Presumably from many of the same places GETCO's (significant) revenue comes from: by selling liquidity services. Market makers aren't a new concept.

I find financial tech fascinating, have had a lot of projects that involved attacking them (sometimes at a financial-domain level; ie, constructing technology-centric frontrunning schemes by leveraging software bugs), and so have had a chance to learn a bit about the field. Not as much as others on this thread.

I am defensive, it's true, but not about HFT (if exchanges adopted technical countermeasures to prohibit HFT, that'd actually be a win for me: one more thing for my team to test!) What bugs me is the knee-jerk comments, often from people with severely broken mental models of how trading markets work, piling on with "HFT flash-crashed the CDO meltdown" stuff.

The strategic and technical games that go on in the markets are engaging to watch, but they're basically ways of winning the most money (from the investor's/speculator's viewpoint). The more complex they get, and the higher the bid prices for talent which can win these games, the more the talent and energy is diverted from fields that could advance society more (say, basic research, or new product/tech development). So you get more smart kids going to biz school with an eye towards a place on Wall Street, instead of a broader distribution. That's my view on why financial jobs, and possibly large-scale investment, in general should be less profitable - though how to achieve that is a very open question (not sure how well capital gains taxes would work).

The cash comes from traders/investors who are impatient. If you want to trade immediately instead of waiting and hoping for someone else to hit your order, you have to pay the spread. Market-makers make money by allowing impatient traders to transact with them, and then holding the inventory until other impatient traders want to buy/sell it.

This requires the market-maker to take a risk. The spread compensates them for the risk. The size of the spread is (currently, with HFT) set by competition between market-makers. Before HFT, there was much less competition between market-makers, and spreads were hence much wider. Back then, this resulted in the transfer of significant wealth from investors to exchange specialists. In modern markets with HFT market-makers instead of specialists, these transaction costs are much lower, which saves you and your pension fund money.

Example:

Suppose the national best bid on stock ABCDE is $15.17 and the best offer is $15.18. The "spread" is $0.01. (These limit orders were almost certainly placed by market-makers using HFT.)

If you want to buy ABCDE, you can do one of two things: - You can place a limit order to buy at 15.17 and wait and hope that someone sells some to you. - Alternately, you can place a market order that will cross the spread and buy at 15.18 instantly.

The market order protects you from the roughly 50-50 chance that ABCDE prices start increasing and your order never gets filled. It costs $0.01 per share, which is basically paying the HFT market-maker for liquidity (the ability to trade immediately).

Before HFT, the spread might have been $0.05 or even $0.10. You would still have the same two choices, but instead of $0.01, you would have to pay some human specialist $0.05-0.10+ if you wanted immediacy. His father and grandfather would have also been specialists, and his bonus would have been several million dollars that year. HFT market-makers simply out-competed these parasites. There is no longer a monopoly on market-making, so liquidity has gotten cheaper.

Correspondingly, it is cheaper for you to trade (ditto for mutual funds, pension funds, hedge funds, etc.). This allows you to keep more of your investment profits.