Decimalisation and the Death of Spread Capture

Until 2001, U.S. stocks traded in fractions of a dollar — eighths, then sixteenths, a convention inherited from the Spanish dollar being physically divisible into eight "pieces of eight." A stock could quote a bid of $50 and an ask of $50 1/16 ($50.0625), a minimum possible spread of just over six cents, no matter how liquid the stock was or how tight competition among market makers should have pushed the spread. Decimalisation — the SEC-mandated switch to pricing in pennies, completed across U.S. exchanges by April 2001 — let stocks quote a one-cent spread instead. The minimum spread fell from 6.25 cents to 1 cent, an 85% reduction imposed by a single rule change, on a single date, across the entire market at once.

Why the old spread was a subsidy, not a market outcome

A minimum tick of one-sixteenth wasn't set by supply and demand — it was a rule. Market makers were guaranteed at least 6.25 cents of spread on any stock, regardless of how much competition existed or how liquid the stock actually was, because the tick size floor prevented anyone from quoting a tighter market even if they wanted to win order flow by doing so. For a heavily traded, genuinely liquid stock — one where true market-making risk might justify a spread of two or three cents — the sixteenth-based minimum forced a spread more than double what competition alone would have produced. That gap between the rule-imposed minimum and the competitively justified spread was pure economic rent, paid by every investor crossing the spread, collected by whoever was market-making that name.

Worked example. Before decimalisation, a liquid large-cap stock quotes $50 bid / $50 1/16 ask — a 6.25-cent spread. A market maker capturing that spread on 500,000 shares of daily two-sided flow earns roughly $500{,}000 \times 0.0625 = 31{,}250$ dollars a day, before costs, purely from being the one posting both sides of a spread that regulation guaranteed couldn't get any tighter. After decimalisation, competing market makers immediately quote $50.00 / $50.01 — a one-cent spread — because nothing stops them from doing so and whoever quotes tighter wins the order flow. The same 500,000 shares now generates $500{,}000 \times 0.01 = 5{,}000$ dollars a day in spread revenue: an 84% collapse in this single revenue line, overnight, on the same stock, the same volume, the same market maker.

What replaced it

Post-decimalisation, market makers couldn't rely on a guaranteed minimum spread and had to compete on other dimensions instead. Speed became the differentiator: the market maker who could update quotes fastest in response to new information, or detect an informed order arriving, could avoid getting picked off and still profit on a one-cent spread, while a slower competitor got adversely selected and lost money at the same spread. This is the direct lineage from decimalisation to the rise of high-frequency market making over the following decade — the industry didn't shrink so much as it re-armed around latency, because tick-size arbitrage was no longer available to subsidize slower, less sophisticated quoting.

What this means today

Every subsequent tick-size debate — the SEC's 2016–2018 Tick Size Pilot for small caps, ongoing arguments about whether sub-penny quoting should be allowed more broadly — is a rerun of the same underlying tension: a wider mandated tick subsidizes market makers and can improve displayed liquidity for illiquid names, while a tighter tick benefits investors crossing the spread but compresses market-making economics toward pure speed competition. Anyone evaluating a market-making strategy's edge should always ask which part of its P&L is genuine risk compensation and which part depends on a regulatory tick-size floor that could be narrowed by the next rule change.

In interviews

State the mechanism precisely: the pre-2001 minimum tick of one-sixteenth of a dollar set a spread floor unrelated to competition or true liquidity, and moving to pennies let competition compress spreads toward their competitive level almost immediately. Use the concrete before/after revenue numbers to show you understand this wasn't gradual decay — it was a discontinuous regulatory shock. If asked what came next, connect it directly to the rise of speed-based, high-frequency market making as the industry's replacement source of edge once tick-size rents disappeared.