24 Hour Markets

The exchanges on which securities are traded in the global financial markets are constrained by the limited ‘market hours’ that the exchanges are open. This creates frictions that affect the way securities are traded. With the rapid expansion of the crypto markets, a 24 hour a day, 7 day a week model has been established and adopted as industry norm among crypto exchanges. I believe that in order to evolve the technological infrastructure of the financial industry to the next level, traditional security markets should consider removing the ‘market hours’ constraints and move towards a 24/7 model, which has numerous advantages and disadvantages that I will attempt to cover.

When I moved from New York City to San Francisco, one of the biggest differences was the time frame that you had to be awake in order to capture the open market hours of the major U.S. exchanges. Take the New York Stock Exchange that is open from 9:30AM Eastern Time to 4:30PM Eastern Time. Assuming an hour and a half prep time, it is reasonable for a trader working in NYC to arrive at the desk by 8AM, a trader working in San Francisco would have to be at the desk at 5AM to capture the NYSE market hours. This effect is further exacerbated when you look at a trader in the fixed income markets. When I was working on a desk focused on the US Treasury market in NYC, our morning trading would start at ~7:30AM, which usually meant that I would try to be in the office no later than 6:30AM to get ready for the trading day. This dynamic translated to Pacific Time, would mean a 3:30AM show time on the west coast. Now, I know this specific example sounds a bit extreme and is a good reason why west coast based companies like Janus Henderson and PIMCO have offices on the east coast, but I do have west coast based friends who wake up long before the sun comes up to accommodate for these “market hours”. Sure, the counterargument here is that on the west coast traders go home much earlier than their east coast counterparts, but I don’t think that detracts from the argument that 24-hour markets in traditional securities are something that the world needs to move to.

Switching from managing traditional wall street assets to crypto, there are too many differences to name, but one glaring distinction that does not get much attention is how crypto trading is 24/7 and the exchanges never close and the large OTC desks, including ours, have 24/7 (or very close to 24/7) staffing.

Let’s start with taking a brief look at the history of exchange trading. Markets started operating in continuous form in the late 1800s, with a schedule of 10AM to 3PM Monday through Friday with a brief two-hour session on Saturday established in 1887. The weekend session was done away with in 1952 and throughout the late 1900s the hours changed by 30 minutes here and there, finally expanding to the current 9:30AM to 4PM schedule. An entire century went by before an hour and a half were added to the original weekday schedule set in 1887 and absolutely no relevant changes were made to these hours with the advent and adoption of the internet. I have very strong conviction that given the technological landscape and global connectivity of today’s markets, the current system is incredibly outdated and is in a desperate need of an overhaul.

What advantages would a 24/7 cycle bring to the traditional securities markets? For one, the dislocations caused by a divergence in spot prices vs futures pricing that sometimes converge violently at market opens, particularly as new information is released during market close periods, will no longer occur. Currently, the trading volume is mostly concentrated at the open and the 30 minutes leading into the close. With constantly open markets, there should theoretically be less concentration around particular points in time which should reduce overall volatility of price movements. None of this is surprising to market participants, these effects have been critiqued over time and researched in detail, most pointedly in a 1997 research paper published by the Journal of Empirical Finance (Andersen, Bollerslev) titled “Intraday Periodicity and Volatility Persistence in Financial Markets”.

Volume and Volatility are heavily concentrated in the beginning and end of the market day

Chart from Andersen / Bollerslev paper

The interesting thing about this paper is that it was written before there was distributed cloud technology and before there was the blockchain, so there was not a clear solution to the problem that didn’t involve a massive and unrealistic infrastructure buildout to logically scale markets into 24/7 operations that would completely get rid of the intraday variation of volumes that are directly affecting spreads and ultimately causing return volatility that is discussed by Andersen/Bollerslev paper in depth.

