High-Frequency Trading for Bitcoins
Also director primacy, mutual-fund antitrust and private secondary markets.
It is not original to me, but one thing that I think and write a lot is that cryptocurrency enthusiasts keep re-learning the lessons that regular finance learned decades ago, and that you can see a lot of financial history replaying itself, sped up, by observing cryptocurrency. (I have occasionally also argued that the story of cryptocurrency might actually be the opposite, that it’s about traveling back in time to progressively forget the lessons of modern finance, but never mind that.)
In many ways this is a snarky and condescending thing to think; the implication is that the crypto people had simplistic and naive expectations about how trustless decentralized purely market-based finance could work, and are slowly discovering the obvious-to-the-rest-of-us benefits of trust and central counterparties and regulation and non-market mechanisms. On this theory, financial history is a journey from darkness into enlightenment, and those of us who have seen the light can watch in amusement as cryptocurrencies make the same journey.
On the other hand that’s not actually how many people think of financial history! “The most important financial innovation that I have seen the past 20 years is the automatic teller machine,” Paul Volcker famously said, and there are plenty of people who would argue that at least the past few decades of financial history have been a story of reckless deregulation, risk, scandal, inequality, over-financialization and rent-seeking. On this view, if cryptocurrency does quickly repeat the history of conventional finance—if in two years we end up with too-big-to-fail Bitcoin banks that use chat rooms to manipulate crypto indexes and set up fake accounts for their users—then that will be bad. Cryptocurrency’s original promise wasn’t simplistic and naive; it was idealistic and pure, and importing all the controversial features of scandal-plagued modern finance will be a tragedy.
Anyway Bitcoin has discovered co-location for high-frequency traders:
Coinbase Inc., which operates the largest U.S. cryptocurrency exchange, said on Tuesday that it would upgrade its systems with services that cater to ultrafast traders. The upgrade, planned for later this year, will make Coinbase one of the first bitcoin exchanges to welcome the controversial business of high-speed trading. ...
San Francisco-based Coinbase plans to introduce “low-latency performance,” the company said in a blog post, using a term in the exchange industry that means extremely fast processing times.
Coinbase also said it would allow trading firms to place their servers directly in its data center, a practice called co-location.
That’s fine! Catering to professional market makers—having professional market makers, for that matter—is probably a way to make the market better and more useful for most investors. “These additions will allow for a more efficient price discovery process to occur, creating tighter markets, deeper liquidity, and increased certainty of execution,” says Coinbase. It is a stage of enlightenment, an adoption of useful ideas from conventional finance. (Along with the co-location, Coinbase is also “developing several tools to lure institutional investors onto its platform,” including “custodial services where investors can store large amounts of digital currencies”; obviously having a safe place to put your Bitcoins would be a positive development—and a change from Bitcoin’s original promise of decentralization.)
On the other hand that’s not actually how many people think about exchanges that cater to high-frequency traders! I mean, co-location, my word:
Coinbase’s move is likely to raise eyebrows, since many investors view high-speed traders with suspicion. Critics like Michael Lewis, author of the 2014 best-seller “Flash Boys,” have alleged that HFT firms take advantage of slower-moving players.
Some number of people got into Bitcoin because they felt like the conventional financial system was rigged against them, and I suspect that some number of them felt like that because stock exchanges let high-frequency traders pay to run their algorithms right next to the exchanges’ servers so they could have faster access to the exchange than anyone else. And now here we are.
Obviously neither of these narratives is really right; financial history is not a story of uninterrupted progress to pure efficiency nor one of absolute corruption by evil entrenched interests. It’s mostly a series of good-faith tradeoffs under uncertainty, many of which could conceivably have gone the other way. U.S. securities laws, for instance, have an onerous and one-size-fits-all set of disclosure requirements for anyone who wants to raise money by selling securities to the general public; this makes it much easier to police fraud, but also makes it harder for disruptive entrepreneurs to raise money to fund real projects and for small investors to participate in high-growth investments. And there are those in the crypto community who argue that the tradeoff should go the other way in cryptocurrency regulation: Let a million blockchain projects bloom, accept that most of them will be frauds, but do it anyway to foster innovation.
That is interesting, or at least potentially interesting. (Not all of the regulators are moved by it! But some seem to be.) Watching cryptocurrency create an alternate financial history, one in which some of those choices go another way, in which the balance is struck (say) in favor of more fraud and more innovation, or more democracy and less professionalization, or whatever, is the real appeal of the cryptocurrency revolution. If, after learning all of its lessons, it just converges entirely on old-fashioned finance—but with a different set of powerful incumbent billionaires—then what was the point?
Elsewhere in crypto exchanges, here's a story about how Israeli crypto exchange eToro will open to U.S. investors. And: “Crypto Exchange Kraken Says It Will Probably Register With SEC.” And: “‘Privacy Coin’ ZCash Lands on Winklevoss’s Gemini Exchange.”
