Following the rise of decentralized finance (DeFi) in 2020, decentralized exchanges (DEXfor its acronym in English) cemented their place in the cryptocurrency and finance ecosystems. Since DEXs are not as regulated as centralized exchanges, users can list any token they want.
With DEXs, high-frequency traders can trade coins before they hit major exchanges. Also, decentralized exchanges are non-custodial, which means that creators can’t do an exit fraud, in theory.
Therefore, high-frequency trading firms that used to broker one-time trades with crypto exchange operators have turned to decentralized exchanges to conduct their business.
What is high frequency trading in cryptocurrencies?
High frequency trading (HFTfor acronyms in English) is a trading method that uses complex algorithms to analyze large amounts of data and perform quick trades. As such, the HFT can analyze multiple markets and execute a large volume of orders in a matter of seconds. In the realm of trading, fast execution is often the key to profit.
HFT eliminates small bid-ask spreads by making large volumes of trades quickly. Also allows market participants to take advantage of price changes before they are fully reflected in the order book. As a result, HFT can generate profits even in volatile or illiquid markets.
HFT first emerged in traditional financial markets, but has since made its way into the crypto space due to improvements in crypto exchange infrastructure.. In the world of cryptocurrencies, HFT can be used to trade DEXes. It is already used by several high-frequency trading houses, including Jump Trading, DRW, DV Trading and Hehmeyer, as reported by the Financial Times.
Decentralized exchanges are becoming more and more popular. They offer many advantages over traditional centralized exchanges (CEXs), such as improved security and privacy. Therefore, the appearance of HFT strategies in cryptocurrencies is a natural evolution.
The popularity of HFTs has also resulted in some cryptocurrency-focused hedge funds employ algorithmic trading to produce huge returnswhich has led critics to condemn HFTs for giving larger organizations an edge in cryptocurrency trading.
In any case, HFT seems to be here to stay in the world of cryptocurrency trading. With the right infrastructure, HFT can be used to generate profits by taking advantage of favorable market conditions in a volatile environment..
How does high frequency trading work on decentralized exchanges?
The basic principle of HFT is simple: buy low, sell high.. For it, HFT algorithms analyze large amounts of data to identify patterns and trends that can be exploited for profit. For example, an algorithm may identify a particular price trend and execute a large number of buy or sell orders in rapid succession to take advantage of it.
The United States Securities and Exchange Commission does not use a specific definition of high frequency trading. However, it lists five main aspects of HFT:
Use of complex and high-speed programs to generate and execute orders
Reduction of possible delays and latencies in the flow of data through the use of colocation services offered by exchanges and other services
Use of short terms to open and close positions
Submit multiple orders and cancel shortly after submission
- Reduce exposure to overnight risk by holding positions for very short periods
In a nutshell, HFT uses sophisticated algorithms to continuously scan all cryptocurrencies across multiple exchanges at very high speeds. The speed at which HFT algorithms operate gives them a significant advantage over human traders. They can also trade multiple markets simultaneously and with different asset classes, which makes them very versatile.
HFT algorithms are designed to detect trading triggers and trends that are not easily visible to the naked eye., especially at the speeds necessary to open a large number of positions simultaneously. Ultimately, the goal of the HFT is to be first in line when the algorithm identifies new trends.
After a large investor opens a long or short position in a cryptocurrency, for example, the price usually moves. HFT algorithms exploit these subsequent price movements by trading in the opposite direction, quickly making a profit..
Having said that, large cryptocurrency sales are often detrimental to the market because they tend to drag prices down. Nevertheless, when the cryptocurrency returns to normal, the algorithms “buy the dip” and exit the positionsallowing the HFT firm or trader to profit from the price movement.
HFT in cryptocurrencies is possible because most digital assets are traded on decentralized exchanges. These exchanges do not have the same centralized infrastructure as traditional exchanges and therefore can offer much faster trading speeds. This is ideal for HFT as it requires split-second decision making and execution. Usually, high-frequency traders execute numerous trades every second to accumulate modest profits over time and generate a large profit.
What are the main HFT strategies?
Although there are too many types of HFT strategies to list, some of them have been around for a long time and are not new to experienced investors. The idea of HFT is often related to conventional trading techniques that take advantage of cutting-edge computing capabilities.. However, the term HFT can also refer to more fundamental ways of seizing opportunities in the market.
In a nutshell, HFT can be considered a strategy in itself. As a result, instead of focusing on HFT as a whole, it is important to analyze the particular trading techniques that employ HFT technologies.
crypto arbitrage
The crypto arbitrage is the process of making profits by taking advantage of price differences of the same cryptocurrency on different exchanges. For example, if a bitcoin (BTC) costs $30,050 on Exchange A and $30,100 on Exchange B, one could buy it on the first exchange and then immediately sell it on the second for a quick profit.
The HFT is very beneficial for arbitrageurs because the window of opportunity to carry out arbitrage strategies is usually very small (less than a second). To quickly seize short-term market opportunities, HFTs are based on robust computer systems that can scan markets quickly. In addition, heHFT platforms not only discover arbitrage opportunities, but can also trade up to hundreds of times faster than a human trader.
market making
Another common HFT strategy is market making. Consists in place orders to buy and sell a security at the same time and benefit from the spread between the offer and the offerthat is, the difference between the price that one is willing to pay for an asset (ask price) and the price at which one is willing to sell it (offer price).
Large companies called market makers provide liquidity and good order in a market and are well known in conventional trading.. Market makers can also be tied to a cryptocurrency exchange to ensure market quality. On the other hand, there are also market makers who have no agreement with the exchange platforms: their goal is to use their algorithms and benefit from the spread.
Market makers constantly buy and sell cryptocurrencies and fix their bid and ask spreads to make a small profit on each trade.. For example, they can buy bitcoin at $37,100 (the buy price) from someone who wants to sell their bitcoin holdings and offer it at $37,102 (the ask price).
The $2 difference between the bid and ask prices is called the spread, and it is primarily how market makers make money.. And, although the difference between the buy and sell price may seem insignificant, day trading volumes can lead to a significant portion of profits.
The spread ensures that the market maker is compensated for the legacy risk that accompanies these trades. Market makers provide liquidity to the market and make it easy for buyers and sellers to trade at fair prices.
short term opportunities
High-frequency trading is not intended for swing traders and buy-and-holders. Instead, it is used by speculators who want to bet on short-term price fluctuations. As such, high frequency traders move so quickly that price may not have time to adjust before they act again.
For example, when a whale dumps a cryptocurrency, its price typically falls for a short time before the market adjusts to meet the supply-demand balance. Most manual traders will lose out on the dip because it can only last a few minutes (or even seconds), but high frequency traders can take advantage of it. They have time to let their algorithms work, knowing that the market will stabilize eventually.
volume trading
Another common HFT strategy is volume trading. It consists of keeping track of the number of shares traded in a given period and then making trades accordingly. The underlying logic is that, as the number of shares traded increases, so does the liquidity of the market, making it easier to buy or sell a large number of shares without the market moving too much.
In a nutshell, volume trading is all about taking advantage of market liquidity.
High-frequency trading allows traders to execute a large number of trades quickly and benefit from even the smallest fluctuations in the market.
The license for this article is available. Developed by SharpShark.
Clarification: The information and/or opinions expressed in this article do not necessarily represent the views or editorial line of Cointelegraph. The information set forth herein should not be taken as financial advice or investment recommendation. All investment and commercial movement involve risks and it is the responsibility of each person to do their due research before making an investment decision.
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