In a scheme that would boil Brad Katsuyama’s blood, two brothers, Francois and Joseph Blanc became the first traders to successfully implement an information arbitrage strategy on a data network.
The year was 1834 and in the French city of Bordeaux, the brothers had devised a scheme to hijack the worlds first data network. The data network, built by Napoleon, was a mechanical telegraph system consisting of towers with wooden arms spaced aprox 10 miles apart. The arms had around 40 different configurations which were ascribed to numbers and letters. With a codebook to translate the messages, secret military and government information could be sent from one end of France to the other in minutes. Latency that even another set of Brothers, McKay, would be proud of.
The Blanc brothers managed to bribe one of the government operators in Paris to insert a character, into the message, which would be a signal for markets going up or down, quickly followed by a back space. The uncorrupted message made its way through the network of mechanical towers.
Perched on a hill in Bordeaux a retired operator could observe the Mechanical Telegraph station waiting for the “unintended” character (signal). Information about the markets was transmitted in minutes versus the 2-3 day horseback lag experienced by fellow traders in Bordeaux.
The brothers began trading this strategy in 1834 and after 2 years had a track record and sharp ratio that even Mark Gorton would have to question.
The scheme remained undetected but alas the Parisian operator fell ill (possibly a case of fat fingers) and tried to recruit a colleague to take his place. Francois and Joseph Blanc were placed on trial. To the despair of the prosecutors, the pair walked free as there was no law in place covering the misuse of data networks. The kind of defence that even Goldman Sachs wouldn’t be able to appeal against.
Is there a moral to this story? I guess it depends at which end of the information curve you sit but there’s no doubt, access to a low latency network can significantly increase your PNL.