From Front Running Algorithms to Bot Fraud… Or How We’ve Lost Control of the Bits…

I’ve just finished reading Michael Lewis’ Flash Boys, a cracking read about algorithmic high frequency trading and how the code and communication systems that contribute to the way stock exchanges operate can be gamed by front-running bots. (For an earlier take, see also Scott Patterson’s Dark Pools; for more “official” takes, see things like the SEC’s regulatory ideas response to the flash crash of May 6, 2010, an SEC literature review on high frequency trading, or this Congressional Research Service report on High-Frequency Trading: Background, Concerns, and Regulatory Developments).

As the book describes, some of the strategies pursued by the HFT traders were made possible because of the way the code underlying the system was constructed. As Lessig pointed out way back way in Code and Other Laws of Cyberspace, and revisited in Codev2:

There is regulation of behavior on the Internet and in cyberspace, but that regulation is imposed primarily through code. The differences in the regulations effected through code distinguish different parts of the Internet and cyberspace. In some places, life is fairly free; in other places, it is more controlled. And the difference between these spaces is simply a difference in the architectures of control — that is, a difference in code.

The regulation imposed on the interconnected markets by code was gameable. Indeed, it seems that it could be argued that it was even designed to be gameable…

Another area in which the bots are gaming code structures is digital advertising. A highly amusing situation is described in the following graphic, taken from The Bot Baseline: Fraud in Digital Advertising (via http://www.ana.net/content/show/id/botfraud):

ANA-White_Ops_-_The_Bot_Baseline_-_Fraud_in_Digital_Advertising_pdf

A phantom layer of “ad laundering” fake websites whose traffic comes largely from bots is used to generate ad-impression revenue. (Compare this with networks of bots on social media networks that connect to each other, send each other messages, and so on, to build up “authentic” profiles of themselves, at least in terms of traffic usage dynamics. Examples: MIT Technlogy Review on Fake Persuaders; or this preprint on The Rise of Social Bots.)

As the world becomes more connected and more and more markets become exercises simply in bit exchange between bots, I suspect we’ll be seeing more and more of these phantom layer/bot audience combinations on the one hand, and high-speed, market stealing, front running algorithms on the other.

PS Not quite related, but anyway: how you’re being auctioned in realtime whenever you visit a website that carries ads – The Curse of Our Time – Tracking, Tracking Everywhere.

PPS Interesting example of bots reading the business wires and trading on the back of them: The Wolf of Wall Tweet: A Web-reading bot made millions on the options market.