And elsewhere in crypto, the Consensus 2018 conference is going on in New York this week and it is exhausting just to read about. Here’s a story about how the BitMex exchange rented some Lamborghinis to sit around revving outside the conference because, you know, crypto Bitcoin blockchain Lambo Lambo Lambo Lambo Lambo Lambo. Here's a story about how “the smell of marijuana wafted through a half-filled event space in Manhattan’s Meatpacking District, as a group of cryptocurrency believers downed champagne and blood orange margaritas” and listened to Snoop Dogg at an afterparty thrown by Ripple Labs Inc.:
Around 9 p.m., Snoop Dogg arrived to an adoring crowd sporting Patagonia fleeces, button-up shirts and Team Ripple tees.
“So what we get drunk, so what we smoke weed,” they sang along as Snoop strutted onstage flanked by dancers in rhinestone bras and a person in a canine costume, wearing a jacket with ‘Dirty Dogg’ written on the back.
Do you think that the majority of people at the majority of Snoop Dogg shows circa 2018 are wearing button-up shirts and Patagonia fleeces? Surely yes, right? These days I feel like the dress code for any Snoop Dogg show is probably business casual.
CBS v. Redstone.
We talked yesterday about CBS Corp.’s amazing effort to get rid of its controlling shareholder, Shari Redstone’s National Amusements Inc., by issuing enough voting stock to other shareholders to dilute away NAI’s control. The point of this effort would be to prevent Redstone and NAI from using their voting power to fire CBS’s directors and try to force through a merger with Viacom Inc., another company controlled by Redstone. A flaw in CBS’s plan is that it had to give Redstone notice of the board meeting (scheduled for tomorrow) at which it will issue those new shares, and so she can fire them before they hold that meeting. But it asked a Delaware court to enjoin her from doing that, so it could go and get rid of her in peace.
Later yesterday NAI filed its reply to that lawsuit, which denies the basic conflict that CBS claimed—
Plaintiffs suggest that NAI intends to force such a merger by removing and replacing the CBS independent directors. There is no truth to that. NAI does not have, and has never had, any intention of replacing the CBS Board or taking other action to force a merger. Plaintiffs’ supposed belief to the contrary is based on unsourced media reports and conjecture.
—but also notes that, even if it were true, diluting away Redstone’s ownership “would still be egregiously overbroad and unjustified”:
If Plaintiffs were genuinely concerned that NAI would seek to force a merger upon the company, and NAI had not committed to refrain from doing so during the pendency of this action, the relief to which Plaintiffs would even plausibly be entitled would be an injunction to prevent NAI from forcing a merger upon the company while this litigation is pending. It would not be to dilute NAI’s voting power, for all purposes, now and forever. This is an unprecedented usurpation of a controlling stockholder’s voting power.
Look: That is obviously correct. If the controlling shareholder wants to do something bad and wrong over the board’s objection, then the board should say no. The board shouldn’t fire the controlling shareholder. That’s not even a thing. You can sort of understand the board’s point of view though. If the chief executive officer wanted to do something bad and wrong over the board’s objection, then the board really might fire him. Firing the CEO for doing bad things is how the board exerts its power, how it demonstrates that it is in control of the corporation. If the board really is supreme, if it is in control of the corporation and the shareholders are just sources of capital, then why shouldn’t it fire the shareholders too, if they make it mad enough?
By the way yesterday I expressed some surprise that the board would even try, but apparently there is precedent for boards trying to get rid of their controlling shareholders while the shareholders weren’t looking. (“You go on one long vacation out of cell-phone coverage and, bam, you’re out,” I wrote yesterday.) It didn’t work though. From NAI’s filing:
The proposed dilutive stock dividend would be invalid under Adlerstein v. Wertheimer. There, the Court recognized that where a controlling stockholder has the power to forestall board action by preemptively removing directors, the board cannot take steps to neutralize the controlling stockholder’s voting power in order to effectuate the board action. In Adlerstein, the controller had the power to remove certain directors and, recognizing this, the board kept the controller in the dark about a board proposal that destroyed his voting control over the corporation until it was too late for the controller to act. Recognizing that the controller was entitled to an adequate opportunity to protect his interests, the Court held that the directors’ decision to keep the controller uninformed about the proposal invalidated the board’s approval of the proposal.
Still, good effort.
Oh, disclosure: CBS’s lawyers here are from Wachtell, Lipton, Rosen & Katz, where I worked long ago. I remain very fond of Wachtell, and I don’t think that I am biased when I say that it is undoubtedly the U.S.’s leading advocate of the theory of “board primacy” in corporate governance. I don’t really think they will, but if they do convince a Delaware court that boards of directors should be able to get rid of shareholders they disagree with, then that would be quite a total victory for board primacy.
Should index funds be illegal?
