Mt4 Expert Advisors are wildly popular. They let investors trade the intellectual property in an algorithm, and provide developers with revenues.
Are they a good business model for algorithm developers? Here’s our take (hint, they’re effective but inefficient).
The MT4 EA business model
EAs are effective: there is a market for them. Metaquotes, Myfxbook, etc., are active communities where some investors pay for EAs. When compared to Signal Services, EAs have 2 pros, namely that developers do NOT
- Disclose their strategy’s intellectual property (VERY important for good algorithms!)
- Need permission to manage investments, since strictly speaking it’s the investors who decide to connect software to their trading accounts
This makes EAs as good a business model as can be, right?
MT4 EAs & investor surplus
Hold your horses!
EAs don’t harvest consumer surplus, and this makes them economically inefficient.
Consumer surplus is “the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price)”. (Learn all about it at the Khan Academy, a project improving millions of lives, potentially yours!).
Apply microeconomics to EAs by replacing “Consumer” by “Investor” and “Producer” by “Developer” above. Investor Surplus is the difference between the amount that investors are willing and able to pay for an EA and the total amount that they actually pay the Algorithm Provider.
Assume for a second that you developed the best EA in the history of financial markets, an algorithm multiplying ANY amount invested by 25% every year – for ever. Other than investing whatever money you had in it, how would you make MORE from SUPER EA?
Assume you charged every investor 25.000 USD to use it (or 2 million USD, any number, really, as long as it was FIX).
Would that be a smart move?
Not really 🙁
- Investors with less than 500.000 USD could not “afford” SUPER EA (wrong: for now ignore they could borrow, if you’re getting greedy and wonder how much you’d be willing to mortgage yourself to buy SUPER EA, work it out here and post the solution as a comment to this post:-)
- An investor with 500.000 USD would be super-happy: he bought for 2 odd months worth of profit something with substantially higher lifetime value to him (a lot of non-harvested investor surplus from the developer standpoint!)
- An investor with 1 Million USD would be ecstatic…
And you see where this is going – the bigger the investor, the more consumer surplus the developer “gives away” to investors – that’s why they’re inefficient from the developer standpoint.
Developer Surplus is much higher with variable success fee (e.g. 20% success, etc.) because it extracts ALL investor surplus. ANY investor is willing and able to pay 20% of profits. Who would say no to 20% net compound returns (100-20%) * 25% for ever, without exception? Further, because the price is a variable function of investor surplus, EVERY investor can afford it without borrowing.
MT4 EAs & Rival Good Economics
Charging inefficiently is lethal to EA developer economics because of scalability: once enough investors buy EAs, slippage makes profits fade.
No strategy in the world, not even SUPER EA, can multiply ANY amount invested, because profits are contingent on available market liquidity, and market liquidity is a rival good.
In a nutshell: when SUPER EA told all the world and their sister (who would not buy it?) to buy the same asset at the same asset time, the asset price would JUMP.
The later the investor, the worse the price. Ditto for sales – which makes SUPER EA profits winner-takes all: only the first investor hits the jackpot.
MT4 EAs & Darwinex
Darwinex is designed to replace EAs as a business model for algorithm developers.
Because market liquidity/slippage limits the total absolute profit in a strategy, DARWIN providers earn a variable profit share. This harvests investor surplus from every investor: the only way for investors to enjoy DARWIN profits is to pay success fees because trades are NEVER disclosed.
The rival good nature of liquidity is tracked via slippage. Slippage on some DARWINs is a lot worse than on other (theoretically similar) ones: presumably some providers sell them as EAs on the side and this induces market slippage as investors with multiple brokers move the market against the EA and each other. This is not banned (anyway we have no way to enforce a prohibition), nor is there a need for a ban as we shut down DARWINs to new investment once slippage is too bad.
Mt4 EAs & You
The question though is: why sell via EAs when a DARWIN IPO legally harvests all consumer surplus for your algorithm?
Any thoughts? Do you currently sell EAs? Do you agree with the above reasoning?