Called ‘Flash Boys 2.0’ after the Michael Lewis Wall Street expose, the paper suggests that through higher fees, the bots are able to participate in frontrunning and transaction reordering (both illegal) to make massive profits.

Frontrunning is the process of paying slightly higher fees in order to preemptively enter a trade prior to a larger trade that will then move the market. The resulting arbitrage (price change for the same product during a short time window) is then pocketed by either buying back or selling the underlying security at the new price.

Transaction reordering, a banking term, refers to changing the order of financial transactions to maximize fees and other costs for consumers. Because blockchain smart contracts require transaction ordering, having priority ordering capabilities also allows bots to move funds into and out of positions for rapid gains. Both of these illegal activities are common on fiat-based trading platforms.

How Severe is Cryptocurrency Market Manipulation?

The problem, per the report, is most apparent on decentralized exchanges where such transaction changes are seen by the community. The report tracks bot trading on six such exchanges including Bancor and EtherDelta. Both showed arbitrage bots making as much as $20,000 per day.

We explain that DEX design flaws threaten underlying blockchain security. These bots exhibit many similar market-exploiting behaviors — front running, aggressive latency optimization, etc. — common on Wall Street, as revealed in the popular Michael Lewis expose ‘Flash Boys.

Simply put, the creation of cryptocurrency exchanges has opened the door for traditional illegal trading methods to proliferate. This could be worse on centralized exchanges where the data is not as accessible. The authors suggest these profit schemes could be in the range of billions of dollars.

More broadly, it is important to observe that DEXes are just the tip of the iceberg. At the time of writing, IDEX, the largest, is ranked #119 by volume by coinmarketcap.com. It has about 1M USD in 24h volume, compared with 970M USD for Binance, the leading centralized exchange. DEX volume is roughly 0.01% that on centralized exchanges.

Can You Trust Decentralized Exchanges?

In every trading market, insiders exist who will continue to seek to profit from the small-time investors. Sadly, as BeInCrypto recently revealed, even Bloomberg writers are on the take for making markets move. With all this underhanded practice going on, traders are left wondering who to trust.

The answer, of course, is that proper research and trading on fundamental value will generally produce positive results. Seeking ways to beat the market in the extreme short-term is gambling after all, and just like gambling, insiders always have advantages that the little guys don’t.

However, over the long term, investments with genuine underlying fundamental value will always bring profit to those who hold them. Investors who buy based on value and not on hype will find that their returns should outweigh any attempts made to outwit any insider trading.

Do you think bot-assisted arbitrage trading should be tracked and halted? Will the practice always plague the investment market? Let us know your thoughts in the comments below!

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