INTO THE NEXT STAGE: Another Nikkei in Finance News

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johnstonBy GEORGE TOSHIO JOHNSTON

About a month ago, the name of Temple City, Calif., resident and former private citizen Dorian Prentice Satoshi Nakamoto became the center of a media firestorm when Newsweek revealed or outed him — “doxed,” in the slang of the hacker underground — as founding Bitcoin developer Satoshi Nakamoto.

(Bitcoin is a “virtual currency,” or in this case, software that allows easy transfers of said currency via computer networks without governmental or bank oversight between anyone anywhere in the world.)

Whether Newsweek got it right, that DPSN is the Bitcoin Nakamoto — possibly a pseudonym for an individual or group of programmers — remains to be seen. DPSN has since retained legal counsel and taken a vow of silence until further notice.

Since then, another Japanese last name — this time 100 percent real, attached to a real person — also was in the financial news. That name is Brad Katsuyama, a Japanese Canadian who is one of the principal subjects of a just-published book titled “Flash Boys,” written by Michael Lewis.

flash boysAn excerpt from the book was the cover story of a recent New York Times Magazine (http://tinyurl.com/n46fqc6) and a segment on CBS’ “60 Minutes” (http://preview.tinyurl.com/kbs7vm5) on March 30. (I read said excerpt and listened to the “60 Minutes” episode as a podcast; reading Lewis’ just-released book is on my to-do list.)

“Flash Boys” is an expose, explanation and whodunit of a fairly recent phenomenon know as “HFT,” or high-frequency trading. In a nutshell, in today’s world of computerized stock trading, speed confers advantage. Even when dealing with the speed of light, geographic proximity to an electronic market can provide milliseconds in which an as-yet legal but morally ambiguous intermediary can raise the asking price of a stock as the trade is taking place, a practice known as “front-running.”

That superior speed combined with nondisseminated knowledge can make a huge difference in an outcome is nothing new in the world of finance. One of the most famous apocryphal stories on that account is that of Nathan Rothschild, who learned of Napoleon’s 1815 defeat at Waterloo via carrier pigeon before everyone else in London and subsequently reaped a financial windfall from that knowledge.

According to Lewis’ book, nearly all the big markets (and some big financial institutions) were using HFT to front-run traders, essentially legally fleecing not only large institutional investors but also small-fry individual investors, even though it was just pennies per transaction. In the course of a day, week, month or year, we’re talking a skim totaling millions or billions of dollars.

That’s where, according to Lewis, Katsuyama comes in. A former highly paid employee of the Royal Bank of Canada or RBC, Katsuyama was dogged in his pursuit to the answer to a question he and many, many others in the financial field had been encountering: Why would he make an order to buy equities at one price but consistently pay at a slightly higher price?

To make a long story short, he and his assembled cohorts, including software programmers and networking experts, unraveled something that many had been suspecting for years: The system, Katsuyama asserted, was rigged.

I’m condensing what Lewis conveys in his book, but essentially Katsuyama learned that the higher-speed connections to the markets used by intermediaries were faster than the high-speed connections used by everyone else.

Software programmers came up with methods to exploit that difference of milliseconds to jump in, jack up the price slightly and, over the course of many, many trades, make lots of money.

While writing his book about HFT, Lewis kept hearing from those he interviewed that he needed to talk with Brad Katsuyama, that Katsuyama had figured it out, that he was an honest player trying to correct an unequal system.

Brad Katsuyama (CNBC)

Brad Katsuyama (CNBC)

Following the release of “Flash Boys,” the New York Times Magazine story and the “60 Minutes” segment, Katsuyama again was in the news, this time because of a lively debate on CNBC between himself and BATS Global Markets President William O’Brien. (Watch it at: http://tinyurl.com/nma7vvx)

It ignited a firestorm on the message boards and social communications networks. O’Brien comes off as a loudmouthed, pushy bully in defense of the status quo; Katsuyama, meantime, keeps his cool and manages to cut O’Brien off at the knees. BATS later had to issue a retraction when it was learned Katsuyama was correct. From CNBC’s website:

“What do you use to price trades in your matching engine on Direct Edge?” Mr. Katsuyama asked Mr. O’Brien.

Mr. O’Brien said, “We use the direct feeds.”

When Mr. Katsuyama said Direct Edge used the slower SIP (Securities Information Processor), Mr. O’Brien insisted they did not.

Turns out, Mr. Katsuyama was right.

Katsuyama, incidentally, has since left RBC to form a new exchange, the IEX, that is touted to level the playing field for all traders by, in essence, slowing down the speed of trading so everyone gets the same info at the same time.

To invoke one of Katsuyama’s fellow Canadians, it appears the system was Ben Johnson, the Olympic sprinter who won gold — until the blood test results came back indicating the presence of performance-enhancing steroids. He cheated.

If you don’t remember how that story ended, Johnson’s gold was revoked and his legacy was disgraced. Whether HFT and the entities and individuals that profited from it will find the same fate as Ben Johnson remains to be seen.

Meantime, it’s worth noting that one of Lewis’ previous books was “Moneyball,” which focused on how smaller-market baseball teams could compete with bigger market, deep-pocketed rivals by using better metrics to measure baseball players’ performance and statistics. It became a moderately successful movie starring Brad Pitt.

It seems to me as though “Flash Boys” might have the same trajectory, becoming a Hollywood movie, since it has all the right elements. Hopefully it won’t, however, again star Brad Pitt in a black wig and prosthetic makeup as Brad Katsuyama!

Sayonara, Mr. Yunioshi Dept.: Speaking of prosthetic makeup, Mickey Rooney died April 6 at age 93. Though famously short in stature, he cast a long shadow in Hollywood, for both his on-screen roles and popularity, and his off-screen antics, including numerous marriages.

But it will be his yellowface Japanese photographer Mr. Yunioshi in “Breakfast at Tiffany’s” that will always be a role that will live in infamy in an otherwise beloved career, not unlike FDR and E.O. 9066.

For a take on Rooney and Yunioshi, read Jeff Yang’s post at http://tinyurl.com/ldm7t2u.

Until next time, keep your eyes and ears open.

(George Toshio Johnston has written this column since 1992 and can be reached at [email protected] The opinions expressed in this column are solely those of the author and do not necessarily reflect policies of this newspaper or any organization or business. Copyright © 2014 by George T. Johnston. All rights reserved.)

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  1. Why Bitcoin? If you are thinking of investing go for Zetacoin, it’s going to blow up in the next few months and is x1000 cheaper than Bitcoin. The best part? ZET is x20 faster than Bitcoin and is being used as a mobile payment method right now (they have a super-fast app on Google Play). The payment app on Google Play will come pre-installed on all new smart-phone 2015/16 bought around Africa (lead developers in Kenya right now working on the small details). You can get Zetacoin via the major exchanges Cryptsy/Mintpal/Bter. Do an article about Zetacoin, I’m surprised how little PR they have!

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