Industrial-Grade Front-Running In an Age of Military-Grade Apathy

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In Brief
  • It is well-known that poor trading conduct is commonplace across the cryptocurrency markets.

  • Due to the transparent nature of the blockchain, bots can also be used to unfairly take advantage of upcoming market moves

  • We are more than capable of working together to help level the playing field and make this a fair market for everyone.

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It is well-known that poor trading conduct is commonplace across the cryptocurrency markets. Unfortunately, there isn’t much to speak of in terms of enforcement.

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In addition, wholesale market conduct regulation doesn’t seem to be forthcoming. This leaves innocent market participants with little option but to turn a blind eye and carry on swimming through the glue.

It is therefore up to us to do something about it in the meantime. Interim solutions are possible. However, if we attempt to start penalizing abusive trading behavior in the absence of regulation, we need to come together as an industry. We need to agree on a common set of principles, and effectively “cold-shoulder” the bad actors out of the market.

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This kind of self-regulation sounds almost unachievable at face value, but it’s not like it hasn’t been done before. Fair trading rules are commonplace on almost all mainstream financial markets venues. Many trade surveillance tools offer an array of market manipulation scenarios off the shelf.

Adopting well-trodden standards

Author Dale Carnegie once said that “inaction breeds doubt and fear, action breeds confidence and courage.” With this in mind, the financial “old-world” gives us plenty of precedents on which to base action.

For a start, we could take elements of existing regulatory standards. These include MiFID or the Global FX Code. We could apply them to our market where it makes sense to do so. There are also plenty of publicly available MTF rulebooks from which we can draw inspiration.

Adopting some sensible well-trodden standards of integrity and fair play now, instead of waiting to see what happens down the line, will help inject some much-needed consumer confidence into our market.

The alternative is to sit back, relax and wait for the punters to lose all hope and vacate the casino. Failure to act now could easily turn this into a reality, and it’s not too difficult to imagine.

Front-running explained

Picture this: You execute a trade in good faith based on the prevailing market price. Only to have a bigger player trade immediately ahead of you and dump it again, right after you’ve been filled. This leaves you with a significantly overvalued position and a gaping hole in the books. Sound familiar?

In the mainstream financial world, we called this “front-running,” which happened a lot. On the old open-outcry trading floors, your order would be flashed on the boards above the pit for all to see. Then as if by magic, there would be a spike in the market just before your order was filled.

Inevitably, the filling of your order would be followed by a sharp correction. This happened as the pit traders got out with a profit and went about their business. Bruised and battered, you were left with little option but to retire to the drawing-room and nurse your wounds over a few stiff measures of pre-war Cognac.

By the mid-2000s, regulations matured, and surveillance systems became more advanced. As such, brazen activity such as front running had started to die out.

It still does happen occasionally. However, it is nowhere near as prevalent as it used to be, despite what you might see on Netflix.

Case-in-point

Source: dextools.io

The three trades above at 09:45:05 show a bot (…a91b) trading immediately before and after a legitimate trade (…1322). This caused the legitimate trade to be priced well-above market rate (…1322 buys @ 0.576, a huge premium to the prevailing market rate, which immediately drops back to 0.359 after the bot has dumped).

Take the above image as a case-in-point. In today’s financial mainstream, a trading pattern like this would light up the systems at the regulator like a Christmas tree before you’d even started to count the money.

You’d already be a pantomime villain in the financial press. The shock-troops would already be on their way to come and disappear you.

The case in trading crypto

Unfortunately, for many crypto traders, scenes like this are an all too familiar occurrence. Due to the transparent nature of the blockchain, bots typically used for arbitrage can also be used to unfairly take advantage of upcoming market moves by trading ahead of transactions as they are processed on the chain.

These bots will routinely jump in ahead of you. They will profit from their dominant position at your expense, all with relative impunity.

The above example shows that there’s still plenty of complacency across the DEX world regarding front-running. To put it bluntly, in the absence of any binding market conduct regulation, there’s nothing to stop centralized exchanges from doing the same if they so wished.

The sad truth is that there isn’t much being done about it, and it’s all a bit unfair. Why, then, do we all seem so content to accept this kind of behavior as commonplace in the crypto market? Why do we shrug our shoulders and gloss over it, like Arsene Wenger feigning ignorance at a clear-cut penalty call? When is something going to be done about it, and perhaps more importantly, who will do something about it? 

The regulator issue

Now, if this is the part where you’re expecting a squadron of regulators to fly in on Hueys with Ride of the Valkyries being broadcast from a reel-to-reel, then prepare to be disappointed.

In addition to hunting the assets of contract killers, terrorists, and human traffickers, regulators have been busy tracking down all the extra drug money that has made its way into the crypto market.

This on account of certain fiat banks becoming less accommodating to the Sinaloa Cartel than they once might have been. To top it all off, our industry hasn’t exactly been helping to speed things up.

You only need to look at how slow some industry elements are in adopting something as simple as the “travel rule” to get an idea of how far away we are from anything that resembles market conduct enforcement.

Add this to an existing array of larger macro problem areas, such as tax treatment, jurisdictional legality, and market infrastructure complexity and you can see just how much of a herculean effort it will be for regulators to achieve global consensus and implement wholesale regulation of the crypto markets.

Making trading fair

It doesn’t have to be like this. We are more than capable of working together to help level the playing field and make this a fair market for everyone. We owe our customers this much, at least.

Trading platforms are coming to the market using smart order routing technology to aggregate liquidity and reduce the signals generated from trading. This allows users to go about their business safely in the knowledge that they won’t be hung out to dry by the bigger players.

Some platforms are also investing in compliance teams. These will routinely monitor for manipulative behavior and take appropriate action against poor conduct.

Disclaimer

All the information contained on our website is published in good faith and for general information purposes only. Any action the reader takes upon the information found on our website is strictly at their own risk.
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Mark has over 20 years of experience in the financial markets industry, half of which was dedicated to direct frontline compliance at top-tier institutions such as Barclays Capital, Citibank, and Standard Chartered, where he has led compliance coverage for several businesses across the trading floors, focusing on Currencies and OTC fixed income markets. Most recently, Mark has been focused on electronic foreign exchange trading, where he has written global policies and standards on algorithmic trading compliance. This puts him in the perfect position to oversee Finxflo’s overall regulatory compliance.

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