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Challenges of SAAS in High-Frequency Trading

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January 10, 2012

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HFT, VC

Microsoft Chicago DatacenterBusiness’s with software as a service (SAAS) products are exciting because their business
model scales cheaply. Companies that have a software product, host it on the web, offer subscription/ad based access to any customer in the world, and spawn instances of that software at near zero marginal cost for new customers whet the appetite of investors and entrepreneurs for recurring revenue with high margin profits. However, there are many challenges to the SAAS business model in high-frequency trading (HFT) due to the latency sensitivity of the customer base. While every asset class has its own particularities, I’ve tried to focus here on the most generalizable challenges of SAAS in HFT.

High Performance Hardware (Marginal Cost)
HFT traders demand dedicated computing resources. They don’t want a virtualized OS sharing CPUs and memory with other customers, or even among their own trading models. They want root access to dedicated, top of the line Pentium boxes where they can pin trading strategies to dedicated cores and memory. Dedicated hardware for each new customer introduces high-marginal costs.

Co-Location Facilities (Marginal Cost)
HFT traders need their trading models as physically close to the electronic exchanges as possible. Ideally, they would have it located right next to it. But since that is not possible, co-locating in the same datacenter is the next best thing. Co-located rack space costs a premium.

Cross-Connects (Marginal Cost)
Cross-connects are physical fiber or copper cables that connect one computer to another in a datacenter. They provide low-latency, high-bandwidth connectivity between machines and it is how HFT traders connect to exchanges. Notice, HFT traders do not use the internet to connect to exchanges, which is more latent, but much cheaper. Cross-connects are charged monthly by datacenters and become large cost centers as traders connect to additional exchanges.

Low-Latency Circuits (Marginal Cost)
To connect to an exchange not located in the same datacenter, HFT traders want dedicated, low-latency ciruicts. They will not use the internet because it is too slow. These dedicated circuits create costs for each new customer.

Exchange Connection Fees (Marginal Cost)
Many exchanges charge fixed monthly feeds per customer.

Feel free to reach out with questions in the comments below or message me with feedback.

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