable since 2015. Unlike the publicly listed exchanges like NYSE and NASDAQ, IEX does not generate significant revenues from market data or listings.
I am by no means an expert on the very complex structure of the US equity market or the business models of the exchanges. Here are a few observations and questions anyways:
Exchanges should be monopolies because the marginal transaction should receive the best execution on the venue with the most liquidity. However, the equity landscape is in fact very fragmented among exchanges and dark pools. I think the fragmentation persists because the brokers and high frequency trading (HFT) firms earn substantial profits from the current set-up and so wish it to continue. Also, execution quality can be difficult to measure and so even if investors are being ripped off, the cost is easily obscured.
The progress IEX has made to-date seems disappointing in the context of the initial hype. IEX has not catalyzed any meaningful shift in the scalping occurring in the US equity market and I doubt the exchange is earning meaningful profits.
Could it be that a market with HFT predation is the “worst, except for all the others”? The problem of investors being ripped off is obvious; the alternative market structures are far from clear. Would we need alternative liquidity providers without HFTs? Are HFTs really providing liquidity given they appear to generate risk-free profits? Without direct and indirect profits from high frequency trading, might equity commissions and bid-ask spreads rise to replace lost revenues at the exchanges and brokers?
The exchanges, brokers, and HFTs all make a lot of money off the current market structure. They will only change if compelled, either by regulation or public opinion. The market structure withstood the Flash Boys onslaught. What could realistically trigger a shift in attitudes at this point?
Even if a change is compelled by regulation or public opinion, would IEX really be the winner? Couldn’t the NYSE and/or NASDAQ just adjust their exchange model to mimic IEX?
Is Brad Katsuyama happy to have been profiled as the Robin Hood of the equity markets? Sitting in 2020, I doubt it. Thanks to you, Mr. Lewis, Brad will forever be known as the man who founded IEX to take on HFT. If he has signed up for an unwinnable war, how can he possibly extricate himself with his reputation intact? As the public face of market reform, Brad’s departure from IEX would be a strong statement, and perhaps an admission that some of the concerns raised in the book were misplaced (or at least that the reality is more nuanced).
You celebrated Billy Beane after he had already changed baseball, Brad Katsuyama was only mid-journey! I’m betting against this one being turned into a movie. What’s the Hollywood ending? The stock market was rigged…and a decade later it’s still rigged!?
Thanks again for sharing the story!
Jason