What is Front-Running in Crypto and NFT Trading?
Cryptocurrency and non-fungible tokens (NFTs) have revolutionized the trading market, offering access to high-growth markets and leveraging the power of blockchain technology. As more crypto traders get involved in this financial market, it’s important to first understand what is front-running and why it has become a major issue for crypto and NFT traders.
Understanding Front-Running
Front-running is a form of market manipulation that is illegal in many stock or bond markets. It involves an investor trying to maximize the profits of a trade by acquiring the security before anyone else can and then selling it back at a higher price. This gives the investor an advantage over other traders as they can capitalise on the increased demand and higher prices as a result of their front-running activities.
In crypto and NFT trading, front-running is the same concept but on a much larger scale. The bad actors involved in front-running transactions can view the order books to identify orders from large investors and liquidity providers, including market makers, and then take advantage of these orders by quickly executing the same trade before the large investor does.
What Are the Risks of Front-Running?
The consequences of front-running can be detrimental to all investors in the market. It can lead to significant losses for both the large investors whose orders are front-run and for customers, who will pay higher prices for their orders due to the big investors being unable to execute the trade at the best available price.
The risks of front-running are greater in the decentralized finance (DeFi) and NFT markets because they are not regulated and thus not eligible for traditional consumer protection laws. This means there’s no guarantee that customers’ money is safe and that they’re getting the best deal.
Preventative Measures
The good news is that, while front-running is hard to eradicate completely, there are some preventive measures that traders can take to reduce the chances of it happening. These include:
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Utilizing Decentralized Exchanges: Decentralized exchanges, or DEXs, are seen as the best defense against front-running as they don’t have any order book and are powered by smart contracts. This means that all transactions are executed anonymously, eliminating the need for front-runners to identify large orders.
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Using Limit Orders: Placing a limit order, which is when you set a maximum buying or minimum selling price, is another way to reduce the chances of being front-run. This essentially stops an investor from entering a trade until the market reaches the price they set.
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Hiding Volume: Hiding the volume of a trade is another way to limit the chances of front-running. Traders can choose one of a variety of decentralized applications (dApps) that offer automated volume hiding.
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Staggered Order Entry: Splitting up large orders into smaller ones and entering them one at a time at different prices is another method that traders can use to reduce the chances of being front-run.
Front-running is a significant issue for crypto and NFT traders, as it can lead to substantial losses and has the potential to reduce the market’s liquidity. Fortunately, there are some measures that traders can take to reduce the chances of it happening; from utilizing DEXs to utilizing automated volume-hiding software. Educating yourself on the risks of front-running and being aware of the methods used to prevent it is one of the best defenses traders have against it.
