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How does high-frequency trading work on decentralized exchanges?

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How does high-frequency trading work on decentralized exchanges?

Following the decentralized finance (DeFi) boom of 2020, decentralized exchanges (DEXs) solidified their place in the ecosystems of both cryptocurrency and finance. Since DEXs are not as heavily regulated as centralized exchanges, users can list any token they want. 

With DEXs, high-frequency traders can make trades on coins before they hit major exchanges. Plus, decentralized exchanges are noncustodial, which implies that creators cannot pull an exit fraud — in theory.

As such, high-frequency trading firms that used to broker unique trading 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 a large volume of orders in a matter of seconds. In the realm of trading, fast execution is often the key to making a profit.

HFT eliminates small bid-ask spreads by making large volumes of trades rapidly. It 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 cryptocurrency space owing to infrastructural improvements in crypto exchanges. In the world of cryptocurrency, HFT can be used to trade on DEXs. It is already being used by several high-frequency trading houses such as Jump Trading, DRW, DV Trading and Hehmeyer, the Financial Times reported.

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

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

In any case, HFT appears to be here to stay in the world of cryptocurrency trading. With the right infrastructure in place, 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 exploited for profit. For example, an algorithm might 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. However, it lists five main aspects of HFT:

  • Using high-speed and complex programs to generate and execute orders

  • Reducing potential delays and latencies in the data flow by using colocation services offered by exchanges and other services

  • Using short time frames to open and close positions

  • Submitting multiple orders and then canceling them shortly after submission

  • Reducing exposure to overnight risk by holding positions for very short periods 

In a nutshell, HFT uses sophisticated algorithms to continually 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 also trade on multiple exchanges simultaneously and across different asset classes, making them very versatile.

HFT algorithms are built to detect trading triggers and trends not easily observable to the naked eye, especially at 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.

After a large investor opens a long or short position on a cryptocurrency, for instance, the price usually moves. HFT algorithms exploit these subsequent price movements by trading in the opposite direction, quickly booking a profit.

That said, large cryptocurrency sales are typically harmful to the market because they usually drag prices down. However, when the cryptocurrency rebounds to normal, the algorithms “buy the dip” and exit the positions, 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 offer much faster trading speeds. This is ideal for HFT, as it requires split-second decision-making and execution. In general, high-frequency traders execute numerous trades each second to accumulate modest profits over time and generate a large profit.

What are the top HFT strategies?

Although there are too many types of HFT strategies to list, some of them have been around for a while and aren’t new to experienced investors. The idea of HFT is frequently connected to conventional trading techniques that take advantage of cutting-edge IT capabilities. However, the term HFT can also refer to more fundamental ways of taking advantage of opportunities in the market.

Related: Crypto trading basics: A beginner’s guide to cryptocurrency order types

Briefly put, HFT may be considered a strategy in itself. As a result, instead of focusing on HFT as a whole, it’s important to analyze particular trading techniques that employ HFT technologies.

Crypto arbitrage 

Crypto arbitrage is the process of making a profit by taking advantage of price differences for the same cryptocurrency on different exchanges. For example, if one 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 exchange for a quick profit.

Example of a crypto arbitrage strategy

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

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

Market making

Another common HFT strategy is market making. 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’re willing to pay for an asset (ask price) and the price at which you’re willing to sell it (bid 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 linked to a cryptocurrency exchange to guarantee market quality. On the other hand, market makers that do not have any agreements with exchange platforms also exist—their aim is to use their algorithms and profit from the spread.

How market making strategy works

Market makers are constantly buying and selling cryptocurrencies and setting their bid-ask spreads so that they make a small profit on each trade. They may, for example, buy Bitcoin at $37,100 (the ask price) from someone wanting to sell their Bitcoin holdings and offer to sell it at $37,102 (the bid price). 

