After the decentralized finance (DeFi) boom of 2020, decentralized exchanges (DEXs) have cemented their place in the ecosystem of both cryptocurrency and finance. Since DEXs are not as heavily regulated as centralized exchanges, users can list any tokens they wish.

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With DEXs, high-frequency traders can trade coins before they hit the major exchanges. Furthermore, decentralized exchanges are non-custodial, meaning that creators cannot pull off an exit fraud – in theory.

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As such, high-frequency trading firms that used to conduct unique business transactions with cryptocurrency exchange operators have turned to decentralized exchanges to conduct business.

What is High-Frequency Trading in Crypto?

High-frequency trading (HFT) is a trading method that uses complex algorithms to analyze large amounts of data and make quick trades. As such, HFT can analyze multiple markets and execute large volume orders in a matter of seconds. In the trading arena, fast execution is often the key to making a profit.

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HFT quickly eliminates small bid-ask spreads by trading large volumes. This allows market participants to take advantage of price changes before they are fully reflected in the order book. As a result, HFT can make profits even in volatile or liquid markets.

HFT first emerged in traditional financial markets, but has since made its way into the cryptocurrency space due to structural improvements in crypto exchanges. In the world of cryptocurrency, HFTs can be used to trade on DEXs. It is already being used by many high-frequency trading houses such as Jump Trading, DRW, DV Trading and Hehmeyer, Financial Times informed of,

Decentralized exchanges are becoming increasingly popular. They offer several advantages over traditional centralized exchanges (CEXs), such as improved security and privacy. As such, the rise of HFT strategies in crypto is a natural evolution.

The popularity of HFT has resulted in some crypto trading-focused hedge funds also employing algorithmic trading to produce large returns, prompting critics to condemn HFT for giving an edge to large organizations in crypto trading. .

In any case, HFT appears 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 market.

How does high frequency trading work on decentralized exchanges?

The basic principle behind HFT is simple: Buy low, sell high. To do this, HFT algorithms analyze large amounts of data to identify patterns and trends that can be used to their advantage. For example, an algorithm may identify a particular price trend and then execute a large number of buy or sell orders in quick succession to take advantage of it.

The United States Securities and Exchange Commission does not use a specific definition of high-frequency trading. although it lists The five main aspects of HFT:

  • Using high speed and complex programs to generate and execute commands

  • Minimizing potential delays and delays in data flow by using colocation services provided by exchanges and other services

  • Using shorter time frames to open and close positions

  • Submitting multiple orders and then canceling them immediately after submission

  • Mitigating the risk of overnight exposure by holding the position for a very short period

In short, HFT uses sophisticated algorithms to continuously analyze 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 be traded on multiple exchanges simultaneously and across different asset classes, making them very versatile.

The HFT algorithm is built to detect trading triggers and trends that are not easily observable with the naked eye, especially at the speeds required to open a large number of positions simultaneously. Ultimately, the goal with HFT is to be the first in line when new trends are identified by the algorithm.

For example, after a large investor opens a long or short position on a cryptocurrency, the price usually moves. HFT algorithms take advantage of these subsequent price movements by trading in the opposite direction, quickly booking profits.

That said, large cryptocurrency sales are usually detrimental to the market as they usually drag prices down. However, when the cryptocurrency returns to normal, algorithms “buy the dip” and exit the position, allowing the HFT firm or trader to profit from the price movement.

HFT in cryptocurrency is made possible because most digital assets are traded on decentralized exchanges. These exchanges do not have the same centralized infrastructure as traditional exchanges, and as a result, they can provide very fast trading speeds. It is ideal for HFT, as it requires split-second decision making and execution. In general, high-frequency traders execute multiple trades each second to accumulate modest gains over time and generate a large profit.

What are the Top HFT Strategies?

Although there are a variety of HFT strategies to list, some of them have been around for some time and are not new to experienced investors. The idea of ​​HFT is often associated with traditional trading techniques that take advantage of state-of-the-art IT capabilities. However, the term HFT can also refer to more fundamental ways of taking advantage of opportunities in the market.

Crypto Trading Basics: A Beginner’s Guide to Cryptocurrency Order Types

In short, HFT can be considered a strategy in itself. As a result, it is important to analyze specific trading techniques that employ HFT technologies, rather than focusing on HFT as a whole.

crypto arbitrage

Crypto arbitrage is the process of making profit by taking advantage of the price difference for the same cryptocurrency on different exchanges. For example, if a bitcoin (BTC) is priced at $30,050 on exchange A and $30,100 on exchange B, one can buy it on the first exchange and then sell it on another exchange for an immediate profit.

Example of Crypto Arbitrage Strategy

Crypto traders who profit from these market anomalies are called arbitrageurs. By using efficient HFT algorithms, they can take advantage of discrepancies before anyone else. In doing so, they help stabilize the markets by balancing prices.

HFT is highly beneficial to arbitrageurs because the window of opportunity for operating arbitrage strategies is usually very small (less than a second). To quickly seize short-term market opportunities, HFTs rely on robust computer systems that can scan the markets quickly. Furthermore, HFT platforms not only discover arbitrage opportunities but can also trade hundreds of times faster than a human trader.

market making

Another common HFT strategy is to market. This involves placing buy and sell orders for a security at the same time and profiting from the bid-ask spread – the difference between the price you are willing to pay for an asset (the ask price) and The price at which you are ready to sell it (the bid price).

Large companies called market makers provide liquidity and good orders in the market and are famous in traditional trading. Market makers can also be linked to a cryptocurrency exchange to guarantee the quality of the market. On the other hand, market makers who do not have an agreement with the exchange platform are also present – they aim to use their algorithms and profit from the spread.

How does a market making strategy work?

Market makers are constantly buying and selling cryptocurrencies and setting their bid-ask spreads so that they make a small profit on each trade. For example, they can buy bitcoin at $37,100 (ask price) from someone who wants to sell their bitcoin holdings and offer to sell it at $37,102 (bid price).

The $2.00 difference between the bid and ask price is called the spread, and is primarily how market makers make money. And, while the difference between the ask and bid price may seem insignificant, the volume can account for a significant portion of the profit resulting from day trading.

The spread ensures that the market maker is compensated for the risk inherited with such trades. Market makers provide liquidity to the market and make it easy for buyers and sellers to trade at a fair price.

short term opportunity

High frequency trading is not intended for swing traders and buyers and holders. Instead, it is employed by speculators to bet on short-term price fluctuations. As such, high-frequency traders move so quickly that the price may not have time to adjust before acting up again.

For example, when whales dump cryptocurrency, its price will typically drop for a short period of time before the market adjusts to meet the supply-demand balance. Most manual traders will lose out on this drop as it can only last for minutes (or even seconds), but high-frequency traders can take advantage of it. They have time to let their algorithms do the work, knowing that the market will eventually stabilize.

volume trading

Another common HFT strategy is volume trading. It involves tracking the number of shares traded in a given period and then trading accordingly. The reasoning behind this is that as stocks are traded, so does market liquidity, which makes it easier to buy or sell a large number of shares without much movement in the market.

On-Chain Volume vs. Trading Volume: Differences Explained

Simply put, volume trading is all about taking advantage of market liquidity.

High-frequency trading allows traders to quickly execute a large number of transactions and profit from even the smallest market fluctuations.

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