Thanks. So the exchange really are messing with price-time priority in exchange for cash? Wow ...
But then why would any non-flasher ever place a single order on these exchanges? Couldn't a boycott could solve this problem without any legislation --- they could just go to an alternative venue which wasn't selling them out in exchange for more fees?
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Appendix: Bear with me while I think out loud so anyone can point out mistakes I'm making.
Time n-1, Order #0: Some seller posts an offer of size N > 5000 at $21.00. (It has to be $21.00, otherwise Order #2 would have nothing to buy at that price).
Time n, Order #1: Mutual fund sends buy 5000 "at market" (i.e. fill me at any price from here to the moon).
Time n+1, Order #2: Would-be flasher sends buy N at $21.00.
Time n+2, Order #3: Would-be flasher sends sell 5000 at $21.01 (and prays that no other flasher beats him to it).
Time n+3: Repeat from time n-1.
Under normal price-time priority, #1 matches #0, #2 matches #0 and becomes best bid, #3 doesn't match anything, and your new market is $21.00 / .01. The total traded volume is N. (The would-be flasher is now long N - 5000 and has to trade out at a loss of fees + stamp duty, so the first time around the total traded volume is 2N - 1, but that doesn't happen again: he either stops doing this shit or goes out of business).
With "flash trading", #2 matches #0 (despite #1 having time priority) and #3 matches #1 (despite not even being in the market at the time #1 arrived). The total traded volume is N + 5000. The exchange earns some extra fees, the flasher gets the arbitrage profits, the mutual fund gets screwed, and the sellers (#0) don't care either way because they were willing to trade at $21.00 all along. Weird.
Yeah, we're getting ever closer to the era in which:
- you step out to home depot to buy a $20 hammer
- when you get there "The Flash" (of dc comics fame) figures out you're looking to buy a hammer and buys all the $20 hammers
- he leaves a post-it note saying "if you want a hammer meet me in aisle 7"
- you get there and he offers to sell you a $20 hammer for $21
- either you buy it or you don't; once you've made your decision he returns either (N-1) or (N) hammers back to the store (30 day return policy and all that)
- if you head over to lowe's instead well he is "The Flash"
Not an exact metaphor for "flash trading" (as sketched it's riskless) but it's imho a relevant thought experiment.
At the individual level the winners and losers are pretty obvious. At the systemic level it's unclear any actual efficiency is gained; differentiating between actual "efficiency gains" and "red queen" scenarios is tricky.
Because the truth is that this is business and all the people who aren't in on the flash would be if they could afford to be/had the expertise in-house.
But then why would any non-flasher ever place a single order on these exchanges? Couldn't a boycott could solve this problem without any legislation --- they could just go to an alternative venue which wasn't selling them out in exchange for more fees?
--- Appendix: Bear with me while I think out loud so anyone can point out mistakes I'm making.
Time n-1, Order #0: Some seller posts an offer of size N > 5000 at $21.00. (It has to be $21.00, otherwise Order #2 would have nothing to buy at that price).
Time n, Order #1: Mutual fund sends buy 5000 "at market" (i.e. fill me at any price from here to the moon).
Time n+1, Order #2: Would-be flasher sends buy N at $21.00.
Time n+2, Order #3: Would-be flasher sends sell 5000 at $21.01 (and prays that no other flasher beats him to it).
Time n+3: Repeat from time n-1.
Under normal price-time priority, #1 matches #0, #2 matches #0 and becomes best bid, #3 doesn't match anything, and your new market is $21.00 / .01. The total traded volume is N. (The would-be flasher is now long N - 5000 and has to trade out at a loss of fees + stamp duty, so the first time around the total traded volume is 2N - 1, but that doesn't happen again: he either stops doing this shit or goes out of business).
With "flash trading", #2 matches #0 (despite #1 having time priority) and #3 matches #1 (despite not even being in the market at the time #1 arrived). The total traded volume is N + 5000. The exchange earns some extra fees, the flasher gets the arbitrage profits, the mutual fund gets screwed, and the sellers (#0) don't care either way because they were willing to trade at $21.00 all along. Weird.