Risks and benefits of high-frequency trading (HFT) of crypto assets | CoinDesk JAPAN | Coin Desk Japan

I recently had a meaningful conversation about High-Frequency Trading (HFT) in the cryptocurrency market. I knew I had to think about this area in general, and just in time, I had the opportunity to talk to someone who was actually involved.

I see HFT as a style of quantitative trading that combines individual quantitative analysis skills with technical tools to take advantage of price differentials. Market makers in the stock and derivatives markets are known to utilize HFT techniques, using their programming and technical skills to seize trading opportunities before anyone else.

What is High Frequency Trading?

HFT trading often involves arbitrage when an asset is priced differently on two exchanges. For example, if you can buy an asset for $10 on one exchange and sell it almost immediately for $10.25 on another exchange, you have secured a risk-free profit. Repeating this is extremely profitable. Investment firms such as Jump Trading, Citadel Securities, Hudson River Trading and Virtu are well known in the HFT world.

HFT first appeared in the media in the 2014 book by Michael Lewisflash boys billionth of a second menand the 2018 movie “Hummingbird Project 0.001 Second Men“Such.

A true story and a fiction, respectively, depicting efforts to improve trading response speed by billions of seconds by laying fiber optic cables in a straighter line across mountains and rivers. Today’s fastest companies are leveraging microwave and shortwave radio frequencies.

On the other hand, there are definitely people who are critical of HFT. Some consider it a complete cheat because the faster throughput allows for “front-running.”

Some argue that it is an unequal way that favors companies over individuals. Some blame HFT for the rapid price crash.

Front-running: In conventional financial transactions, “financial instruments business operators and their officers who receive orders from customers (investors) execute their own transactions at a price that is more favorable than the customer’s order before the customer’s transaction is completed. (Source: Daiwa Securities)

The use of HFTs in cryptocurrency markets could raise such criticisms to choral levels. But still, my enjoyment of the meeting of market and technology makes me want to dig deeper.

That curiosity led me to talk with Keone Hon, CEO of Monad Labs. Monad Lab’s current mission centers around working with proof-of-stake (PoS) blockchains that increase transaction throughput and maintain compatibility with the EVM (Ethereum Virtual Machine). Previously, he was head of the quantitative trading team at another HFT firm.

So far I’ve told you what I know, but now I want to share what I learned from Mr. Hong. I tried to summarize the important points.

What HFT Brings to Crypto Assets

The novelty of crypto assets creates an advantage. Compared to traditional markets, there are fewer participants, so prices are more likely to fluctuate and higher returns are likely to occur. As more and more participants enter, such opportunities will become less and less.

Buyers and sellers are not ready to trade at the same time, so HFT companies fill the time lag, buying from sellers and selling to buyers. In addition, you will be competing with other traders to price as tightly as possible.

“There are automated trading services for professionals, but in the end, they probably aren’t,” said Hong.

Different HFT strategies

There are various strategies in HFT. One of them is the aforementioned arbitrage, where traders take advantage of price differences between different exchanges.

Other strategies seek high alpha (the difference between the expected rate of return and expected rate of return), starting with “quantitative signatures generated by measuring what is happening in the order book.” becomes.

What impressed me the most about the strategy was the importance of not only careful consideration of execution, but also position management and evaluation of exchanges. Trading across exchanges requires management at the exchanges, so there is counterparty risk, especially in the case of centralized exchanges.

To that end, Hong feels it is imperative that decentralized exchanges (DEXs) catch up with centralized exchanges (CEXs) in terms of user experience (UX) and execution. My impression is that one of Hong’s Monad Lab missions is to bridge the gap between CEX and DEX.

Regulation

When talking about crypto assets and trading, one cannot avoid talking about regulation. In that sense, Mr. Hong’s view may surprise some.

I got the impression that Hong thinks sensible regulation is a good thing, if only because it allows participants to move within a defined framework.

“There are benefits to making sure exchanges follow their rules. It’s good to do proof of reserves and make sure you own what you claim to be holding.” (Mr. Hong)

This is similar to what other crypto insiders have told me. Clear rules that are not maliciously enforced will enable cryptocurrency market participants to move more effectively, efficiently, and quickly.

｜Translation and editing: Akiko Yamaguchi, Takayuki Masuda
| Image: Dylan Calluy/Unsplash
｜Original: The Risks and Rewards of High-Frequency Crypto Trading