Decentralised exchanges (DEXs) cemented their position in the cryptocurrency and financial ecosystems following the decentralised finance (DeFi) boom of 2020. Users can list any cryptocurrency on DEXs since they are not centralised exchanges.in terms of strict control.
High-frequency traders engage in crypto trading before being listed on major crypto exchanges, thanks to DEXs. Decentralised exchanges can be noncustodial, meaning some exchanges can not engage in an exit scam.
As a result, high-frequency trading (HFT) firms that once arranged special trading deals between crypto exchange operators have shifted to using decentralised exchanges.
Table of Contents
What Is High-Frequency Trading In Cryptocurrency?
High-frequency trading (HFT) is a trading technique that uses sophisticated algorithms to evaluate vast volumes of data and place trades quickly. HFT can, therefore, promptly execute many orders after analysing several markets. Fast execution is frequently the secret to success in the world of trading.
By making a lot of trades quickly, HFT removes minor bid-ask spreads. Additionally, it enables market participants to benefit from price adjustments before they reflect in the order book. HFT can thus make money even in erratic or thinly traded markets.
Due to infrastructure advancements in cryptocurrency exchanges, HFT, which first appeared in conventional financial markets, has entered the cryptocurrency world. HFT can be used to trade on DEXs in the realm of cryptocurrencies.
Decentralised exchanges are gaining popularity. They provide several benefits over conventional centralised exchanges (CEXs), including enhanced security and anonymity. HFT tactics’ development in the cryptosphere is, therefore, a logical progression.
Some hedge funds that specialize in cryptocurrency trading have employed algorithmic trading as a result of HFTs’ popularity to generate significant returns, which has led some detractors to charge that HFTs provide larger firms with an advantage in the cryptocurrency market.
How High-Frequency Trading Works On Decentralized Exchanges
Buy cheap, sell high is the straightforward fundamental tenet of HFT. HFT algorithms examine many data to find patterns and trends you can use to make money. To profit from a particular price trend, for instance, an algorithm might spot it and then quickly execute a large number of buy or sell orders.
High-speed HFT analyses every cryptocurrency across different crypto exchanges, using complex algorithms. HFT algorithms hedge human traders due to their high operating speed. They are incredibly adaptable and can trade across many asset classes and on several exchanges simultaneously.
In particular, at speeds needed to start a lot of positions at once, HFT algorithms are designed to detect trade triggers and patterns that are difficult to see with the unaided eye. Being the first to take advantage of new trends that the algorithm discovers is the ultimate objective of HFT.
For instance, the price of a cryptocurrency often changes after a significant investor opens a long or short position. By trading in the opposite direction of these following price changes, HFT algorithms leverage them and convert them to profit.
Nevertheless, because they frequently cause prices to fall, substantial bitcoin sales are generally bad for the market. However, when the cryptocurrency returns to normal, the algorithms “buy the dip” and exit the positions, allowing the HFT company or trader to profit from the price movement.
There is the trade of most digital assets on decentralised exchanges, which allows HFT in cryptocurrencies. Due to the lack of a centralised infrastructure like regular exchanges, these exchanges can offer substantially faster trading speeds. Since HFT calls for split-second decision- and action-making, this is perfect. In general, high-frequency traders place a lot of deals every second to make a lot of money in the long run.
Top HFT Strategies
1. Money Making
By simultaneously placing buy and sell orders for a security, you can make money off the bid-ask spread, which is the difference between the price you’re willing to pay for an asset (the asking price) and the price you’re ready to sell it for (the bid price).
Large organisations known as “market makers” are well-known in traditional trading and are responsible for ensuring that a market is liquid and well-ordered. You can connect market makers to crypto exchanges to maintain the market’s integrity. However, market makers also intend to use their algorithms and make money from the spread without having any agreements with exchange platforms.
The goal of market makers is to make a modest profit on each trade. Thus, they continuously purchase and sell cryptocurrencies while setting their bid-ask spreads. For instance, they might offer to acquire Bitcoin at $40,200 (ask price) and then sell it to someone who wants to sell their Bitcoin at $40,205 (the bid price).
The spread, the $5.00 difference between the ask and bid prices, is the primary source of income for market makers. Additionally, day trading in volume can provide a sizable profit, despite the seemingly insignificant spread between the ask and bid prices.
2. Crypto Arbitrage
Crypto arbitrage is the technique of generating income by profiting from price variations for the same cryptocurrency on various exchanges. For instance, if a single Bitcoin (BTC) costs $42,350 on Exchange A and $42,400 on Exchange B, one may buy it on Exchange A and sell it on Exchange B right once to make a quick profit.
Arbitrageur traders make money off of these market discrepancies in the cryptocurrency space. They can profit from differences before anyone else by using practical HFT algorithms. By balancing prices, they thereby contribute to market stabilisation.
Because there is typically a very narrow window of opportunity for implementing arbitrage tactics, HFT is especially advantageous to arbitrageurs (less than a second). HFTs rely on robust computer systems with swift market scan capabilities to immediately grab short-term market opportunities. Additionally, HFT platforms may execute transactions hundreds of times faster than a human trader. They can also find arbitrage possibilities.
3. Volume Trading
Volume trading entails keeping track of the number of shares that have been traded over a specific time frame and then executing trades by that information. The share volume growth is in direct proportion to market liquidity, thereby making the purchase and sale of shares simple.
Simply put, volume trading is all about utilising the market’s liquidity. HFT enables investors to leverage the market swings with quick transaction completions.
4. Short-Term Opportunities
Buy-and-hold investors and some traders have not intended users of HFT. In contrast, it is helpful for speculators who wish to make bets on sudden price changes. Because of this, high-frequency traders operate so quickly that the price might not have time to adapt before they take another action.
For instance, when a whale dumps Bitcoin, the price will generally fall for a brief period before the market corrects itself to match the supply-demand equilibrium. Most manual traders will miss this downturn because it might only linger for a few minutes (or even seconds), but high-frequency traders can profit from it.
HFT could be a tactic in and of itself. So instead of concentrating on HFT as a whole, it’s crucial to examine specific trading strategies that use HFT technologies.