One of the many consequences of global warming is that it’s now, for the first time, possible to drill under the sea bed of the Arctic ocean. The oil companies are all there, of course, running geological tests and bickering with each other about the potential environmental consequences of an oil spill. But they’re not the only people drilling. Because there’s something even more valuable than oil just waiting to be found under the Arctic.
What is worth so much money that three different consortiums would spend billions of pounds to retrofit icebreakers and send them into some of the coldest and most dangerous waters in the world? The answer, of course, is information.
A couple of days ago, I called a friend in Tokyo, and we had a lovely chat. If he puts something up on Twitter, I can see it immediately. And on the web there are thousands of webcams showing me what’s going on in Japan this very second. It doesn’t look like there’s any great information bottleneck there: anything important which happens in Japan can be, and is, transmitted to the rest of the world in a fraction of a second.
But if you’re a City trader, a fraction of a second is a veritable eternity. Let’s say you want to know the price of a stock on the Tokyo Stock exchange, or the exact number of yen being traded for one dollar. Just like the light from the sun is eight minutes old by the time it reaches us, all that financial information is about 188 milliseconds old by the time it reaches London. That’s zero point one eight eight seconds. And it takes that much time because it has to travel on fiber-optic cables which take a long and circuitous route: they either have to cross the Atlantic, and then the US, and then the Pacific, or else they have to go across Europe, through the Middle East, across the Indian Ocean, and then up through the South China Sea between China and the Philippines.
But! If you can lay an undersea cable across the Arctic, you can save yourself about 5,000 miles, not to mention the risk of routing your information past a lot of political flash points. And when you’re sitting in your office in London and you get that dollar/yen exchange rate from Tokyo, it’s fresh from the oven, comparatively speaking: only 0.168 seconds old. If everybody else is using the old cables and you’re using the new ones, then you have somewhere between 20 milliseconds and 60 milliseconds when you know something they don’t.
Those are periods of time so short that humans can barely notice them. This essay, for instance, is about 900,000 milliseconds long, and it takes me hundreds milliseconds just to say the word “cable”. Which is a word with more than one meaning. To you, it probably means some kind of wire. But to City traders, it means 1.6254, or something very close to that number. Because in the City, “cable” means the pound/dollar exchange rate. And it’s named that after a transatlantic cable which was used to telegraph the exchange-rate information from London to New York as far back as 1858.
So what we’re talking about here is nothing new, in terms of kind. Nathan Rothschild built a significant chunk of his fortune by using a system of couriers who told him the result of the Battle of Waterloo a full day before anybody else in London knew it. And my own employer, the Reuters news agency, was founded on sending financial information between Brussels and Aachen using carrier pigeons.
What’s new is that billions of pounds can be made by having access to information not a day in advance, or an hour, or even a second, but even just a millisecond or two. Stock exchanges aren’t physical places where human beings bargain with each other any more: they’re racks of computers in places like Mahwah, New Jersey, where the cables are carefully measured to be exactly the same length so that no one has an infinitesimal advantage thanks to the amount of time it takes information to travel an extra few millimeters down a wire. (...)
Most of the trading on US stock exchanges is done by something called algobots, these days. These are algorithms: they’re computers which are programmed to put in orders, take out orders, trade in big size, trade in small size – all according to very sophisticated rules, called algorithms. And one of the ironies about the flash crash is that it was actually caused in large part by algobots not trading. The US has over a dozen different stock exchanges, places where stocks are bought and sold. Most of us have only ever heard of the listing exchanges, the New York Stock Exchange and the Nasdaq. But there are many more you probably haven’t heard of, with names like Arca and BATS, as well as sinister-sounding things called Dark Pools. What happened in the flash crash is that when the trading got completely crazy, the algobots just switched themselves off. This was something they weren’t used to, they didn’t know how to react, and so they just went away. And there was suddenly no liquidity in the market. No one was offering to trade. And with no one offering to trade, the prices just plunged, all the way down to one cent. Because there were no bids in the market any more.
The algobots can be very useful, on a day-to-day basis. If a normal person like me buys a few shares in some company or other, that trade doesn’t even happen on any stock exchange at all. It just happens directly with a broker, an algobot, who’s happy to take the other side of my trade because small individual investors like me are normally pretty stupid, and tend to buy high and sell low.
In any case, if any given stock exchange is an incredibly complicated thing, the fragmentation of the stock exchanges has created a much more complex system yet. Most big banks and stockbrokers — and the algobots they control — have access to all of the different exchanges, and they trade wherever they think they can get the best prices. Since the best prices tend to be found wherever the most traders are trading, you end up with something a bit like six-year-olds playing football: everybody’s running towards the ball at the same time. And the result is these huge waves of activity, where traders move en masse, from one stock exchange to the next, in very unpredictable ways. If you layer that unpredictability on top of the complexity inherent in any system of multiple stock exchanges, you end up with something which will almost certainly break in a pretty catastrophic manner at some point. We don’t know how, and we don’t know when, but there’s an ironclad rule of any system: the more complex it is, the less predictable it is, and the more likely it is to fail catastrophically in some unforeseeable manner.
