As much as there are a lot of people in the world (many of them right here on Hacker News!) who don't care about the mechanics of how liquidity is provisioned in markets and consequently have kind of backwards views of HFT most of these people aren't, you know, trading stocks.
So here's my question: since the people that are trading do tend to understand these things (if for no other reason that they'll go bust if they don't), won't liquidity providers run away from IEX as fast as they can? How do Brad Katsuyama and his partners think they'll actually scare up enough liquidity to get maintain a functioning market?
I've actually been thinking a lot about this. So, every other dark pool in existence, has started with the same premise as Brad and his merry band. That is, "man our big investors are getting killed due to good pricing in the markets". So the first thing they do is come up with a variety of schemes to obfuscate the order flow of these big investors. Invisible order books, ice berg orders, preferential routing, min. qty. orders etc.
These schemes succumb to 1 of 2 problems
1) they are trivial to game by market makers. That is, the exchanges make their money on fees, the market makers make their money on finding inefficiencies in the markets, who is better positioned to find the places that a market protection scheme falls down? Of course it is the market makers. This is why you see stories of HFT "pinging" black pools, or creating routing tables, or whatever other wild information advantage that they can come up with. At the end of the day, big brokers/ibanks still get to eat if their schemes don't work, market makers don't.
2) If an exchange actually does find a way to limit market maker profits, they simply stop trading there. The liquidity dries up and the dark pool has to figure out some way to justify it's existence. Usually by relaxing their rules and allowing the tricks described in 1) or by negotiating a preferential deal with a couple of HFT firms that have some sort of price protection involved (which may be as shady as, only screw my clients I don't care about).
Brad, Lewis, and the IETX backers have figured out another strategy. Convince enough of the "dumb" money to demand that their trades be routed through IEX that they can create a self sustaining dark pool. They actually don't care about retail investors. If a couple of thousand of them call up and demand that their broker get on IETX that's fine. They've made the barrier to entry cheap enough that it doesn't cause a lot of overhead. But what they are really looking for is the uninformed institutional investor. The East Gary Fireman's Booster Union, needs to unload 65k of GOOG that some shady Morgan broker sold them. They think of IETX first. There sits Einhorn and his fund ready to hit it for all he's worth. No intelligent liquidity provider there to take any of his execution costs.
It's sort of brilliant and shows why I'm a dumb HFT market maker technologist instead of a billionaire (or millionaire in Brad's case) Wall Street type.
You think they'll succeed with this third strategy? Are there enough gullible East Gary Fireman's Booster Unions to make it work? It still seems a little far fetched to me. How much will regulations protect Mr. East Gary from shooting himself in the foot when the IEX price moves away from everyone else?
PS: You've probably already watched it, but if you haven't you should really watch the YouTube video on the iextrading.com homepage. It's...really something.
I don't know what their success criteria is. Do I think that they will sweep the markets and become the dominate exchange? Absolutely not. Do they have a chance to drive enough volume to the dark pool to keep their backers execution costs + investment less than their execution costs on other exchanges? Maybe. If they do that though they may have another class of problem. Other investors looking to back them. If broaden that pool it gets harder and harder to keep their execution costs down.
So here's my question: since the people that are trading do tend to understand these things (if for no other reason that they'll go bust if they don't), won't liquidity providers run away from IEX as fast as they can? How do Brad Katsuyama and his partners think they'll actually scare up enough liquidity to get maintain a functioning market?
I'm a little befuddled by this.