The $2.00 difference between the bid and ask prices is called the spread, and it’s mainly how market makers earn money. And, while the difference between the ask and bid price might seem insignificant, day trading in volumes can result in a significant chunk of profit.

The spread ensures that the market maker is compensated for the inherited risk that accompanies such trades. Market makers provide liquidity to the market and make it easier 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’s employed by speculators wanting to wager on short-term price fluctuations. As such, high-frequency traders move so quickly that the price might not have time to adjust before they act again.

For instance, when a whale dumps cryptocurrency, its price will typically drop for a short time before the market adjusts to meet the supply-demand balance. Most manual traders will lose out on this dip because it may only last for minutes (or even seconds), but high-frequency traders can capitalize on it. They have the time to let their algorithms work, knowing the market will eventually stabilize.

Volume trading

Another common HFT strategy is volume trading. This involves tracking the number of shares traded in a given period and then making trades accordingly. The logic behind this is that as the number of shares traded increases, so does the market’s liquidity, making it easier to buy or sell a large number of shares without moving the market too much.

Related: On-chain volume vs. Trading volume: Differences explained

To put it simply, volume trading is all about taking advantage of the market’s liquidity. 

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

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California fraud cases highlight the need for a regulatory crackdown on crypto

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California fraud cases highlight the need for a regulatory crackdown on crypto

The California Department of Financial Protection and Innovation (DFPI) announced last month that it had issued desist and refrain orders to 11 entities for violating California securities laws. Some of the highlights included allegations that they offered unqualified securities as well as material misrepresentations and omissions to investors.

These violations should remind us that while crypto is a unique and exciting industry for the public at large, it is still an area that is rife with the potential for bad players and fraud. To date, government crypto regulation has been minimal at best, with a distinct lack of action. Whether you are a full-time professional investor or just a casual fan who wants to be involved, you need to be absolutely sure of what you are getting into before getting involved in any crypto opportunity.

California has toyed with setting up a crypto-specific business registration process for those looking to do business in the state. The proposed framework was vetoed by Governor Gavin Newsom as the resources required to establish and enforce such a framework would be prohibitive for the state. While this type of compliance infrastructure has not been employed yet, it points to concerns that regulatory authorities have related to the crypto industry.

There appears to be a pattern that new industries, especially those that garner as much international attention as crypto, are especially susceptible to fraud. One must go only as far back as cannabis legalization to find the last time California had to deal with fraudulent schemes at this scale.

Related: The feds are coming for the metaverse — from Axie Infinity to Bored Apes

It appears inevitable that California, known to be a first mover in regulation and compliance, will create some form of crypto-specific compliance infrastructure in the name of consumer protection. If history is any indication, once California releases its framework, other states will follow.

Federal and state representatives have been attempting to draft legislation to establish financial standards for crypto with little luck to date. At the federal level, Senators Cory Booker, John Thune, Debbie Stabenow and John Boozman co-sponsored a bill to empower the Commodities Futures Trading Commission (CFTC) to serve as the regulatory body for crypto, while Senators Kirsten Gillibrand and Cynthia Lummis co-sponsored a bill to establish more clear guidance on digital assets and virtual currencies. Lawmakers have even reached out to tech luminaries such as Mark Zuckerberg to weigh in on crypto fraud.

Cryptocurrencies, California, CFTC, Legislation, Law, Scams, Fraud, Bitcoin Scams
Source: Chainalysis

None of these or other similarly crypto-focused bills are expected to pass in 2022, but this level of bipartisan cooperation has been unprecedented in recent times. The collaboration should reflect just the sheer magnitude of the need for a regulatory framework. Said another way, Democrats and Republicans speaking to one another about anything should stop the presses, but the fact that they are co-sponsoring multiple bills should tell us that there is a monumental requirement for guidance.

How should one approach investing in the crypto space if the government is not going to establish controls for crypto? There are a few general points that one should consider if they are presented with a crypto investment opportunity.