An interesting phenomenon that has grown over the last decade with the rise of passive index investing and currently accounts for ~8% of S&P 500 volume is the so called “4PM trade”. This Wall Street Journal Article does a great job describing this anomaly. Basically, the wall street banks collect buy and sell orders throughout the day and rather than executing them on exchange will pair them off internally and then send the imbalances to the exchange or decide to hold them on their books overnight. This process allows the banks to book larger profits, as there are no outright hedging costs for an entity in an agency capacity on matching direct counter-flow, while at the same time leaving customers wondering if they in-fact achieved best execution. In my opinion this is one of what is most likely many frictions in global securities markets that can be done away with if markets were open 24/7 powered by blockchain technology. I also want to make sure to note that the crux of this argument is specifically focused on 24/7 markets versus the set hours that exchanges currently have, rather than a ‘blockchain at all costs’ argument that is common in the crypto community. In fact, even distributed cloud technology could successfully transform markets in a similar way that blockchain could as long as the principles of replication of redundancy are built in to the system, but I will leave the details of how and why for another time.

Should stocks and bonds also be traded 24/7 much like cryptos do? The primary argument against this that came to mind was that the global trading support infrastructure would need to ramp up to work nights and weekends. For those readers who have never worked in an institutional trading environment, the infrastructure that supports trading is an immense and complicated system supported by hundreds of thousands of employees. As a quick example, for every share of stock that gets traded, after the trader books the trade, there are confirmations, settlements, accounting, compliance, risk and other personnel and systems that touch the trade inside the entity that executed the trade. Then there are third party custodians, transfer agents, clearinghouses, banks etc. that also touch the trade and let’s not forget all of the technology groups that support every single group that was just mentioned. Between all these groups and entities are thousands of employees that would be required to provide more coverage, requiring companies to double up on staff to meet the 24/7 market challenge.

I would argue, however, that if securities trading is tokenized then banks and funds will not need nearly as many support employees as I have described in the previous paragraph. Yes, a trading desk will still need operations, accounting and compliance people, but not nearly as many. One of the reasons large banks have so many employees in support functions is because the general level of technology is incredibly old and outdated. Michael Lewis’ “Flash Boys” described the tech at wall street firms as a giant roll of duct tape that the technology staff would have to patch up every time something is broken, and this ball of tape has gotten so large that a complete rebuild of the system would be untenable. Based on my experience and the experiences of my friends and acquaintances working in large financial institutions, this is a very accurate description.

It’s all for show anyway at this point

Contrasting that with the experience of trading blockchain based assets, new technology design is very flexible and easily adapted to what is needed in a robust trading environment. The blockchain settlement process takes no more than 20 minutes (sometimes under a minute) for most cryptos and there is not a chain of centralized custodians / clearinghouses / transfer agents that need to apply their own set of actions to process a trade, the settlement is decentralized and final. One of the most popular topics of conversation in the crypto markets is the need for a trusted third-party custodianship when it comes to the trading of crypto assets. There are many articles, blogs and twitter chains debating this topic so I will not address this topic in depth, but will simply say that I believe that the very transparent nature of blockchain settlement and address identification infrastructure, in fact, is already taking the place of the functionality a custodian provides in the traditional markets. In addition, the advent of using smart contracts to execute atomic swaps is basically replacing the functionality that clearinghouses provide to derivatives trading. The delivery vs payment (DVP) mechanics that are currently in place within the established clearing institutions such as the Depositary Trust & Clearing Corporation (DTCC) are handled via atomic swaps and their use of hash timeclock contracts that largely eliminate counterparty risk from transactions.

In conclusion, there are various catalysts that can accelerate the pace of the transition away from set market hours on exchanges, I think that this year we have seen progress towards this goal with the involvement from the Intercontinental Exchange (ICE) group and their investment in Bakkt, as well as many other projects that are looking to build out a ‘security token’ exchange infrastructure. There are many obstacles and challenges to making this a reality, but I feel like market participants are working to move towards this goal.