Crisis Architects, Digital Discipline and the Federal Government’s Wall Street Makeover

WASHINGTON, DC ­– On August 3, Senators Debbie Stabenow (D-MI) and John Boozman (R-AR) submitted the Digital Commodities Consumer Protection Act to the upper house of Congress calling for a mandatory framework to govern digital assets under the jurisdiction of the Commodity Futures Trading Commission (CFTC), an independent agency of the US government tasked with regulating financial derivatives markets and commodities trading.

In the very first paragraph of the overview attached to the bill’s press release, Bitcoin is invoked as the seminal innovation that allowed people “to transact directly on a blockchain”, attributing the emergence of “thousands of digital assets” to its creation, and tacitly affirming what some have suspected all along about the electronic cash technology ostensibly designed to circumvent the very government now singing its praises.

Since March, when President Joe Biden issued an executive order calling for the regulation of cryptocurrencies in the United States, the notorious polarization that has characterized the American political establishment over the last several years has magically dissipated to produce not one, but three bipartisan bills following the recent upheaval in the crypto markets, punctuated by tragic suicides, mass layoffs and federal indictments.

Crises have become a regular part of the political strategies used to implement system-wide changes that may otherwise find too much resistance among the vested interests benefiting from established mores and entrenched ways of doing business. The transformation of the world economy into a data-driven casino has been in the works for many decades and the current push to institutionalize digital assets and cryptocurrencies is only the latest phase in that process.

First Byte of the Apple

Ten days before Richard Nixon inaugurated the age of fiat currency on national television on August 15, 1971, the groundwork for the data economy was laid by former chairman of the Federal Reserve, William McChesney Martin Jr., who presented  a whitepaper  commissioned by the New York Stock Exchange (NYSE) that put forth a plan to consolidate the nation’s regional exchanges into a central market system.

Seen by the nation’s regional exchanges as a transparent attempt by the NYSE to maintain its control over market mechanisms, the report was not well-received. Nevertheless, the tectonic shifts experienced in the sector over the previous half decade demanded some form of restructuring and most of the industry acknowledged the need for a coordinated approach. Securities and Exchange Commission (SEC) chairman, William Casey, stepped in to assuage their concerns and set the regulatory wheels in motion.

Reagan’s future CIA director endorsed the idea of a central market system and the creation of a comprehensive quotation system using “the technological innovation of recent years”, alluding to the massive overhaul of back-office operations precipitated by the so-called “paperwork crisis” of 1968 that forced trading firms all over the country to switch from pen and paper to hugely expensive computer systems. More than a hundred companies were liquidated or absorbed by bigger competitors in the process and marked the beginning of the financial industry’s lurch into the digital casino economy.

Wall Street’s big investment firms and brokerage houses were behind the tectonic shift as a phenomenon known as block trading, pioneered by Goldman Sachs’ long-time trading department head Gus Levy, allowed institutional investors – hedge funds, mutual funds and other holders of large pools of capital –, to assert their dominance over the stock market, edging out a central feature of America’s traditional private enterprise system: the individual investor. 

Unable to cope with an exponential increase in trading volume, the overwhelmed clerical staff of several brokerage and specialty trading firms led, in turn, to the bear market of 1969-1970 and opened the door for the introduction of electronic trading systems. The first of these to enter the market was AutEX, a computerized messaging system designed to connect sellers with brokers automatically, developed by WWII Army veteran, Alan F. Kay. By the end of 1969, a company called Institutional Networks Corporation released a direct investor-to-seller platform called Instinet, which eliminated brokers and commission fees altogether, and even the NYSE began testing its own proprietary system called the Block Automation System (BAS) early in 1970.

The relative complexity of block trading and other institutional investment practices like currency trading and capital allocation decisions were especially suited for algorithmic analysis methods, such as those developed in the 1940’s by the U.S. Air Force in Project SCOOP (Scientific Computation of Optimal Programs), which tackled the logistical problems of war-planning through linear programming applications. SCOOP’s research was immediately applied to the commodities markets in Chicago after its findings were presented at a conference organized by the Cowles Commission for Research in Economics.

One of Instinet’s early backers, Bill Lupien, took advantage of the back-office computer upgrades at the Pacific Stock Exchange (PSE) in California, to design the world’s first automated exchange system (SCOREX) with a team of programmers in 1969 and executed the first electronic trade – an Occidental Petroleum stock – in history. The ambitious Chicago native got a visit from Gus Levy himself, who flew all the way from New York to try and stop the exchange from using the algorithmically-driven trade system. 

SCOREX’s instantaneous trade execution capabilities were a real threat to the New York financial establishment, who were still trying to preserve the carefully constructed social pecking order of the investment world. But, the writing was on the wall and Levy had to back down after Lupien reached out to California’s Corporations Commissioner, an old friend and partner at the law firm run by Warren Buffet’s right-hand man, Charlie Munger, who shot back at the Goldman Sachs legend with the prospect of a sure-fire antitrust lawsuit.

Recommended by McChesney Martin, Lupien was called to form part of Casey’s 9-man investigatory inquiry in 1971 to determine the issues that needed to be ironed out in order to implement a central market system. Predictably, consensus was impossible to reach as the regional exchanges vied to serve their own interests, while also fending off New York’s bully tactics. Meanwhile, the founding of the National Association of Securities Dealers Automated Quotations (NASDAQ) index earlier that February left no doubt about which way the wind was being made to blow.

Phoenix Rising

The impasse in the financial sector continued through 1975, when the SEC took matters into its own hands and passed the Securities Act Amendments, which called for the creation of the National Market Advisory Board and signaled to the financial industry that if they did not come to an agreement to allow equal (electronic) access to every marketplace, the federal government would do it for them. That same year, the National Institute for Standards and Technology (NIST) staged a mock competition, calling for vendors to submit proposals for the development of a national encryption standard. 

Only one submission was received from IBM, which had already been surreptitiously contracted for the job, and was to be performed under the careful supervision of the National Security Agency (NSA). Based off of the Lucifer encryption algorithm, a block cipher developed by leading IBM engineer Horst Feistel, another team of computer scientists and their NSA counterparts designed the first federal Data Encryption Standard (DES). Released in 1977, the DES would underpin the earliest encryption algorithms for compromised communication systems of the banking sector, and the precursor to digital ledger technologies known as blockchain.

The next crisis was a decade away and would move the needle one step closer to a full-fledged data economy. Despite having installed systems like AutEX and Instinet in their offices, Wall Street giants like Bear Sterns, Barney Smith & Co., and J.P. Morgan made sparing use of them. Fear that the new automated systems would inhibit business as usual was still palpable in the late 1980s, when computerized trading algorithms were blamed for the crash of 1987.

Known as Black Monday, the losses sustained by the stock market on that day remain the most ever. On January 8th, 1988, just months after the biggest debacle in Wall Street history, The Economist published their famous “World Currency” issue featuring a phoenix – symbol of transformation through fire – on the cover. Printed without attribution, the article suggested ways in which the governments of the world could “subordinate their domestic objectives” to achieve global financial stability. A “few more” black Mondays or exchange rate crises, the anonymous author mused, might do the trick.

CORRECTION: The article originally attributed the creation of AutEx to Xerox PARC computer scientist, Alan Kay, instead of Alan F. Kay. We regret the error.