No, write Thomas Lambert and Michael Sykuta of the University of Missouri, in “The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms”:
We show that the theory of anticompetitive harm from institutional investors’ common ownership is implausible and that the empirical studies supporting the theory are methodologically unsound. The theory fails to account for the fact that intra-industry diversified institutional investors are also inter-industry diversified and rests upon unrealistic assumptions about managerial decision-making. The empirical studies purporting to demonstrate anticompetitive harm from common ownership are deficient because they inaccurately assess institutional investors’ economic interests and employ an endogenous measure that precludes causal inferences.
Even if institutional investors’ common ownership of competing firms did soften market competition somewhat, the proposed policy solutions would themselves create welfare losses that would overwhelm any social benefits they secured.
The point that “intra-industry diversified institutional investors are also inter-industry diversified” is worth emphasizing. When people worry that common ownership of multiple firms in the same industry by big institutional investors reduces competition in that industry—the antitrust worry that I often shorthand as “should index funds be illegal?”—the theory is more or less that if all the airlines raise prices, rather than compete with each other on price, then they will all make higher profits and benefit their common shareholders at the expense of customers. But, in general, the mutual funds also own the customers. Lambert and Sykuta write:
Intra-industry diversified mutual funds tend also to be inter-industry diversified, and maximizing one industry’s profits requires supracompetitive pricing that tends to reduce the profits of firms in complementary industries. A leading Vanguard fund, for example, holds around 2% of each major airline (1.85% of United, 2.07% of American, 2.15% of Southwest, and 1.99% of Delta) but also holds:
• 1.88% of Expedia Inc. (a major retailer of airline tickets),
• 2.20% of Boeing Co. (a manufacturer of commercial jets),
• 2.02% of United Technologies Corp. (a jet engine producer),
• 3.14% of AAR Corp. (the largest domestic provider of commercial aircraft maintenance and repair),
• 1.43% of Hertz Global Holdings Inc. (a major automobile rental company), and
• 2.17% of Accenture (a consulting firm for which air travel is a significant cost component).
Each of those companies—and many others—perform worse when airlines engage in the sort of supracompetitive pricing (and corresponding reduction in output) that maximizes profits in the airline industry.
If you do want to believe the index-funds-should-be-illegal thesis, then it may not be as simple as “giant diversified mutual funds that own lots of companies in an industry want to maximize the profits of that industry in anti-competitive ways.” Their objective function has to be a bit broader: They must want to maximize the profits of corporations, broadly, at the expense of individual consumers (and workers). That is a more nebulous theory; it is not as simple as “companies in an industry should try to keep prices high and not undercut each other by competing for market share,” but more like “companies in every industry should try to keep corporate profits high generally and not undercut each other by being nice to household consumers or workers.” It is harder to see how corporate managers would maximize that. But it is a pleasingly Marxist diagnosis of institutional investors as advocates, not of reduced competition in any particular industry, but of the interests of the capitalist class generally against those of workers and consumers.
People are worried about unicorns.
Private markets, I sometimes say, are the new public markets; companies used to have to go public to raise a lot of money or create secondary liquidity or achieve widespread name recognition or whatever, but now they can do all of that in the private markets. Still companies do go public sometimes, often because their venture capitalists find it easier to cash out by selling to the public than by relying on the relatively limited liquidity in private secondary markets. But the VCs are working on fixing that problem too:
New Enterprise Associates, one of Silicon Valley’s largest venture-capital firms, plans to sell off a big chunk of its startup investments in response to a dearth of initial public offerings, according to people familiar with the discussions.
The firm plans to sell roughly $1 billion worth of its stakes in about 20 startups to a new firm it is seeking to create, one of the people said, in an effort to return capital to its limited-partner investors. These companies will mostly be those that initially raised money from NEA about eight to 10 years ago.
I mean it is all just pots of money. You are a private company, you go to a pot of money called “venture capital,” it gives you some money, you grow, the venture capitalists want to cash out, you go public, and the VCs sell to another pot of money called “mutual funds” or whatever. If the VCs set up a new pot of money called, like, “private secondary liquidity funds” or whatever (you might want a catchier name), then you kind of get rid of the need to go public. The trick is that those funds have to look more like mutual funds than the VC funds do; if they are buying big high-valuation stakes in mature but somehow-not-yet-public companies, then they need to be big, and they can’t expect too many of those stakes to produce enormous returns. On the other hand they shouldn’t expect most of them to go bust, either; they should expect steady reliable returns from most of their mature private investments. They just have to accept that the private markets are the new public markets.
SoftBank Group Corp.’s near-$100 billion Vision Fund has yet to close, but its acquisitive founder is already gauging interest for a second fund.
“Vision Fund II will definitely come. It’s just a matter of time,” SoftBank CEO Masayoshi Son said during an interview at The Wall Street Journal’s CEO Council meeting in Tokyo on Tuesday.
And why shouldn’t all the money in the world be in private tech investment funds?
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