Related: GameFi developers could be facing big fines and hard time

When reviewing any opportunity, do your due diligence! Do not take anyone’s word without some level of substantive support. If crypto is not an area of expertise, reach out to professionals who do have qualified experience. Make sure to utilize crypto monitoring and blockchain analysis tools, if possible, as part of the vetting process.

A common strategy of fraudsters is putting undue pressure or artificial timelines on a potential close. Slow down the process and use any and all time necessary to make an investment decision.

If it sounds too good to be true, it probably is. As overplayed as the cliché may be, it does bring up a valid point. There have been instances of schemes offering to pay initial and ongoing dividends for any new investors that are brought in and for additional dividends to be paid from any investors that those new investors bring in. If this sounds like a pyramid or multi-level marketing scheme, that’s because it is. Terms like “No Risk Investment” get thrown around as well. Ultimately, if no one knows where the opportunity is coming from, beware.

While crypto can be a fun and electrifying topic with many legitimate opportunities, there are bad players who will take advantage of the lack of government oversight and the excitement of overenthusiastic or undereducated investors.

Zach Gordon is a certified public accountant (CPA) and vice president of crypto accounting for Propeller Industries, serving as fractional chief financial officer and adviser to a portfolio of crypto and Web3 clients. He has been named a Forty Under 40 CPA, sits on the Digital Assets Committee for the NYSSCPA and has been working with crypto clients in a variety of capacities since 2016.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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NFT space bridges passions for tennis legend Maria Sharapova

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NFT space bridges passions for tennis legend Maria Sharapova

Tennis legend Maria Sharapova appeared at the Binance Blockchain Week Paris 2022 to share her interest in nonfungible tokens (NFTs).

During an exclusive interview with Cointelegraph, Sharapova mentioned that “she is exposing herself to this new world of crypto and Web3,” noting that the sector will help her better engage with her fans. Sharapova was also one of the strategic investors behind MoonPay’s Series A financing round, yet she mentioned that she aims to bridge her personal experiences to the digital world moving forward.

Maria Sharapova (right) with Cointelegraph senior reporter Rachel Wolfson (left) at Binance Blockchain Week Paris 2022. Source: Rachel Wolfson

Cointelegraph: What are you doing here today at Binance Blockchain Week Paris?

Maria Sharapova: I’m crypto curious and would like to figure out how to bridge the incredible physical experiences that I’ve been able to have with my fans over so many years. I’m now finding ways to include experiences in the digital world, so that’s what I’m most excited about. Also, as a female entrepreneur, I believe it’s important to pave the way for other women to enter Web3. Money is a topic that I feel we don’t speak enough about as women.

CT: Do you have plans to launch an NFT project?

MS: I’ve been looking at this space for several months now, as I’m someone who is more in favor of opportunities for the long haul. When I saw the opportunity to bridge physical with digital experiences, I knew I wanted it to be a long-term experience for myself. Storytelling is very important and it’s a huge component of Web3. I think stories will be told better for both parties when thinking about a project long-term.

Recent: The Caribbean is pioneering CBDCs with mixed results amid banking difficulties

CT: Do you think NFTs can help create better fan engagement?

MS: Absolutely. NFTs are about finding ways to communicate with the right communities interested in what I’m doing within a different type of space. For example, I was seen on a television screen every week playing tennis for so many years, yet I no longer have that platform on a daily basis because I retired a couple of years ago. The Web3 experience has given me access to my fans in entirely new ways. I feel like I’m more engaged with them, as opposed to them just being engaged by watching me compete.

CT: As a female entrepreneur and former athlete, do you have plans to get more women involved in Web3?

MS: I want to allow women to have a space where they experiment with Web3. For example, I was 17 when I won my first grand slam and social media was in no way part of that experience. It took years for me to get comfortable with social media over time. I think Web3 is also an area where one has to get out there in order to learn and grow from it. As I mentioned earlier, the conversation about money, finance, crypto and blockchain is a taboo conversation. People may feel that unless they know about these topics, they shouldn’t speak up. But I think this should be the other way around — you learn a lot more if you ask questions and get involved.

