Front running is a big problem in crypto trading. But it actually started with stock trading. The stock phrase front running has been used to describe the use of information “from the kitchen” about some upcoming deals to open a new position in the market before the competition is aware of what’s next. All you need to have is insider information, and then all hell can break loose.
This is illegal and causes problems for stock markets because it can drive up or down prices before something happens, which could cause some confusion in the market, and of course – profit certain shady individuals, against the fair traders.
What’s front running in the cryptocurrency market?
Some crypto exchanges and NFT traders are also part of the scheme when it comes to crypto front running. What’s happening is they are prioritizing their own orders. This means that when you place an order, you may be paying an advantage for the exchange to fill its own order first. There are even more sinister variants where exchanges can manipulate your orders by canceling and placing new ones at higher or lower prices.
Is front running in crypto legal?
The cryptocurrency market is unique in that all transactions are saved in distributed ledgers. This makes front running – one of the most common scams – legal, because any investor can check a wallet’s history and see when trade orders have been placed. Most cryptocurrency trading platforms will not allow wallets to be funded using future assets and will return the coins or assets for any attempt of payment for a position without going through a standard order on the exchange. As a result, you can buy Bitcoin with debit card and enjoy a smooth experience.
However, not all exchanges are created equal. While front-running is banned in traditional markets like the NYSE, a crypto trader using a DEX – Decentralized Exchange is able to use that data simply because it’s out there. Technically speaking, this means that an investor or trader isn’t truly reaping the benefits of insider information.
Front-running bots – a menace in disguise
A front-running bot is a common issue that can occur in cryptocurrency trading. Front-runner bots are designed to scan the blockchain for pending transactions and then pays a more significant gas fee so that miners process its transaction first to front-run a major trade that will affect market pricing. Transactions generally occur on the Ethereum platform between machines, but front-running bots typically operate at a millisecond timescale, making the process practically impossible for manual operators to match and react.
The NFT market is prone to wash trading due to the lack of identity verification on most platforms. Although a user can trade with another person from different wallets, there is no way to track how many wallets are created and distributed by one person at any given time (i.e. multiple wallets for multiple identities), making it impossible to distinguish the source of a fraudulent transaction. While it’s not a typical NFT trading front running, it’s one of the most used scams created so far, and, to be honest – it has ruined the reputation of NFT art by quite a lot.
Classic front-running schemes in the crypto world
There are a couple of front-running tactics that happen in the crypto world. Let’s see them.
1. Sandwich attacks
Sandwiching is a special type of front-running that happens on decentralized networks like Ethereum. In a sandwich attack, the malicious trader will place one order in front of and one behind an ongoing trade. This manipulation allows them to take advantage of others’ pending trades and manipulate asset prices for their own benefit. Because both orders are placed simultaneously, it is much harder (but still possible) for exchanges to detect these attacks before they happen.
2. Displacement attacks
A displacement attack is the process of using market orders to displace large orders from an order book. This leaves that order hanging in the air without a fair price, and it can cause a disruption in the regular flow of prices across the network. The larger the scale of this attack, the more noticeable its effects on a cryptocurrency’s value.
3. Suppression attack
During a crypto-trade suppression attack, attackers use a method called the DDoS attack, because all they have to do is to stop the victim from placing the buy order. If a large block of the transaction is intended to be processed, the crypto trade is prevented from doing so, hence getting a lower chance of running it.
How to detect front-runners?
To identify front-running, search for any long liquidity in the same instrument to notice any potential front-running tactics. Analysts can also monitor a user’s trade data, such as their wallet address and series of fund transfers, to spot buy/sell orders close to a user’s own. If there’s much activity over there, you have to become suspicious of dubious activities. Since Ethereum is a public blockchain ledger, you can check all transactions without any issue.
How to stop front-running from happening?
For one, breaking transactions into smaller parts means that transactions will be more difficult to front-run. As a result, the value of any tokens that a trader in a smart contract holds will not decrease as quickly, leading them to pass the new transaction along and leave early-comers with no option but to wait for it to mine. This way, regular traders will go “under the radar” and won’t be spotted by the front-running bots which would otherwise react quickly.
The problem of bots and scammers engaging in “front-running” is a major issue for cryptocurrency transactions. Because many transactions are essentially flawed from the start, it’s important to be aware of this problem and take steps to avoid it. Since it’s not technically illegal (all transactions are recorded on the ledger), people should be very wary about their cryptocurrency trades, especially high-volume ones, and check NFT sellers’ wallets before they enter the NFT market, which is also a subject of interest for fraudsters.