Why Front Running Tactics Work on Some Crypto Exchanges

How the front running strategy has found its way onto cryptocurrency trading platforms

From breakout tactics to scalping, and momentum moves to reversals, many traditional day trade strategies have made their way from the stock market to the crypto boards. Traders have had to fine-tune these approaches to work for them in a new trading ecosystem, particularly in the decentralized trading zone. One tactic in particular that has proven popular for intra-day trading is “front running”. Front running is a method of waiting, watching, and getting in front of a public trade just as the price rises or drops. It’s a tactic that works well on decentralized exchanges — and here’s why.

How front running works on DEX

First of all, let’s look at how front running works. Front running is when a trader stays with the trade, watching the price accumulation, and figuring out when to slip past the other traders at the very last minute in order to make a profit. While in traditional trading front running is considered illegal because the trader would be using non-public data, on a decentralized exchange (DEX), the trader is working with publicly available information on the blockchain, and is therefore technically not shorting the system.

Front running as a DEX trading tactic is effective if you know the list of buy or sell orders ahead of time and can insert your order before other trades are inserted. For example, as a trader you know that there is an incoming buy order at 100 for 10 thousand, and currently, there are sell offers at 90 for the same volume. In this case, you can buy the asset at 90 for 10 thousand and immediately insert the sell order at 100. So your profit will be the difference between the buy price and the sell price minus exchange fees.

Centralized versus decentralized

Why does front running work on a decentralized exchange and not on a centralized exchange? It’s simply due to the data being made publicly accessible on DEXs, and front running is a practice that can only be implemented on information that is made public. For centralized exchanges, for example, the only people who could hypothetically engage in front running are exchange owners themselves (other traders cannot have access to the list of orders and insert their own orders before the owners.)

The tactic is feasible on decentralized exchanges, thanks to the specific nature of blockchain. If a decentralized exchange is built on top of a public blockchain (eg. Ethereum), the trader will be able to view incoming orders locked into smart contracts on the decentralized exchange. Then – where it is economically practical – the trader can set a higher fee for placing the order than that of the incoming orders. As a result, the trader will be able to claim more profitable orders.

Effective front running strategies

Considering that the volume of transactions via decentralized platforms is currently rather small and that the exchanges themselves try to curtail the practice of front running (in the future it may be fully curtailed, it works perfectly fine for now), this tactic is probably only economically viable for small developer teams. Keep in mind, however, that although the algorithm used for front running may seem quite trivial at first, you may run into some technical difficulties if you attempt to implement it yourself.

Opinions on front running tactics

Members of the crypto trade community have varying opinions on the ethics of front running as a trading strategy. Some see it as fair game with publicly traded information. Others, decentralized exchanges particularly, are against the practice as it is technically a method of manipulating their prices. Some members of the community are also acutely aware of the potential for Denial of Service (DoS) attacks, should this trading tactic fall into the wrong hands.

One decentralized exchange that was dealing with the particular pain point of front running on their platform, decided to solve the issue by hiring the front runner who caused them the problems in the first place. They are now working together to come up with a solution to this crypto trading loophole. An effective strategy for the exchange, but in the same breath, it also goes to show how profitable front running can be for a trader who knows what to do – and when.

What’s your opinion on front running tactics on decentralized crypto exchanges? Let us know.