D-Limit Court Battle In The Spotlight
Plus: Robinhood earnings, Bitcoin ETFs, $200 million whistleblowers, and more
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Citadel Takes SEC To Court To “Protect Millions Of Retail Investors”: FT reporter Robin Wigglesworth wrote a tweet the other day that perfectly sums up my feelings about many parts of this industry:
Equity market structure is such a complex subject that the vast majority of people either:
Don’t know enough to have an opinion, or
Only know enough because they’re incentivized to know, adding strong bias to their view & opinions.
It is very hard to have both an well-informed AND non-biased opinion about equity market structure. I think we should keep Wigglesworth’s tweet in mind when learning about a recently-argued court battle between Citadel Securities & the SEC, which you can hear for yourself at the ~55 minute mark of this video. The battle concerns IEX’s D-Limit order type, a new order that was approved by the SEC last year which tries to negate the impact of latency arbitrage for customers who use it. The D-Limit order allows IEX to change the quotes on its order book to keep HFT firms from front-running orders routed to its exchange. Citadel Securities sued to block this order when it was announced & has finally seen its day in court.
The arguments between Citadel Securities & the judges in this case are what interest me most. Early on we heard this exchange:
Judge: “Do you think latency arbitrage exists?”
Citadel: “I don’t think the court has to get into it…”
Judge: “Well, part of the argument is whether or not the algorithm & the speed bump & all the things that IEX have done here are sufficiently tailored enough to reduce latency arbitrage. I couldn’t tell from your brief whether you acknowledge its existence, and if you don’t acknowledge its existence it’s hard to know how you could make an argument that the algorithm & the speed bump are not sufficiently tailored.”
Citadel: “I think there’s good reason to be extremely skeptical. Ten, twelve years ago? Sure, maybe. Now? No…”
Citadel Securities doesn’t like the D-Limit order type because it raises their trading costs when interacting with IEX. Their argument is because Citadel Securities handles a large amount of retail orders on behalf of Robinhood & other brokers, IEX is raising costs on retail investors. The SEC & IEX’s rebuttal is that Citadel Securities also trades on its own behalf & engages in latency arbitrage, a trading strategy that promotes unfair & inefficient markets. Citadel’s lawyers say latency arbitrage hasn’t existed for over a decade; I’m skeptical to believe them given their keen interest in stopping IEX’s experiment. The courts will decide who’s right in the end, but for now the D-Limit order continues to live.
In my opinion, this is one of those cases that fall squarely in line with Robin Wigglesworth’s tweet. IEX is small - they only control ~2% of trading volume & haven’t been able to grow for nearly a decade. If they want to experiment with a new order type & the SEC thinks it’s okay, who am I to stop them or make it seem like a bigger deal than it really is?
Robinhood Reports Q3 Earnings: Everyone’s favorite brokerage app gave their latest quarterly update this week. While YoY results looked strong - users, assets under custody & revenue all grew substantially vs. Q3 2020 - the real story was the slowdown in activity vs. the prior quarter. Robinhood’s first quarter results were buoyed by a spike in equity trading & retail fee capture amid the GameStop/Reddit drama. As that meme faded in Q2 Robinhood again got a boost from the Dogecoin pump in May & June. In Q3 there were no such memes for the brokerage app to capitalize. Crypto interest moved to rival dog token $SHIB which is tradeable on exchanges like Coinbase & FTX but not on Robinhood. Equity volatility remains muted. Options remain the company’s cash cow product but didn’t grow sequentially either. Add this all together and we’re left with a rather un-exciting quarter.
HOOD management did touch on a few interesting themes during their earnings call including big investments in crypto & social. The broker opened the waitlist for a new crypto wallet product & got over 1 million sign-ups; it expects to launch the product later this year. Robinhood is also investing in its widely popular Snacks newsletter & podcast and partnering with social platforms like Snapchat to engage new retail users. Lastly, Robinhood mentioned the upcoming launch of a “recommendations engine” - an algorithm that helps app users choose their next investment. Given the pressure on Big Tech algorithms like Facebook & Google, this recommendations engine to me seems like a future scandal in the making.
I continue to avoid Robinhood’s stock given its valuation, regulatory uncertainty & a lack of meme trading frenzy to drive future results.
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Other Stories I’m Reading
Chart of the Week
Last week we talked about how the SEC’s Bitcoin ETF approval would impact CME’s futures market. With so much pent up interest in a Bitcoin ETF from retail & institutional investors, CME’s Bitcoin futures were bound to see an uptick in volume & open interest.
What I didn’t expect was how quickly & violently we’d see the ETF’s impact show up in CME’s data. $BITO’s launch broke records, becoming the fastest ETF to amass $1 billion in assets with massive trading volumes during its first week. The fund now has so many assets that it’s running up against CME futures position limits, forcing it to buy longer-dated contracts & consider trading swaps or structured products to make up the difference. CME’s Bitcoin futures OI spiked nearly +50% in the week following $BITO’s launch, now approaching $6 billion of notional.
If its first week is any indication, a Bitcoin ETF is looking like a huge win for CME and its increasingly important crypto market.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Solana.