CT: Why did you decide to invest in MoonPay?

MS: I want to diversify my portfolio. In the beginning, my investments were around consumer goods. For example, I invested in the sunscreen brand Supergoop early on. I am now exposing myself to an entirely new category.

CT: What do you think are the biggest challenges associated with Web3 and how can we overcome these?

MS: I’d love to see the quality of Web3 experiences come through a bit more and improve, specifically in the digital space.

Recent: Are decentralized digital identities the future or just a niche use case?

CT: Any additional comments?

MS: I’m really interested in the NFT space because it bridges my passion for fashion, interior design and creating spaces that are unique to individuals and communities. I’ve become more interested in this space because it has more of a design perspective. It’s also an entirely new revenue stream that both artists and women are discovering.

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Bill Aims to Limit Crypto Mining in Kazakhstan Only to Registered Companies

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Bill Aims to Limit Crypto Mining in Kazakhstan Only to Registered Companies

Bill Aims to Limit Crypto Mining in Kazakhstan Only to Registered Companies

New legislation proposed in the parliament of Kazakhstan will allow only authorized miners to mint digital currency, if adopted. The draft has been designed to comprehensively regulate the industry and reduce what its sponsors label as uncontrolled consumption of electricity in the sector.

Lawmakers in Kazakhstan Submit Crypto Mining Law, Seek to Curb ‘Gray’ Mining

Members of the Mazhilis, the lower house of Kazakhstan’s parliament, have put forward a new bill introducing rules for the extraction of cryptocurrencies in the country. Under its provisions, only companies registered at the Astana International Financial Center (AIFC) or non-resident entities that have agreements with licensed data centers, will be permitted to mine digital coins.

Kazakhstan became a magnet for crypto miners following China’s crackdown on the industry and the influx of mining businesses has caused a growing power deficit. AIFC, the Central Asian nation’s financial hub, is in the focus of government efforts to place the country’s growing crypto sector under oversight. Earlier this year, exchanges registered there were allowed to open accounts with local banks.

The current procedure for notifying authorities of mining activities is voluntary, the crypto news outlet Forklog noted in a report on the legislative attempt. The process is regulated by an order issued by the minister of digital development. Only a third of all mining companies operating in Kazakhstan have registered, Member of Parliament Ekaterina Smyshlyaeva revealed.

“The uncontrolled use of electricity by ‘gray’ miners poses a threat to the energy security of Kazakhstan,” the lawmaker insisted. Smyshlyaeva added that the current legislation does not regulate the mechanism for the sale of the mined cryptocurrency or the role of local financial service providers and the circulation of digital assets. “The procedure for their production and the establishment of property rights to them are regulated only at sub-legislative level,” she explained.

According to Kazakhstan’s State Revenue Committee, the contributions of crypto mining entities to the state budget reached $1.5 million in the first quarter of 2022. In July, President Kassym-Jomart Tokayev signed into law a bill amending the country’s Tax Code to impose higher tax rates on crypto miners. The levies now depend on the amount and average price of electricity consumed for the minting of bitcoin and other cryptocurrencies.

Do you expect the new law to reduce the number of entities authorized to mine cryptocurrencies in Kazakhstan? Tell us in the comments section below.

Lubomir Tassev

Lubomir Tassev is a journalist from tech-savvy Eastern Europe who likes Hitchens’s quote: “Being a writer is what I am, rather than what I do.” Besides crypto, blockchain and fintech, international politics and economics are two other sources of inspiration.

Image Credits: Shutterstock, Pixabay, Wiki Commons

Disclaimer: This article is for informational purposes only. It is not a direct offer or solicitation of an offer to buy or sell, or a recommendation or endorsement of any products, services, or companies. Bitcoin.com does not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.

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